Chapter Seven Activity-Based Costing: A Tool to Aid Decision Making.
Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision...
Transcript of Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision...
![Page 1: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/1.jpg)
Activity Based Costing: A Decision Making Tool
with Dr. Joseph Ugras October 2016
1
![Page 2: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/2.jpg)
7-2
Learning Objectives Need for Cost and Profitability?
How do traditional and activity-based costing differ?
What are the cost drivers?
Why is it important to analyze the drivers of costs?
What are value-added and non-value-added activities?
How are product costs computed using an activity-based
costing system?
Under what conditions is activity-based costing useful in
an organization and what information do activity-based
costing systems provide to management?
What criticisms have been directed at activity-based
costing?
![Page 3: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/3.jpg)
7-3
How important is cost information?
• Why do we need to know the cost of making the
product or cost of providing a service?
1. Profitability
▫ By Product
▫ By Customer
2. Decision Making using Cost data
▫ Pricing
▫ Value Chain Analysis and Outsourcing Decision
▫ ……
3. Performance Evaluation
![Page 4: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/4.jpg)
7-4
The emergence of ABC/ABM
• 1987 book by Johnson/Kaplan
• Cooper and Kaplan’s re-
introduced ABC in the 90’s
![Page 5: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/5.jpg)
7-5
What are the costs of running a
business in a manufacturing
environment?
▫ Product Costs (Direct Materials, Direct Labor,
Manufacturing Overhead) – become inventory
Balance Sheet prior to moving to the Income
Statement
▫ Period Costs (Selling and Administrative
Expenses)
Income Statement immediately
![Page 6: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/6.jpg)
7-6
Traditional Product Costing System
• Direct Material and Direct Labor traceable to the
product
• Overhead is applied using a cost driver (e.g.,
Labor Cost, Machine Hours, etc.)
▫ Overhead’s growth over time with increased use
of automation
▫ We might have to change from the single OH
driver to multiple cost drivers
![Page 7: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/7.jpg)
7-7
Some Points of Cost Trends
The relative proportions of what go into product
costs have changed significantly with direct labor
content dropping to between 5% to 15%,
materials content falling between 45% and 55%,
and overhead soaring to between 30% and 50%.
![Page 8: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/8.jpg)
7-8
How Overhead Costs are Treated
Under Different Systems
Overhead Allocation
Plantwide
Overhead
Rate
Departmental
Overhead
Rates
Activity Based
Costing
![Page 9: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/9.jpg)
7-9
Plantwide Overhead Rate
Companies tend to use direct labor
as the overhead allocation base.
![Page 10: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/10.jpg)
7-10
A two stage process is
necessary because costs
are allocated to departments
and then to products.
Finishing Department
Shipping Department
Painting Department
Departmental Overhead Rates
![Page 11: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/11.jpg)
7-11
Department
1
Department
2
Department
3 Cost pools
Indirect
Labor
Indirect
Materials
Other
Overhead Stage One:
Costs assigned
to pools
Departmental Overhead Rates
![Page 12: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/12.jpg)
7-12
Department
1
Department
2
Department
3 Cost pools
Stage One:
Costs assigned
to pools
Products
Stage Two:
Costs applied
to products
Direct
Labor
Hours
Machine
Hours
Raw
Materials
Cost
Departmental Allocation Bases
Departmental Overhead Rates
Indirect
Labor
Indirect
Materials
Other
Overhead
![Page 13: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/13.jpg)
7-13
Activity–Based Costing (ABC)
ABC is designed to provide managers with
cost information for strategic and other
decisions that potentially affect
capacity, and therefore, affect “fixed”
as well as variable costs.
ABC is a
good supplement
to our traditional
cost system
I agree!
![Page 14: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/14.jpg)
7-14
How Costs are Treated Under Activity–Based Costing
ABC differs from traditional cost accounting in three ways.
Manufacturing
costs
Nonmanufacturing
costs
ABC assigns both types of costs to products.
Traditional
product costing
ABC
product costing
![Page 15: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/15.jpg)
7-15
How Costs are Treated Under Activity–Based Costing
ABC does not assign all manufacturing costs to products.
Manufacturing
costs
Nonmanufacturing
costs
Traditional
product costing
ABC
product costing
All
Som
e
ABC differs from traditional cost accounting in three ways.
