chap 008 abc

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Activity-Based Costing:

A Tool to Aid Decision Making

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ActivityBased Costing (ABC)

ABC is designed toprovide managers with

cost information forstrategic and other

decisions thatpotentially aect

capacity and therefore

aect xedas well as variable

costs.

ABC is agood supplementto our traditional

cost system

I agree!

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Learning Objective

Understand activityUnderstand activity

based costing and howbased costing and how

it diers from ait diers from a

traditional costingtraditional costing

system.system.

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!o" Costs are Treated #nderActivityBased Costing

ABC di$$ers $ro% traditional cost acco&nting in t'ree "ays


Man&$act&ring

costs

on%an&$act&ring

costs

ABC assigns bot' ty*es o$ costs to *rod&cts

TraditionalTraditional*rod&ct costing*rod&ct costing

ABCABC*rod&ct costing*rod&ct costing

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ABC does not assign all %an&$act&ring costs to *rod&cts

Man&$act&ring

costs

on%an&$act&ring

costs

TraditionalTraditional*rod&ct costing*rod&ct costing

ABCABC*rod&ct costing*rod&ct costing

All Most+b&tnotall

,o%e



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Plantwide

OverheadRate

Plantwide

OverheadRate

DepartmentalOverhead

Rates

DepartmentalOverhead

Rates

ActivityBasedCosting

ActivityBasedCosting

Numer o cost pools

"e

velo!com

ple#ity

ABC &ses %ore cost *ools



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ABC &ses %ore cost *ools

ac' ABC cost *ool 'as itso"n &ni.&e %eas&re o$ activity

ac' ABC cost *ool 'as itso"n &ni.&e %eas&re o$ activity

ABC di$$ers $ro% traditional cost acco&nting in t'ree "aysABC di$$ers $ro% traditional cost acco&nting in t'ree "ays

Traditional cost syste%s &s&ally relyTraditional cost syste%s &s&ally rely

on vol&%e %eas&res s&c' as direct laboron vol&%e %eas&res s&c' as direct labor

'o&rs and/or %ac'ine 'o&rs to allocate'o&rs and/or %ac'ine 'o&rs to allocateall over'ead costs to *rod&ctsall over'ead costs to *rod&cts

Traditional cost syste%s &s&ally relyTraditional cost syste%s &s&ally rely

on vol&%e %eas&res s&c' as direct laboron vol&%e %eas&res s&c' as direct labor

'o&rs and/or %ac'ine 'o&rs to allocate'o&rs and/or %ac'ine 'o&rs to allocateall over'ead costs to *rod&ctsall over'ead costs to *rod&cts

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Activity An event t'at ca&ses t'econs&%*tion o$ over'eadreso&rces

ActivityCost 0ool

A 1cost b&cket2 in "'ic'costs related to a single

activity %eas&re areacc&%&lated

$

$

$ $

$$


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ActivityMeas&re

ActivityMeas&re

An allocation basein an activity-based

costing syste%

An allocation basein an activity-based

costing syste%


T'e ter% cost driver isalso &sed to re$er toan activity %eas&re

T'e ter% cost driver isalso &sed to re$er toan activity %eas&re

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,i%*le co&nt,i%*le co&nt

o$ t'e n&%ber o$o$ t'e n&%ber o$ti%es an activityti%es an activity

occ&rsocc&rs

Transactiondriver

A %eas&reA %eas&re

o$ t'e a%o&nto$ t'e a%o&nto$ ti%e neededo$ ti%e needed$or an activity$or an activity

D&rationdriver

%wo common types o activity measures&


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Traditional cost syste%s &s&ally rely on vol&%eTraditional cost syste%s &s&ally rely on vol&%e%eas&res s&c' as direct labor 'o&rs and/or %ac'ine%eas&res s&c' as direct labor 'o&rs and/or %ac'ine

'o&rs to allocate all over'ead costs to *rod&cts'o&rs to allocate all over'ead costs to *rod&cts

Traditional cost syste%s &s&ally rely on vol&%eTraditional cost syste%s &s&ally rely on vol&%e%eas&res s&c' as direct labor 'o&rs and/or %ac'ine%eas&res s&c' as direct labor 'o&rs and/or %ac'ine

'o&rs to allocate all over'ead costs to *rod&cts'o&rs to allocate all over'ead costs to *rod&cts

ABC de$inesABC de$ines$ive levels o$ activity$ive levels o$ activity

t'at largely do not relatet'at largely do not relateto t'e vol&%e o$ &nitsto t'e vol&%e o$ &nits

