*Intended learning outcomes: Elaborate job-order costing and activity-based costing using an example. Compare job-order costing and activity-based costing.*

## 16.7.1 Job-Order Costing

Two products A and B are produced from material Z with a batch size of 40. Consumption is the same for each product: 50 g per product A or B. The cost of 1 kg of material Z is $20.

For the sake of simplicity and
comparison in our example, the *manufactur**ing process* is the same for
products A and B: two operations (1 and 2) at two work centers (WC1 and WC2).
The standard time for each operation is 1 hour per 40 units. Assume that setup
time is negligible.

To calculate the costs of the manufacturing process, it is important to take into account the costs of the two work centers WC1 and WC2 in addition to the standard times. As Figure 16.7.1.1 shows, WC1 is more machine intensive, while WC2 is more employee intensive. The investments will be depreciated in 5 years, assuming 1000 productive hours per year. Further, assume that these costs make up the full manufacturing costs.

**Fig.
16.7.1.1** Work
center costs data.

Following the principle of job-order costing, determine the cost accumulation values for products A and B marked “?” in the tables in Figures 16.7.1.2 and 16.7.1.3 (compare Figure 16.2.2.1).

**Fig.
16.7.1.2** Graphical
representation of the cost accumulation for product A.

**Fig.
16.7.1.3** Graphical
representation of the cost accumulation for product B.

*Hint:* The full cost of goods manufactured will be the same for both product A and B (why?): $4.75 per unit produced, or $190 for a batch size of 40.

## 16.7.2 Activity-Based Costing

Think again about products A and B described above. After reading Section 16.1.4, you know that tooling costs make up a sizable proportion of the fixed costs. If the costs of the tools used for products A and B are different, this should be apparent in the cost accumulation. However, that can only be achieved if we view tool utilization as a process in its own right. Following the principle of ABC and the steps involved (see Section 16.4.2), the characteristic variables for this process are defined as follows:

*ABC process:*tool utilization, or use.*Process costs:*the manufacturing or procurement costs of the tool.*Activity cost driver:*the number of units produced with the tool. Why? Usually, it is not the length of time that a tool is utilized that determines its wear, but rather production of a certain number of units of the product. A good example would be pressing tools.*Process cost rate:*process costs divided by the total quantity of product units that are produced using the tool until the tool is used up or worn out.

Figure 16.7.2.1 shows a breakdown of the fixed costs in machine costs and costs for tools and devices.

**Fig.
16.7.2.1** Work
center costs data.

As in exercise 16.7.1 above, the investitures in machines will be depreciated in 5 years, whereby 1000 productive hours are assumed annually. It is further assumed that a tool can be used to manufacture 20,000 products A or B before it is used up or worn out, no matter whether it is an expensive or inexpensive tool.

Since one hour of capacity is utilized for 40 units of products A or B, 200,000 products can be manufactured in 5000 productive hours. This means that, in that period, 10 tools will be required.

In the following, assume also that the same number of units of products A and B is manufactured. In this case, work center 1 will use 10 tools (5 T1 and 5 T2 tools), which represents an investment of $100,000. Work center 2 uses 10 tools (5 T3 and 5 T4 tools), which represents an investment of $50,000. The sum of fixed costs is thus the same as in exercise 5 above.

Determine the values marked “?” in the cost accumulation tables in Figures 16.7.2.2 and 16.7.2.3 below (compare Figure 16.2.2.1).

To calculate the process cost of the tool, use the following:

- The process quantity or quantity per for the ABC process “tool use for operation 1 (or 2)” is 1 (one use per unit produced).
- The total (target) quantity is the number of units produced.
- The process variable, or activity cost driver, is the “use of the tool.”
- The process cost rate (or cost per unit) is the cost of the tool divided by the number of units that can be produced until the tool is used up.
- The process costs (target) are the product of the total (target) quantity times the cost per unit.

**Fig.
16.7.2.2** Graphical
representation of the cost accumulation for a product A.

**Fig.
16.7.2.3** Graphical
representation of the cost accumulation for a product B.

*Problem-solving hints:*

The full cost of goods manufactured will *not* be the same for products A and B (why?): In fact, we calculate $4.30 per unit produced of product A (or $172 for a batch size of 40), and $5.20 per unit produced of product B (or $208 for a batch size of 40).

## 16.4.3 Comparing Job-Order Costing and Activity-Based Costing

a. Why is the cost per unit produced in the conventional job order costing exercise 16.7.1 ($4.75) exactly the mean of the costs per unit of the two products in the ABC exercise 16.7.2 ($4.30 and $5.20)?

b. What product pricing considerations would you take into account on the basis of the results when calculating manufacturing costs by ABC?

c. Would a change of the batch size (40 in both exercises) imply different results? Is this generally the case in the world of practice? What assumption made in the problem description for the sake of simplicity led to the special case of the two exercises?

## Course sections and their intended learning outcomes

##### Course 16 – Cost Estimating, Job-Order Costing, and Activity-Based Costing

Intended learning outcomes: Produce a review on costs, cost elements, and cost structures. Explain cost estimating in detail. Describe job-order costing. Disclose activity-based costing.

##### 16.1 Costs, Cost Elements, and Cost Structures

Intended learning outcomes: Produce an overview on actual, direct, and overhead costs. Differentiate between average costs and standard costs as well as between variable costs and fixed costs. Explain the cost accumulation breakdown that is the cost breakdown structure of a product.

##### 16.2 Cost Estimating

Intended learning outcomes: Present an algorithm for cost estimation of goods manufactured. Produce a representation of the cost accumulation and an overview of the comprehensive calculation for a product line.

##### 16.3 Job-Order Costing

Intended learning outcomes: Describe actual quantities and actual costs. Explain cost analysis. Produce an overview on the interface from order management to cost accounting.

##### 16.4 Activity-Based Costing

Intended learning outcomes: Disclose the limits of traditional product costing. Explain activity-based costing: aim, basic premise, requirements, and technique. Present typical processes (activities) and process variables as well as the activity-based product cost estimation.

##### 16.5 Summary

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##### 16.6 Keywords

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##### 16.7 Scenarios and Exercises

Intended learning outcomes: Elaborate job-order costing and activity-based costing using an example. Compare job-order costing and activity-based costing.

##### 16.8 References

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