![Page 16: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/16.jpg)
7-16
How Costs are Treated Under Activity–Based Costing
Plantwide
Overhead
Rate
Departmental
Overhead
Rates
Activity–Based
Costing
Number of cost pools
Level o
f co
mp
lexit
y
ABC uses more cost pools.
ABC differs from traditional cost accounting in three ways.
![Page 17: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/17.jpg)
7-17
How Costs are Treated Under Activity–Based Costing
Each ABC cost pool has its
own unique measure of activity.
Traditional cost systems usually rely
on volume measures such as direct labor
hours and/or machine hours to allocate
all overhead costs to products.
ABC differs from traditional cost accounting in three ways.
ABC uses more cost pools.
![Page 18: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/18.jpg)
7-18
Activity An event that causes the
consumption of overhead
resources.
Activity
Cost Pool
A “cost bucket” in which
costs related to a single
activity measure are
accumulated.
$
$
$ $
$ $
How Costs are Treated Under Activity–Based Costing
![Page 19: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/19.jpg)
7-19
Activity
Measure
An allocation base
in an activity-based
costing system.
How Costs are Treated Under Activity–Based Costing
The term cost driver is
also used to refer to
an activity measure.
![Page 20: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/20.jpg)
7-20
Cost Driver Analysis
•Cost drivers are factors that have a direct cause–effect relationship to a cost ▫ Limit the number of cost drivers and
combine into cost pools
▫ Cost of measurement should not exceed benefit of using the cost driver
▫ Easy to understand
▫ Directly related to the activity being performed
▫ Appropriate for measurement
![Page 21: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/21.jpg)
7-21
How Costs are Treated Under Activity–Based Costing
Traditional cost systems usually rely on volume
measures such as direct labor hours and/or machine
hours to allocate all overhead costs to products.
ABC defines
five levels of activity
that largely do not relate
to the volume of units
produced.
![Page 22: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/22.jpg)
7-22
Manufacturing
companies typically combine
their activities into five
classifications.
Unit-Level
Activity
Batch-Level
Activity
Product-Level
Activity
Customer-Level
Activity Organization-
sustaining
Activity
How Costs are Treated Under Activity–Based Costing
![Page 23: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/23.jpg)
7-23
Some Examples:
• Unit-level costs
▫ direct material, direct labor, some of the utility
costs
• Batch-level costs
▫ setup, inspection
• Product-level costs
▫ engineering changes, product development
• Organization Sustaining costs
▫ building depreciation, plant manager’s salary
• Customer Level costs
▫ Specific customer specific design, inspection, etc.
![Page 24: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/24.jpg)
7-24
Product Cost Behavior
•Unit-level costs are variable in relation
to change in production volume
•Batch, product/process, and
organizational level costs are variable
for reasons other than changes in
production volume
![Page 25: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/25.jpg)
7-25
Product Cost
Batch-Level
Costs Cost per unit
in batch
Allocate over number
of units in batch
Product-
Level Costs
Allocate over number
of units produced in
related product line
Cost per unit
in product line
Cost per unit Unit-Level
Costs
Allocate over number
of units produced
![Page 26: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/26.jpg)
7-26
Activity-Based Costing
Costs in
General Ledger
Accumulate in
Activity Center
Cost Pools Cost
Driver
Activity
Driver
Cost
Objects
![Page 27: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/27.jpg)
7-27
![Page 28: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/28.jpg)
7-28
ABC Steps:
1. Define Activities, Activity Cost Pools, and
Activity Measures
2. Assign Overhead Costs from General Ledger
to Activity Cost Pools
3. Calculate Activity Rates
4. Assigning Overhead to Products
5. Prepare Management Reports such as:
▫ Product Profitability
▫ Customer Profitability
▫ Cost of Non-value adding activities
▫ Other reports
![Page 29: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/29.jpg)
7-29
Baxter Battery – An ABC Example
Sales 50,000,000$
Cost of goods sold
Direct materials 15,000,000$
Direct labor 12,000,000
Manufacturing overhead 14,000,000 41,000,000
Gross margin 9,000,000
Selling and administrative expenses
Shipping expenses 3,000,000
Marketing expenses 2,000,000
General administrative expenses 6,000,000 11,000,000
Net operating incomeoperating loss (2,000,000)$
Baxter Battery Company
Income Statement
Year Ended December 31, 2014
Manufacturing overhead is allocated to products using
a single plantwide overhead rate based on machine hours.
