Copyright © 2003 Pearson Education Canada Inc. Slide 5-54 Chapter 5 Activity - Based Costing and Activity - Based Management

Copyright © 2003 Pearson Education Canada Inc. Slide 5-55 Traditional (Peanut Butter) Costing Peanut Butter Costing Approaches a traditional costing approach which uses broad averages to spread costs among products and services even though the resources are are consumed in a non-uniform way leads to overcosting and undercosting of products and services Pages Product cost cross-subsidization if some products are overcosted, other products are undercosted the overcosted products are subsidizing the undercosted products

Copyright © 2003 Pearson Education Canada Inc. Slide 5-56 Refining a Costing System Three things to consider to improve an existing costing system 1.Direct-cost tracing reduce the amount of indirect costs by classifying more costs as direct 2.Indirect-cost pools expand the number of indirect-cost pools until the costs in each pool are homogeneous 3.Cost-allocation bases consider using a different cost-allocation base for each indirect-cost pool based on what causes the cost pool to change Page 152

Copyright © 2003 Pearson Education Canada Inc. Slide 5-57 Activity-Based Costing (ABC) refinement of an existing cost system which focuses on individual activities as the basic cost objects an activity is an event, task, or unit of work with a specified purpose examples of activities include designing the product or service, set up of machinery, operating machinery, distribution of finished product, administration Fundamental Cost Object Allocations to Other Cost Objects Cost of Product Service Customer Pages Costs of Activities Activities

Copyright © 2003 Pearson Education Canada Inc. Slide 5-58 Cost Hierarchies when thinking about splitting indirect costs into homogeneous cost pools considering four cost hierarchies or cost categories 1.Output unit-level costs: costs relating to individual units of output such as materials 2.Batch-level costs: costs relating to batches of output such as set-up charges 3.Product-sustaining costs: costs relating to the support of a particular product such as product design costs 4.Facility-sustaining costs: costs relating to the organization as a whole Pages

Copyright © 2003 Pearson Education Canada Inc. Slide 5-59 Traditional versus ABC Costing Traditional Costing System Pages Indirect Costs / DLHs = $2,000,000 / 40,000 = $50 per DLH Total Indirect Costs Simple Lens Complex Lens Direct Costs ABC Costing System Indirect Cost Pool A Simple Lens Complex Lens Direct Costs Pool A Indirect Costs / DLHs = $500,000 / 40,000 = $12.50 per DLH Pool B Indirect Costs / MHs = $1,500,000 / 10,000 = $150 per MH Indirect Cost Pool B

Copyright © 2003 Pearson Education Canada Inc. Slide 5-60 Benefits of ABC Systems Promotes the use of activity-based management (ABM) within the organization ABM focuses management’s attention on the activities that cause costs to be incurred results in better product and pricing decisions reduced costs performing activities more efficiently eliminating activities that do not add value improving product design eventually leads to improved operations and processes, satisfied customers, and increased profits Pages

Copyright © 2003 Pearson Education Canada Inc. Slide 5-61 “Tell-Tale” Signs of Need to Consider ABC 1.Significant amounts of costs are allocated using one or two cost pools 2.All or most of the costs are identified as output unit-level costs 3.Products make diverse demands on resources 4.Main products show little profit while secondary products show large profits 5.Complex products appear to be profitable while simple products appear to be losing money 6.Operations and accounting staff disagree about the costs of manufacturing and marketing products Pages

Copyright © 2003 Pearson Education Canada Inc. Slide 5-62 Growing Interest in Activity-Based Costing Factor% More accurate cost information for product pricing61 More accurate profit analysis61 By product22 By customer20 By process 24 By department43 Improved performance measures43 Improved insight into cost causation37 Source: Armitage, H., and R. Nicholson, “Activity-Based Costing: A Survey of Canadian Practices”, supplement to CMA Magazine (1993) Page 163