CH 5 Activity-based costing (ABC) and Activity-based Management (ABM) (SU3)

product design, process design, and prototyping can all be classified as?

"Design" activity

Simple or complex sequence process follows these three steps:

1. Design products and processes 2. Manufacture lenses 3. Distribute lenses

3 *Guidelines* for Refining a Costing System:

1. Direct-cost tracing 2. Indirect-cost pools 3. Cost-allocation bases

5 Behavioral Issues in Implementing ABC Systems:

1. Gain management support 2. Create a guiding coalition 3. Educate and train employees 4. Seek small, short-run processes 5. Know that ABC is not perfect

_______________ unit-level costs are the cost of activities performed on each individual unit of a product or service.

Output unit-level costs

Using cost info for strategic decisions: ________________ products will overpricing, causing those products to lose market to competitors and lose their market share.

Overcosted

What is the cost driver of: 1. molding machine 2. operations of molding machine 3. process control of molding machine

cost driver = machine hours

A ____________ ______________________ categorizes various activity cost pools om the basis of the different types of cost drivers, cost-allocation bases, or cause-and-effect (benefit received) relationships.

cost hierarchy

Managers choose the level of detail to use in a costing system by evaluating the expected ___________ of the system against the expected ________________ that result from better decisions.

costs, benefits

When packages increase, a truck driver's wages ___________.

increase

ABC systems distinguish costs _____________ from resources ___________ to design, manufacture, and deliver products and services.

incurred, used

Benefits and Costs of ABC Systems: Significant amounts of ____________ costs are allocated using only one or two cost pools.

indirect

Activity-based __________________ is a method of management decision making that uses activity-based costing information to improve customer satisfaction and profitability.

management

Benefits and Costs of ABC Systems: All or more of the indirect costs are identified as ______________ unit-level costs (few indirect costs are described as batch-level costs, product-sustaining costs, or facility-sustaining costs).

output

____________-_____________ costing broadly *averages* or *spreads* the cost of resources uniformly to cost object when in fact, individual products or services use those resources in a non-uniform way.

peanut-butter

When a product consumes a low level of resources but reports to have a higher cost per unit:

product overcosting

When a product consumes a high level of resources but reports to have a lower cost per unit:

product undercosting

means that if a company undercosts one of its products, it will overcost at least one of its other products, and vice versa. Formula?

product-cost cross-subsidization Formula = total X ratio

A ______________-_______________ system reduces the broad averages for assigning the cost of resources to cost objects (such as jobs, products, or services).

refined-costing system

A __________-_____________ system allocates OH costs broadly in an easy, inexpensive, and reasonably accurate way. Historically used for companies that produced a limited variety of products.

simple-costing

*Benefits and Costs of ABC Systems: products that a company is well-suited to make and sell show ______________ profits; whereas products that a company is less-suited to make and sell show ___________ profits.

small, larger

Hospitals use __________-_____________ _______________-__________ costing system (TBABC)

time-based activity-based

ABC system that use available time (set-up hours) to calculate the cost of a resource and to allocate costs to cost objects are sometimes called ______________-_____________ ______________-________________ costing systems (TBABC).

time-based activity-based costing systems

Example of batch-level costs:

-set-up hours -material handling -quality-inspection costs associated with batches -cost of placing purchase order -receiving materials -paying invoices related to the # of PO's placed rather than the number of value of material purchased

activity descriptions aka . . .

. . . activity list or activity dictionary

List the 7 Steps to a Simple-costing System:

1. Identify products that are the *chosen cost objects.* (What will be produced?) 2. Identify the *direct costs of the products.* (DM + DL) 3. Select the *cost-allocation bases to use for allocating indirect (or overhead) costs* to the products. (Everything besides DL and DM). 4. Identify the *indirect costs associated with each cost-allocation base.* (If using simple-costing, then only one indirect cost pool). 5. Compute the *rate per unit of each cost-allocation base.* (Use budgeted indirect-cost rate formula). 6. Compute the *indirect costs allocated to the products.* 7. *Compute the total cost* of the products *by adding all direct and indirect costs assigned to the products.*

3 *Reasons* to Refine a Costing System:

1. Increase in product diversity 2. Increase in indirect costs 3. Competition in product markets

3 steps to define an activity:

1. break down by dept 2. evaluate and classify based on pools 3. combine activities that have same cost driver into a single activity

Two ways companies deduct facility-sustaining costs:

1. deduct as one large lump sum from OI (better choice) 2. allocate them to products

Examples of an activity:

1. designing products 2. setting up machines 3. operating machines 4. distributing products . . . . activities are verbs; things the firm does.