![Page 30: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/30.jpg)
7-30
Define Activities, Activity Cost Pools, and Activity Measures
At Baxter Battery, the ABC team selected the following
activity cost pools and activity measures:
![Page 31: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/31.jpg)
7-31
• Customer Orders - assigned all costs of resources
that are consumed by taking and processing
customer orders.
• Design Changes - assigned all costs of resources
consumed by customer requested design changes.
• Order Size - assigned all costs of resources
consumed as a consequence of the number of units
produced.
• Customer Relations – assigned all costs associated
with maintaining relations with customers.
• Other – assigned all organization-sustaining costs
and unused capacity costs
Define Activities, Activity Cost Pools, and Activity Measures
![Page 32: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/32.jpg)
7-32
Assign Overhead Costs to
Activity Cost Pools
![Page 33: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/33.jpg)
7-33
Direct materials, direct labor, and shipping are excluded
because Baxter Battery’s existing cost system can directly
trace these costs to products or customer orders.
Assign Overhead Costs to
Activity Cost Pools
![Page 34: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/34.jpg)
7-34
At Baxter Battery the following distribution of resource
consumption across activity cost pools is determined.
Assign Overhead Costs to
Activity Cost Pools
![Page 35: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/35.jpg)
7-35
Assign Overhead Costs to
Activity Cost Pools
Indirect factory wages $6,000,000
Percent consumed by customer orders 30%
$1,800,000
![Page 36: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/36.jpg)
7-36
Assign Overhead Costs to
Activity Cost Pools
Factory equipment depreciation $3,500,000
Percent consumed by customer orders 20%
$ 700,000
![Page 37: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/37.jpg)
7-37
Assign Overhead Costs to
Activity Cost Pools
![Page 38: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/38.jpg)
7-38
Calculate Activity Rates
The ABC team determines that Baxter Battery will
have these total activities for each activity cost
pool: ▫ 10,000 customer orders,
▫ 4,000 design changes,
▫ 800,000 machine-hours,
▫ 2,000 customers served.
Now the team can compute the individual
activity rates by dividing the total cost for
each activity by the total activity levels.
![Page 39: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/39.jpg)
7-39
Calculate Activity Rates
![Page 40: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/40.jpg)
7-40
Traced Traced Traced
Direct
Materials
Direct
Labor
Shipping
Costs Overhead Costs
Cost Objects:
Products, Customer Orders, Customers
Activity–Based Costing at Baxter
Battery
![Page 41: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/41.jpg)
7-41
Direct
Materials
Direct
Labor
Shipping
Costs
Cost Objects:
Products, Customer Orders, Customers
First-Stage Allocation
Customer
Orders
Order
Size
Customer
Relations Other
Design
Changes
Activity–Based Costing at Baxter
Battery
Overhead Costs
![Page 42: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/42.jpg)
7-42
Direct
Materials
Direct
Labor
Shipping
Costs
Cost Objects:
Products, Customer Orders, Customers
Customer
Orders
Order
Size
Customer
Relations Other
First-Stage Allocation
Second-Stage Allocations
$/Order $/Change $/MH $/Customer
Unallocated
Design
Changes
Activity–Based Costing at Baxter
Battery
Overhead Costs
![Page 43: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/43.jpg)
7-43
Baxter Battery Information
SureStart
1. Requires no new design resources.
2. 800,000 batteries ordered with 4,000 separate orders.
3. Each SureStart requires 36 minutes of machine
time for a total of 480,000 machine-hours.
LongLife
1. Requires new design resources.
2. 400,000 batteries ordered with 6,000 separate orders.
3. 4,000 custom designs prepared.
4. Each LongLife requires 48 minutes of machine
time for a total of 320,000 machine-hours.
Assigning Overhead to Products
![Page 44: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/44.jpg)
7-44
Assigning Overhead to Products
![Page 45: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/45.jpg)
7-45
Let’s take a look at how Baxter Battery’s system works for just one of the 2,000 customers – Acme Auto Parts who placed a total of twelve orders. Note that the four orders
for LongLifes required a design change.
