BMGT 221: Chapter 7

Benchmarking

A systematic approach to identifying the activities with the greatest potential for improvement.

Organization-sustaining Activities

Activities that are carried out regardless of which customers are served, which products are produced, how many batches are run, or how many units are made.

Customer-level Activities

Activities that are carried out to support customers, but that are not related to any specific product; relates to specific customers

Batch-level Activities

Activities that are performed each time a batch of goods is handled or processed, regardless of how many units are in the batch. The amount of resource consumed depends on the number of batches run rather than on the number of units in the batch. Costs at the batch level depend on the number of batches processed rather than on the number of units produced, the number of units sold, or other measures of volume.

Unit-level Activities

Activities that are performed each time a unit is produced. Cost of unit-level activities should be proportional to the number of units produced.

Product-level Activities

Activities that relate to specific products that must be carried out regardless of how many units are produced and sold or batches run; relates to specific products.

Activity-Based Cost

Activity Rate x Activity

Activity Measure

An allocation base in an activity-based costing system, ideally, a measure of the amount of activity that drives the costs in an activity cost pool.

Activity

An event that causes the consumption of overhead resources in an organization.

ABC

Differs from traditional absorption costing in that: 1) Nonmanufacturing as well as manufacturing costs may be assigned to products, but only a cause-and-effect basis. 2) Some manufacturing costs may be excluded from product costs. 3) Numerous overhead cost pools are used, each of which is allocated to products and other cost objects using its own unique measure of activity.

Traditional Costing

Overcosts and reports a lower product margin

ABC Limitations

Substantial resources required to implement and maintain Desire to fully allocate all costs to products Resistance to unfamiliar numbers and reports Potential misinterpretation of unfamiliar numbers Does not conform to GAAP. Two costing systems may be needed.

Second-stage Allocation

The process by which activity rates are used to apply costs to products and customers in activity-based costing.

First-stage Allocation

The process by which overhead costs are assigned to activity cost pools in an activity-based costing system.

Individual Activity Rates

Total Cost for each activity/Total activity levels

ABC

ordinarily used as a supplement to a company's usual costing system; used for internal decision making and for managing activities.

Transaction drivers and Duration drivers

two most common types of activity measures.

Cost Driver

used to refer to an activity measure because the activity measure should "drive" the cost being allocated.

Transaction Drivers

A simple count of the number of times an activity occurs (i.e. number of bills sent out to customers). Most often driver used due to less effort to record.

Steps for Implementing Activity-Based Costing

1)Define activities, activity cost pools, and activity measures 2)Assign overhead costs to activity cost pools. 3)Calculate activity rates. 4)Assign overhead costs to cost objects. 5) Prepare management reports.

Activity-based costing (ABC)

A costing method based on activities that is designed to provide managers with cost information for strategic and other decisions that potentially affect capacity and therefore fixed as well as variable costs.

Activity-based Management (ABM)

A management approach that focuses on managing activities as a way of eliminating waste and reducing delays and defects.

Duration Drivers

A measure of the amount of time required to perform an activity (i.e. time spent preparing individual bills for customers). More accurate measures of resource consumption but takes more effort to record.

Reasons for Difference

Traditional allocates all MOH to products, while ABC only assigns MOH costs consumed by products to those products. Traditional allocates using a volume-related allocation base. ABC uses non-volume related allocation bases Traditional disregards selling and administrative expenses because they are assumed to be period expenses. ABC directly traces shipping costs to products and includes nonMOH caused by products in the activity cost pools that are assigned to products.

Activity-Based Costing

Undercosts and reports a higher product margin

Activity Cost Pool

a "bucket" in which costs are accumulated that relate to a single activity measure in an activity-based costing system.