abc assmnt

8/2/2019 ABC Assmnt.

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ACTIVITY BASED COSTINGACTIVITY BASED COSTINGDEFINITION:

Activity Based Costing (ABC) is a managerial accounting

system which determines the cost of activities without distortion andprovides management with relevant and timely information. It does notrepresent just a new set of overhead allocation rules or techniques to valueinventory. ABC represents a way to look at operating costs and providesmethods to dissect the underlying activities, which cause costs to exist.

Basics of ABC:

Cost of a product is the sum of the costs of all activities required tomanufacture and deliver the product. Products do not consume costs directly Money is spent on activities Activities are consumed by product/services.

ABC assigns Costs to Products by tracing expenses to activities. EachProduct is charged based on the extent to which it used an activity.

Provides ways of assigning the costs of indirect support resources to

activities, business processes, customers, products.


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Building an ABC Model

IdentifyResources IdentifyActivitiesIdentifyCost Objects

DefineActivityDriversDefineResourceDrivers

EnterResourceCostsEnterResourceDriver Qty.

EnterActivityDriver Qty.CalculateCosts


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THROUGHPUT COSTINGTHROUGHPUT COSTING

DEFINITION::

Method of costing a product where only the unit-level direct costs areMethod of costing a product where only the unit-level direct costs areassigned to the product.assigned to the product.

It is a management accounting technique used as the performancemeasures in the Theory of Constraints (TOC). It is a relatively newmanagement accounting approach based largely on the identification offactors that limit an organization from reaching its goal.It is neither cost accounting nor costing because it is cash focused anddoes not allocate all costs (variable and fixed expenses, including

overheads) to products and services sold or provided by an enterprise.


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Differentiate between ABC and Throughput Costing

Account based Costing Throughput Costing

1.Refinement and improvement ofclassical cost accounting (absorbingaccounting)

2. Does not take into account impacton throughput

3. Any increase in efficiency isacceptable.

4.It targets operating expensesreduction .

Updated version of contributionaccounting.

Increase in throughput is the mainfocus.

Only increases in efficiencies thatincrease throughput or that reduces

overall costs are acceptable.

It considers operating expenses be alesser concern and makes no attemptto allocate operating expenses to anytype of cost object.


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Account based Costing Throughput Costing

5.It works well in labor intensiveproduction environment where laborresources are more flexible.

6.It is a complicated system to createand maintain as it allocate costsbased on cost drivers and tends to

focus management attention onoperating expenses reduction.

It tends to yield better results inmachine intensive production areaswhere machine usage is prevalent.

It is much easier than ABC to calculateas it completely avoids any attempt tocreate cost pools, identify cost drivers

or allocate costs based on thosedrivers.


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Lets illustrate the concept of activity based costing by looking at Two

common manufacturing activities:(1) the setting up of a production machine for running batches of products,and

(2) the actual production of the units of product.

It is assumed that a company has annual manufacturing overhead costsof $2,000,000of which $200,000 is directly involved in setting up theproduction machines. During the year the company expects to perform400 machine setups. Lets also assume that the batch sizesvaryconsiderably, but the setup efforts for each machine are similar. The costper setup is calculated to be $500 ($200,000 of cost per year divided by

400 setups per year).Under activity based costing, $200,000 of the overhead will be viewed as a

batch-level cost. This means that $200,000 will first be allocated tobatches of products to be manufactured (referred to as aStage 1 allocation), and then be assigned to the units of product in each

batch (referred to as Stage 2 allocation).

Illustration of ABC with example
http://www.accountingcoach.com/terms/B/batch-size.htmlhttp://www.accountingcoach.com/terms/B/batch-level-cost.htmlhttp://www.accountingcoach.com/terms/S/stage-one-allocation.htmlhttp://www.accountingcoach.com/terms/S/stage-two-allocation.htmlhttp://www.accountingcoach.com/terms/S/stage-two-allocation.htmlhttp://www.accountingcoach.com/terms/S/stage-one-allocation.htmlhttp://www.accountingcoach.com/terms/B/batch-level-cost.htmlhttp://www.accountingcoach.com/terms/B/batch-size.html


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For example, ifBatch X consists of 5,000 units of product, the setup cost perunitis $0.10 ($500 / 5,000 units).

IfBatch Y is 50,000 units, the setup cost per unit is $0.01 ($500 / 50,000 units).For simplicity, lets assume that the remaining $1,800,000 of manufacturingOverhead is caused by the production activities that correlate with thecompanys 100,000 machine hours. For our simple two-activity example, let's see how the rates for allocating the manufacturing overhead would lookwith

activity based costing andwithout

activity based costing:With ABC WithoutABC

Mfg overhead costs assigned to setups

Number of setups

Mfg overhead cost per setup

Total manufacturing overhead costs

$200,000

400

$500

$2,000,000

$ 0

N.A

$ 0

$2,000,000


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With ABC Without ABC

Less: Cost traced to machine setups

Mfg O/H costs allocated on machine hours

Machine hours (MH)

Mfg overhead costs per MH

Mfg Overhead Cost Allocations

200,000

$1,800,000

100,000

$18

$500 setupcost per batch+ $18 per MH

0

$2,000,000

100,000

$20

$20 per MH

Next, let's see what impact these different allocation techniques and overheadrates would have on the per unit cost of a specific unit of output. Assumethat a company manufactures a batch of 5,000 units and it produces 50 unitsper machine hour, here is how the cost assigned to the units with activitybased costing and without activity based costing compares:


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For Batch X With ABC Without ABC

Mfg. overhead for setting up machine

No. of units in batch

Mfg O/H caused by set up per unit

Mfg O/H costs per machine hr

No. of units produced per hr

Mfg O/H caused by production per unit hrTotal Mfg O/H Allocated per hr

$ 500

500

$0.10

$18

50

$0.36$0.46

0

N.A.

N.A.

$20

50

$0.40$0.40


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For Batch Y With ABC Without ABC

Mfg overhead for setting up machine

No. of units in batch

Mfg O/H caused by Setup Per Unit

Mfg overhead costs per machine hourNo. of units produced per machine hour

Mfg O/H caused by Production Per Unit

Total Mfg O/H Allocated Per Unit

$50

050,000

$0.01

$1850

$0.36

$0.37

$0

N.A.

N.A

$2050

$0.40

$0.40

If a company manufactures a batch of 50,000 units and produces 50 unitsper machine hour, here is how the cost assigned to the units with ABC andwithout ABC compares:


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As the tables above illustrate, with activity based costing the cost per unitDecreases from $0.46 to $0.37 because the cost of the setup activity isspread over 50,000 units instead of 5,000 units. Without ABC, the cost perunit is $0.40 regardless of the number of units in each batch.If companies base their selling prices on costs, a company notusing an ABCapproach might lose the large batch work to a competitor who bidsa lower price based on the lower, more accurate overhead cost of $0.37.Its also possible that a company not using ABC may find itself being

the low bidder for manufacturing small batches of product, since its $0.40 islower than the ABC model of $0.46 for a batch size of 5,000 units. With its bidprice based on manufacturing overhead of $0.40but a true cost of $0.46the company may end up doing lots of production for little or no profit.

Our example with just two activities (production and setup) illustrates how thecost per unit using the activity based costing method is more accurate inreflecting the actual efforts associated with production. As companies beganmeasuring the costs of activities (instead of focusing on the accountantsdepartmental classifications), they began using ABC cost information to

practice activity based management.
http://www.accountingcoach.com/terms/A/activity-based-management.htmlhttp://www.accountingcoach.com/terms/A/activity-based-management.html

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