ch05
DESCRIPTION
CH05TRANSCRIPT
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CHAPTER 5Activity-Based Costing
andActivity-Based Management
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Job CostingOverview
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Broad AveragingHistorically, firms produced a limited variety
of goods while their indirect costs were relatively small.
Allocating overhead costs was simple: use broad averages to allocate costs uniformly regardless of how they are actually incurred.Peanut-butter costing
The end-result: overcosting and undercosting
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Over and Undercosting Example
Emma JamesJessic
aMatthe
w TotalAverag
e
Entrée $11 $20 $15 $14 $60 $15 Dessert 0 8 4 4 16 4
Drinks 4 14 8 6 32 8
Total $15 $42 $27 $24 $108 $27
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Over and UndercostingOvercosting—a product consumes a low level
of resources but is allocated high costs per unit.
Undercosting—a product consumes a high level of resources but is allocated low costs per unit.
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Cross-subsidizationThe results of overcosting one product and
undercosting another.The undercosted product is left with too little
cost, making it seem more profitable than it really is.
The overcosted product absorbs too much cost, making it seem less profitable than it really is.
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Quick Check Overcosting a particular product may result in: A) loss of market share B) pricing the product too lowC) operating efficiencies D) understating total product costs
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An Example: PTM
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PTM and Simple Costing
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Simple Costing System Activity-Based Cost System
DirectMaterial
Costs
DirectLaborCosts
DirectMaterial
Costs
DirectMaterial
Costs
DirectLaborCosts
DirectLaborCosts
OverheadCosts
OverheadCosts
OverheadCosts
OverheadCosts
DirectTrace
DirectTrace
DirectLabor Hours(Cost Driver)
DirectLabor Hours(Cost Driver)
ProductsProducts
DirectTrace
DirectTrace
ProductsProducts
MachiningActivity
Costs
MachiningActivity
Costs
MachineHours
(Cost Driver)
MachineHours
(Cost Driver)
Number ofParts
(Cost Driver)
Number ofParts
(Cost Driver)
Number ofInspections
(Cost Driver)
Number ofInspections
(Cost Driver)
AssemblyActivity
Costs
QualityInspection
ActivityCosts
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Cost Hierarchy
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Cost HierarchyABC uses a four-level cost structure to
determine how far down the production cycle costs should be pushed:Unit-level (output-level)
e.g., machine operation Batch-level
e.g., machine setup, material handling, quality inspection
Product-sustaining-level e.g., product design
Facility-sustaining-level e.g., factory rent, building security
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PTM and ABC Illustrated
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PTM and ABC Rate Calculation
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Plastim and ABC Product Costs
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Plastim: Simple and ABC Compared
4,980,000
4,980,000
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ConclusionsEach method is mathematically correct.Each method is acceptable.Each method yields a different cost figure, which
will lead to different gross margin calculations.Total costs for the entire firm remain the same—
they are just allocated to different cost objects within the firm.
Selection of the appropriate method and drivers should be based on a cost-benefit analysis of each option under consideration.
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Cost Benefit TestDo the benefits of adopting ABC exceed the costs?
ABC is generally perceived to produce superior costing figures due to the use of multiple drivers across multiple levels.
Benefits are higher when:Increase in product diversityIncrease in indirect costsIncrease in competition
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Cost Benefit TestCosts of Adopting ABC
Generally lower with Accounting and information system expertise
to develop the system Advance information technology
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Quick Check Refining a cost system includes: A) classifying as many costs as indirect costs as
is feasible B) creating as many cost pools as possible C) identifying the activities involved in a
process D) seeking a lesser level of detail
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Quick Check Design of an ABC system requires: A) that the job bid process be redesigned B) that a cause-and-effect relationship exists
between resource costs and individual activities
C) an adjustment to product mix D) Both B and C are correct.
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Quick Check ABC is most likely to yield benefits for
companies with all of the following characteristics except:
A) numerous products that consume different amounts of resources
B) operations that remain fairly consistent C) a highly competitive environment, where cost
control is critical D) accessible accounting and information systems
expertise to maintain the system
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Activity-Based ManagementA method of management that uses ABC as
an integral part in critical decision-making situations, including:Pricing and product-mix decisionsCost reduction and process improvement
decisionsPlanning and managing activities
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Pricing and Product Mix DecisionsChange the prices for products after
identifying the different total costDecide to market the higher profitability
product Shift the product mix away from less
profitable products
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ABM ExamplesPricing decisions:
The cost of making the simple lens
A special order: A price of $53 for the simple lens
Simple Costing $58.75
ABC $48.98
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ABM Examples (Cont’d)Product-mix decisions:
Simple Lenses
Complex Lenses
Selling price $63.00 $137.00
Cost per unit under simple costing 58.75 97.00Profit margin under simple costing 4.25 40.00Profit margin % under simple costing 6.75% 29.20%
Cost per unit under ABC 49.98 132.07Profit margin under ABC 13.02 4.93Profit margin % under ABC 20.67% 3.60%
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Quick Check Companies use ABC system information to: A) analyze costs B) prepare budgets C) evaluate performance D) All of these answers are correct.
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Quick Check It is important that the product costs reflect
as much of the diversity and complexity of the manufacturing process so that:
A) product costs will reflect their relative consumption of resources
B) nonvalue-added costs can be eliminated C) there is less likelihood of cross subsidizing of
product costs D) All of these answers are correct.
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ABC and Service/Merchandising FirmsABC implementation is widespread in a
variety of applications outside manufacturing, including: Health CareBankingTelecommunicationsRetailingTransportation