Slide 1

Are You ready ForABC Flip it for the next slideACTIVITY BASED COSTING (ABC) AND ACTIVITY BASED MANAGEMENT (ABM)

Prepared by:Rubai OhimHelmy Handjana G

ELS2Introduction

What is The ProblemUndercosting and Overcosting of products and servicesUndercosting andOvercosting ExampleJose, Roberta, and Nancy orderseparate items for lunch.Joses order amounts to $14Roberta consumed 30Nancys order is 16Total$60What is the average cost per lunch?Undercosting andOvercosting Example$60 3 = $20Jose and Nancyare overcosted.Roberta isundercosted.What Is ABC

Activity Based Cost (ABC) system isA cost accounting system that uses both unit and non-unit-based activity drivers to assign costs to cost objects (Hansen Mowen Guan)ACTIVITY BASED COSTINGCIMA : An approach to the costing and monitoring of activities, which involves tracing resource consumption and costing final outputs. Resources are assigned to activities and activities to cost objectsHorngren and Foster (2003:39) : An approach to costing that focuses on activities as the fundamental cost objects. It uses the costs these activities as the basis for assigning costs to other cost objects such as products, services or customer.ACTIVITY BASED COSTING MODEL

Design Steps For an ABC System

PISANG KEJU FACTORYCan ABC Help Our Company?Traditional, Volume-Based Product-Costing SystemAerotech produces three complex printed circuit boards referred to as Mode I, Mode II, and Mode III.The following information is obtained from company records:

Traditional, Volume-Based Product-Costing SystemAdditional information includes:

Manufacturing overhead is determined as followsTraditional, Volume-Based Product-Costing System

Budgeted manufacturing overhead $3,894,000 Budgeted direct-labor hours 118,000= $33 per hour

Traditional, Volume-Based Product-Costing SystemWith these product costs, Aerotech established target selling prices (Cost 125%).

209.00 x 1.25Traditional, Volume-Based Product-Costing SystemAerotech wishes to see what target selling prices would be suggested when using activity-based costing.

Lets see how ABC works.Activity Based Costing System (ABC)ABC systems follow a two-stage procedure to assign overhead costs to products.

Assigningoverhead to products is adifficult process.I agree!Activity Based Costing System (ABC)ABC systems follow a two-stage procedure to assign overhead costs to products.

Lets beginby identifyingour major activities.Stage OneIdentify significantactivities and assign overheadcosts to each activity inproportion to resources used.Activity Based Costing System (ABC)ABC systems follow a two-stage procedure to assign overhead costs to products.

Overhead assigned to activities are called activity cost pools.Stage TwoIdentify cost driversappropriate to each activityand allocate overhead tothe products.Overhead CostsTotal budgeted cost = $3,894,000ActivityCostPoolsMachinerycost pool$1,212,600Setupcost pool$3,000Engineeringcost pool$700,000Facilitycost pool$507,400UnitLevelBatchLevelProduct-SustainingLevelFacilityLevelIdentificationof ActivityCost PoolsActivitymust bedone oneach unitproduced.Activityperformedon eachbatchproduced.Activities needed to supportan entire product lineActivity required in orderfor the productionprocess to occur.Overhead CostsTotal budgeted cost = $3,894,000ActivityCostPoolsMachinerycost pool$1,212,600Setupcost pool$3,000Engineeringcost pool$700,000Facilitycost pool$507,400MoreCostPoolsUnitLevelBatchLevelProduct-SustainingLevelFacilityLevelIdentificationof ActivityCost PoolsReceiving/Inspectioncost pool $200,000Material-Handlingcost pool $600,000Quality-Assurancecost pool $421,000Packaging/Shippingcost pool $250,000Machinerycost pool$1,212,600Setupcost pool$3,000Engineeringcost pool$700,000Facilitycost pool$507,400UnitLevelBatchLevelProduct-SustainingLevelFacilityLevelVarious overheadcosts relatedto machineryMaintenanceDepreciationComputer SupportLubricationElectricityCalibrationMachinery Cost PoolTotal budgeted cost = $1,212,600ActivitycostpoolSTAGE ONECalculatethe poolrateBudgeted Machinery Costs $1,212,600 Budgeted Machine Hours 43,000 $28.20/hourCostAssignmentSTAGE TWO==

Calculation oftotal setup costSetup Cost PoolTotal budgeted cost = $3,000ActivitycostpoolSTAGE ONE

