Chapter 7

Customer-level Activities

Relate to specific customers (sales calls, catalog mailings, technical support not tied to a specific product)

Product-level Activities

Relate to specific products and typically must be carried out regardless of how many batches are run or units produced (designing a product, advertising a product, or maintaining a product manager and staff)

Assigning Overhead Costs to Cost Objects

Second-stage allocation

Transaction Drivers

Simple counts of the number of times an activity occurs (number of bills sent out to customers)

How ABC Differs From Traditional Absorption Costing

1. Non manufacturing as well as manufacturing costs may be assigned to product, but only on a cause-and-effect basis 2. Some manufacturing costs may be excluded from product costs 3. Numerous over head cost pools used, each allocated to products and other cost objects using its own measure of activity

2 common types of costing systems

1. Official costing systems used to prepare external financial reports 2. ABC methods used for internal decision making and managing activities

2 types of manufacturing costs ABC systems assign to products

1. All direct manufacturing costs (salesperson commission, shipping costs, warranty repair costs) 2. Indirect manufacturing costs whenever the products have presumably caused the cost to be incurred

Steps for 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 5. Prepare management reports

Reasons ABC is used for external reports

1. External reports are less detailed than internal reports 2. Difficult to make changes in a company's acct. system 3. A lot of ABC systems do not conform to generally accepted acct. principles 4. Auditors uncomfortable with allocations based on interview with company's employees

2 types of manufacturing cost ABC systems do not assign to product

1. Organization-sustaining costs (security guard wages, plant controllers salary, cost of supplies used by secretary) 2. Unused or idle capacity (products only charged for capacity they use)

3 Essential Characteristics of a Successful ABC implementation

1. Strong support from top managers 2. Top managers should ensure that ABC data is linked to how people are evaluated and rewarded 3. Cross-functional team created to design and implement the ABC system

3 Reasons Traditional and ABC Systems Report a Different Product Margin

1. Traditional allocates all manufacturing overhead costs to products, ABC find some of these costs arbitrary 2. Traditional allocates all man. overhead costs using volume related alloc. base - machine hours - may not reflect what actually causes the costs 3. ABC system assign non man. overhead costs on a cause-and-effect basis

Activity-Based-Costing (ABC)

A costing method based on activities that is designed to provide managers with the cost information for strategic and other decisions that potentially affect capacity and therefore fixed as well as variable costs

Benchmarking

A systematic approach to identifying the activities with the greatest room for improvement

Second-stage Allocation

Activity rates are used to apply overhead costs to products and customers

Organization-sustaining activities

Carried out regardless of which customers are served, which products are produced, how many batches are run, or how many units are made. (heating factory, cleaning execs offices, providing a computer network, arranging for loans, preparing annual reports for shareholders)

Defining Activities, Activity Cost Pools, and Activity Measures for ABC

Cross-functional team members interview other employees who work in overhead departments asking them to describe their major activities

Assigning Overhead Costs to Activity Cost Pools

General ledgers classify costs within the department the cost is incurred. Excludes direct material, direct labor and shipping costs b/c existing system already traces these costs to products. First stage allocation

Activity-based Management

Involves focusing on activities to eliminate waste, decrease processing time, and reduce defects

Duration Drivers

Measure the amount of times required to perform an activity (time spent preparing individual bills for customers)

Preparing Management Reports

Most common reports prepared in ABC data are product and customer profitability reports

Batch-level Activities

Performed each time a batch is handled or processed regardless of how many units in the batch. Costs at the batch level depend on number of batches processed.

Unit-level Activities

Performed each time a unit is produce. Costs of unit-level activities should be proportional to units produced.

First-stage Allocation in an ABC System

Process of assigning functionally organized overhead costs derived from a companies general ledger to the activity cost pools

Action Analysis Report

Provides more detail about costs and how they might adjust to changes in activity

Difference btw ABC and Traditional Product Costs

Traditional cost system over costs standard stanchions and reports a lower product margin than ABC systems

Plantwide Overhead Rates

Used to assign manufacturing overhead costs to products. PW overhead rate = Total est. man. overhead / Total est. machine hours

Cost Driver

Used to refer to an activity measure. The measure should "drive" the cost being allocated.

Activity Cost Pool

a "bucket" in which costs are accumulated that relate to a single activity measure in the ABC system

Activity Measure

an allocation base in an ABC system

Activity

any event that cause the consumption of overhead resources