key topics: traditional versus abc systems activities and their identification cost hierarchy
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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. Traditional Overhead Cost Allocation System. ABC Cost Allocation System. - PowerPoint PPT PresentationTRANSCRIPT
Chapter 7
Key Topics:–Traditional versus ABC systems–Activities and their identification–Cost hierarchy–ABC procedures–ABM–Benefits and costs of ABC and ABM–Uncertainties
Chapter 7Activity-Based Costing and
Management
Chapter 7
Traditional Overhead CostAllocation System
Chapter 7
ABC Cost Allocation System
Chapter 7
What Are Activities, and How Are They Identified?
• ActivityType of task or function performed in an
organization
• Activity Identification* Tracking the use of resources* Using the cost hierarchy* Grouping homogeneous costs
Chapter 7
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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Cost Hierarchy
• Product-sustaining 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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ABC Procedures
1.Identify the relevant cost object2.Identify activities3.Assign (trace and allocate) costs to
activity based cost pools4.For each ABC cost pool, choose a cost
driver
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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
Chapter 7
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 DriverMachine setup Number of setupsMaterial handling Number of parts Machining Machine hoursAssembly Direct labor hoursInspection Number of finished units
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Develop allocation rate(not shown in textbook problem)
ActivityMachine setup $200,000Material handling $320,000 Machining $208,000Assembly $66,000Inspection $264,000Cost DriverNumber of setups 4,000Number of parts 640,000Machine hours 8,000Direct labor hours 3,000Number of finished units 22,000
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Cost allocation rates
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Product information
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Developing ABC unit cost
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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
Chapter 7
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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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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ABM Applied
• Environmental costs• Quality
* Prevention activities* Appraisal activities* Production activities* Post-sales activities
• Constrained resources
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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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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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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