CMA_02 - ABC Method

8/21/2019 CMA_02 - ABC Method

1/40

Activity Based Costing

(ABC)Cost & Management Accounting


2/40

Traditional Costing Systems

• Product Costs

– Direct labor

– Direct materials

– Factory Overead

• Period Costs

– Administrative e!"ense

– Sales e!"ense

A""ear on teincome statement#en goods aresold$ "rior to tattime tey are

stored on tebalance seet asinventory%A""ear on teincome statementin te "eriodincurred%


3/40


• Product Costs

– Direct labor

– Direct materials

– Factory Overead

• Period Costs

– Administrative e!"ense

– Sales e!"ense

Direct labor anddirect materials areeasy to trace to"roducts%

Te "roblem

comes #itactory overead%


4/40


• Ty"ically used one rate to allocateoveread to "roducts%

•

Tis rate #as oten based on directlabor dollars or direct labor ours%

• Tis made sense$ as direct labor #asa ma'or cost driver in earlymanuacturing "lants%


5/40

Problems #it TraditionalCosting Systems

• Manuacturing "rocesses and te"roducts tey "roduce are no# morecom"le!%

• Tis results in overcosting or undercosting%

– Com"le! "roducts are not allocated an

adeuate amount o overead costs%

– Sim"le "roducts get too muc%


6/40

Today*s ManuacturingPlants

• Are more com"le!

• Are oten automated

•

Oten ma+e more tan one "roduct• ,se "ro"ortionately smaller amount

o direct labor ma+ing direct labor a

"oor allocation base or actoryoveread%


7/40

-en te manuacturing"rocess is more com"le!.

• Ten multi"le allocation basessould be used to allocateoveread e!"ense%

• /n suc situations$ managersneed to consider using activitybased costing (ABC)%


8/40

ABC De0nitions

• Activity based costing is an a""roacor allocating overead costs%

• An activity is an event tat incurscosts%

• A cost driver is any actor or activitytat as a direct cause and e1ectrelationsi" #it te resourcesconsumed%


9/40

ABC Ste"s

• Overead cost drivers aredetermined%

• Activity cost "ools are created%

– A activity cost "ool is a "ool o individualcosts tat all ave te same cost driver%

• All overead costs are ten allocatedto one o te activity cost "ools%


10/40

ABC Ste"s2

• An overead rate is ten calculatedor eac cost "ool using te ollo#ingormula.

– Costs in activity cost "ool3base

– Te base is$ o course$ te cost driver

• Overead costs are ten allocated to

eac "roduct according to o# muco eac base te "roduct uses%


11/40

Let’s work an example . . .

• Assume tat a com"any ma+es#idgets

• Management decides to install anABC system


12/40

Overhead Cost Drivers areDetermined:

• Management decides tat alloveread costs only ave tree costdrivers4sometimes called activities

(obviously a sim"li0cation o te real#orld)

– Direct labor ours

– Macine ours

– 5umber o "urcase orders


13/40

All overhead costs are then allocated toone of the activity cost pools.

Direct 6abor

Macine 7ours

8 o Purcase Orders

General LedgerPayroll taxes $1,000

Machinemaintenance

$500

Purchasing Dept.

labor

$,000

!ringe bene"ts $#,000

Purchasing Dept.upplies

$#50

%&uipment

depreciation

$'50

%lectricity $1,#50

(nemploymentinsurance

$1,500Which overhead costs do you think are driven y

direct laor hours!


14/40


Direct 6abor

Macine 7ours

8 o Purcase Orders


Machinemaintenance

$500

Purchasing Dept.

labor

$,000



$#50

%&uipment

depreciation

$'50

%lectricity $1,#50


$1,500

9:$;;; $=;;

Overhead driver y directlaor hours


15/40


Direct 6abor

Macine 7ours

8 o Purcase Orders


Machinemaintenance

$500

Purchasing Dept.

labor

$,000



$#50

%&uipment

depreciation

$'50

%lectricity $1,#50


$1,500

9:$;;; $=;;

Which overhead costsare driven y machinehours!

9 =;; ?=; :$


16/40


Direct 6abor

Macine 7ours

8 o Purcase Orders


Machinemaintenance

$500

Purchasing Dept.

labor

$,000



$#50

%&uipment

depreciation

$'50

%lectricity $1,#50


$1,500

9:$;;; $=;;

And "nally# whichoverhead costs aredriven y $ of purchase

orders!

9 =;; ?=; :$


17/40

An overhead rate is then calculated foreach cost pool:

Direct 6abor

Macine 7ours

8 o Purcase Orders

9:$;;; $=;;

9 =;; ?=; :$


18/40

Overhead costs are then allocated toeach product accordin& to how much of

each ase the product uses.

$,500/1,000 = $!50 "er directlabor hour $2,500/250 = $10 "er #achine hour

$,250/100 = $2!50 "er "urchase order

-he )/ rates are+

Lets assume the company maes to products,idget ) and idget +Let2s also assume that each product uses the *olloing &uo* o3erhead cost dri3ers+

ase idget ) idget -otalDirect laborhours 00 00 1,000

Machine hours 100 150 #50

Purchaseorders 50 50 100

6oticethatall baseunitsareaccounte

d *or.


19/40

'ow let’s allocate overhead toWid&et A:

ase ) 7ate )llocated

Direct laborhours 00

$.50

$1,800.00

9ust lie e learned in )ccounting #0#0, ethe base used by the rate.

:n this case, 00 hours used to mae idgemultiplied by the rate o* $.50. -his gi3es t

applied *or this acti3ity cost pool o* $1,800idget ).


