CHAPTER © jsnyderdesign / iStockphoto 7 ACTIVITY-BASED COSTING & ACTIVITY-BASED MANAGEMENT

7 WHAT’S UP WITH C&C SPORTS? ► Costs skyrocketed ► Variance analysis – 4 th quarter Lining: $6,250 F price; $8,000 U quantity DL: $1,650 U rate; $14,400 U efficiency VOH: $26,195 U spending; $3,955 U efficiency ► Additional jackets appear to have added complexity to production processes ► Need to better understand product costs

ACTIVITY-BASED COSTING Unit Unit 7.2Unit 7.3 © Tomwang112 / iStockphoto

7 TRADITIONAL COSTING AND POR S

7 ACTIVITY-BASED COSTING CONCEPT

7 WHAT’S THE COST DRIVER? Suppose one batch of jackets takes 15 hours and three batches of jerseys take 15 hours. Do both products consume the same amount of forklift resource? DLHS? BATCHES MOVED?

7 TYPES OF ACTIVITIES ► Unit-level ► Batch-level ► Product-level ► Customer-level ► Organization-level

7 TYPES OF ACTIVITIES ► Unit-level Incurred by production or acquisition of a single unit of product or the delivery of a single unit of service ► Batch-level Incurred when a group of similar things are made, handled or processed at the same time ► Product-level Incurred in support of different products or processes ► Customer-level Incurred to support and sustain a specific customer ► Organization-level Incurred to support and sustain a business unit

7 UNIT LEVEL ACTIVITIES ► Volume or level of activity is proportional to the number of units produced ► Costs incurred to perform these activities can be allocated using traditional methods such as DLH or MH ► C&C – operating sewing machines

7 BATCH-LEVEL ACTIVITIES ► Volume or level of activity is proportional to the number of batches produced ► Costs are incurred when a group of similar things are made or handled at the same time ► C&C – Moving batches of products; cutting fabric

7 PRODUCT-LEVEL ACTIVITIES ► Activities that support the production and sale of individual products ► Related to all units and batches produced, regardless of volume ► C&C – creating patterns for new products

7 CUSTOMER LEVEL-ACTIVITIES ► Activities performed to support specific customers ► Not dependent on the number of units or products sold to that customer ► Costs for these resources do not affect product cost ► C&C – making sales calls

7 ORGANIZATION-SUSTAINING ACTIVITIES ► Activities performed to maintain the plant facility and provide managerial infrastructure ► Not dependent on the volume of production, just the number of facilities maintained ► The cost of these resources is not allocated to products ► C&C – renting factory space

7 Cost CategoryGAAP-Based Product CostActivity-Based Product Cost Direct Materials ✔✔ Direct Labor ✔✔ COMPARISON OF GAAP AND ABC COSTS Manufacturing Overhead Unit-Level ✔✔ Batch-Level ✔✔ Product-Level ✔✔ Organization-Level ✔ S&A Expense Unit-Level ✔ Batch-Level ✔ Product-Level ✔ NOTICE: Under traditional costing, S&A expenses are not allocated to products NOTICE: Under ABC, organization-level costs are not allocated to products

DEVELOPING ACTIVITY-BASED PRODUCT COSTS Unit Unit 7.2 Unit 7.3 © Tomwang112 / iStockphoto

7 FIVE STEPS TO IMPLEMENT ABC ► Identify activities ► Develop activity cost pools ► Calculate activity cost pool rates ► Allocate costs to products or services ► Calculate unit product costs

7 ACTIVITY-BASED COSTING (STEPS 1 & 2) See Exhibit 7-5 for details of costs to activity pools

7 ACTIVITY-BASED COSTING (STEP 3) See Exhibit 7-6 for details of activity cost pool rates

7 ACTIVITY-BASED COSTING (STEP 4) See Exhibit 7-7 for details of cost allocations to each product

7 ACTIVITY-BASED COSTING (STEP 5)

7 COMPARISON OF TRADITIONAL & ABC COSTING

7 UNDER TRADITIONAL COSTING SYSTEMS… ► Small volume jobs are typically under-costed ► Large volume jobs are typically over-costed ► In ABC, this is corrected as batch-related and product-level costs are allocated using appropriate batch and product cost drivers

ACTIVITY-BASED MANAGEMENT Unit Unit 7.2 Unit 7.3 © Tomwang112 / iStockphoto

7 MANAGEMENT SAYS… Labor costs are too high. What’s your first reaction? Reduce headcount

7 THE KEY IS ACTIVITY MANAGEMENT ► Inefficient production processes ► Poor facilities layout ► Non-value added activities ► Untrained workforce LOOK AT THE ACTIVITIES THAT USE LABOR RESOURCES

7 WHAT ADDS VALUE TO THE PRODUCT? ► Look at your activities ► If customers are willing to pay for an activity, it is value-added ► If customers aren’t willing to pay for it, the activity is non-value-added ► Eliminate the non-value-added activities and the related resources to reduce costs

7 HOW IS ABC INFORMATION USED? An ABC analysis may reveal interesting information about product profitability. Source: Activity Based Costing: How ABC is Used in the Organization, Copyright 2005, SAS Institute Inc., Cary, NC. All Rights Reserved. Reproduced with permission of SAS Institute Inc., Cary, NC

7 TRADITIONAL VS ABC PROFITABILITY

7 DOES ABC CHANGE PRODUCTION COSTS? NO ABC re-allocates costs based on the activities consumed by the products

7 ACTIVITY-BASED COSTING RECAP ► Recognizes that various activities and cost levels exist ► Gathers costs into related cost pools ► Uses multiple cost drivers to assign costs to products and services based on the consumption of resources by activities ► ABC focuses on attaching costs to products and services based on the activities used to produce, perform, distribute or support those products and services