C250 - Chapter 7 - Activity-Based Costing

Action Analysis Report

A report showing what costs have been assigned to a cost object, such as a product or customer, and how difficult it would be to adjust the cost if there is a change in activity.

Benchmarking

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

1. define activities, activity cost pools, and activity measures. (Steps for implementing activity-based costing)

Activities should be grouped together that are highly correlated (ex: batch or product level)

Duration Driver

A measure of the amount of time required to perform an activity.

3. Calculate activity rates (Steps for implementing activity-based costing)

the activity rates are computed by dividing the total cost for each activity by its total activity

1. nonmanufacturing costs and activity-based costing

1. ABC system trace all direct nonmanufacturing costs to products. (ex: commissions to salespersons, shipping costs) 2. ABC systems allocate indirect nonmanufacturing costs to products whenever the products have presumably caused the costs to be incurred. (ex: overhead = all indirect costs, manufacturing and nonmanufacturing)

3. Cost pools, allocation bases, and activity-based costing

1. ABC system uses more cost pools and unique measures of activity to better understand the cost of managing product diversity. (ex: overhead resources such as product design engineers, production scheduler labor) 2. activity cost pool is a bucket in which costs are accumulated that relate to a single activity measure

2. Manufacturing costs and activity-based costing

1. ABC systems do not assign organization-sustaining costs to products. (ex: security guard's wages, plant controller's salary, costs of supplied used by secretary) 2. ABC system products are only charged for the costs of the capacity they use- not for the costs of capacity they don't use like traditional systems.

what causes traditional and activity-based costing systems to report different product margins?

1. The ABC system assigns nonmanufacturing overhead costs to products on a cause-and-effect basis as appropriate 2. Traditional cost systems allocate all of the manufacturing overhead costs to products using a volume-related allocation base. 3. Traditional cost systems allocate all manufacturing overhead costs to products.

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 using the activity rates and activity measures 5. Prepare management reports

activity-based costing differs from traditional absorption in 3 ways

1. nonmanufacturing as well as manufacturing costs may be assigned to products, but only on a cause-and-effect basis 2. some manufacturing costs may be excluded form 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

Activity Cost Pool

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

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.

Transaction Driver

A simple count of the number of times an activity occurs.

Organization-Sustaining Activities (one of 5 levels of activity)

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. (In ABC costing (Activity-Based costing) - treats these costs as period expenses rather than product costs) (ex: heating factory, cleaning, computer network, preparing annual reports) (level 5)

Customer-Level Activities (one in 5 level of activity)

Activities that are carried out to support customers, but that are not related to any specific product. (ex: sales calls, mailings, technical support) (level 4)

Batch-Level Activities (one of the 5 levels of activity)

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 resources consumed depends on the number of batches run rather than on the number of units in the batch. (ex: Placing purchase orders, setting up equipment, arranging for shipment to customers) (level 2)

Product-Level Activities (one of the 5 level of activity)

Activities that relate to specific products that must be carried out regardless of how many units are produced and sold or batches run. (ex: designing a product, advertising, maintaining a product manager and staff) (level 3)

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.

2. assign overhead costs to activity cost pools (Steps for implementing activity-based costing)

Divide types of overhead costs among activity cost pools via an allocation process called First stage allocations (see definition) - based on the results of interviews with employees.

5. Prepare management reports (Steps for implementing activity-based costing)

Product and customer profitability reports These reports help companies channel their resources to their most profitable growth opportunities while at the same time highlighting products and customers that drain profits.

4. Assign overhead costs to cost objects (Steps for implementing activity-based costing)

Second stage allocation - activity rates are used to apply overhead costs to products and customers.

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.

Unit-Level Activities (one of the 5 levels of activity)

activities that are preformed each time a unit is produced. costs should be proportional to the number of units produced. (ex: power is consumed in proportion to the number of units produced) (level 1)

product margin

function of sales and the direct and indirect costs that the product causes.