Calculatethe poolrate Budgeted Setup Costs $3,000Planned Production Runs 15 runs $200 per runCostAssignmentSTAGE TWO==

Various overheadcosts relatedto engineeringEngineering salariesEngineering suppliesEngineering softwareDepreciationEngineering Cost PoolTotal budgeted cost = $700,000ActivitycostpoolSTAGE ONEAllocate basedon engineeringtransactionsCostAssignmentSTAGE TWOEngineering Cost PoolTotal budgeted cost = $700,000

Various overheadcosts relatedto generaloperationsPlant depr.Plant mgmt.Plant maint.Property taxesInsuranceSecurityFacility Cost PoolTotal budgeted cost = $507,400ActivitycostpoolSTAGE ONECalculatethe poolrate Budgeted Facilities Cost $507,400Budgeted Direct-Labor Hours 118,000 $4.30/hourCostAssignmentSTAGE TWO==

Product Cost from ABC

Here are the new product costs so far . . .Other Overhead Costs

Product Cost from ABC

These are the new product costs when Aerotech uses ABC.Product DiversityBoth original and ABC target selling prices are based on (Cost 125%).

[$209.00 1.25][$183.44 1.25]The selling price of Mode I and II are reducedand the selling price for Mode III is increased.Cost DriversA characteristic of an event or activity that results in the incurrence of costs. In selecting a cost driver, we must consider . . .Degree ofCorrelationCost ofMeasurementBehavioralEffects

Homogeneous Activity Cost PoolsA homogeneous cost pool is a grouping of overhead costs in which each cost component is consumed in roughly the same proportion by each product line.

A homogeneous cost pooluses a single cost driver.Transaction Costing

Activities

PaperworkUsuallyResult InTransactionprocessingprovides areadilymeasurablegauge ofdepartmentalactivity.StoryboardingA procedure used to develop a detailed process flow chart, which visually represents activities and the relationships among activities.Step1Step2Step3Step4

These are the steps wefollow to build amemory board.Direct versus Indirect CostsVolume-Based CostingAll production costs except direct materials and direct labor are lumped together in one overhead cost pool.Activity-Based CostingAn effort is made to account for as many costs as possible as direct costs of production.IndirectCosts

Indicators of Need for ABCLine managers do notbelieve the productcosts reportsMarketing does notuse costs reports forpricing decisionsProduct-line profitmargins are hardto explainSales are increasing,but profits are declining.Some products thathave reported highprofit margins are notsold by competitorsDirect labor is asmall percentageof total costs

Optimal Product-Costing SystemHighHighLowLowCostInformationSystemAccuracyOptimalsystemTotal CostDesign, implementationand maintenance costsCost ofinferiordecisionsresultingfrominaccurateinformation.Cost Management SystemsMeasure the cost of resources consumed.Identify and eliminate non-value-added costs.Determine the efficiency and effectiveness of all major activities.Identify and evaluate new activities that can improve future performance.

ObjectivesNon-Value-Added CostsSuppose our production process looks like this:StorageTimeWaitingTimeProcessTimeMoveTimeInspectionTimeVANVANVANVANVAVA = Valued-added activityNVA = Non-value-added activity

Non-Value-Added CostsVA = Valued-added activityNVA = Non-value-added activityOur goal is to reduce or eliminate the non-value-added activities.StorageTimeWaitingTimeProcessTimeMoveTimeInspectionTimeVANVANVANVANVA

ABC in the Service IndustryImplementationProblemsHigh proportion offacility-level costsActivities tend tobe nonrepetitivehuman tasks.

Video ABCNext ABM What Is ABM

Activity Based Management (ABM) is a systemwide, integrated approach thatfocuses managements attention on activities with the objectives of improving customervalue and increasing the profit achieved by providing this value (Hansen Mowen Guan)The Relationship Between Activity Based Costing and Activity Based ManagementActivity-based costing(ABC) is the major source of information for activity-based managementThe activity-based management model has two dimensions:a cost dimension a process dimension.The Two-Dimensional Activity-BasedManagement Model

