activity-based costing systems
DESCRIPTION
Activity-Based Costing Systems. Activity-Based Costing. Activity-based costing (ABC) involves determining the cost of activities and tracing their costs to cost objectives on the basis of the cost objectives utilization of units of activity. Part of “Activity-Based Analysis”. - PowerPoint PPT PresentationTRANSCRIPT
ABC - 1
Activity-Based Costing Systems
ABC - 2
Activity-Based Costing
Activity-based costing (ABC) involves determining the cost of activities and tracing their costs to cost objectives on the basis of
the cost objectives utilization of units of activity.
Part of “Activity-Based Analysis”
ABC - 3
FAULTY COST SYSTEMSymptoms
Competitive analysis is confusing
Conflicting signals from functional areas and the accounting system
Accounting system problems
ABC - 4
WHY ABC NOW?
Competitive demands for diverse products/services
Increased significance of overhead costs– Growth of nonunit-based overhead– Consumption ratios of unit-based and
nonunit-based overhead items differ Improved information technology Significance of strategic decisions
ABC - 5
Activity-Based Costing
Activities performed to fill customer needs Activities performed to fill customer needs consume resources that cost money.consume resources that cost money.
Customer ActivitiesServed
by activities
Resources
Activities consume resources
CostsResources
cost money
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Activity-Based Costing
The cost of resources consumed by activities The cost of resources consumed by activities should be assigned to cost objectives.should be assigned to cost objectives.
Costs ResourcesAssigned
to resources
Activities
Assigned to activity cost
pools
Cost objectives
Reassigned to cost
objectives
ABC - 7
Identifying activities. Assigning costs to activities. Determining the basis for assigning the
cost of activities to cost objectives. Determining the cost per unit of activity. Reassigning costs from the activity to the
cost objective on the basis of the cost objective’s consumption of activities.
Activity-Based Costing
Operationalizing the two-stage model requires:
ABC - 8
Two-Stage Activity Based Costing Method
First stage: First stage: Costs assigned to resources are Costs assigned to resources are reassigned to activities.reassigned to activities.
Activity 1
Activity 2
Activity 3
Activity 4
Activity n
Cost of Resource 1
Cost of Resource 2
Cost of Resource n
Continued on next slide
ABC - 9
Two-Stage Activity Based Costing Method
Second stage: Second stage: Costs assigned to activities are reassigned to Costs assigned to activities are reassigned to cost objectives using an activity cost driver.cost objectives using an activity cost driver.
Activity 1
Activity 2
Activity 3
Activity 4
Activity n
Objective 1
Objective 2
Objective 3
Objective n
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Unit level activitiesUnit level activities Batch level activitiesBatch level activities Product level activitiesProduct level activities Facility level activitiesFacility level activities
Manufacturing Cost Hierarchy
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Cost of raw materials Cost of inserting a
component Utilities cost of
operating equipment Some costs of
packaging Sales commissions
Unit Level Examples
This activity is performed for each
unit of product produced and sold.
Manufacturing Cost Hierarchy
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Cost of processing sales order
Cost of issuing and tracking work order
Cost of equipment setup
Cost of moving batch between workstations
Cost of inspection
Batch Level
This activity is performed for each
batch of product produced or sold.
Examples
Manufacturing Cost Hierarchy
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Cost of product development
Cost of product marketing, such as advertising
Cost of specialized equipment
Cost of maintaining specialized equipment
Product Level Examples This activity is
performed to support each different
product that can be produced.
Manufacturing Cost Hierarchy
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Cost of maintaining general facilities
Cost of nonspecialized equipment
Cost of maintaining nonspecialized equipment
Cost of real property taxes Cost of general advertising Cost of general
administration
Facility Level ExamplesThis activity is
performed to maintain general manufacturing
capabilities.
