1. ABC - 1 Activity- Based Costing Systems

2. ABC - 2 Activity-Based Costing Activity-based costing (ABC) involves determining the cost of activities and tracing their costs to cost objectives on the basis of the cost objectives utilization of units of activity. Part of “Activity-Based Analysis”

3. ABC - 3 FAULTY COST SYSTEM Symptoms  Competitive analysis is confusing  Conflicting signals from functional areas and the accounting system  Accounting system problems

4. ABC - 4 WHY ABC NOW?  Competitive demands for diverse products/services  Increased significance of overhead costs –Growth of nonunit-based overhead –Consumption ratios of unit-based and nonunit- based overhead items differ  Improved information technology  Significance of strategic decisions

5. ABC - 5 Activity-Based Costing Activities performed to fill customer needs consume resources that cost money. Customer Activities Served by activities Resources Activities consume resources Costs Resources cost money

6. ABC - 6 Activity-Based Costing The cost of resources consumed by activities should be assigned to cost objectives. Costs Resources Assigned to resources Activities Assigned to activity cost pools Cost objectives Reassigned to cost objectives

7. ABC - 7  Identifying activities.  Assigning costs to activities.  Determining the basis for assigning the cost of activities to cost objectives.  Determining the cost per unit of activity.  Reassigning costs from the activity to the cost objective on the basis of the cost objective’s consumption of activities. Activity-Based Costing Operationalizing the two-stage model requires:

8. ABC - 8 Two-Stage Activity Based Costing Method First stage: Costs assigned to resources are reassigned to activities. Activity 1 Activity 2 Activity 3 Activity 4 Activity n Cost of Resource 1 Cost of Resource 2 Cost of Resource n Continued on next slide

9. ABC - 9 Two-Stage Activity Based Costing Method Second stage: Costs assigned to activities are reassigned to cost objectives using an activity cost driver. Activity 1 Activity 2 Activity 3 Activity 4 Activity n Objective 1 Objective 2 Objective 3 Objective n

10. ABC - 10  Unit level activities  Batch level activities  Product level activities  Facility level activities  Unit level activities  Batch level activities  Product level activities  Facility level activities Manufacturing Cost Hierarchy

11. ABC - 11  Cost of raw materials  Cost of inserting a component  Utilities cost of operating equipment  Some costs of packaging  Sales commissions Unit Level Examples This activity is performed for each unit of product produced and sold. Manufacturing Cost Hierarchy

12. ABC - 12  Cost of processing sales order  Cost of issuing and tracking work order  Cost of equipment setup  Cost of moving batch between workstations  Cost of inspection  Cost of processing sales order  Cost of issuing and tracking work order  Cost of equipment setup  Cost of moving batch between workstations  Cost of inspection Batch Level This activity is performed for each batch of product produced or sold. Examples Manufacturing Cost Hierarchy

13. ABC - 13  Cost of product development  Cost of product marketing, such as advertising  Cost of specialized equipment  Cost of maintaining specialized equipment Product Level Examples This activity is performed to support each different product that can be produced. Manufacturing Cost Hierarchy

14. ABC - 14  Cost of maintaining general facilities  Cost of nonspecialized equipment  Cost of maintaining nonspecialized equipment  Cost of real property taxes  Cost of general advertising  Cost of general administration Facility Level Examples This activity is performed to maintain general manufacturing capabilities. Manufacturing Cost Hierarchy

15. ABC - 15 Volume-Based Unit Level Analysis Activity-Based Multiple-Level Analysis Variable: Only one type of variable cost is considered: Unit level Variable: Many types of variable cost drivers are considered, including: Unit level Batch level Product level Changing Composition of Total Manufacturing Costs

16. ABC - 16 Volume-Based Unit Level Analysis Activity-Based Multiple-Level Analysis Fixed: Costs that do not vary with the number of units Fixed: Costs that do not respond to change in variable cost drivers are considered: Facility level Changing Composition of Total Manufacturing Costs

17. ABC - 17  Unit level activities  Order level activities  Customer level activities  Facilities level activities A merchandising organization or the sales division of a manufacturing organization might use the following hierarchy: Customer Cost Hierarchy

18. ABC - 18  Unit level activities  Order level activities  Customer level activities  Market segment level activities  Facility level activities An organization that sells to distinct market segments might have the following cost hierarchy: Customer Cost Hierarchy

19. ABC - 19 Benefits Of Activity Based Costing  Greater understanding of the nature of operations  More accurate product costing  Improvement in cost control  Integration with strategic management accounting

20. ABC - 20 Limitations Of Activity Based Costing  Costly implementation process  ABC is NOT a guarantee of becoming a “world-class” company

21. ABC - 21 Practical Advice for Implementing ABC 1. Capture the attention of top management. 2. Don’t shoot the customer. 3.Decide the form ABC will take. 4.Supplement the ABC measures creativity where appropriate. 5.Be careful in costing bottlenecks that create excess capacity. 6. Challenge managers who believe their costs are fixed. 7.Calculate costs top-down and bottom-up. 8.Account for cost of capital. 9. Use multi-functional teams. 10. Don’t underestimate the need for managing change.

22. ABC - 22 Danger of Error with the Unit Level Approach Using the High-Low Method June: Produced 12,000 units at a cost of $247,250 July: Produced 13,200 units at a cost of $258,900 3,200 units of product A and 10,000 units of product B

23. ABC - 23 Danger of Error with the Unit Level Approach Using the High-Low Method June: Produced 12,000 units at a cost of $247,250 July: Produced 13,200 units at a cost of $258,900 b = ($258,900 - $247,250)/(13/200 - 12,000) b = $9.708 a = $247,250 - ($9.708 x 12,000 total units) a = $130,754

24. ABC - 24 Danger of Error with the Unit Level Approach Using the High-Low Method The formula for predicting total cost is: Y = $130,754 + $9.708X Predicted production for August is 1,500 units of product A and 13,000 units of product B. Y = $130,754 + $9.708(14,500) Y = $271,520

25. ABC - 25 Danger of Error with the Unit Level Approach Using the High-Low Method A complete analysis of activities and activity cost gives predicted costs for August of $294,300, which is $22,780 greater than the predicted costs determined by using high-low.

26. ABC - 26 Danger of Error with the Unit Level Approach Failure to Separately Account for Batch Level Costs A company produces two products, C and D. Both have identical monthly production volumes of 50,000 units. The only difference is batch size, 50,000 units for C and 5,000 units for D.

27. ABC - 27 Danger of Error with the Unit Level Approach Failure to Separately Account for Batch Level Costs Y = [$1 x (50,000C + 50,000D) units] + [$20,000 x [($20,000 x (1C + 10D) batches] Both C and D cost $1 per unit Both C and D cost $20,000 per batch Y = $320,000 The average cost per unit is $3.20 ($320,000/100,000).

28. ABC - 28 Unit level costs: C: $1 x 50,000$ 50,000 D: $1 x 50,000$ 50,000 Batch level costs: C: $20,000 x 120,000 D: $20,000 x 10200,000 Total costs$ 70,000$250,000 Units  50,000  50,000 Average unit cost$ 1.40$ 5.00 Danger of Error with the Unit Level Approach Product C Product D Compared to $3.20

29. ABC - 29 $6 --- $5 --- $4 --- $3 --- $2 --- $1 --- $0 --- 0 5,000 25,000 Average Unit Cost | | Volume based unit level cost analysis assumes units of product is the only cost driver. Activity-based multiple level analysis considers unit and batch level costs. Cost Estimate Errors with Unit Level Analysis