Overview of Lecture
Review of cost behaviors Rationale for ABC approach Factors supporting an ABC system Cost flows Steps in implementation Examples Level of acceptance of ABC costing
Relating Costs to Objectives Traceable costs
Direct labor Direct material
Allocated costs Fixed overhead Variable overhead
Traditional Allocation Method
Purchasing
Warehousing
Engineering
Maintenance Product B
Product A
Direct Labor Hours
Rational for ABC Approach
Single allocation rate not sufficient Currently many firms must target
price their products ABC assists in target pricing Advent of high speed computing
power made ABC feasible
Environmental Factors Supporting ABC Approach
High levels of competition Very diverse product mix Low cost of measurement for
additional data required
ABC Cost Flow Schematic
Warehouse
Maintenance
Purchasing
Engineering
Product A
Product B
Purchase Orders
Number of Receipts
Number of Hours Number of Hours
Implementation Steps
Identify the cost objectives Identify the direct costs of the
products Identify the overhead cost pools Select the appropriate drivers Test the assumptions Install
Example of Product Costing
Raw Material $150,000
15,000 Receipts
Purchased Parts$600,000
1,000 Receipts
Material Movements250,000
250 Setups
Product A Product B Product C Product D
Raw Materials Department$1,000,000
Allocation Using Single Driver
$1,000,000 16,000 Receipts = $62.50 per receipt
No. ofProduct Receipts Rate Allocated Cost
A 4,040 $62.50 $252,500 B 6,200 $62.50 387,500 C 2,000 $62.50 125,000 D 3,750 $62.50 235,000
16,000 $1,000,000
Calculation of Multiple Rates
No. of Per Cost Pool Pool Dollars Drivers Driver Driver
Raw Material $ 150,000 15,000 $10 Per ReceiptPurchased Parts 600,000 1,000 $600 Per Receipt
Material Handling 250,000 250 $1,000 Per Setup
$1,000,000
Products Number Rate Number Rate Number Rate
A 4,000 $10 40 $600 50 $1,000
B 6,000 $10 200 $600 80 $1,000
C 1,500 $10 500 $600 70 $1,000
D 3,500 $10 260 $600 50 $1,000
Totals 15,000 1,000 250
Raw Materials Purchased Parts Setups
Use of Activities by Products
Allocation to Products
A B C D Total
Raw Materials 40,000$ 60,000$ 15,000$ 35,000$ 150,000$
Purchased Parts 24,000 120,000 300,000 156,000 600,000
Material Handling 50,000 80,000 70,000 50,000 250,000
Totals 114,000$ 260,000$ 385,000$ 241,000$ 1,000,000$
Comparison of Two Methods
Product Traditional ABC Method Variance
A $ 252,500 $ 114,000 $ 138,500 Over
B 387,500 260,000 127,500 Over
C 125,000 385,000 260,000 Under
D 235,000 241,000 6,000 Under
Totals $1,000,000 $1,000,000 $ 0
Traditional Allocation
Soft Fresh Package Drinks Produce Goods Totals
Percent of Sale 19.30% 51.20% 29.50% 100.00%
Sales 26,450$ 70,020$ 40,330$ 136,800$
Costs: Cost of Goods Sold 20,000 50,000 30,000 100,000 Store Support Costs 5,790 15,360 8,850 30,000 Totals 25,790 65,360 38,850 130,000
Operating Income 660$ 4,660$ 1,480$ 6,800$
Operating Income as Percent of Sales 0.0250 0.0666 0.0367 0.0497
Identify Cost Pools and Drivers
No. of Cost perActivity Driver Cost Pool Drivers Driver
Ordering # of P.O. $5,200 52 $100
Delivery # of Del. $8,400 105 $ 80
Stocking # of L.H. $5,760 280 $ 20
Cust. Sup. # of Items $10,240 51,200 .20
Bottle Return $400
Total $30,000
New Cost Drivers
Soft Fresh Package Activity Cost Per Driver Drinks Produce Goods Totals
Ordering $100 per P. O. 12 28 12 52
Delivery $80 per delivery 10 73 22 105
Stocking $20 per labor hour 18 180 90 288
Customer Support $.20 per item sold 4,200 36,800 10,200 51,200
Bottle Return Direct allocation $400 $400
Results Applying ABCSoft
DrinksFresh
ProducePackageGoods Totals
Sales 26,450$ 70,020$ 40,330$ 136,800$ Costs: Cost of sales 20,000 50,000 30,000 100,000 Bottle return 400 400 Ordering 1,200 2,800 1,200 5,200 Delivery 800 5,840 1,760 8,400 Stocking 360 3,600 1,800 5,760 Customer support 840 7,360 2,040 10,240 Totals 23,600 69,600 36,800 130,000
Operating Income 2,850$ 420$ 3,530$ 6,800$
Percent of Operating Income to Sales 0.1078 0.0060 0.0875 0.0497
Acceptance of ABC Costing
Approximately 60% of manufacturing firms in the US have tried ABC
10%-20% finally kept it in place Reasons for rejection:
Cost of gathering information Complexity outweighs usefulness Disagreement on proper drivers
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