module3 abc
TRANSCRIPT
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ACTIVITY-BASEDCOSTING (ABC)
BA 220
Class TTh, 4 5:20
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Objectives: Compare and contrast traditional costing
systems with alternative costing systems,e.g., Activity-Based Costing (ABC);
Show how traditional cost systems cansometimes distort product costs;
See how ABC links resource costs to theactivities the organization performs and thenfrom the activities to cost objects, such asproducts and customers;
Learn to use the information from an activity-based cost system to improve operations andto make better decisions about products andcustomers.
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Traditional Costing Systems
Costing systems typically:
assign direct labor and direct materials
costs to products;accumulate indirect costs, such asmachine expenses, scheduling, qualitycontrol, purchasing, maintenance,supervision, and general factory
expenses as support departmentexpenses;
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Traditional Costing Systems
(Contd):
allocate these expenses to productiondepartments in simple proportion to the
direct labor hours worked (or directlabor costs) in each department;
calculate overhead allocation rates foreach production department and usethese to 333drive indirect and supportexpenses to the products processedthrough each prodn dept.
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Taken from:
Accounting Concepts and Applications, 8eby Albrecht, Stice, Stice, Skousen
PowerPoint slides by:
Michael Blue, Bloomsburg University
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Activity-Based Costing (ABC)
A method of attributing costs toproducts based on:
Costs Activities Products
assigning costs ofresources to activities
assigning costs ofactivities to products
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Unit-Based Costing (UBC)
The traditional method of allocating costs(manufacturing overhead) to products based onnumber of units produced. If only three productsare produced (one of each), then:
Costs ProductionDepartments
Products
$9,000
Overhead $3,000
Overheadper product
=
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Relationship BetweenUBC and ABC
Unit-Based Costing(UBC)
Model of Costs
Activity-Based Costing(ABC) Hierarchical
Product Cost Model
Costs ofDirect Materials
Costs ofDirect Labor
VariableManufacturing
Overhead Costs
Costs ofUnit-Level Activities
Fixed Manufacturing
Overhead Costs
Costs ofBatch-Level Activities
Costs ofProduct Line
Activities
Costs of Facility
Support Activities
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What is the hierarchical product cost model?
Facility Support Activities
Product Line Activities
Batch-Level Activities
Unit-Level ActivitiesProdu c
t
Costs
Com
mon
Co
sts
ABCAllocating Resource Costs toActivities
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ABCAllocating Resource Costs toActivities
Facility Support Activities
Product Line Activities
Unit-Level ActivitiesTake place each time a unit is produced
PackingAssembly
Depreciation
Maintenance
Batch-Level Activities
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Unit-Level Activities
ABCAllocating ResourceCosts to Activities
Facility Support Activities
Batch-Level ActivitiesNumber of setups
Setup hours
Movements of materialsOrders for nonstocked items
Inspections
Product Line Activities
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Facility Support ActivitiesProperty taxes
Plant security
Landscaping
Accounting and legal
General administrative salaries
Product Line Activities
Batch-Level Activities
Unit-Level Activities
ABCAllocating Resource Costs toActivities
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Does a hammer really cost THAT MUCH?
If a UBC factory produces only three products (ahammer, a clock, and a Ferrari) and a hammer incurs$4 of direct labor and materials, how much will thehammer cost if manufacturing overhead is allocated
evenly over finished products?
Cross-Subsidization
$9,000
Overhead
?
Overheadper
product=
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Does a hammer really cost THAT MUCH?
Cross-Subsidization
$9,000
Overhead
$3,000
Overheadper
product
3 Products
$3,004 !?1 Hammer =
=
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Does a hammer really cost THAT MUCH?
Cross-Subsidization
$9,000Overhead
?Overhead
per product
Under UBC (unit-based costing), some products may beinappropriately assigned costs that actually belong toanother product line (in this case, the hammer and clock areobviously cross-subsidizing the Ferrari product line).
=
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$ -hen one product is crossubsidizing,nother it p p e a r snprofitable to producend is often mistakenly.iscontinued
$ hen facility support( )ommon activity costs arellocated to individual,roduct lines they maya p p e a r nprofitable and
Product Cost Distortions
What are the Hazards of AllocatingCosts?
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$8 $20 $100,0002 10 70,0002 5 25,000
$4 $ 5 $ 5,000
RevenueMaterialsLabor
Profit
Hazards of Allocating Costs
Product profitability before:overhead allocationHammer Clock Ferrari
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Hazards of Allocating Costs
Product profitability after overhead allocation:
RevenueMaterialsLaborOverhead
Profit
$ 8 $ 20 $100,0002 10 70,0002 5 25,000
3,000 3,000 3,000
$(2,996) $(2,995) $ 2,000
Hammer Clock Ferrari
In actuality, most of the $9,000 manufacturingoverhead is attributable to the Ferrari, revealing it to
be the real money loser.