*rod&ced*rod&ced

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'anuacturing

companies typically cominetheir activities into ive

classiications(

)nit*"evelActivity

Batch*"evelActivity

Product*"evelActivity

Customer*"evelActivityOrgani+ation*

sustainingActivity


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C'aracteristics o$ ,&ccess$&l ABC3%*le%entations

,trong topmanagement support,trong topmanagement support

Cross*unctionalinvolvement

Cross*unctionalinvolvement

"in- to evaluationsand rewards

"in- to evaluationsand rewards

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Ba4ter Battery An ABC 4a%*le

Man&$act&ring over'ead is allocated to *rod&cts &singa single *lant"ide over'ead rate based on %ac'ine 'o&rs

Man&$act&ring over'ead is allocated to *rod&cts &singa single *lant"ide over'ead rate based on %ac'ine 'o&rs

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De$ine Activities+ Activity Cost 0ools+ and Activity Meas&res

At Ba#ter Battery. the ABC team. selected the ollowingactivity cost pools and activity measures&

At Ba#ter Battery. the ABC team. selected the ollowingactivity cost pools and activity measures&

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C&sto%er Orders - assigned all costs o$ reso&rcest'at are cons&%ed by taking and *rocessingc&sto%er orders

Design C'anges - assigned all costs o$ reso&rces

cons&%ed by c&sto%er re.&ested design c'anges Order ,i5e - assigned all costs o$ reso&rces

cons&%ed as a conse.&ence o$ t'e n&%ber o$ &nits*rod&ced

C&sto%er 6elations assigned all costs associated"it' %aintaining relations "it' c&sto%ers

Ot'er assigned all organi5ation-s&staining costs and&n&sed ca*acity costs

C&sto%er Orders- assigned all costs o$ reso&rcest'at are cons&%ed by taking and *rocessingc&sto%er orders

Design C'anges- assigned all costs o$ reso&rces

cons&%ed by c&sto%er re.&ested design c'anges Order ,i5e- assigned all costs o$ reso&rces

cons&%ed as a conse.&ence o$ t'e n&%ber o$ &nits*rod&ced

C&sto%er 6elations assigned all costs associated"it' %aintaining relations "it' c&sto%ers

Ot'er assigned all organi5ation-s&staining costs and&n&sed ca*acity costs

De$ine Activities+ Activity Cost 0ools+ and Activity Meas&res

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Learning Objective 7

Assign costs to costAssign costs to cost

pools !sing a rstpools !sing a rst

stage allocationstage allocation..

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Assign Over'ead Costs to Activity Cost 0ools

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Direct %aterials+ direct labor+ and s'i**ing are e4cl&dedDirect %aterials+ direct labor+ and s'i**ing are e4cl&dedbeca&se Ba4ter Battery8s e4isting cost syste% can directlybeca&se Ba4ter Battery8s e4isting cost syste% can directly

trace t'ese costs to *rod&cts or c&sto%er orderstrace t'ese costs to *rod&cts or c&sto%er orders


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At Ba4ter Battery t'e $ollo"ing distrib&tion o$ reso&rcecons&%*tion across activity cost *ools is deter%ined


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3ndirect $actory "ages 9+;;;+;;; 0ercent cons&%ed by c&sto%er orders ;;+;;;

3ndirect $actory "ages 9+;;;+;;; 0ercent cons&%ed by c&sto%er orders ;;+;;;

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?actory e.&i*%ent de*reciation 9

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Learning Objective ;;+;;; batteries ordered "it' +;;; se*arate orders>;;+;;; batteries ordered "it' +;;; se*arate orders;+;;; %ac'ine-'o&rs

"ong"ie 6e.&ires ne" design reso&rces7 ;;+;;; batteries ordered "it' +;;; se*arate orders %in&tes o$ %ac'ineac' LongLi$e re.&ires > %in&tes o$ %ac'ine

ti%e $or a total o$

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Assigning Over'ead to 0rod&cts

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"et2s ta-e a loo- at how Ba#ter Battery2s system wor-s or /ustone o the 3.444 customers Acme Auto Parts who placed atotal o twelve orders( Note that the our orders or "ong"ies

re5uired a design change(

Orders ig't orders $or ; ,&re,tarts *er orderig't orders $or ; ,&re,tarts *er order

77 ?o&r orders $or @; LongLi$es *er order?o&r orders $or @; LongLi$es *er order

Orders ig't orders $or ; ,&re,tarts *er orderig't orders $or ; ,&re,tarts *er order77 ?o&r orders $or @; LongLi$es *er order?o&r orders $or @; LongLi$es *er order

