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Activity Based Costing

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Action: Conduct Activity Based Costing (ABC) by understanding the ABC process ... Chicken Kiev 15.00. Top Sirloin 20.00. Caesar Salad 9.00. Coffee 2 _at_1.00 2.00 ... – PowerPoint PPT presentation

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Title: Activity Based Costing


1
Activity Based Costing
2
Terminal Learning Objective
  • Action Conduct Activity Based Costing (ABC) by
    understanding the ABC process and then allocating
    costs to activities for managerial decision
    making.
  • Condition Given a. DFAS-IN Manual
    37-100. b. DFAS-IN Regulation 37-1
  • Standard Conduct an Activity Based Costing
    (ABC) analysis. Conduct Cost Allocation.

3
Introduction
  • Inability to Manage Cost Well Will Result In
    Excessive Loss of Combat Capability

4
Consider the Alternatives to Meet a 10 Budget Cut
  • Dumb Cut 10 of the Budget Spent on Oil and
    Lubricants
  • Eliminate Combat Effectiveness
  • Mindless Salami Slice All 10
  • Reduce Combat Effectiveness 10?????
  • Rational Manage Cost Smarter
  • Maintain or Increase Combat Effectiveness

5
Chief Financial Officers Act
  • Billions Of Dollars Lost Each Year Through ...
    Mismanagement
  • Losses Could Be Significantly Decreased By
    Improved Management
  • Great Need Of Fundamental Reform In Financial
    Management
  • Current Practices Do Not Provide Timely
    Information Required For Efficient Management

6
Cost Management Requires Cost Measurement
  • Management Must Have Cost Measurement to Fight
    Cost War
  • Cost Measurement
  • Informs Management of Financial Implications of
    Management Decisions
  • Is Prerequisite to Cost Reduction
  • Eliminates Free Goods
  • Facilitates Best Use of Limited Resources

7
Cost Information Enables Efficient Use of
Resources
  • Which Metal is Best for Transmission?

Metal A
Metal B
Metal C
Conductivity

8
ABC a Self Made Tool for Managerial Cost
Accounting
  • Seek To Understand True Economic Cost
  • Based on Cause-Effect Relationships
  • Reflecting Drivers of Resource Consumption
  • With Reasonable, But Not Precise Accuracy
  • Promote Better Resource Management
  • Eliminate Free Goods
  • Stimulate Behavioral Change
  • Enable Accountability for Cost Management

9
A Broad Definition of Managerial Costing
10
Why Is This Translation Needed?
  • Accounting Systems Usually Measure Input or
    Source Costs
  • Labor, Overhead, Materials
  • Salaries, Benefits, Supplies, Contracts
  • Managers Want Measurements Based on Output or
    Consumption
  • Product, Service, Project
  • Consuming Organization, Customer

11
Managerial Costing Terms
cost pool
raw accounting data
managerial costing translation
method of distribution

managerially useful information
12
Terminology
  • Cost Pool
  • An Aggregation of Incurred or
  • Source Costs to be Distributed
  • Examples
  • Salary and Benefits, Supplies, Travel, etc. in
    Airfield Operations Center
  • Utility Bills for Garrison

cost pool
13
Terminology (Condt)
  • Method of Distribution
  • The Mechanics of Deriving
    Management Information
    from the Cost Pool
  • Example
  • Determine Unit Cost By
    Adding All Input Costs and
    Dividing by Number of Units

method of distribution
14
Terminology (Condt)
  • Cost Driver
  • Good cost drivers distribute cost
  • based on cause and effect, reflecting
  • true cost consumption by a cost object
  • Examples
  • Activity Cost Driver
  • Heating Square Footage
  • Personnel Training Hours
  • Accounting Reports requested

Activity Cost Pool
allocation based on cost driver
15
Terminology (Condt)
  • Cost Object
  • The product, service, or object that created the
    costs
  • Examples
  • 120mm Tube Product Cost
  • Morale, Welfare, Recreation Cost
  • Finance School Cost

