Chapter 7 Managerial Accounting: Activity-Based Costing: A Tool to Aid Decision-Making

product margin

profit from a product; a function of the product's sales and the direct and indirect costs that the product causes

first-stage allocation

the process by which overhead costs are assigned to activity cost pools in an activity-based costing system

activity rate formula

total cost/ total activity

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

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

duration drivers

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

transaction drivers

a simple count of the number of times an activity occurs

customer-level activities

activities that are carried out to support customers, but that are not related to any specific product ex: sales calls, catalog mailings, general technical support

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; amount of resource consumed depends on the number of batches run rather than on the number of units in the batch ex: placing purchase orders, setting up equipment, arranging for shipments to customers **costs at the batch level depend on the number of batches processed

unit-level activities

activities that are performed each time a unit is produced ex:providing power to run processing equipment **costs of unit-level activities should be proportional to the number of units 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 ex: designing a product, advertising a product, maintaining a product manager and staff

Margin formula

(price-cost)/price

ABC costing does not conform to _______.

Generally Accepted Accounting Principles (GAAP)

activity-based costing model

cost objects (e.g., products and customers)-->activities-->consumption of resources-->cost

organization-sustaining costs

factory security guard's wages, plant controller's salary, cost of supplies used by the plant manager's secretary -in ABC costing they are treated as period expenses

unused capacity costs

in ABC costing products are charged only for the capacity they use

Limitations of ABC costing

1) major project requires substantial resources 2)more costly than a traditional costing system 3)produces numbers, such as product margins, that are at odds with numbers produced by traditional costing systems 4)data can be misinterpreted

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 5)prepare management reports

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

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

Activity-based costing systems purposely do not assign 2 types of manufacturing overhead costs to products:

1)organization-sustaining costs 2)unused capacity costs (also called idle capacity costs)

2 most common types of activity measures

1)transaction drivers 2)duration drivers

Activity-based costing defines 5 levels of activity:

1)unit-level 2)batch-level 3)product-level 4)customer-level 5)organization-sustaining

activity-based management

a management approach that focuses on managing activities as a way of eliminating waste and reducing delays and defects

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 ex: heating the factory, cleaning executive offices, providing a computer network, arranging for loans, preparing annual reports to shareholders

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

activity

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

The fourth step in the implementation of activity-based costing is called ______.

second-stage allocation

second-stage allocation

the process by which activity rates are used to apply costs to products and customers in activity-based costing