Manufacturing Cost Hierarchy
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Volume-Based Unit Level Analysis
Activity-Based Multiple-Level
Analysis
Variable: Only one type of variable cost is considered:
Unit level
Variable: Many types of variable cost drivers are considered, including:
Unit levelBatch levelProduct level
Changing Composition of TotalManufacturing Costs
ABC - 16
Volume-Based Unit Level Analysis
Activity-Based Multiple-Level
Analysis
Fixed: Costs that do not vary with the number of units
Fixed: Costs that do not respond to change in variable cost drivers are considered:
Facility level
Changing Composition of TotalManufacturing Costs
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Unit level activitiesOrder level activitiesCustomer level activitiesFacilities level activities
A merchandising organization or the sales division of a manufacturing organization
might use the following hierarchy:
Customer Cost Hierarchy
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Unit level activitiesOrder level activitiesCustomer level activitiesMarket segment level
activitiesFacility level activities
An organization that sells to distinct market segments might have the
following cost hierarchy:
Customer Cost Hierarchy
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Benefits Of Activity Based Costing
Greater understanding of the nature of operations
More accurate product costing
Improvement in cost control
Integration with strategic management accounting
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Limitations Of Activity Based Costing
Costly implementation process
ABC is NOT a guarantee of becoming a “world-class” company
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Practical Advice for Implementing ABCPractical Advice for Implementing ABC
1. Capture the attention of top management.2. Don’t shoot the customer.3. Decide the form ABC will take.
4. Supplement the ABC measures creativity where appropriate.
5. Be careful in costing bottlenecks that create excess capacity.
6. Challenge managers who believe their costs are fixed.7. Calculate costs top-down and bottom-up.
8. Account for cost of capital.
9. Use multi-functional teams.
10. Don’t underestimate the need for managing change.
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Danger of Error with theUnit Level Approach
Using the High-Low Method
June: Produced 12,000 units at a cost of $247,250July: Produced 13,200 units at a cost of $258,900
3,200 units of product A and 10,000 units of product B
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Danger of Error with theUnit Level Approach
Using the High-Low Method
June: Produced 12,000 units at a cost of $247,250July: Produced 13,200 units at a cost of $258,900
b = ($258,900 - $247,250)/(13/200 - 12,000)b = $9.708a = $247,250 - ($9.708 x 12,000 total units)a = $130,754
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Danger of Error with theUnit Level Approach
Using the High-Low Method
The formula for predicting total cost is:
Y = $130,754 + $9.708X
Predicted production for August is 1,500 units of product A and 13,000 units of product B.
Y = $130,754 + $9.708(14,500)Y = $271,520
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Danger of Error with theUnit Level Approach
Using the High-Low Method
A complete analysis of activities and activity cost gives predicted costs for August of $294,300, which is $22,780
greater than the predicted costs determined by using high-low.
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Danger of Error with theUnit Level Approach
Failure to Separately Account for Batch Level Costs
A company produces two products, C and D. Both have identical monthly
production volumes of 50,000 units. The only difference is batch size, 50,000 units
for C and 5,000 units for D.
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Danger of Error with theUnit Level Approach
Failure to Separately Account for Batch Level Costs
Y = [$1 x (50,000C + 50,000D) units] + [$20,000 x [($20,000 x (1C + 10D) batches]
Both C and D
cost $1 per unitBoth C and D
cost $20,000 per batch
Y = $320,000
The average cost per unit is $3.20 ($320,000/100,000).
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Unit level costs:C: $1 x 50,000 $ 50,000D: $1 x 50,000 $ 50,000
Batch level costs:C: $20,000 x 1 20,000D: $20,000 x 10 200,000
Total costs $ 70,000 $250,000Units 50,000 50,000Average unit cost $ 1.40 $ 5.00
Danger of Error with theUnit Level Approach
Product C Product D
Compared to $3.20
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$6 ---
$5 ---
$4 ---
$3 ---
$2 ---
$1 ---
$0 ---0 5,000 25,000
Average Unit Cost
| |
Volume based unit level cost Volume based unit level cost analysis assumes units of analysis assumes units of
product is the only cost driver.product is the only cost driver.
Activity-based multiple level Activity-based multiple level analysis considers unit and analysis considers unit and
batch level costs.batch level costs.
Cost Estimate Errors withUnit Level Analysis