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B U T ecause the otherroducts are -rosssubsidizing , hey appearnprofitable and will beiscontinued from.roduction$ 8 $ 20 $100,0002 10 70,000
2 5 25,0003,000 3,000 3,000
$(2,996) $(2,995) $ 2,000
RevenueMaterialsLaborOverhead
Profit
Hazards of Allocating Costs
Hammer Clock Ferrari
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Hammer Clock Ferrari
$100,00070,00025,0008,990
$ (3,990)
RevenueMaterialsLaborOverhead
Profit
Hazards of Allocating Costs
The result?
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Next slides developed from
Chapter 4 of
Atkinson (Management Accounting)
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Traditional Costing Systems
Example:Cooper Pen Costs Blue Black Red PurpleMaterials ,75 000 ,60 000 ,14 040 ,1 650 Direct labor ,30 000 ,24 000 ,5 400 600 *Overhead ,90 000 ,72 000 ,16 200 ,1 800Total ,195 000 ,156 000 ,35 640 ,4 050
* , / ,$180 000 Total Overhead $60 000 Total= % (Direct Labor Costs 300 applied to
.)Direct labor costs of Dept
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Traditional Costing SystemsExample:
Cooper Pen Costs Blue Black Red PurpleMaterials ,75 000 ,60 000 ,14 040 ,1 650
Direct labor ,30 000 ,24 000 ,5 400 600Overhead *?? *?? *?? *??
* ,Since this is completely arbitrarythe amount of overhead charged to each
pen color can range from $0 to the, .entire $180 000 Overhead cost* ,Thing is people usually demand that
these common costs be chargeable to
( ) .at least something
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Alternative Costing Systems
,ut since people usuallyemand that these commonosts be chargeable to,omething what could be a( ) / /ore fair equitable/easonable appropriateallocation?
: - !nter Activity Based Costing costing system based onctivities linkingrganizational spending onesources to the products and
ervices produced and .elivered to customers
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Activity-Based Costing
hile traditional cost systemsse actual departments or costenters for accumulating and,edistributing costs ABCystems use activities nsteadf cost centers for.ccumulating costs
n our example : utomation atooper s has caused directabor costs to decrease and .ndirect expenses to increase, -s custom low volume products( ) ,ED and PURPLE were added theld cost system may now beiving distorted signals about.rofitability
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Activity-Based Costing :teps to be taken
nderstand how resources are used(o perform activities such as& )cheduling product support urn our attention to understandinghe demands for these activitiesy the 4 different products e able to relate the cost oferforming activities to the.ndividual products
Activity ctivity Cost Driver andle prod n runs roduction runs et up machines etup hours upport products umber of products un machines achine hours rovide fringe benefits abor amount
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Activity Cost Drivers (Cooper)
ctivity cost driverBlue Black RedPurpleTotal .o of units ,0 000 ,0 000 ,000 ,000 /irect labor hr unit .02 .02 .02 .02 . .otal d l hours ,000 800 180 20 ,000 /achine hr unit .1 .1 .1 .1 .otal machine hrs ,000 ,000 900 100,0 000 rod n runs 70 65 50 15 200 /etup time run 4 .4 .6 .6 .otal setup hrs 280 156 280 84 800 .o of products 1 1 1 1 4
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Activity Expense per product
ctivity Cost river Rate Blue Black Red Purple 330 per run ,23 100 ,21 450 ,16 500 ,4 950 42 per etup hour ,11 760 ,6 552 ,11 760 ,3 528 ,3 600 er product ,3 600 ,3 600 ,3 600 ,3 600 .4 20 per achine hour ,21 000 ,16 800 ,3 780 $420
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See New ABC ProductsProfitability Report
(Exhibit 4 7)
DO: CASE:
NetCom.Inc
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Costs Activities Products
Activity-Based Management (ABM)
, ,anaging costs quality andimeliness of activities throughhe identification and use ofo s t D r i v e r s nd e r f o r m a n c eM e a s u r e s . Cost Drivers
Performance Measures
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Activity-Based Management
he set of actions that,anagement can take basedn the information from an- ,ctivity based cost systemo increase profitability( - ,r improve decision making, .)uch as pricing etc he actions include makingperational improvements to- ,igh cost processeshanging product prices and,roduct mix andestructuring customer
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ABC: Extensions:
:an be applied to USTOMERS as ost Object . Service .irms
:oints to consider rocess improvements -ctivity Based Pricing anaging Relationships
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ABC: Implementation Issues:
ack of clear businesspurpose ack of senior management
commitment elegating the project toconsultants oor ABC Model design ndividual and rganizational Resistanceo Change