module3 abc

8/8/2019 Module3 ABC

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ACTIVITY-BASEDCOSTING (ABC)

BA 220

Class TTh, 4 5:20


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Objectives: Compare and contrast traditional costing

systems with alternative costing systems,e.g., Activity-Based Costing (ABC);

Show how traditional cost systems cansometimes distort product costs;

See how ABC links resource costs to theactivities the organization performs and thenfrom the activities to cost objects, such asproducts and customers;

Learn to use the information from an activity-based cost system to improve operations andto make better decisions about products andcustomers.


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Traditional Costing Systems

Costing systems typically:

assign direct labor and direct materials

costs to products;accumulate indirect costs, such asmachine expenses, scheduling, qualitycontrol, purchasing, maintenance,supervision, and general factory

expenses as support departmentexpenses;


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(Contd):

allocate these expenses to productiondepartments in simple proportion to the

direct labor hours worked (or directlabor costs) in each department;

calculate overhead allocation rates foreach production department and usethese to 333drive indirect and supportexpenses to the products processedthrough each prodn dept.


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Taken from:

Accounting Concepts and Applications, 8eby Albrecht, Stice, Stice, Skousen

PowerPoint slides by:

Michael Blue, Bloomsburg University


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Activity-Based Costing (ABC)

A method of attributing costs toproducts based on:

Costs Activities Products

assigning costs ofresources to activities

assigning costs ofactivities to products


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Unit-Based Costing (UBC)

The traditional method of allocating costs(manufacturing overhead) to products based onnumber of units produced. If only three productsare produced (one of each), then:

Costs ProductionDepartments

Products

$9,000

Overhead $3,000

Overheadper product

=


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Relationship BetweenUBC and ABC

Unit-Based Costing(UBC)

Model of Costs

Activity-Based Costing(ABC) Hierarchical

Product Cost Model

Costs ofDirect Materials

Costs ofDirect Labor

VariableManufacturing

Overhead Costs

Costs ofUnit-Level Activities

Fixed Manufacturing

Overhead Costs

Costs ofBatch-Level Activities

Costs ofProduct Line

Activities

Costs of Facility

Support Activities


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What is the hierarchical product cost model?

Facility Support Activities

Product Line Activities

Batch-Level Activities

Unit-Level ActivitiesProdu c

t

Costs

Com

mon

Co

sts

ABCAllocating Resource Costs toActivities


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Unit-Level ActivitiesTake place each time a unit is produced

PackingAssembly

Depreciation

Maintenance



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Unit-Level Activities

ABCAllocating ResourceCosts to Activities


Batch-Level ActivitiesNumber of setups

Setup hours

Movements of materialsOrders for nonstocked items

Inspections



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Facility Support ActivitiesProperty taxes

Plant security

Landscaping

Accounting and legal

General administrative salaries



Unit-Level Activities



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Does a hammer really cost THAT MUCH?

If a UBC factory produces only three products (ahammer, a clock, and a Ferrari) and a hammer incurs$4 of direct labor and materials, how much will thehammer cost if manufacturing overhead is allocated

evenly over finished products?

Cross-Subsidization

$9,000

Overhead

?

Overheadper

product=


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Cross-Subsidization

$9,000

Overhead

$3,000

Overheadper

product

3 Products

$3,004 !?1 Hammer =

=


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Cross-Subsidization

$9,000Overhead

?Overhead

per product

Under UBC (unit-based costing), some products may beinappropriately assigned costs that actually belong toanother product line (in this case, the hammer and clock areobviously cross-subsidizing the Ferrari product line).

=


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$ -hen one product is crossubsidizing,nother it p p e a r snprofitable to producend is often mistakenly.iscontinued

$ hen facility support( )ommon activity costs arellocated to individual,roduct lines they maya p p e a r nprofitable and

Product Cost Distortions

What are the Hazards of AllocatingCosts?


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$8 $20 $100,0002 10 70,0002 5 25,000

$4 $ 5 $ 5,000

RevenueMaterialsLabor

Profit

Hazards of Allocating Costs

Product profitability before:overhead allocationHammer Clock Ferrari


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Product profitability after overhead allocation:

RevenueMaterialsLaborOverhead

Profit

$ 8 $ 20 $100,0002 10 70,0002 5 25,000

3,000 3,000 3,000

$(2,996) $(2,995) $ 2,000

Hammer Clock Ferrari

In actuality, most of the $9,000 manufacturingoverhead is attributable to the Ferrari, revealing it to

be the real money loser.


