Chapter 7 Activity Based Costing: A tool to aid decision making
How do manufacturing costs in ABC differ?
Activity-based costing systems do not arbitrarily assign these types of costs, which are called organization-sustaining costs, to products. Activity-based costing treats these types of costs as period expenses rather than product costs. activity-based costing, products are only charged for the costs of the capacity they use—not for the costs of capacity they don't use. This provides more stable unit product costs and is consistent with the goal of assigning to products only the costs of the resources that they use.
How should ABC system activities be grouped together?
Batch-level activities should not be combined with unit-level activities or product-level activities with batch-level activities and so on. In general, it is best to combine only those activities that are highly correlated with each other within a level.
Example of batch level
For example, tasks such as placing purchase orders, setting up equipment, and arranging for shipments to customers are batch-level activities. For example, the cost of setting up a machine for batch processing is the same regardless of whether the batch contains one or thousands of items.
How does a cross functional team contribute to the ABC?
Furthermore, tapping the knowledge of cross-functional managers lessens their resistance to ABC because they feel included in the implementation process. Time after time, when accountants have attempted to implement an ABC system on their own without top-management support and cross-functional involvement, the results have been ignored.
Examples of how ABC system activities should be grouped together?
The number of customer orders received is likely to be highly correlated with the number of completed customer orders shipped, so these two batch-level activities (receiving and shipping orders) can usually be combined with little loss of accuracy.
What are more accurate? Duration or transaction drivers?
duration drivers are more accurate measures of resource consumption than transaction drivers, but they take more effort to record.
Examples of Organization-sustaining activities
heating the factory, cleaning executive offices, providing a computer network, arranging for loans, preparing annual reports to shareholders, and so on.
What's the appeal of ABC?
it uses more cost pools and unique measures of activity to better understand the costs of managing and sustaining product diversity.
Example of a unit level activity
providing power to run processing equipment would be a unit-level activity because power tends to be consumed in proportion to the number of units produced.
How is the original lengthy list of activities is usually reduced to a handful by combining similar activities?
several actions may be involved in handling and moving raw materials—from receiving raw materials on the loading dock to sorting them into the appropriate bins in the storeroom. All of these activities might be combined into a single activity called material handling.
What are the two types of nonmanufacturing costs that ABC systems assign to products
1. ABC systems trace all direct nonmanufacturing costs to products. 2. ABC systems allocate indirect nonmanufacturing costs to products whenever the products have presumably caused the costs to be incurred
When is activity based costing ordinarily used?
ABC is ordinarily used as a supplement to , rather than as a replacement for, a company's usual cost system.
Summarize Chapter 7 lesson 1
ABC product cost calculations include all direct costs that can be traced to products and all indirect costs that are caused by products. The need to distinguish between manufacturing and nonmanufacturing costs disappears—which is very different from earlier chapters that focused solely on determining the manufacturing cost of a product.
Define transaction drivers
simple counts of the number of times an activity occurs, such as the number of bills sent out to customers
Two most common types of activity measure are
transaction drivers and duration drivers.
What levels of activity does ABC define?
unit-level, batch-level, product-level, customer-level, and organization-sustaining
What does cost driver mean?
used to refer to an activity measure because the activity measure should "drive" the cost being allocated.
Define duration drivers
measure the amount of time required to perform an activity, such as the time spent preparing individual bills for customers
Define unit level activities?
performed each time a unit is produced. The costs of unit-level activities should be proportional to the number of units produced.
Define/ example Customer-level activities
relate to specific customers and include activities such as sales calls, catalog mailings, and general technical support that are not tied to any specific product.
Define Product-level activities
relate to specific products and typically must be carried out regardless of how many batches are run or units of product are produced or sold.
What is expanded in ABC?
The definition of overhead to include all indirect costs—manufacturing and nonmanufacturing.
Pros and cons of the first step of implementing an ABC system/
The length of such lists of activities poses a problem. On the one hand, the greater the number of activities tracked in the ABC system, the more accurate the costs are likely to be. On the other hand, a complex system involving large numbers of activities is costly to design, implement, maintain, and use. Consequently, the original lengthy list of activities is usually reduced to a handful by combining similar activities.
Example of Product-level activities
activities such as designing a product, advertising a product, and maintaining a product manager and staff are all product-level activities.
Define activity measure
an allocation base in an activity-based costing system
What is an activity in ABC?
any event that causes the consumption of overhead resources
Define Organization-sustaining activities
are carried out regardless of which customers are served, which products are produced, how many batches are run, or how many units are made
Steps of implementing ABC
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
How is the customer orders cost pool assigned?
All costs of resources that are consumed by taking and processing customer orders, including costs of processing paperwork and any costs involved in setting up machines for specific orders.
Examples of nonmanufacturing costs that can be directly traced to individual products.
Commissions paid to salespersons, shipping costs, and warranty repair costs are examples of nonmanufacturing costs that can be directly traced to individual products.
three essential characteristics of a successful activity-based costing implementation
First, top managers must strongly support the ABC implementation because their leadership is instrumental in properly motivating all employees to embrace the need to change. Second, top managers should ensure that ABC data is linked to how people are evaluated and rewarded. If employees continue to be evaluated and rewarded using traditional (non-ABC) cost data, they will quickly get the message that ABC is not important and they will abandon it. Third, a cross-functional team should be created to design and implement the ABC system.
What is the first step in implementing an ABC system?
Identify the activities that will form the foundation for the system.
How are manufacturing costs assigned in TAC?
In traditional absorption costing, manufacturing costs are assigned to products and nonmanufacturing costs are not assigned to products.
Who should the team include as representatives?
Marketing, production, engineering, and accounting departments.
Marketing, production, engineering, and accounting departments should represent the team how?
These cross-functional employees possess intimate knowledge of many parts of an organization's operations that is necessary for designing an effective ABC system.
Most organizations that use ABC have what types of systems?
Two costing systems: The official costing system is used for preparing external financial reports The activity based costing system is used for internal decision making and for managing activities
How is the product design pool cost assigned?
Will be assigned all costs of resources consumed by designing products.
Define activity cost pool
a "bucket" in which costs are accumulated that relate to a single activity measure in the ABC system
Define activity-based costing
a costing method 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.
How does ABC differ from TAC
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 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.
Define batch level activities?
are performed each time a batch is handled or processed, regardless of how many units are in the batch. They are incurred once for each batch (or customer order). 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.