'achine*hours

T'e >; ,&re,tarts re.&ired 7>> %ac'ine-'o&rsT'e >; ,&re,tarts re.&ired 7>> %ac'ine-'o&rs77 T'e 7;; LongLi$es re.&ired ; %ac'ine 'o&rsT'e 7;; LongLi$es re.&ired ; %ac'ine 'o&rs

'achine*hours

T'e >; ,&re,tarts re.&ired 7>> %ac'ine-'o&rsT'e >; ,&re,tarts re.&ired 7>> %ac'ine-'o&rs77 T'e 7;; LongLi$es re.&ired ; %ac'ine 'o&rsT'e 7;; LongLi$es re.&ired ; %ac'ine 'o&rs

Assigning Over'ead to C&sto%ers

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Assigning Over'ead to C&sto%ers

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Learning Objective @

Use activitybasedUse activitybased

costing to comp!tecosting to comp!te

prod!ct and c!stomerprod!ct and c!stomer

margins.margins.

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0re*are Manage%ent 6e*orts

Product 'argin Calculations

T'e $irst ste* in co%*&ting *rod&ct %argins is togat'er eac' *rod&ct8s sales and direct cost data

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T'e second ste* in co%*&ting *rod&ct %argins is toincor*orate t'e *revio&sly co%*&ted activity-based

cost assign%ents*ertaining to eac' *rod&ct

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T'e t'ird ste* in co%*&ting *rod&ct%arginsis to ded&ct eac' *rod&ct8sdirect and indirect costs $ro% sales

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T'e *rod&ct %argins can be reconciled "it't'e co%*any8s net o*erating inco%e as $ollo"s:


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Customer 'argin AnalysisT'e $irst ste* in co%*&ting Ac%e A&to 0arts8 c&sto%er

%argin is to gat'er its sales and direct cost data

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Customer 'argin AnalysisT'e second ste* is to incor*orate Ac%e A&to 0arts8

*revio&sly co%*&ted activity-based cost assign%ents

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Customer 'argin Analysis

T'e t'ird ste* is to co%*&te Ac%e A&to 0arts8 c&sto%er %argin o$9 by ded&cting all its direct and indirect costs $ro% its sales

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0rod&ct Margins Co%*&ted #sing t'eTraditional Cost ,yste%

T'e $irst ste* in co%*&ting *rod&ct %argins is togat'er eac' *rod&ct8s sales and direct cost data

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Plantwide manuacturing

overhead rate

$67.444.444

844.444 '1 9 $6:(;4 per machine*hour9

T'e second ste* in co%*&ting *rod&ct %arginsis to co%*&te t'e *lant"ide over'ead rate

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T'e t'ird ste* in co%*&ting *rod&ct %argins isallocate %an&$act&ring over'ead to eac' *rod&ct

>;+;;; 'o&rs 9@; *er 'o&r 9>+;;+;;;>;+;;; 'o&rs 9@; *er 'o&r 9>+;;+;;;

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T'e $o&rt' ste* is to act&allyco%*&te t'e *rod&ct %argins

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T'e traditional cost

syste% overcostst'e,&re,tarts and re*ortsa lo"er *rod&ct

%argin $or t'is *rod&ct

T'e traditional cost

syste% &ndercostst'eLongLi$es and re*ortsa 'ig'er*rod&ct

%argin $or t'is *rod&ct

Di$$erences Bet"een ABC and Traditional0rod&ct Costs

Di$$ B ABC d T di i l

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T'ere are t'ree reasons "'y t'ere*orted *rod&ct %argins $or t'e t"o

costing syste%s di$$er $ro% one anot'er

Traditional costing allocates all %an&$act&ring over'ead to *rod&cts ABC costing only assigns %an&$act&ring over'ead costs cons&%ed by *rod&cts to t'ose *rod&cts

Di$$ B t ABC d T diti l

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Traditional costing allocates all %an&$act&ring over'ead costs &sing a vol&%e-related allocation base ABC costing also &ses non-vol&%e related allocation bases



Di$$ B t ABC d T diti l

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Traditional costing disregards selling and ad%inistrative e4*enses beca&se t'ey are

ass&%ed to be *eriod e4*enses ABC costing directly traces s'i**ing costs to *rod&cts and

incl&des non%an&$act&ring over'ead costs ca&sed by *rod&cts in t'e activity cost *ools t'at are assigned to *rod&cts



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Targeting 0rocess 3%*rove%ent