4 Ways Managers use ABM to Make Decisions

1. pricing and product-mix decisions 2. cost reduction decisions 3. process improvement decisions 4. evaluate effect of current product and process design on activities and costs and to identify new designs to reduce costs 5. planning and managing activities

Formula for Budgeted Indirect-cost Rate:

= Budgeted total costs in indirect-cost pool/ Budgeted total quantity of cost-allocation base

___________-____________ costs are the costs of activities related to a group of units of a product or service rather than each individual unit of product or service.

Batch-level

This refining guideline that suggests to use the cost driver (indirect costs cause) as the cost-allocation base for each homogenous indirect-cost pool (the effect).

Cost-allocation bases

Direct-cost tracing: *maintenance activity* =

DL costs (salaries and wages to workers)

This refining guideline identifies as many direct costs as economically feasible. This guideline aims to reduce the amount of costs classified as indirect costs, thereby minimizing "allocated vs traced."

Direct-cost tracing

_____________-___________________ costs are costs of activities that managers cannot trace to individual products or services but that support the organization as a whole.

Facility-sustaining

First or second-stage of allocation? - determining cost of activity pool (salary, wages, electricity, maintenance).

First-stage allocation

Examples of facility-sustaining costs:

General admin costs such as: -top management compensation -rent -building security

This refining guideline expands the nuber of indirect-cost pools until each pool is more homogenous. All costs in homogenous pool have same or similar cause-and-effect (benefits received) relationship with a single cost driver that is used as a cost allocation base.

Indirect-cost pools

Example of output unit-level costs:

Machine operating costs such as: -depreciation -energy costs -machine hours . . . which increases cost with additional activity.

Benefits and Costs of ABC Systems: __________________ staff has substantial disagreement with the reported costs of manufacturing and marketing products and services.

Operations

Benefits and Costs of ABC Systems: ____________________ make diverse demands on resources because of differences in volume, process steps, batch size, or complexity.

Products

First or second-stage of allocation? - focusing on the allocation of costs of activity cost pools to products (find cost driver!).

Second-stage allocation (aka cost-allocation bases)

How does USPS (public service institution) use ABC differently?

Since it cannot charge higher prices for delivering mail to remote places, the cost is spread evenly, however, ABC is valuable for understanding, managing, and reducing costs but not for pricing decisions.

Single indirect-cost pool vs. ABC system: True or False: ABC system traces more costs as direct costs.

True

Single indirect-cost pool vs. ABC system: True or False: ABC systems create homogenous cost pools linked to different activities.

True

Single indirect-cost pool vs. ABC system: True or False: for each activity-cost pool. ABC systems seek a cost-allocation base that has a cause-and-effect relationship with costs in the cost pool.

True

True or False: The widespread use of ABC systems in *service and merchandising companies* reinforces the idea that ABC systems are used by managers for *strategic decisions rather than inventory valuation.*

True

True or False: Averaging leads to inaccurate and misleading data.

True

True or False: Broad averaging often leads to overcosting or undercosting of products or services.

True

True or False: Product-cost cross-subsidization is very common when a cost is uniformly spread (averaged) across multiple products.

True

True or False: The ABC system focuses on refining the assignment of indirect costs to departments, processes, products, or other cost objects.

True

Using cost info for strategic decisions: ________________ products will underpriced and lead to sales that result in losses because cost outweighs its revenue.

Undercosted

An __________________ is an event, task, or unit of work with a specified purpose

activity (verb . . . things the firm does)

USAA Bank uses ___________-____________ costing system.

activity-based

One of the best tools for refining a cost system, _______________-_______________ costing refines a costing system by identifying individual activities as the fundamental cost objects.

activity-based costing (ABC)

Consider __________________ and reliable __________ and _________________ when choosing a cost-allocation base.

availability, data, measure