Chp 4 - Activity Based Costing
examples of non-value added activities
-inventory storage -moving materials, work in process, or finished goods from one location to another -inspecting goods -fixing defective goods under warranty -machine setup -in-process inspections -FDA certification
In allocating overhead costs, it is necessary to know the expected use of cost drivers for each product. To allocate overhead costs, Atlas multiplies the activity-based overhead rates per cost driver (Ill. 4-9) by the number of cost drivers expected to be used per product (Ill. 4-10).
Allocate Overhead Costs to Products (Step 4)
activity
Any event, action, transaction, or work sequence that incurs costs when producing a product or performing a service.
1. More cost pools, therefore more accurate product costing. 2. Enhanced control over overhead costs. 3. Better management decisions.
BENEFITS OF ABC
Performed every time a company produces another batch of a product. Example: Batch of ice cream equitment setup purchase ordering inspection
Batch level
-significant reduction or elimination of manufacturing inventories -enhanced product quality -reduction or elimination of rework costs and inventory storage -production cost savings from the improved flow of goods through the processes -elimination of separate raw materials and WIP inventory accounts
Benefits of JIT processing
-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.
Components of applying ABC to service industries
Next, the company computes an activity-based overhead rate per cost driver.
Compute Activity-Based Overhead Rates (Step 3)
dependable suppliers multiskilled workforce total quality control system (no defects)
Elements of JIT Processing
Required to support or sustain an entire production process. Example: A hospital these costs do not vary as a function of the number of units, batches, or products. plant manager salaries plant depreciation property taxes utilities
Facility Level
Allocates overhead using a predetermined rate
How do traditional costing systems allocate overhead?
Cost driver must accurately measure the actual consumption of the activity by the various products. a high degree of correlation must exist between the cost driver and the actual consumption of the overhead costs in the cost pool.
Identify Cost Drivers (Step 2)
Overhead costs are assigned directly to the appropriate activity cost pool.
Identify and Classify Activities and Allocate Overhead to Cost Pools (Step 1)
direct labor as the relevant activity base
Job order costing uses
expensive to use arbitrary allocations remain
Limitations
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.
Managers use ABC via ABM for/to
Identify key activities that generate costs and keep track of how many of those activities are completed for each service performed
Overall objective in applying ABC to service industries
Performed every time a company produces a new type of product. Example: Time spent testing a new drug by a pharmaceutical company product design engineering changes
Product level
Identify and classify the activities involved in the manufacture of specific products and assign overhead to cost pools
STEP 1
Identify the cost driver that has a strong correlation to the costs accumulated in each cost pool
STEP 2
Compute the activity based overhead rate for each cost pool
STEP 3
Allocate overhead costs to products using the overhead rates determined for each cost pool
STEP 4
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.
The Advantage of Multiple Cost Pools
the more activities and cost drivers are likely to be present
The more complex a product's manufacturing operation...
overpricing and losing market share to competitors underpricing and sacrificing profitability
Traditional costing system could lead to over pricing which causes.... and underpricing which causes...
performed for each unit of production -assembly of cell phones machine related labor related
Unit level
1. Product lines differ in volume and manufacturing complexity. 2. Product lines are numerous and diverse. 3. Overhead costs constitute a significant portion of total costs. 4. Manufacturing process or the number of products has changed significantly. 5. Production or marketing managers are ignoring data.
When to use
1. Tremendous change in manufacturing and service industries 2. Decrease in amount of direct labor usage 3. Significant increase in total overhead costs 4. Inappropriate to use plantwide predetermined overhead rates when a lack of correlation exists 5. Complex manufacturing processes may require multiple allocation bases
Why do we need a new approach?
activity-based management
a management tool that focuses on reducing costs and improving process and decision-making
value-added activities
increase the perceived value of a product or service to customers
to eliminate all manufacturing inventories JIT strives to eliminate inventories by using a "pull approach" in manufacturing.
objective of JIT processing
machine hours may be the relevant activity base
process costing uses:
activity cost pool
the overhead cost attributed to a distinct activity (e.g. ordering materials or setting up machines)
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)
ABC allocates overhead in a two-stage process:
OH into various cost pools in an effort to provide more accurate cost info -it supplements other cost systems
ABC does not replace an existing job order or process cost system. ABC instead segregates
Examples of value added activities
engineering design machining assembly painting performing surgery performing legal research delivering packages
non value added activities
adds costs to, or increases the time spent on, a product/service without increasing its perceived value
cost driver
any factor or activity that has a direct cause-effect relationship with the resources consumed
Activity-based costing
approach for allocating overhead costs. allocates overhead to multiple activity cost pools and then assigns the activity cost pools to products and services by means of cost drivers
Just-in-time manufacturing
dedicated to having the right amount of materials, parts, or products just as they are needed