Activity Based Costing
Just-in-time (JIT) Processing
A processing system dedicated to having the right amount of materials, parts, or products arrive as they are needed, thereby reducing the amount of inventory.
What are the limitations of ABC costing?
ABC can be expensive to use and some arbitrary allocations continue.
Examples of non-value added activities in a service company:
Taking appointments, reception, bookkeeping, billing, traveling, ordering supplies, advertising, cleaning, and computer repair.
Batch-Level Activities
Activities performed for each bath of products rather than for each unit.
Unit-level activities
Activities performed for each unit of production.
Product-level activities
Activities performed in support of an entire product line, but not always performed every time a new unit or batch of products is produced.
Facility-level activities
Activities required to support or sustain an entire production process.
Value-added activity
An activity that increases the worth of a product or service.
Activity-based Costing
An overhead cost-allocation system that allocates overhead to multiple activity cost pools and assigns the activity cost pools to products or services by means of cost drivers that represent the activities used.
Activity
Any event, action, transaction, or work sequence that incurs cost when producing a product or providing a service.
Cost driver
Any factor or activity that has a direct cause-effect relationship with the resources consumed. In ABC, cost drivers are used to assign activity cost pools to products or services.
What is the fourth (and final) step in calculating the unit costs under ABC?
Assign manufacturing overhead costs for each cost pool to products, using the overhead rates (cost per driver).
What is the third step in calculating the unit costs under ABC?
Compute the overhead rate for each cost driver.
Traditional Costing is calculated as
Estimated overhead divided by direct labor hours = predetermined overhead rate. multiply that rate by the actual amount of DL hours to get applied overhead.
Activity-Based Overhead Rate
Estimated overhead per activity divided by expected use of cost drivers per activity.
Activity Cost Pool
The overhead cost attributed to a distinct type of activity or related activities.
What are the benefits of ABC costing?
The primary benefit of ABC is more accurate product costing because: ABC leads to more cost pools, ABC leads to enhanced control over overhead costs, ABC leads to better management decisions.
What are the two stages of how ABC allocates overhead?
1. Allocates overhead costs to activity cost pools. (Traditional costing systems, in contrast, allocate these costs to departments or to jobs). 2. Assigns the overhead allocated to the activity cost pools to products, using cost drivers.
Companies often use ________ to help identify the ABC activities.
Activity flowcharts.
Non-value added activity
An activity that adds cost to or increases the time spent on a product or service without increasing its market value.
Examples of value added activities in a manufacturing operation:
Engineering design, machining, assembly, painting, and packaging.
What are some types of BATCH LEVEL activities?
Equipment setups, purchase ordering, inspection, material handling.
What is the first step in calculating the unit costs under ABC?
Identify and classify all the major activities involved in the manufacture of the specific products, and allocate manufacturing overhead costs to cost pools.
What is the second step in calculating the unit costs under ABC?
Identify the cost driver that has a strong correlation to the costs accumulated in the cost pool.
What are some type of UNIT LEVEL activities?
Machine related: Drilling, cutting, milling, trimming, and pressing. Labor related: Assembling, painting, sanding, sewing.
Examples of value added activities in a service company:
Performing surgery, providing legal research for legal services, or delivering packages by a delivery service.
What are some types of FACILITY LEVEL activities?
Plant management salaries, plant depreciation, property taxes, and utilities.
What are some types of PRODUCT LEVEL activities?
Product design and engineering changes.
The reasoning behind ABC cost allocation
Products consume activities, and activities consume resources.
Examples of non-value added activities in a manufacturing operation:
Repairing machines, the storage of inventory, the moving of raw materials, assemblies, and finished product within the factory.
What do cost drivers measure?
The number of individual activities undertaken or performed to produce products or provide services.
What is the main difference between Traditional costing and ABC costing?
Tradition costing only uses one base to determine the amount of overhead to be assigned to a product (such as direct labor hours or machine hours), ABC costing uses multiple bases to determine the amount of overhead to allocate.