ACC 220 Chapter 4

Facility-level activities

Activities that are carried out regardless of which products are produced, how many batches are run, or how many units are made; include items such as factory management salaries, insurance, property taxes, and building depreciation; costs cannot be traced on a cause-and-effect basis to individual products

The Key to Successful Implementation of an Activity-Based Costing System

Identifying the key activities that generate costs and tracking how many of those activities are performed for each service the organization provides

Activity-based management

involves focusing on activities to eliminate waste, decrease processing time, and reduce defects; used in organizations as diverse as manufacturing companies, hospitals, and the U.S. Marine Corps

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; include maintaining inventories of parts for a product, issuing engineering change notices to modify a product to meet a customer's specifications, and developing special test routines when a product is first placed into production

Activity-based costing (ABC)

technique that attempts to assign overhead costs more accurately to products than the simpler methods discussed thus far

Hierarchy of Activities

unit-level activities, batch-level activities, product-level activities, facility-level activities

Activity cost pool

A "cost bucket" in which costs related to a single activity measure are accumulated.

Characteristics of companies most likely to benefit from Activity-Based Costing

1. Products differ substantially in volume, batch size, and in the activities they require. 2. Conditions have changed substantially since the existing cost system was established. 3. Overhead costs are high and increasing and no one seems to understand why. 4. Management does not trust the existing cost system and ignores cost data from the system when making decisions

Limitations of Activity-based costing

1. The cost of implementing and maintaining an activity-based costing system may outweigh the benefits — first, cost system must be designed, preferably by a cross-functional team which requires taking valued employees away from other tasks for a major project; second, the data used must be collected and verified which sometimes requires collecting data that has never been collected before; implementing and maintaining this system can present a formidable challenge and management may decide that the costs are too great to justify the expected benefits 2. It would be naive to assume that product costs provided even by an activity-based costing system are always relevant when making decisions — relies on critical assumptions such as that the cost in each activity cost pool is strictly proportional to its activity measure, evidence suggests that as activity increase, the average drops (increasing returns to scale); product costs computed by activity-based costing will be overstated for the purpose of making decisions — modifying the model if product costs are to be used by managers for internal decisions

Activity rate

An overhead rate in activity-based costing; Each activity cost pool has its own activity rate which is used to assign overhead to products and services

Activity dictionary

Defines each of the activities that will be included in the activity-based costing system and how the activities will be measuredd

Benefits of Activity-based costing

Improves the accuracy of product costs in three ways 1. Activity-based costing usually increases the number of costs pools used to accumulate overhead costs — rather than accumulating all overhead costs in a single, plantwide pool, or accumulating them in departmental pools, the company accumulates costs for each major activity 2. The activity cost pools are more homogeneous than departmental cost pools — all the costs in an activity cost pool pertain to a single activity while departmental cost pools contain the costs of many different activities carried out in the department 3. Activity-based costing uses a variety of activity measures to assign overhead costs to products, some of which are correlated to volume and some of which are not Activity-based costing makes it clear that batch setups, engineering change orders, and other activities cause overhead costs rather than just direct labor; Managers thus have a better understanding of the causes of overhead costs, which should lead to better decisions and better cost control Activity-based costing highlights the activities that could benefit most from process improvement initiatives; thus activity-based costing can be used as a part of programs to improve operations

Batch-level activities

Tasks that are performed each time a batch is processed; such as processing purchase orders, setting up equipment, packing shipments to customers, and handling material; costs at this level depend on the number of batches processed rather than on the number of units produced; the cost of processing a purchase order is the same no matter how many units of an item are ordered

Benchmarking

a systematic approach to identifying the activities with the greatest potential for improvement; based on comparing the performance in an organization with the performance of other, similar organizations known for their outstanding performance

Unit-level activities

activities that are performed each time a unit is produced; activity costs should be proportional to the number of units produced; providing power to run processing equipment — power tends to be consumed in proportion to the number of units produced

Activity

an event that causes the consumption of overhead resources; such as setting up machines, admitting patients to a hospital, scheduling production, performing blood tests at a clinic, billing customers, maintaining equipment, ordering materials or supplies, stocking shelves at a store, meeting with clients at a law firm, preparing shipments, inspecting materials for defects, opening an account at a bank; each has its own overhead cost pool (activity cost pool), its own activity measure and own overhead rate (activity rate)

Activity measure

expresses how much of the activity is carried out and is used as the allocation base for applying overhead costs to products and services; such as the number of patients admitted is a natural choice for the activity admitting patients to the hospital