20/40

Continuin& the calculation:

idget ) ase 7ate )llocated

Direct labor

hours 00

$

.50

$

1,800.00

Machine hours 100 $

10.00$

1,000.00

Purchaseorders 50

$#.50

$#,1#5.00

-otal

$

,;#5.00

Let2s do the same thing *or the other to rates, to get theo* o3erhead applied to idget )+


21/40

5o# let*s allocate overead to-idget B.

6et*s do te same ting or te oter t#o rates$ to get te total ao overead a""lied%

idget ase 7ate )llocated

Direct laborhours @;;

9>%=; 9


22/40

Same Problems TraditionalMetod

• O+ay$ so #at i #e ad allocated teoveread in tis com"any usingtraditional cost accounting allocation%

• 6et*s assume te base is direct laborours%

• -at #ould be te amount allocatedto eac "roduct


23/40

Calculation


Machinemaintenance

$500

Purchasing Dept.

labor

$,000



$#50

%&uipment

depreciation

$'50

%lectricity $1,#50


$1,500

Tis is te totaloveread #e#ere given$ tetotal amount is

9::$


24/40

Calculation

• Te rate #ould be.

– O7 Gate Overead3Direct 6abor 7ours

– 9::$


25/40

Com"arison

idget ) idget -otal-raditionalMethod

$,500 $,'50 $11,#50

)cti3ity ased/osting

$,;#5 $,$#5 $#5 >0>

&hich is #ore accurate!

)/ /ostingH

6ote these are total costs. -o get per>unit costs e ould

number o* units produced.


26/40

-en do #e use ABCcosting

• When one or more of the followin&conditions are present:

• Product lines di1er in volume and

manuacturing com"le!ity%

• Product lines are numerous and diverse$and tey reuire di1erent degrees o

su""ort services%• Overead costs constitute a signi0cant

"ortion o total costs%


27/40

-en do #e use ABCcosting

• Te manuacturing "rocess or numbero "roducts as canged signi0cantly4or e!am"le$ rom labor intensive to

ca"ital intensive automation%• Production or mar+eting managers are

ignoring data "rovided by te e!istingsystem and are instead using

IbootlegJ costing data or oteralternative data #en "ricing orma+ing oter "roduct decisions%


28/40

Additional ,ses o ABC

• Activity Based Management (ABM)

– K!tends te use o ABC rom "roductcosting to a com"reensive management

tool tat ocuses on reducing costs andim"roving "rocesses and decision ma+ing%

– ,ses ABC inormation to su""ortorganiLational strategy$ im"rove

o"erations$ and manage costs%

– K%g% -%S% /ndustries


29/40

ABM

• ABM classi0es all activities as valueadded or nonvalueadded%

– alueadded activities increase te #ort

o a "roduct or service to te customer%• K!am"le. Addition o a sun roo to an

automobile%

– 5onvalue added activities don*t%

• K!am"le. Te cost o moving or storing te"roduct "rior to sale%


30/40

Te Ob'ective o ABM % % %

• To reduce or eliminate nonvaluerelated activities (and tereorecosts)%

• Attention to ABM is a "art ocontinuous im"rovement oo"erations and activities%


31/40

Possible Cost Drivers

• Macine ours

• Direct labor ours

•

5umber o setu"s• 5umber o "roducts

• 5umber o "urcase orders

• 5umber o em"loyees• 5umber o suare eet


32/40

Common Classi0cationSystem

• ,nitlevel activities% Activities "erormedor eac unit o "roduction%

• Batclevel activities% Activities

"erormed or eac o bat o "roducts%• Productlevel activities% Activities

"erormed in su""ort o an entire

"roduct line%• Facilitylevel activities% Activities reuired

to sustain an entire "roduction "rocess%


33/40

Common Classi0cationSystem

• Tis system "rovides a structured#ay o tin+ing about relationsi"bet#een activities and te resources

tey consume%


34/40

Facility Sustaining Activities

• 7ave no good cost driver

• May or may not be allocated to"roducts de"ending u"on te"ur"ose or #ic te inormation isto be used

• K!am"les

– 7ouse+ee"ing

– Factory yard maintenance


35/40

Manuacturing Systems

• Traditional

– INustinCase%J

• /nventories o ra# materials are maintained

'ust in case some items are o "oor uality or+ey su""liers don*t delivery on time%

– Pus a""roac manuacturing%

• Materials are "used troug te

manuacturing "rocess% – Based on standard costs% Once a

standard is reaced im"rovement ceases%


36/40

Manuacturing Systems

• Progressive

– INust in Time%J

• Ga# materials arrive 'ust in time or use in

"roduction%• Finised goods are manuactured 'ust in time

to meet customer needs%

– Pull a""roac manuacturing%

• Ga# materials are not "ut into te "rocessuntil te ne!t de"artment reuests tem%

– Continuous uality im"rovement%

Tree im"ortant elements


37/40

Tree im"ortant elementsmust e!ist or N/T systems to

#or+.• De"endable su""liers #o candelivery on sort notice%

• Multis+illed #or+orce #o can #or+in #or+ cells or #or+ stations%

– One #or+er may o"erate several +indso macines%

• Total uality management% Ob'ectiveis no deects%


38/40

Ob'ectives o N/T

• Geduction or elimination oinventories

• Knanced "roduction uality

• Geduction or elimination o re#or+costs

•

Production cost savings romim"roved o# o goods troug te"rocess%


39/40

ABC in Service /ndustry

• Similar to tat in manuacturing industry

• T#ostage costing model.

– Assign te resource costs to activity cost "ools

– ,se cost drivers to assign te costs in tese

"ools• To various services "rovided and customers served%

• K!%. 7ealtcare services cos%$ Ban+ing$BPOs

• ABC and ABM systems


40/40

Tan+sH

CMA_02 - ABC Method

Documents

Transcript of CMA_02 - ABC Method