16
Alternative Methods of Distribution
  • Managers Can Obtain the Needed View of Cost in
    Several Ways
  • Guessing Gut Feel of Cost Distribution
  • Direct Costing Detailed Record Keeping of all
    Incurred Cost Transactions by Every Cost Object
  • Allocation Distribution of Cost Pool in the Same
    Proportion as a Cost Driver

17
Most Systems Combine Methods
cost pool
18
Choosing a Method of Distribution
  • Use Guessing for Simple Decision Making
  • Keep Detailed Records When Accounting Cost is Low
    and High Accuracy Useful
  • Allocate Overhead, Support, and Indirect Costs
    When Appropriate
  • Consider Managements Needs for Precision and
    Timeliness

19
Discussion Telephone Charges
  • Should These be Allocated or Charged Via
    Detailed, Call-by-Call Records
  • Issues to Consider
  • What Does Management Need?
  • Is Telephoning a Core Mission or Support
    Function?
  • Are Detailed Records Available?

20
Two Allocation Methods
  • Rate Method
  • Uses a Computed Rate per Driver Unit
  • Proportion Method
  • Computes a Proportional Share of the Total Cost
    Based on Driver Usage
  • Both Methods
  • Yield Same Results
  • Represent the Same Underlying Algebra

21
Reconciling the Two Methods
Total Cost Pool Total Number of Driver Units
Rate Method
Equals
Proportion Method
Number of Driver Units Used Total Number of
Driver Units
22
Split the Dinner Check
Chez Buntingham
Fillet and Lobster
35.00 Chicken Kiev
15.00 Top Sirloin
20.00 Caesar Salad
9.00 Coffee 2 _at_1.00
2.00 House Wine 4 _at_5.00
20.00 Champagne
24.00 Ice Cream
4.00 Chocolate Cheesecake
6.00 Sampler
10.00 Soup/Salad
8.00 Aperitif
7 .00 Total 160.00
Carol
Alice
Thank You
Bob
Ted
23
Allocation Mechanics .xls
24
Allocation by Proportion
25
Allocation by Rate Method
1. Determine Overhead Rate

Total Cost
Total
diners

Rate per
diner

160


4

40


2. Compute Allocation
Usage by Cost Object
x
Rate

Allocation
Bob
1
x
40



40


Ted
1
x
40



40


Carol
1
x
40



40


Alice
1
x
40



40


Total
160


26
The Results
Cost Allocation for dinner check based on diners
40
Bob
30
Ted
20
Carol
Alice
10
Print
-
Reset
27
Cross Subsidization
Is This Fair?
Consumption Cost allocation
28
This Can Be a Significant Problem
29
Incremental EffectsWhat Happens if Bob Spends
10 More?
90
80
70
60
Original
50
40
Incremental
Change
30
20
10
0
Bob Consumes
Bob Pays
30
Incremental EffectsWhat Happens if Bob Spends
10 Less?
80
70
60
Incremental Savings
50
40
Decreased Amount
30
20
10
0
Bob Consumes
Bob Pays
31
Measurement Effects Motivation
  • Managerial Costing Inevitably Impacts Behavior
  • Design of Managerial Costing Systems Must
    Recognize and Anticipate This Effect
  • Consider in this Example
  • What Incentives Exist to Spend More?
  • What Incentives Exist to Spend Less?
  • What Would You Do if You Went to Dinner with Them
    Tonight?

32
Conclusion
  • Allocation Based on Number of Diners Failed to
    Reflect Resource Consumption
  • Results
  • Unfair Cross-Subsidizations
  • The Creation of Almost Free Incremental Goods
  • Dysfunctional Behavioral Motivation
  • Detailed Record Keeping May be Best in This
    Problem -- i.e. Separate Checks

33
Terminal Learning Objective
  • Action Conduct Activity Based Costing (ABC)
    by understanding the ABC process and
    then allocating costs to activities for
    managerial decision making.
  • Condition Without references.
  • Standard Conduct Activity Based Costing with
    100 accuracy.
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