Activity-based %anage%ent is&sed in conj&nction "it' ABC toidenti$y areas t'at "o&ld bene$it

$ro% *rocess i%*rove%ents

Activity-based %anage%ent is&sed in conj&nction "it' ABC toidenti$y areas t'at "o&ld bene$it

$ro% *rocess i%*rove%ents

E'ile t'e t'eory o$ constraintsa**roac' disc&ssed in C'a*ter is a *o"er$&l tool $or targeting

i%*rove%ent e$$orts+ activity ratescan also *rovide val&able cl&es on

"'ere to $oc&s i%*rove%ent e$$orts

E'ile t'e t'eory o$ constraintsa**roac' disc&ssed in C'a*ter is a *o"er$&l tool $or targeting

i%*rove%ent e$$orts+ activity ratescan also *rovide val&able cl&es on

"'ere to $oc&s i%*rove%ent e$$orts

Benc'%arkingBenc'%arking can be &sed to co%*are activity costcan be &sed to co%*are activity costin$or%ation "it' "orld-class standards o$ *er$or%ancein$or%ation "it' "orld-class standards o$ *er$or%ance

ac'ieved by ot'er organi5ationsac'ieved by ot'er organi5ations

Benc'%arkingBenc'%arking can be &sed to co%*are activity costcan be &sed to co%*are activity costin$or%ation "it' "orld-class standards o$ *er$or%ancein$or%ation "it' "orld-class standards o$ *er$or%ance

ac'ieved by ot'er organi5ationsac'ieved by ot'er organi5ations

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Activity-Based Costing and 4ternal 6e*orting

Most co%*anies do not &se ABC$or e4ternal re*orting beca&se

4ternal re*orts are less detailed t'an internal

re*orts

7 3t %ay be di$$ic&lt to %ake c'anges to t'e co%*any8sacco&nting syste%

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ABC Li%itations

,&bstantial reso&rces,&bstantial reso&rcesre.&ired to i%*le%entre.&ired to i%*le%ent

and %aintainand %aintain

6esistance to6esistance to&n$a%iliar n&%bers&n$a%iliar n&%bers

and re*ortsand re*orts

Desire to $&llyDesire to $&lly

allocate all costsallocate all coststo *rod&ctsto *rod&cts

0otential0otential

%isinter*retation o$%isinter*retation o$&n$a%iliar n&%bers&n$a%iliar n&%bers

Does not con$or% toDoes not con$or% toFAA0 T"o costingFAA0 T"o costing

syste%s %ay be neededsyste%s %ay be needed

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ABC Action Analysis

A**endi4 >A

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Learning Objective

#Appendix $A%#Appendix $A%

&repare an action&repare an action

analysis report !singanalysis report !singactivitybased costingactivitybased costing

data and interpret thedata and interpret the

report.report.

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A**endi4 >A: ABC Action Analysis

Conventional ABC analysis does notidenti$y *otentially relevant costs An

action analysis re*ort 'el*s beca&se it:

G,'o"s "'at costs 'ave been assigned to a cost object

G3ndicates 'o" di$$ic&lt it "o&ld be to adj&st t'ose costs in res*onse to c'anges in t'e level o$ activity

Conventional ABC analysis does notidenti$y *otentially relevant costs An

action analysisre*ort 'el*s beca&se it:

G,'o"s "'at costs 'ave been assigned to a cost object

G3ndicates 'o" di$$ic&lt it "o&ld be to adj&st t'ose costs in res*onse to c'anges in t'e level o$ activity

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Constr&cting an action analysis re*ortbegins "it' t'e $irst-stage allocation *rocess

3n addition to co%*&ting an overall activityrate $or eac' activity cost *ool+ an activity

rate is co%*&ted $or eac' ty*e o$ over'eadcost t'at is cons&%ed s&**orting a given

activity

Let8s revisit t'e stage-one allocations$ro% t'e Ba4ter Battery Co%*any e4a%*le

t'at "e disc&ssed earlier


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9+>;;+;;; H ;+;;; orders 9>; *er order

Ot'er entries in t'e table are co%*&ted si%ilarly

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9>; *er order +;;; orders 97;+;;;Ot'er entries in t'e table are co%*&ted si%ilarly

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9>; *er order +;;; orders 9+;>;+;;;Ot'er entries in t'e table are co%*&ted si%ilarly

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e4t+ label eac' cost &sing an ease o$ adj&st%entcode:

GFreen costs adj&st %ore or less a&to%atically to c'anges in activity level "it'o&t any action by

%anagersGIello" costs can be adj&sted to c'anges in activity level+ b&t it "o&ld re.&ire %anage%ent action to reali5e t'e c'ange in cost

G6ed costs can be adj&sted to c'anges in activity level only "it' a great deal o$ di$$ic&lty and "it' %anage%ent intervention


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#sing a Modi$ied ?or% o$ Activity-BasedCosting to Deter%ine 0rod&ct Costs $or

4ternal 6e*ortsA**endi4 >B

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Learning Objective

#Appendix $B%#Appendix $B%

Use activitybasedUse activitybased

costing techni'!es tocosting techni'!es tocomp!te !nit prod!ctcomp!te !nit prod!ct

costs for externalcosts for external

reports.reports.