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B U T ecause the otherroducts are -rosssubsidizing , hey appearnprofitable and will beiscontinued from.roduction$ 8 $ 20 $100,0002 10 70,000

2 5 25,0003,000 3,000 3,000

$(2,996) $(2,995) $ 2,000


Profit




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$100,00070,00025,0008,990

$ (3,990)


Profit


The result?


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Next slides developed from

Chapter 4 of

Atkinson (Management Accounting)


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Example:Cooper Pen Costs Blue Black Red PurpleMaterials ,75 000 ,60 000 ,14 040 ,1 650 Direct labor ,30 000 ,24 000 ,5 400 600 *Overhead ,90 000 ,72 000 ,16 200 ,1 800Total ,195 000 ,156 000 ,35 640 ,4 050

* , / ,$180 000 Total Overhead $60 000 Total= % (Direct Labor Costs 300 applied to

.)Direct labor costs of Dept


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Traditional Costing SystemsExample:

Cooper Pen Costs Blue Black Red PurpleMaterials ,75 000 ,60 000 ,14 040 ,1 650

Direct labor ,30 000 ,24 000 ,5 400 600Overhead *?? *?? *?? *??

* ,Since this is completely arbitrarythe amount of overhead charged to each

pen color can range from $0 to the, .entire $180 000 Overhead cost* ,Thing is people usually demand that

these common costs be chargeable to

( ) .at least something


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Alternative Costing Systems

,ut since people usuallyemand that these commonosts be chargeable to,omething what could be a( ) / /ore fair equitable/easonable appropriateallocation?

: - !nter Activity Based Costing costing system based onctivities linkingrganizational spending onesources to the products and

ervices produced and .elivered to customers


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Activity-Based Costing

hile traditional cost systemsse actual departments or costenters for accumulating and,edistributing costs ABCystems use activities nsteadf cost centers for.ccumulating costs

n our example : utomation atooper s has caused directabor costs to decrease and .ndirect expenses to increase, -s custom low volume products( ) ,ED and PURPLE were added theld cost system may now beiving distorted signals about.rofitability


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Activity-Based Costing :teps to be taken

nderstand how resources are used(o perform activities such as& )cheduling product support urn our attention to understandinghe demands for these activitiesy the 4 different products e able to relate the cost oferforming activities to the.ndividual products

Activity ctivity Cost Driver andle prod n runs roduction runs et up machines etup hours upport products umber of products un machines achine hours rovide fringe benefits abor amount


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Activity Cost Drivers (Cooper)

ctivity cost driverBlue Black RedPurpleTotal .o of units ,0 000 ,0 000 ,000 ,000 /irect labor hr unit .02 .02 .02 .02 . .otal d l hours ,000 800 180 20 ,000 /achine hr unit .1 .1 .1 .1 .otal machine hrs ,000 ,000 900 100,0 000 rod n runs 70 65 50 15 200 /etup time run 4 .4 .6 .6 .otal setup hrs 280 156 280 84 800 .o of products 1 1 1 1 4


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Activity Expense per product

ctivity Cost river Rate Blue Black Red Purple 330 per run ,23 100 ,21 450 ,16 500 ,4 950 42 per etup hour ,11 760 ,6 552 ,11 760 ,3 528 ,3 600 er product ,3 600 ,3 600 ,3 600 ,3 600 .4 20 per achine hour ,21 000 ,16 800 ,3 780 $420


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See New ABC ProductsProfitability Report

(Exhibit 4 7)

DO: CASE:

NetCom.Inc


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Costs Activities Products

Activity-Based Management (ABM)

, ,anaging costs quality andimeliness of activities throughhe identification and use ofo s t D r i v e r s nd e r f o r m a n c eM e a s u r e s . Cost Drivers

Performance Measures


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Activity-Based Management

he set of actions that,anagement can take basedn the information from an- ,ctivity based cost systemo increase profitability( - ,r improve decision making, .)uch as pricing etc he actions include makingperational improvements to- ,igh cost processeshanging product prices and,roduct mix andestructuring customer


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ABC: Extensions:

:an be applied to USTOMERS as ost Object . Service .irms

:oints to consider rocess improvements -ctivity Based Pricing anaging Relationships


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ABC: Implementation Issues:

ack of clear businesspurpose ack of senior management

commitment elegating the project toconsultants oor ABC Model design ndividual and rganizational Resistanceo Change

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