Orders
1. Eight orders for 60 SureStarts per order.
2. Four orders for 50 LongLifes per order.
Machine-hours
1. The 480 SureStarts required 288 machine-hours.
2. The 200 LongLifes required 160 machine hours.
Assigning Overhead to Customers
![Page 46: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/46.jpg)
7-46
Prepare Management Reports
SureStarts LongLifes Total
Sales 31,300,000$ 18,700,000$ 50,000,000$
Direct costs
Direct material 9,000,000 6,000,000 15,000,000
Direct labor 7,000,000 5,000,000 12,000,000
Shipping 2,000,000 1,000,000 3,000,000
Product Margin Calculations
The first step in computing product margins is to
gather each product’s sales and direct cost data.
![Page 47: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/47.jpg)
7-47
Prepare Management Reports Product Margin Calculations
The second step in computing product margins is to
incorporate the previously computed activity-based
cost assignments pertaining to each product.
SureStarts LongLifes Total
Sales 31,300,000$ 18,700,000$ 50,000,000$
Direct costs
Direct material 9,000,000 6,000,000 15,000,000
Direct labor 7,000,000 5,000,000 12,000,000
Shipping 2,000,000 1,000,000 3,000,000
ABC cost assignments
Customer orders 1,808,000 2,712,000 4,520,000
Design changes 3,040,000 3,040,000
Order size 3,120,000 2,080,000 5,200,000
![Page 48: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/48.jpg)
7-48
Prepare Management Reports Product Margin Calculations
The third step in computing product margins is to
deduct each product’s direct and indirect costs
from sales.
Sales 31,300,000$ 18,700,000$
Costs
Direct material 9,000,000$ 6,000,000$
Direct labor 7,000,000 5,000,000
Shipping 2,000,000 1,000,000
Customer orders 1,808,000 2,712,000
Design changes 3,040,000
Order size 3,120,000 2,080,000
Total cost 22,928,000 19,832,000
Product margin 8,372,000$ (1,132,000)$
SureStarts LongLifes
![Page 49: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/49.jpg)
7-49
SureStarts LongLifes Total
Sales 31,300,000$ 18,700,000$ 50,000,000$
Total costs 22,928,000 19,832,000 42,760,000
Product margins 8,372,000$ (1,132,000)$ 7,240,000$
Less costs not assigned to products:
Customer relations 3,080,000
Other 6,160,000
Total 9,240,000
Net operating incomet operating loss (2,000,000)$
Product Margin Calculations
The product margins can be reconciled with the
company’s net operating income as follows:
Prepare Management Reports
![Page 50: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/50.jpg)
7-50
Prepare Management Reports
Customer Margin Analysis
The first step in computing Acme Auto Parts’ customer
margin is to gather its sales and direct cost data.
Acme Auto
Parts
Sales 29,200$
Direct costs
Direct material 7,500
Direct labor 6,700
Shipping 1,700
![Page 51: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/51.jpg)
7-51
Prepare Management Reports
Customer Margin Analysis
The second step is to incorporate Acme Auto Parts’
previously computed activity-based cost assignments.
Acme Auto
Parts
Sales 29,200$
Direct costs
Direct material 7,500
Direct labor 6,700
Shipping 1,700
ABC cost assignments
Customer orders 5,424
Product design 3,040
Order size 2,912
Customer relations 1,540
![Page 52: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/52.jpg)
7-52
Prepare Management Reports
Customer Margin Analysis
The third step is to compute Acme Auto Parts’ customer
margin of $384 by deducting all its direct and indirect
costs from its sales.
Sales 29,200$
Direct costs
Direct material 7,500$
Direct labor 6,700
Shipping 1,700
Customer orders 5,424
Product design 3,040
Order size 2,912
Customer relations 1,540 28,816
Customer margin 384$
Acme Auto Parts
![Page 53: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/53.jpg)
7-53
Product Margins Computed Using the
Traditional Cost System
SureStarts LongLifes Total
Sales 31,300,000$ 18,700,000$ 50,000,000$
Direct costs
Direct material 9,000,000 6,000,000 15,000,000
Direct labor 7,000,000 5,000,000 12,000,000
The first step in computing product margins is to
gather each product’s sales and direct cost data.
