Post on 16-Jan-2016
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)
Chapter 7
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)
Chapter 7
ABC Procedures
1.Identify the relevant cost object
2.Identify activities
3.Assign (trace and allocate) costs to activity based cost pools
4.For each ABC cost pool, choose a cost driver
Chapter 7
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
Chapter 7
Develop allocation rate(not shown in textbook problem)
Activity
Machine setup $200,000
Material handling $320,000
Machining $208,000
Assembly $66,000
Inspection $264,000
Cost Driver
Number of setups 4,000
Number of parts 640,000
Machine hours 8,000
Direct labor hours 3,000
Number of finished units 22,000
Chapter 7
Cost allocation rates
Chapter 7
Product information
Chapter 7
Developing ABC unit cost
Chapter 7
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
Chapter 7
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
Chapter 7
ABM Applied
• Environmental costs
• Quality
* Prevention activities
* Appraisal activities
* Production activities
* Post-sales activities
• Constrained resources
Chapter 7
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
Chapter 7
Costs
• System design
• Accounting system modifications
• Employee training
• Higher costs when:
* There are more activities
* Activities are complex
* ABC system is complex
Chapter 7
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