ACCT 152 Chapter 7

ABC Limitations

- substantial resources required to implement and maintain - resistance to unfamiliar numbers and reports - potential misinterpretation of unfamiliar numbers - does not conform to GAAP. two costing systems may be needed

Customer Relations Cost Pool

- will be assigned all costs associated with maintaining relations with customers, including the costs of sales calls and the costs of entertaining customers - activity measure for this cost pool is the number of customers the company has on its active customer list - represents a customer-level activity

there are 2 types of non-manufacturing costs that ABC systems assign to products:

1. ABC systems trace all direct non-manufacturing costs to products 2. ABC systems allocate indirect non-manufacturing costs to products whenever the products have presumably caused the costs to be incurred

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 is infrequently used for external reporting because:

1. external reports are less detailed than internal reports prepared for decision making 2. it is often very difficult to make changes in a company's accounting system 3. an ABC system does not conform to generally accepted accounting principles 4. auditors are likely to be uncomfortable with allocations that are based on interviews with the company's personnel

Activity-based costing differs from traditional absorption costing in 3 ways:

1. non-manufacturing 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

Characteristics of Successful ABC Implementations:

1. strong top management support 2. link to evaluations and rewards 3. cross-functional involvement

most organizations that use activity-based costing have 2 costing systems:

1. the official costing system that is used for preparing external financial reports 2. the activity-based costing system that is used for internal decision making and for managing activities

3 essential characteristics of a succesful activity-based costing implementation:

1. top managers must strongly support the ABC implementation because their leadership is instrumental in properly motivating all employees to embrace the need to change 2. top managers should ensure that ABC data is linked to how people are evaluated and rewarded 3. a cross-functional team should bee created to design and implement the ABC system

3 reasons why the traditional and activity-based costing systems report different product margins:

1. traditional cost system allocates all manufacturing overhead costs to products 2. traditional cost system allocates all of the manufacturing overhead costs using a volume-related allocation base - machine hours- that may or may not reflect what actually causes the costs 3. ABC system assigns the non-manufacturing overhead costs caused by products to those products on a cause-and-effect basis

3 reasons why the reported product margins for the 2 costing systems differ:

1. traditional costing allocates all manufacturing overhead to products, while ABC costing only assigns manufacturing overhead costs consumed by products to those products 2. traditional costing allocates all manufacturing overhead costs using a volume-related allocation base while ABC costing uses non-volume related allocation bases 3. traditional costing disregards selling and administrative expenses because they are assumed to be period expenses while ABC costing directly traces shipping costs to products and includes non-manufacturing overhead costs caused by products in the activity cost pools that are assigned to products

Traditional Product Margin Calculations

1st step: gather each product's sales and direct cost data 2nd step: compute the plant-wide overhead rate 3rd step: allocate manufacturing overhead to each product 4th step: compute the product margins

ABC Product Margin Calculations

1st step: gather each product's sales and direct cost data 2nd step: incorporate the previously computed activity-based cost assignments pertaining to each product 3rd step: deduct each product's direct and indirect costs from sales

ABC Customer Margin Analysis

1st step: gather sales and direct cost data 2nd step: incorporate previously computed activity-based costing assignments 3rd step: deduct all its direct and indirect costs from sales

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 reduce delays and defects

duration driver

a measure of the amount of time required to perform an activity

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

transaction driver

a simple count of the number of times an activity occurs

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

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

unit-level activitites

activities that are performed each time a unit is 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

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

acitvity

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

ABC uses more cost pools than traditional cost accounting

each ABC cost pool has its own unique measure of activity

in traditional absorption costing systems, all manufacturing costs are assigned to products - even manufacturing costs that are not caused by the products

in contrast, activity-based costing systems purposely do not assign 2 types of manufacturing costs to products

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

the most common management reports prepared with ABC data are 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

the 2 most common types of activity measures:

transaction drivers and duration drivers

traditional cost systems rely exclusively on allocation bases that are driven by the volume of production, while activity-based costing defines 5 levels of activity that largely do not relate to the volume of units produced:

unit-level activities batch-level activities product-level activities customer-level activities organization-sustaining activities

Order Size Cost Pool

- will be assigned all costs of resources consumed as a consequence of the number of units produced, including the costs of miscellaneous factory supplies, power to run machines, and some equipment depreciation - unit-level activity because each unit requires some of these resources - activity measure for this cost pool is machine hours

Product Design Cost Pool

- will be assigned all costs of resources consumed by designing products - activity measure for this cost pool is the number of products designed - product-level activity because the amount of design work on a new product does not depend on the number of units ultimately ordered or batches ultimately run

Customer Orders Cost Pool

- will be 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 - activity measure for this cost pool is the number of customer orders received - batch-level activity because each order generates work that occurs regardless of whether the order is one unit or 1,000 units

Other Cost Pool

- will be assigned all overhead costs that are not associated with customer orders, product design, the size of orders, or customer relations - these costs mainly consist of organization-sustaining costs and the costs of unused, idle capacity - will not be assigned to products because they represent resources that are not consumed by products