Activity-Based Costing and Management (ABC/M)

1
Activity-Based Costing and Management (ABC/M)

• December 20-27, 05
• Chapters 5 16
• Objectives
• Understand the differences between volume-based
  costing systems and activity-based costing system
• Understand how activity-based costing systems
  are used in manufacturing and service industries.
• Understand the role of activity-based costing
  systems in total quality management (TQM)
  philosophy (also see Chapter 16)

2
Product Costing
Product Costing The process of accumulating,
classifying, and assigning direct materials,
direct labor, and factory overhead costs to
products or services Several different product
costing systems are available, including
Methods Product Costing Systems
Cost accumulation method - Job Costing (ch 4) - Process Costing (ch 11)
Cost Measurement Method - Actual costing - Normal costing - Standard costing
Overhead Assignment Method - Traditional (ch 5) - Activity-based costing (ch 5)
3
Overhead AssignmentTraditional Volume-Based
Costing System
Products
4
Overhead AssignmentActivity-based costing system
Products
5
Overhead AssignmentTraditional Volume-Based
Costing System

• Type 1 ________________________
• Simple but omits allocation of service department
  costs
• Use single cost driver throughout the plant
• Type 2 ________________________
• More detailed cost measures, particularly if the
  departments perform quite different activities.
• Cost drivers are determined based on the nature
  of each department.
• Ex

6
Traditional Volume-Based Costing System

• The traditional volume-based costing system may
  provide reasonably accurate costs when a firms
  operation possess the following characteristics
• ________________________________________________
• ________________________________________________
• ________________________________________________
• Similar distribution channels, customer demands,
  and customers

7
Limitations of Traditional Volume-Based Costing
Motivations for ABC

• Recent changes in manufacturing and business
  environments have made traditional volume-based
  costing systems unreliable and inaccurate
• ________________________________________________
• ________________________________________________
• ________________________________________________
• ________________________________________________
• ________________________________________________

8
Limitations of Traditional Volume-Based Costing
Motivations for ABC

• A traditional volume-based overhead costing
  system, whether plantwide or departmental, often
  leads to inaccurate product costs
  (________________________ ________________________
  ____________________)
• Distortions of volume-based overhead cost systems
  increase ___________________________
• Inaccurate cost information can lead to
  undesirable strategic results, such as
  ________________________ _________________________
  ___________________

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Ex1 Volume-based(problem 5-26 pg 168)

• GWS Hospital uses a hospitalwide overhead rate
  based on nurse-hours. The intensive care unit
  (ICU), which has 30 beds, applies overhead using
  patient-days. Its budgeted cost and operating
  data for the year follow
• Budget information
• Hospital total overhead 69,120,000
• Hospital total nurse-hours 1,152,000
• Budget Cost Driver Information

Cost Pool Budget Cost Cost Driver Budget Cost Driver Activity
Beds Equipment Nursing Care 810,000 422,000 457,500 Number of bed-days Number of patient-days Number of nurse-hours 900 845 6,000
In June, GWSs intensive care unit had the
following operating data 5,900 nurse-hours 870
patient days
Required Calculate the ICUs overhead costs for
the month of June using (1) The hospital wide
rate (2) The ICU departmentwide rate (3) The
cost driver for the ICU department (ABC)
10
Activity-Based Costing
Direct labor hours
Activity-Based Costing (ABC) is a costing
approach that assigns resource costs to a cost
object based on activities performed for the cost
object
Machine hours
Lot size
Number of setups
Number of engineering hours
Number of layers
11
Basic Terms in ABC

• An activity is an action or an aggregation of
  actions performed within an organization
• Ex ___________________________________________
• A resource is an economic element needed or
  consumed in performing activities
• Ex ___________________________________________
• A resource consumption cost driver is an activity
  or characteristic that consumes resources
• Ex ___________________________________________
• An activity consumption cost driver measures how
  much of an activity a cost object uses
• Ex ___________________________________________

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Cost Assignment in ABC

• A two-stage cost assignment assigns factory
  overhead costs to activity centers or cost pools
  and then to costs objects
• Activity-based systems differ from traditional
  volume-based costing systems in two ways
• The ABC system defines cost pools as activities
  or activity centers rather than production plant
  or department cost centers
• The cost drivers that the ABC system uses to
  assign activity costs to cost objects are drivers
  based on an activity or activities performed for
  the cost objects

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Steps in Designing an ABC system

• Step 1 _____________________________
• Resource costs
• Categories of activities
• Step 2 _____________________________
• Step 3 _____________________________

next
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Categories of Activity

1. _______________________ An activity that is
   performed for each unit of production
2. _______________________ An activity that is
   performed for each batch of products rather than
   for each unit of production
3. _______________________ An activity that is
   performed to support the production of a given
   product
4. _______________________ An activity that is
   performed to sustain the production of products
   in general

back
16
Traditional volume-based costing vs
ABCIllustrated Example (pg 143-145)
AW SZ
Production volume Unit Selling price Unit direct material and labor costs Direct labor-hours 5,000 400 200 25,000 20,000 200 80 75,000

• HBT., successfully produces and sells two types
  of communication systems, AW and SZ. The company
  has the following financial and cost data for the
  two products
• The companys management accountant has
  identified the following activities, budgeted
  cost pools, and activity drivers

Activity Budgeted Cost Pool Activity Cost Driver
Engineering Setups Machine running Packing 125,000 300,000 1,500,000 75,000 Engineering hours Number of setups Machine-hours Number of packing orders
Total 2,000,000
Activity Consumption Activity Consumption Activity Consumption
Activity Cost Driver AW SZ Total
Engineering hours Number of setups Machine-hours Number of packing orders 5,000 200 50,000 5,000 7,500 100 100,000 10,000 12,500 300 150,000 15,000
REQUIRED Illustrate product profitability (gross
profits or gross margins) obtained from
traditional costing system, using direct
labor-hours as the cost driver, and from the
activity-based costing system, using both
volume-based and nonvolume-based cost drivers.
Comment on the results based on these two costing
systems.
17
Activity-Based Management (ABM)

• ABM can be classified into two categories
• Operational enhances operation efficiency and
  asset utilization and lowers costs
• Strategic attempts to alter the demand for
  activities and increase profitability at the
  current activity efficiency
• ABM uses the following to improve operations
• Cost driver analysis examines, quantifies, and
  explains the effects of the cost driver on the
  cost of an activity
• A cause-and-effect diagram maps out causes that
  affect an activity, process, stated problem, or
  outcome
• A Pareto analysis is a histogram of cost drivers
  that contribute to the total cost
• Performance measurement identifies the work
  performed and the results achieved by an
  activity, process, or organizational unit

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Cause and Effect Diagram
Quality Problem or Desired Outcome
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Pareto Analysis
220 - 200 - 180 - 160 - 140 - 120 - 100 -
80 - 60 - 40 - 20 -
Cumulative
1 Egg size 2 Blending speed 3 Liqueur
4 Blending duration 5 Quality of
chocolate 6 Improper refrigeration
1 2 3 4 5 6
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Activity Analysis

• To be competitive, a firm must assess each of its
  activities based on
• its need by the product or customer
• its efficiency, and
• its value content
• A firm performs an activity because it is
• required to meet the specification of the product
  or service or satisfy customer demand
• required to sustain the organization, or
• deemed beneficiary to the firm
• Identify high-value-added and low-value added
  activities