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A**endi4 >B

ABC *rod&ct costs:G3ncl&de organi5ation-s&staining costs and &n&sed ca*acity costsG4cl&de non%an&$act&ring costs even i$ t'ey are ca&sed by t'e *rod&cts

ABC *rod&ct costs:G3ncl&deorgani5ation-s&staining costs and &n&sed ca*acity costs

G4cl&denon%an&$act&ring costs even i$ t'ey are ca&sed by t'e *rod&cts

A %odi$ied $or% o$ activity-basedcosting can be &sed to develo* *rod&ct

costs $or e4ternal $inancial re*orts

A %odi$ied $or% o$ activity-basedcosting can be &sed to develo* *rod&ct

costs $or e4ternal $inancial re*orts

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A**endi4 >B

,i%%ons8 3nd&stries *rovides t'e $ollo"ing in$or%ation$or t'e co%*any as a "'ole and $or its only t"o*rod&ctsJdel&4e and standard 'edge tri%%ers

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A**endi4 >B

Ass&%ing t'at ,i%%ons8 traditional cost syste% reliesAss&%ing t'at ,i%%ons8 traditional cost syste% relieson one *redeter%ined *lant"ide over'ead rate "it'on one *redeter%ined *lant"ide over'ead rate "it'

direct labor-'o&rs (DL!s) as t'e allocation base+ t'endirect labor-'o&rs (DL!s) as t'e allocation base+ t'en

its *lant"ide over'ead rate is co%*&ted as $ollo"s:its *lant"ide over'ead rate is co%*&ted as $ollo"s:

Ass&%ing t'at ,i%%ons8 traditional cost syste% reliesAss&%ing t'at ,i%%ons8 traditional cost syste% relies

on one *redeter%ined *lant"ide over'ead rate "it'on one *redeter%ined *lant"ide over'ead rate "it'direct labor-'o&rs (DL!s) as t'e allocation base+ t'endirect labor-'o&rs (DL!s) as t'e allocation base+ t'en

its *lant"ide over'ead rate is co%*&ted as $ollo"s:its *lant"ide over'ead rate is co%*&ted as $ollo"s:

0redeter%inedover'ead rate 9@; *er DL! 9+>;;+;;;;;+;;; DL!s

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A**endi4 >B

,i%%ons8 traditional cost syste% "o&ldre*ort &nit *rod&ct costs as $ollo"s:

,i%%ons8 traditional cost syste% "o&ldre*ort &nit *rod&ct costs as $ollo"s:

3(4 D"1 < $7(;4 per D"1

6(4 D"1 < $7(;4 per D"1

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A**endi4 >B

T'e ABC *roject tea% at ,i%%ons 'asdevelo*ed t'e $ollo"ing basic in$or%ation

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A**endi4 >B

Ee can calc&late t'e $ollo"ing activity rates:

#sing t'e ne" activity rates+ let8s assign over'eadto t'e t"o *rod&cts based &*on e4*ected activity

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A**endi4 >BDelu#e Product

,tandard Product

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A**endi4 >B

Activity-based &nit *rod&ct costs $or bot' *rod&ct linesActivity-based &nit *rod&ct costs $or bot' *rod&ct lines

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A**endi4 >B

Activity-based &nit *rod&ct costs $or bot' *rod&ct linesActivity-based &nit *rod&ct costs $or bot' *rod&ct lines

$6.6=4.444 > 644.444 units

$?:4.444 > 344.444 units

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A**endi4 >B

ote t'at t'e &nit *rod&ct cost o$ a ,tandard &nitote t'at t'e &nit *rod&ct cost o$ a ,tandard &nit

decreased $ro% 9@; to 9

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nd o$ C'a*ter >

chap 008 abc

Documents

o costs

traditional cost acconting

oolsac abc cost

activityac abc cost

ore cost

cost bcket2

activitybased costing

rodctstraditional cost