this is learning objective 4.2 for managerial accounting and this learning objective we're going to use activity-based costing while which we'll refer to as ABC to compute predetermined overhead allocation rates and allocate indirect costs in the last learning objective we determine these rates and allocated costs based on first a plant-wide rate and then we'd allocate them uh based on the departmental rates which made our cost calculations somewhat more accurate and ABC now is going to be even more accurate than that and I would say in the real world most companies that can will use this they'll use ABC this is like the core way that things will be costed and this is typically even more accurate than departmental rates like we saw in learning the objective uh 4.1 and today with software right keeping track of costs and getting more accurate measures is easier than it was years ago because computers can handle very very small num small amounts small numbers very large numbers and they can calculate very quick and accurately so that greatly helps the cost accounting process so how do we develop an ABC system okay well activity-based management of which ABC is a part it focuses on the primary activities the business performs right and the uses cost information to make decisions that lead to Greater profits right that's basically the um what it does and what the goal is with AVM okay and one thing one of the main things that's done within ABM is ABC which is the process of determining the cost of the activities so and um what you're practicing what is an activity well we will see that in a moment here so these are all activities that a company does and um notice that it's not product specific so Quality Inspection activity the first activity could be performed on a hundred different products that your company makes same for all the rest of them okay so we're going to allocate our we're going to build up our uh accumulate our cost pools according to activity so our overhead cost pools will have an overhead pool for Quality Inspection we'll have one for warranty one for shipping and so forth and then out of those pools will allocate to each product and this is even more specific remember them departmental rates because in one single Department you can have multiple activities right and again the issue is always that these different activities are done at different rates right different departments will use up you know more set up it'll require more setup than others right something like that so the costs are going to try to be allocated more more accurately so we can cost our product more accurately okay and each activity is going to have an allocation base and generally if you're doing a problem in this class you'll be told what the allocation base is right and these are pretty common so for Quality Inspection it's the number of inspections that's the base okay and all of these bases remember are basically what we call Cost driver and a cost driver is um something that has a direct logical connection to the total cost of the activity right so and usually it has to do with volume so in other words with Quality Inspection the idea is the number of inspections is what drives the overhead cost the more inspections we do the more overhead costs there is right and so on okay so um developing an activity-based cost system involves four steps and these will sound kind of familiar from what we've done before but number one is you want to identify the activities and estimate their total indirect costs so we start with estimates just like we've done before right remember indirect costs it means overhead same thing then we want to identify the allocation base for each activity and estimate the total quantity of each allocation base and generally the information and number two will generally all of it'll be given right you just have to realize how to read how to read the data okay and even a number one often the activities will be identified and the total indirect costs to be given right so the math so to speak starts in step three which is where you compute the predetermined overhead allocation rate by activity instead of by department or plant wide and then in number four you'll allocate that overhead or indirect costs to the cost object right and the cost object is going to be um in our case the cost objects are the premium uh tablet and the standard tablet okay so um again the first step is identify activities used to allocate manufacturing overhead and these are examples from what we saw a couple slides ago so don't really need to go over them again so there's your activities um and here is how it all kind of fits together right there's your activities in the uh purple box or purple rectangles I guess right they're the bases that's what you're going to use to calculate your rate right or set up its number of batches estimated batches for direct labor hours right estimated direct labor hours and so forth and then you're going to allocate some of the overhead from setup to each model and some of the overhead from production to each model and the same for testing right so let's go here oops sorry so Smart Touch learning determines that setup production and testing are the allocation bases as we just saw and then they give us data here so um this is the this data here is the the estimated amounts and again it's best to look at these examples in your book because they the text there right explains you know sentence by sentence what's going on so um those are the estimated numbers so there's your application based your activity notice that you estimate for standard model uh 20 batches but for premium model only 25 batches right so in other words the premium model uh soaks up more overhead cost for setup than the standard model in production it's the standard model that dominates right and it could be because you're producing a lot more standard models than premium that's possible um we'd have to you know dig deeper to find out but in any case remember that we need to know the total estimated for each activity first right so we're focused here at the moment so you take those batches and you do you um those are your denominators and the sorry those batches the 45 batches the the allocation um drivers the cost drivers and the enumerator is the total estimated overhead costs and in your book they give you those estimated costs in a table so here I don't think it mentioned no so those numbers will be given the 18 to 22 and the 60. and you cut you calculate your number so we can see that setup will be at will be allocated four hundred dollars per batch and that's for both types of tablets right and then production will be allocated 1.76 per direct labor hour and so forth so the last thing we need to do is we need to look at the actual batches and direct labor hours and tests right multiply those by these rates for each product so um here uh there are our estimates our predetermined rate and then you multiply it by the actual quantity of the base used so examples for the standard tablet there were actually 20 batches so that means you allocate right eight thousand dollars of setup uh overhead to the standard whereas you can see in the premium we're allocating ten thousand dollars overhead to that setup activity and that's because there were more setups for the premium tablet okay you do that for each one and then you have the total overhead that is allocated to each product by activity right all right these are the activity by activity and this is the total also by activity then to get the overhead cost per unit you simply divide it by the the number of units which is given so you can see that the premium when we use ABC is uh the overhead cost is quite a bit more than each standard tablet and um we do see that um right there can be multiple reasons for that the overhead connect should be high or it can be because um of the volume which is uh the 2000 versus the 500 right when there are fewer units typically each unit right each unit has to soak up so to speak more of this overhead because there are fewer units up here you're spreading it across 2 000 units right that's one thing that could be causing the difference the other thing could be the actual overhead allocations right they're both higher these excuse me no the uh these are both higher actually they're all higher right than the allocations for the premium yet this is more so this difference here between the 76 and the 30 is explained by volume it's because you're only making 500 units versus 2 000 right that that's that's what's causing that cost difference and in a later chapter we're going to talk about variances due to volume okay so then you can allocate the indirect cost to the cost object and so we have the direct materials per unit direct cost direct labor which are given and straightforward manufacturing overhead costs per unit which is what we just calculated right you need to get to these numbers in order to get the per unit cost so the total cost per unit now is 268.8 or standard and 428.80 and these are different from when we use the plant wide and the departmental rates so and here is that comparison right so in terms of which is more precise or more accurate this is going to be the most accurate followed by this followed by this all right so we can see the differences here let's compare one and three because those are the two extremes right so looks like between here and here that's like what that's uh this is almost 269s it's about a four four dollar difference something like that per unit but here look at that that's 425 that's 407 that's like an 18 difference right and then of course here we got we became a little more accurate right so you can see that the cost went down excuse me went up from here to here and it went up from here to there so in other words this single wide rate was under costing the premium model by quite a bit because it wasn't allocating overhead by activity and this uh standard model was over costed using the single allocation right right and you would have cost you might have ended up setting your price somewhat too high right and also your profit projections would be off quite a bit which is another issue and here if you had used this instead of this you might have charged too little for the tablet and you might have actually lost money every time you sold a tablet okay here is another example that you can work through using the slide it is also at the end of learning objective um 4.2 but as you can see it is just a review of what we did where you are allocating um you're determining um allocation rates and notice that uh in number five that's what you're doing and you're using activity-based costing and then six and seven they want to know how much overhead is allocated to um each of the different product lines so regular products and super products for each month I'll see you in learning objective 4.3