![Page 54: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/54.jpg)
7-54
Plantwide manufacturing
overhead rate
$14,000,000
800,000 MH = $17.50 per machine-hour =
The second step in computing product margins is
to compute the plantwide overhead rate.
Production Department
Indirect factory wages 6,000,000$
Factory equipment depreciation 3,500,000
Factory utilities 2,500,000
Factory building lease 2,000,000
Total manufacturing overhead 14,000,000$
Manufacturing Overhead Costs at Baxter Battery
Machine-hours
SureStarts (800,000 @ 0.60 hours) 480,000
LongLifes (400,000 @ 0.80 hours) 320,000
Total machine-hours 800,000
Product Margins Computed Using the
Traditional Cost System
![Page 55: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/55.jpg)
7-55
The third step in computing product margins is
allocate manufacturing overhead to each product.
Machine Overhead Overhead
Hours Rate Allocated
SureStarts 480,000 17.50$ 8,400,000$
LongLifes 320,000 17.50 5,600,000
Total overhead allocated to products 14,000,000$
480,000 hours × $17.50 per hour = $8,400,000
Product Margins Computed Using the
Traditional Cost System
![Page 56: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/56.jpg)
7-56
The fourth step is to actually compute the
product margins.
Sales 31,300,000$ 18,700,000$ 50,000,000$
Cost of goods sold
Direct materials 9,000,000$ 6,000,000$ 15,000,000$
Direct labor 7,000,000 5,000,000 12,000,000
Manufacturing overhead 8,400,000 24,400,000 5,600,000 16,600,000 14,000,000 41,000,000
Product margin 6,900,000$ 2,100,000 9,000,000
Selling and administrative 11,000,000
Net operating incomet operating loss (2,000,000)$
SureStarts LongLifes Total
Shipping expenses 3,000,000$
Marketing expenses 2,000,000
General administrative expenses 6,000,000
11,000,000$
Product Margins Computed Using the
Traditional Cost System
![Page 57: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/57.jpg)
7-57
SureStarts LongLifes
Product margins – traditional 6,900,000$ 2,100,000$
Product margins – ABC 8,372,000 (1,132,000)
Change in reported margins 1,472,000$ (3,232,000)$
The traditional cost
system overcosts the
SureStarts and reports
a lower product
margin for this product.
The traditional cost
system undercosts the
LongLifes and reports
a higher product
margin for this product.
Differences Between ABC and Traditional Product Costs
![Page 58: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/58.jpg)
7-58
Let us Practice –
Gallatin Carpet Cleaning
![Page 59: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/59.jpg)
7-59
Differences Between ABC and Traditional Product Costs
Traditional costing allocates all manufacturing
overhead to products. ABC costing only assigns
manufacturing overhead costs consumed by
products to those products.
There are three reasons why the
reported product margins for the two
costing systems differ from one another.
![Page 60: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/60.jpg)
7-60
Differences Between ABC and Traditional Product Costs
Traditional costing allocates all manufacturing
overhead costs using a volume-related allocation
base. ABC costing also uses non-volume related
allocation bases.
There are three reasons why the
reported product margins for the two
costing systems differ from one another.
![Page 61: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/61.jpg)
7-61
Differences Between ABC and Traditional Product Costs
Traditional costing disregards selling and
administrative expenses because they are
assumed to be period expenses. ABC costing
directly traces shipping costs to products and
includes nonmanufacturing overhead costs caused
by products in the activity cost pools that are
assigned to products.
There are three reasons why the
reported product margins for the two
costing systems differ from one another.
![Page 62: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/62.jpg)
7-62
Let us Practice –
Derinice Icecream
![Page 63: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/63.jpg)
7-63
• ABC models are useful in process analysis and
continuous improvement initiatives, some
consulting firms coined the term activity-based
management (ABM). ABM refers to any of the
actions that might be taken based on the ABC
information.