Use activity-basedcosting systems forActivity-Based managementActivity-Based ManagementABM describes management decisions that useactivity-based costing information to satisfycustomers and improve profits.Product pricing and mix decisionsCost reduction and process improvement decisionsDesign decisionsProduct Pricing andMix DecisionsABC gives management insight into the coststructures for making and selling diverse products.It provides more accurate product costinformation and more detailed informationon costs of activities and the drivers of those costs.Cost Reduction and ProcessImprovement DecisionsManufacturing and distribution personnel useABC systems to focus on cost-reduction efforts.Managers set cost-reduction targets in terms ofreducing the cost per unit of the cost-allocation base.Design DecisionsManagement can identify and evaluate new designsto improve performance by evaluating how productand process designs affect activities and costs.Companies can work with their customers toevaluate the costs and prices of alternative designs.Financial Measures Of Activity EfficencyFormulas For Value Added and Non Value Added Cost

Illustrate The Power of Concept

Activity Based Performance Report

Activity Capacity Variances

ABM Implementation Model

The Responsibility Accounting Model

Responsibility Assignment Compared

Performance Measures Compared

Performance Evaluation Compared

Rewards Compared

Benefit of ABC SystemsSignificant amounts of indirect costs areallocated using only one or two cost pools.All or most costs are identifiedas output unit-level costs.Products make diverse demands onresources because of differences involume, process steps, batch size,or complexity.Benefit of ABC SystemsProducts that a company is well-suited tomake and sell show small profits whileproducts for which a company is lesssuited show large profits.Complex products appear to be veryprofitable and simple productsappear to be losing money.Operations staff have significantdisagreements with the accountingstaff about the costs of manufacturingand marketing products and services.Limitations of ABC SystemsThe main limitations of ABC are themeasurements necessary toimplement the system.ABC systems require managementto estimate costs of activity poolsand to identify and measure costdrivers for these pools.Activity-cost rates also need to beupdated regularly.Very detailed ABC systems are costlyto operate and difficult to understand.ABC In Service andMerchandising CompaniesThe general approach to ABC in theservice and merchandising areas is verysimilar to the approach in manufacturing.Costs are divided into homogeneous costpools and classified as output unit-level,batch-level, product- or service-sustaining,and facility-sustaining costs.The cost pools correspond to key activities.Costs are allocated to products or customersusing activity drivers or cost-allocationbases that have a cause-and-effectrelationship with the cost in the cost pool.ConclusionABC will be used When :1. Products differ greatly in volume and manufacturing complexity2. Products lines are :numerousdiverserequire differing degrees of support services3. Overhead costs constitute a significant portion of total costs4. The manufacturing process or number of products has changed significantly5. Production or marketing managers are ignoring data provided existing system

References2009 South Western, A part of cengage learning, Accounting and Control 6/e, Hansen/Mowen/Guan2007 Mc Graw Hill, Management Control System 12/e, Anthony/Robert/Govinda2003 Prentice Hall Business, Cost Accounting 11/e, Hongren/Data/Foster2002 John Willey Son, Managerial Accounting 6/e, Weygandt/Kieso/Kimmelwww.cimaglobal.comwww.cgma.comhttp://www.mpdv-china.cn/en/why-use-manufacturing execution-system-mes/www.mbabullshit.comwww.flikcr.com

Thank You For Your AttentionSheet1Mode IMode IIMode IIIProduction:Units10,00020,0004,000Runs1 of 10,0004 of 5,00010 of 400

Sheet2

Sheet3

Sheet4

Sheet5

Sheet6

Sheet1Mode IMode IIMode IIIDirect materials$50.00$90.00$20.00Direct labor (hr/board)342Setup time (hr/run)101010Machine time (hr/board)11.252

Sheet2

Sheet3

Sheet4

Sheet5

Sheet6

Sheet1Mode IMode IIMode IIIDirect materials$50.00$90.00$20.00Direct labor60.0080.0040.00Manufacturing overhead99.00132.0066.00Total$209.00$302.00$126.00

Sheet2

Sheet3

Sheet4

Sheet5

Sheet6

Sheet1Mode IMode IIMode IIIUnits produced10,00020,0004,000Direct labor (hr/unit)342Total hours30,00080,0008,000Total hours required118,000

Sheet2

Sheet3

Sheet4

Sheet5

Sheet6

Sheet1Mode IMode IIMode IIIDirect labor (hr/unit)342Overhead rate per hour$33$33$33Overhead per unit$99$132$66

Sheet2

Sheet3

Sheet4

Sheet5

Sheet6

Sheet1Mode IMode IIMode IIIDirect materials$50.00$90.00$20.00Direct labor60.0080.0040.00Manufacturing overhead99.00132.0066.00Total$209.00$302.00$126.00

Sheet2

Sheet3

Sheet4

Sheet5

Sheet6

Sheet1Mode IMode IIMode IIICost per unit$209.00$302.00$126.00Target selling price261.25377.50157.50

