©2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Chapter 4 Activity-Based Costing

Activity Based Costing Volume-based allocation methods work best if the manufacturing environment includes mostly unit-level costs (costs that vary with every unit produced or the volume of production). Activity-based costing provides an alternative to traditional methods. By allocating overhead costs on the basis of activities that lead to the overhead costs, this method is effective in automated, diverse product environments.

Cost Levels As an alternative to traditional costing methods, ABC allocates overhead costs on the basis of activities that drive costs. To do this, it is important to understand the level at which costs are incurred. Unit- LEVEL COSTS Product- LEVEL COSTS Batch- LEVEL COSTS Facility- LEVEL COSTS

Unit-Level Costs Unit-LEVEL COSTS are incurred each time a unit is produced. Examples: Supplies for factory Depreciation of factory machinery Product- LEVEL COSTS Batch- LEVEL COSTS Facility- LEVEL COSTS

Batch-Level Costs Unit-LEVEL COSTS are incurred each time a unit is produced. Examples: Supplies for factory Depreciation of factory machinery Facility- LEVEL COSTS Batch-LEVEL COSTS are incurred for batches of goods produced. Examples: Salaries for purchasing Depreciation for setup equipment Product- LEVEL COSTS

Product-Level Costs Unit-LEVEL COSTS are incurred each time a unit is produced. Examples: Supplies for factory Depreciation of factory machinery Facility- LEVEL COSTS Product-LEVEL COSTS are incurred for each type of product produced. Examples: Salaries of engineers Product development costs Batch-LEVEL COSTS are incurred for batches of goods produced. Examples: Salaries for purchasing Depreciation for setup equipment

Facility-Level Costs Unit-LEVEL COSTS are incurred each time a unit is produced. Examples: Supplies for factory Depreciation of factory machinery Product-LEVEL COSTS are incurred for each type of product produced. Examples: Salaries of engineers Product development costs Batch-LEVEL COSTS are incurred for batches of goods produced. Examples: Salaries for purchasing Depreciation for setup equipment Facility-LEVEL COSTS sustain general facility processes. Examples: Insurance and taxes Salary of plant manager

Summary of Costs Levels Unit-LEVEL COSTS are incurred each time a unit is produced. Examples: Supplies for factory Depreciation of factory machinery Product-LEVEL COSTS are incurred for each type of product produced. Examples: Salaries of engineers Product development costs Batch-LEVEL COSTS are incurred for batches of goods produced. Examples: Salaries for purchasing Depreciation for setup equipment Facility-LEVEL COSTS sustain general facility processes. Examples: Insurance and taxes Salary of plant manager

Assigning Overhead Costs Under ABC

ABC in Service Environments ABC is every bit as important for service providers as it is for manufacturing companies. It has gained widespread acceptance in the service sector (i.e., U.S. Postal Service).

ABC in Service Environments Limitation: Since the type of work done by service companies tends to be nonrepetitive, cost analysis can be difficult with ABC. Limitation: Service-oriented companies tend to have proportionately more facility- level costs than do manufacturing firms. Thus, facility-level costs are allocated arbitrarily to goods and services (if at all).

ABC in Nonmanufacturing Environments Instead of applying ABC to the cost of a product or service, it can be used to determine the cost of providing a particular nonmanufacturing activity, like payroll services. Should a company continue processing payroll in-house or to outsource?

Benefits of ABC Cost Accuracy Increases Better Control Through Identification of Costs Better Day-To-Day Decision Making and Opportunities for Continuous Improvement

Limitations of ABC High Measurement Costs Time Consuming with Multiple Activity Pools and Cost Drivers If the market dictates prices, ABC implementation costs may exceed the expected benefits of more accurate data.

Who Benefits from ABC? ???? Companies Benefiting From ABC Cost Distortions Non- Unit- Level Costs Diverse, Complex Products Higher % of Overhead

End of Chapter 4