Activity Based Management
![Page 64: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/64.jpg)
7-64
• Focus might shift toward more profitable
businesses / customers
• Find ways of performing tasks better, faster, and
cheaper
• Connections to total quality management,
process improvement, reengineering,
elimination of non-value-added activities, lean
management
Through ABC/ABM
![Page 65: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/65.jpg)
7-65
Activity Analysis (Value-added)
Value-added activity • Increases worth of
product or service to a customer
• Customer is willing to pay for it
Non-value-added activity • Increases time spent on
product or service but does not increase worth
• Unnecessary from customer perspective
• Can be reduced, redesigned or eliminated without affecting market value or quality
![Page 66: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/66.jpg)
7-66
Activity Analysis • Create a “Process Map” (detailed flowchart) for
each process
▫ Identify each step the product goes through
• Create “Value Chart”
▫ Identify stages and time spent in stages from
beginning to end of process
Value-Added
Examples:
Processing Time
Service Time
Non-Value-Added
Examples:
Inspection Time
Transfer Time
Idle Time
![Page 67: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/67.jpg)
7-67
Cycle Time Analysis
Goal: Eliminate or minimize activities that add the
most time and cost and the least value
Cycle Value- Non-
Time = Added + Value-Added
Time Time
![Page 68: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/68.jpg)
7-68
Manufacturing Cycle Efficiency Ratio
Value-Added
Processing Time
Total Cycle Time
Manufacturing
Cycle Efficiency
(MCE) =
• 100% efficiency unrealistic
• Reducing non-value-added activities will increase MCE
• Value-added activity usually represents about 10%-20% of total cycle time
![Page 69: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/69.jpg)
7-69
Non-Value-Added Activities
• Attributed to following factors
▫ Systemic
▫ Physical
▫ Human
• Eliminating or reducing non-value-added
activities that create the most costs will
▫ Increase product/service quality
▫ Decrease cycle time and cost
▫ JIT & Lean Implementations are geared to
reduce non-value-added activities
![Page 70: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/70.jpg)
7-70
Targeting Process Improvement Activity-based management is used
in conjunction with ABC to identify
areas that would benefit from
process improvements by focusing
on activities to eliminate waste,
decrease processing time, and
reduce defects.
Benchmarking can be used to compare activity cost
information with standards of performance achieved by
other organizations.
ABC activity rates can also provide valuable clues concerning
where there is waste and the opportunity for improvement.
![Page 71: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/71.jpg)
7-71
Activity-Based Costing and External
Reporting
Most companies do not use ABC
for external reporting because . . .
1. External reports are less detailed than internal
reports.
2. It may be difficult to make changes to the company’s
accounting system.
3. ABC does not conform to GAAP.
4. Auditors may be suspect of the subjective allocation
process based on interviews with employees.
![Page 72: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/72.jpg)
7-72
When to Use ABC
Companies use ABC when:
They have a wide variety of products or services
High overhead costs are not proportional to the
unit volume of individual products
Automation makes it difficult to assign overhead to
products using direct labor or machine hours
Profit margins are difficult to explain
Hard-to-make products show big profits and easy-
to-make products show losses
![Page 73: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/73.jpg)
7-73
The Symptoms of a Broken System
“Do I really know what my products costs?”
• Cooper’s Diagnostic Tools:
▫ Functional managers want to drop seemingly
profitable lines;
▫ Hard-to-make products show big profits;
▫ Departments have their own cost systems;
▫ You have a high-margin niche all to yourself;
▫ Competitors’ prices are unrealistically low.
▫ The existing cost systems were meant primarily to
value inventory and provide data for the profit and
loss statements but are being now used for other
reasons
![Page 74: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/74.jpg)
7-74
Benefits of Activity-Based Costing and
Activity-Based Management Enhanced product profitability analysis
Enhanced customer profitability analysis
More accurate cost determination and analysis of the
true cost of product and customer diversification
Should we outsource some part of the process?
