Activity Based Costing EMBA Session November 17, 2016 Activity Based Costing

Overview of Lecture Review of cost behaviors Rationale for ABC approach Factors supporting an ABC system Cost flows Steps in implementation Examples Level of acceptance of ABC costing

Types of Costs Fixed costs Variable costs Mixed costs

Relating Costs to Objectives Traceable costs Direct labor Direct material Allocated costs Fixed overhead Variable overhead

Traditional Allocation Method Purchasing Product A Warehousing Engineering Direct Labor Hours Product B Maintenance

Rational for ABC Approach Single allocation rate not sufficient Currently many firms must target price their products ABC assists in target pricing Advent of high speed computing power made ABC feasible

Environmental Factors Supporting ABC Approach High levels of competition Very diverse product mix Low cost of measurement for additional data required

ABC Cost Flow Schematic Purchasing Purchase Orders Warehouse Product A Number of Receipts Product B Engineering Maintenance Number of Hours Number of Hours

Implementation Steps Identify the cost objectives Identify the direct costs of the products Identify the overhead cost pools Select the appropriate drivers Test the assumptions Install

Example of Product Costing Raw Materials Department $1,000,000 Raw Material $150,000 15,000 Receipts Purchased Parts $600,000 1,000 Receipts Material Movements 250,000 250 Setups Product A Product B Product C Product D

Allocation Using Single Driver $1,000,000  16,000 Receipts = $62.50 per receipt No. of Product Receipts Rate Allocated Cost A 4,040 $62.50 $252,500 B 6,200 $62.50 387,500 C 2,000 $62.50 125,000 D 3,750 $62.50 235,000 16,000 $1,000,000

Calculation of Multiple Rates No. of Per Cost Pool Pool Dollars Drivers Driver Driver Raw Material $ 150,000 15,000 $10 Per Receipt Purchased Parts 600,000 1,000 $600 Per Receipt Material Handling 250,000 250 $1,000 Per Setup $1,000,000

Use of Activities by Products

Allocation to Products

Comparison of Two Methods Product Traditional ABC Method Variance A $ 252,500 $ 114,000 $ 138,500 Over B 387,500 260,000 127,500 Over C 125,000 385,000 260,000 Under D 235,000 241,000 6,000 Under Totals $1,000,000 $1,000,000 $ 0

Retail Example of ABC Costing

Traditional Allocation

Identify Cost Pools and Drivers No. of Cost per Activity Driver Cost Pool Drivers Driver Ordering # of P.O. $5,200 52 $100 Delivery # of Del. $8,400 105 $ 80 Stocking # of L.H. $5,760 280 $ 20 Cust. Sup. # of Items $10,240 51,200 .20 Bottle Return $400 Total $30,000

New Cost Drivers

Results Applying ABC

Acceptance of ABC Costing Approximately 60% of manufacturing firms in the US have tried ABC 10%-20% finally kept it in place Reasons for rejection: Cost of gathering information Complexity outweighs usefulness Disagreement on proper drivers

Copyright by Frank Ilett, 2016