Ch 17 Activity- Based Costing

TRADITIONAL COSTING SYSTEMS

-Allocates overhead using a predetermined rate. Job order costing: direct labor cost may be the relevant activity base. Process costing: machine hours may be the relevant activity base.

ADVANTAGE OF MULTIPLE COST POOLS (each level)

-Unit level: Performed for each unit of production. Example: Assembly of cell phones -Bathc level: Performed every time a company produces another batch of a product. Example: Batch of ice cream -product level: Performed every time a company produces a new type of product. Example: Time spent testing a new drug by a pharmaceutical company -facility level: Required to support or sustain an entire production process. Example: A hospital

ACTIVITY-BASED COSTING (Steps)

1) Identify and classify the activities involved in the manufacture of specific products and assign overhead to cost pools. 2) Identify the cost driver that has a strong correlation to the costs accumulated in each cost pool. 3) Compute the activity-based overhead rate for each cost pool. 4) Allocate overhead costs to products using the overhead rates determined for each cost pool.

Explain the benefits and limitations of activity-based costing.

ABC has three primary benefits: More cost pools, therefore more accurate product costing. Enhanced control over overhead costs. Better management decisions.

THE ADVANTAGE OF BETTER MANAGEMENT DECISIONS

Activity-based management (ABM), a management tool that focuses on reducing costs and improving processes and decision-making. Managers use ABC via ABM for both strategic and operational decisions or perspectives. to help managers evaluate employees, departments, and business units. to establish performance standards, as well as benchmark against other companies.

THE ADVANTAGE OF ENHANCED COST CONTROL (Non-Value-Added Activities)

Adds cost to, or increases the time spent on, a product/service without increasing its perceived value, such as: -Manufacturing Company Storage of inventory Moving of inventory Inspections Fixing defective goods Set up machines -Service Company Taking appointments Reception Bookkeeping and billing Traveling Ordering supplies Advertising

ACTIVITY-BASED COSTING

An approach for allocating overhead costs. Allocates overhead to multiple activity cost pools. Assigns the activity cost pools to products or services by means of cost drivers.

Apply activity-based costing to a manufacturer (4 steps)

Identify and classify the activities involved in the manufacture of specific products and assign overhead to cost pools. Identify the cost driver that has a strong correlation to the costs accumulated in each cost pool. Compute the activity-based overhead rate for each cost pool. Allocate overhead costs to products, using the overhead rates determined for each cost pool.

THE ADVANTAGE OF ENHANCED COST CONTROL (Value-Added Activities)

Increase the perceived value of a product or service to customers, such as: -Manufacturing Company Engineering design Machining services Assembly Painting -Service Company Performing surgery Legal research Delivering packages

COMPARING UNIT COSTS

Likely consequence of differences in assigning overhead. Overpricing the Ab Bench and possibly losing market share to competitors. Sacrificing profitability by underpricing the Ab Coaster.

SOME LIMITATIONS AND KNOWING WHEN TO USE ABC

Limitations: -Expensive to use. -Arbitrary allocations remain. When to Use -Product lines differ in volume and manufacturing complexity. -Product lines are numerous and diverse. -Overhead costs constitute a significant portion of total costs. -Manufacturing process or the number of products has changed significantly. -Production or marketing managers are ignoring data.

ADVANTAGE OF MULTIPLE COST POOLS

Multiple Cost Pools Used instead of one plantwide pool and a single cost driver. Numerous activity cost pools with more relevant cost drivers. Costs allocated on basis of cost drivers used to produce each product.

Just-In-Time (JIT) Processing

OBJECTIVE: To eliminate all manufacturing inventories. Elements: Dependable suppliers. Multiskilled work force. Total quality control system.

Apply activity-based costing to service industries.

Overall objective: Identify key activities that generate costs and keep track of how many of those activities are completed for each service performed. General approach is to identify activities, cost pools, and cost drivers. Labeling of activities as value-added or non-value-added. Sometimes, a larger proportion of overhead costs are company-wide costs that cannot be directly traced to specific services provided by the company.

Just-In-Time (JIT) Processing (Benefits)

Significant reduction or elimination of manufacturing inventories. Enhanced product quality. Reduction or elimination of rework costs and inventory storage costs. Production cost savings from the improved flow of goods through the processes.

THE NEED FOR A NEW APPROACH

Tremendous change in manufacturing and service industries. Decrease in amount of direct labor usage. Significant increase in total overhead costs. Inappropriate to use plantwide predetermined overhead rates when a lack of correlation exists. Complex manufacturing processes may require multiple allocation bases; this approach is called activity-based costing (ABC).

ACTIVITY-BASED COSTING (overhead)

ABC allocates overhead in a two-stage process: Stage 1: Overhead costs are assigned to activity cost pools (Step 1). Stage 2: Allocates overhead assigned to the activity cost pools to products, using cost drivers (Steps 2-4). The more complex a product's manufacturing operation, the more activities and cost drivers are likely to be present.