More efficient production
Connects well with Quality, Lean Management, JIT
implementations
Ability to link with the ERP system in place
Setting up an activity-based costing system as a
prerequisite for improving business processes and for
any re-engineering program
More effective performance evaluation
![Page 75: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/75.jpg)
7-75
Traditional vs. ABC Costing
•When ABC is implemented cross
subsidy is reduced, i.e.,
▫Cost is reduced for high-volume,
standard products
▫Cost is increased for low-volume,
complex specialty products
![Page 76: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/76.jpg)
7-76
New Cost drivers recognized by
ABC
▫ Product variety—number of different
types of products
▫ Product complexity—number of
processes through which a product
flows
![Page 77: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/77.jpg)
7-77
ABC Costing Considerations
• Number and diversity of products/services produced
• Diversity and differential degree of support services used for different products
• Extent to which common processes are used
• Effectiveness of current cost allocation methods
• Rate of growth of period costs
![Page 78: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/78.jpg)
7-78
Use ABC Costing for…
1. Product Variety and Process Complexity
2. Lack of Commonality in Overhead Costs
3. Problems with Current Cost Allocations
4. Changes in Business Environment
![Page 79: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/79.jpg)
7-79
Use ABC Costing for… 1. Product Variety and Process Complexity
▫ Caused by mass customization
Too many choices, opportunity for errors
Pareto Principle
Commonality of parts
▫ Reduced by
Simultaneous (or Concurrent) Engineering
Design for Manufacturability
![Page 80: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/80.jpg)
7-80
Use ABC Costing when…
2. Lack of Commonality in Overhead Costs
Some products/services use substantially more
overhead than others
3. Problems with Current Cost Allocations
Significant changes in process with no change
in cost allocations
Expense majority of period costs when incurred
4. Changes in Business Environment
Increase in competition or change in
management strategy
![Page 81: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/81.jpg)
7-81
Continuous Improvement • Eliminates non-value-added activities to reduce
cycle time
• Makes products/performs services with zero defects
• Reduces product costs on an ongoing basis
• Simplifies products and processes
ABC Costing Supports
Continuous Improvement
![Page 82: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/82.jpg)
7-82
Advantages of ABC and ABM
• Identify and monitor
significant technology costs
• Trace technology costs
directly to products
• Increase market share
• Identify the cost drivers that
create or influence cost
• Identify activities that do not
contribute to perceived
customer value
• Understand the impact of
new technologies on all
elements of performance
• Translate company goals
into activity goals
• Analyze the performance of
activities across business
functions
• Analyze performance
problems
• Promote standards of
excellence
![Page 83: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/83.jpg)
7-83
ABC Limitations
Substantial resources
required to implement
and maintain.
Resistance to
unfamiliar numbers
and reports.
Desire to fully
allocate all costs
to products.
Potential
misinterpretation of
unfamiliar numbers.
Does not conform to
GAAP. Two costing
systems may be needed.
![Page 84: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/84.jpg)
7-84
Criticisms of ABC
•Significant amount of time and cost
to implement
•Must overcome barriers to change
•Does not conform to GAAP
![Page 85: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/85.jpg)
7-85
Time-Based Activity-Based Costing
• One recent development aimed both at improving
the accuracy of ABC data and reducing the
administrative burden involved with developing
and maintaining the systems is called time-based
ABC. Time-based ABC involves making direct
estimates of the resource demands imposed by
each transaction, product, service, or customer.
• Traditionally, to build an ABC model, employees
are asked to estimate the proportion of their total
time spent in the various activities in which they
are engaged. These estimates are now made by
managers saving time and improving
consistency.
![Page 86: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/86.jpg)
7-86
Characteristics of Successful ABC Implementations
Strong top
management support Link to evaluations
and rewards
Cross-functional
involvement
![Page 87: Activity Based Costing: A Decision Making Tool · PDF fileActivity Based Costing: A Decision Making Tool ... direct cause–effect relationship to a cost ... assigned all costs of](https://reader031.fdocuments.in/reader031/viewer/2022030413/5a9eb08c7f8b9a84178bae01/html5/thumbnails/87.jpg)
7-87
Some Further Reading
• R. S. Kaplan “The Evolution of Management Accounting.”
Accounting Review (July 1984): 390-418.
• H. T Johnson and R. S. Kaplan. Relevance Lost: The Evolution of
Management Accounting (Boston: Harvard Business School Press,
1987):
• R. Cooper, “Does Your Company Need a New Cost System?”
Journal of Cost Management (Spring 1987): 45-49
• R. S. Kaplan, and R. Cooper, “Make Cost Right: Make the Right
Decisions”, Harvard Business Review, September–October 1988
• R. S. Kaplan and R. Cooper, “Cost and Effect: Using Integrated
Cost Systems to Drive Profitability and Performance”, Harvard
Business School Press, 1997
• R. S. Kaplan, and S. Anderson, “Time-Driven Activity Based
Costing”, Harvard Business School Press, 2007