chapter 17: activity based costing

after finding the activity based overhead rates of the drivers you _____

multiply them by the use of each driver/product to get cost assigned to each activity pool

activity cost pool

overhead cost attributed to distant activity

product level

performed every time a company produces a new type of product - ex: Pharma can produce and sell new type of medicine, it must undergo substantial product tests to ensure product is efficient and safe.

cost driver criteria

- must accurately measure actual consumption of activity by various products - high degree of correlation must exist between driver and actual consumption of OH cost

factors when ABC should be used

- product lines differ greatly in volume and manufacturing complexity - product lines are numerous and diverse, requiring various degrees of support services - OH costs constitute significant portion of total costs - manufacturing process or number of products has changed significantly--> labor to capital intensive - production or marketing managers are ignoring data provided by costing system is significant decision that requires considerable cost

benefits of activity based costing

1. abc employs more cost pools and results in more accurate product costing 2. leads to enhanced control over OH costs 3. supports better management decisions

limitation of abc

1. can be expensive 2. more complex than traditional systems 3. same arbitrary allocations remain

4 steps of ABC costing

1. identify and classify activities and allocate overhead to cost pools 2. identify cost driver that has a strong correlation to costs accumulated in pool and establish total annual cost driver 3. compute activity-based overhead rate for each pool 4. assign overhead costs to products using overhead rates and each product's use of driver

cost driver

factor/activity that has a direct cause:effect relationship

non value added activities

Nonessential activities that add costs to, or increase the time spent on, products or services without increasing its perceived value - ex: storagel if company eliminated need to store inv, it would not decrease value of product but it would decrease product costs - inspections--> can eliminate through improving production process

activity based costing

allocates overhead to multiple activity cost pools and assigns activity cost pools to goods/services by means of cost drivers

activity

any event, action, transaciton or work sequence that incurs costs when producing a product or service

value added activities

essential activities of a company's ops that increase the perceived value of a product/service to a customer - supervision of VA activity is itself a value add activity

activity based overhead rate equation

estimated overhead per activity / expected use of cost drivers per activity

activity based management

extends the use of ABC from product costing to a comprehensive management tool that focuses on reducing costs and improving processes and decision making

batch level

performed for each batch or group of units of the products or services; produces another batch of product --to start processing new batch of ice cream, an ice cream producer needs to set up machines. amount of time spent setting up and cleaning machine increases with # of batches produces, not with number of units

unit level

performed for each unit of production --assembly of iphones is UL because any amount of assembly increases with each additional phone assembled

facility level

required to support/sustain an entire produciton process - hosptial; building must be insured and heated, property taxes, etc