Sheet2

Sheet3

Sheet4

Sheet5

Sheet6

Sheet1Mode I:$28.20per hr.1hr. per unit$28.20per unit

Sheet2

Sheet3

Sheet4

Sheet5

Sheet6

Sheet1Mode II:$28.20per hr.1.25hr. per unit$35.25per unit

Sheet2

Sheet3

Sheet4

Sheet5

Sheet6

Sheet1Mode III:$28.20per hr.2hr. per unit$56.40per unit

Sheet2

Sheet3

Sheet4

Sheet5

Sheet6

Sheet1Total budgeted setup cost$20per hour10hr. per setup$200cost per setup15production runs$3,000Total

Sheet2

Sheet3

Sheet4

Sheet5

Sheet6

Sheet1Mode I: (1 Run)$200 per run10,000 units per run=$.02 per unit

Sheet2

Sheet3

Sheet4

Sheet5

Sheet6

Sheet1Mode II: (4 Runs)$200 per run5,000 units per run=$.04 per unit

Sheet2

Sheet3

Sheet4

Sheet5

Sheet6

Sheet1Mode III: (10 Runs)$200 per run400 units per run=$.50 per unit

Sheet2

Sheet3

Sheet4

Sheet5

Sheet6

Sheet1Mode I:25% $700,00010,000 units=$17.50 per unit

Sheet2

Sheet3

Sheet4

Sheet5

Sheet6

Sheet1Mode II:45% $700,00020,000 units=$15.75 per unit

Sheet2

Sheet3

Sheet4

Sheet5

Sheet6

Sheet1Mode III:30% $700,0004,000 units=$52.50 per unit

Sheet2

Sheet3

Sheet4

Sheet5

Sheet6

Sheet1Mode I:$4.30per hr.3hr. per unit$12.90per unit

Sheet2

Sheet3

Sheet4

Sheet5

Sheet6

Sheet1Mode II:$4.30per hr.4hr. per unit$17.20per unit

Sheet2

Sheet3

Sheet4

Sheet5

Sheet6

Sheet1Mode III:$4.30per hr.2hr. per unit$8.60per unit

Sheet2

Sheet3

Sheet4

Sheet5

Sheet6

Sheet1Mode IMode IIMode IIIDirect materials$50.00$90.00$20.00Direct labor60.0080.0040.00Machinery28.2035.2556.40Setup0.020.040.50Engineering17.5015.7552.50Facilities12.9017.208.60

Sheet2

Sheet3

Sheet4

Sheet5

Sheet6

Sheet1Receiving and Inspection Cost PoolBoardOverhead%Units=Cost/UnitMode I$200,0006%10,000=$1.20Mode II200,00024%20,000=2.40Mode III200,00070%4,000=35.00

Sheet2

Sheet3

Sheet4

Sheet5

Sheet6

Sheet1Material-Handling Cost PoolBoardOverhead%Units=Cost/UnitMode I$600,0007%10,000=$4.20Mode II600,00030%20,000=9.00Mode III600,00063%4,000=94.50

Sheet2

Sheet3

Sheet4

Sheet5

Sheet6

Sheet1Quality-Assurance Cost PoolBoardOverhead%Units=Cost/UnitMode I$421,00020%10,000=$8.42Mode II421,00040%20,000=8.42Mode III421,00040%4,000=42.10

Sheet2

Sheet3

Sheet4

Sheet5

Sheet6

Sheet1Packaging and Shipping Cost PoolBoardOverhead%Units=Cost/UnitMode I$250,0004%10,000=$1.00Mode II250,00030%20,000=3.75Mode III250,00066%4,000=41.25

Sheet2

Sheet3

Sheet4

Sheet5

Sheet6

Sheet1Mode IMode IIMode IIIDirect materials$50.00$90.00$20.00Direct labor60.0080.0040.00Machinery28.2035.2556.40Setup0.020.040.50Engineering17.5015.7552.50Facilities12.9017.208.60Other14.8223.57212.85Total$183.44$261.81$390.85

Sheet2

Sheet3

Sheet4

Sheet5

Sheet6

Sheet1Mode IMode IIMode IIITraditional costing$209.00$302.00$126.00ABC costing183.44261.81390.85Original target selling price261.25377.50157.50ABC target selling price229.30327.26488.56

Sheet2

Sheet3

Sheet4

Sheet5

Sheet6