1. Chapter 7 Activity-Based Costing and Management
Key Topics:
Traditional versus ABC systems
Activities and their identification
Cost hierarchy
ABC procedures
ABM
Benefits and costs of ABC and ABM
Uncertainties
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2. Traditional Overhead Cost Allocation System
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3. ABC Cost Allocation System
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4. What Are Activities, and How Are They Identified?
Activity
Type of task or function performed in an organization
Activity Identification
* Tracking the use of resources
* Using the cost hierarchy
* Grouping homogeneous costs
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5. Cost Hierarchy Organization-sustaining activities
Activities and costs associated with overall organization (lease of headquarters office space, salary of CEO)
Facility-sustaining activities
Activities and costs associated with single manufacturing plant or service facility (property taxes, plant manager salary)
Customer-sustaining activities
Activities and costs associated with a single customer (costs of ordering and delivery)
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6. Cost Hierarchy Product-sustaining activities Batch-level activities
Activities or costs associated with product line or one single product (advertising, depreciation)
Batch-level activities
Activities or costs associated with each batch of product (set-up costs, electricity)
Unit-level activities
Activities or costs associated with each unit (indirect materials, indirect labor)
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7. ABC Procedures 1. Identify the relevant cost object
2. Identify activities
3. Assign (trace and allocate) costs to activity based cost pools
4. For each ABC cost pool, choose a cost driver
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8. ABC Procedures 5. For each ABC cost pool, calculate an allocation rate
Allocation Rate = Activity Cost/Volume of Cost Driver
6. For each ABC cost pool, allocate activity costs to the cost object
Allocation = Allocation Rate * Actual Volume of Activity
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9. Using ABC
7.21 Palmer Company uses an activity based costing system. It has the following manufacturing activity areas and has chosen related cost drivers.
Activity Cost Driver
Machine setup Number of setups
Material handling Number of parts
Machining Machine hours
Assembly Direct labor hours
Inspection Number of finished units
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10. Develop allocation rate (not shown in textbook problem)
Activity
Machine setup $200,000
Material handling $320,000
Machining $208,000
Assembly $66,000
Inspection $264,000
Cost Driver
Number of setups ,000
Number of parts ,000
Machine hours ,000
Direct labor hours ,000
Number of finished units 22,000
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11. Cost allocation rates
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12. Product information
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13. Developing ABC unit cost
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14. Selection of Cost Drivers
Need cause and effect relationship between cost driver and activity costs
Requires judgment in choosing and evaluating potential cost drivers
Examples
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15. What Is Activity Based Management (ABM)?
The process of using ABC information to evaluate the costs and benefits of production and internal support activities and to identify and implement opportunities for improvements in profitability, efficiency, and quality within an organization
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16. ABM Applied Customer profitability Product and process design
* Focus resources on value-added activities
* Reduce or eliminate non-value- added activities
* Target and kaizen costing
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17. ABM Applied Environmental costs Quality * Prevention activities
* Appraisal activities
* Production activities
* Post-sales activities
Constrained resources
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18. Benefits Increase awareness of cause and effect relationships
Promote performance improvements
Identify non-value-added activities
Motivate cost reduction
Reduce arbitrariness in cost measurement
Optimize use of constrained resources
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19. Costs System design Accounting system modifications Employee training
Higher costs when:
* There are more activities
* Activities are complex
* ABC system is complex
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20. Uncertainties in ABC and ABM Implementation
Choice of activities
Choice of cost drivers
Inability to foresee all possible uses of information
Choice of denominator in allocation rate
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