Description
This is a PPT about how costs are treated under activity based costing, designing abc system, difference between ABC and traditional product costs, ABC limitations.
ACTIVITY BASED COSTING (ABC)
Activity-Based Costing: A Tool to Aid Decision Making
Activity Based Costing (ABC)
ABC is designed to provide managers with cost information for strategic and other decisions that potentially affect capacity and therefore affect fixed as well as variable costs.
ABC is a good supplement to our traditional cost system
I agree!
How Costs are Treated Under Activity–Based Costing
“Best practice” ABC differs from traditional costing in five ways.
Manufacturing costs Nonmanufacturing costs
Traditional product costing
ABC product costing
? ABC assigns both types of costs to products.
How Costs are Treated Under Activity–Based Costing
“Best practice” ABC differs from traditional costing in five ways.
Manufacturing costs All Nonmanufacturing costs Some
Traditional product costing
ABC product costing
? ABC does not assign all manufacturing costs to products.
How Costs are Treated Under Activity–Based Costing
“Best practice” ABC differs from traditional costing in five ways.
Level of complexity
Activity–Based Costing Departmental Overhead Rates Plantwide Overhead Rate
Number of cost pools ?ABC uses more cost pools.
How Costs are Treated Under Activity–Based Costing
“Best practice” ABC differs from traditional costing in five ways.
Volume measures plus other bases.
Number of Allocation Bases
Bases usually rely solely on volume measures.
Traditional Costing ABC ? ABC uses more allocation bases.
How Costs are Treated Under Activity–Based Costing
“Best practice” ABC differs from traditional costing in five ways.
The most commonly used allocation base in traditional costing is direct labor hours.
Direct labor hours work well when overhead increases as direct labor hours increase.
? ABC uses more allocation bases.
How Costs are Treated Under Activity–Based Costing
“Best practice” ABC differs from traditional costing in five ways.
The most commonly used allocation base in traditional costing is direct labor hours. Problems: ?In many processes, overhead is increasing while direct labor is decreasing. ? Variety and complexity of products is increasing.
? ABC uses more allocation bases.
How Costs are Treated Under Activity–Based Costing
“Best practice” ABC differs from traditional costing in five ways.
ABC uses volume as well as other allocation bases not related to the volume of production.
All overhead costs are not related to volume measures like direct labor hours.
? ABC uses more allocation bases.
How Costs are Treated Under Activity–Based Costing
“Best practice” ABC differs from traditional costing in five ways.
Traditional Costing
The predetermined overhead rate is based on budgeted activity. This results in applying all overhead costs including unused, or idle capacity costs to products.
ABC
Products are charged for the costs of capacity they use – not for the costs of capacity they don’t use. Unused capacity costs are treated as period expenses.
? ABC bases level of activity on capacity.
Characteristics of Successful ABC Implementations
Strong top management support
Link to evaluations and rewards
Cross-functional involvement
Designing an ABC System
Cost Objects (e.g., products and customers)
Activities
Consumption of Resources
Cost
Designing an ABC System
Steps for Implementing ABC
?Identify and define activities and activity cost pools. ?Trace costs to activities and cost objects. ?Assign costs to activity cost pools. ?Calculate activity rates. ?Assign costs to cost objects. ?Prepare management reports.
?Identify and Define Activities and Activity Cost Pools
Unit-Level Activity Batch-Level Activity
Manufacturing companies typically combine their activities into five classifications.
Product-Level Activity
Organizationsustaining Activity
Customer-Level Activity
?Identify and Define Activities and Activity Cost Pools
Activities should only be combined within a level if they are highly correlated. When combining activities, they should be grouped together only at the appropriate level.
?Identify and Define Activities and Activity Cost Pools
An Activity Cost
Pool is a “bucket” in which costs are accumulated that relate to a single activity measure in the ABC system.
$$ $ $ $ $
?Identify and Define Activities and Activity Cost Pools
Two types of activity measures: Transaction driver
Simple count of the number of times an activity occurs.
Duration driver
A measure of the amount of time needed for an activity.
?Identify and Define Activities and Activity Cost Pools
At Classic Brass, the ABC team, selected the following activity cost pools and activity measures:
?Identify and Define Activities and Activity Cost Pools
• Customer Orders - assigned all costs of resources that are consumed by taking and processing customer orders. • Product Designs - assigned all costs of resources consumed by designing products. • Order Size - assigned all costs of resources consumed as a consequence of the number of units produced. • Customer Relations – assigned all costs associated with maintaining relations with customers. • Other – assigned all overhead costs that are not associated with the other cost pools.
?When Possible, Directly Trace Overhead
Costs to Activities and Cost Objects
?Assign Costs to Activity Cost Pools
At Classic Brass the following distribution of resource consumption across activity cost pools is determined.
**Not included because they are directly traced to customer orders.
?Assign Costs to Activity Cost Pools
Indirect factory wages $500,000 Percent consumed by customer orders 25% $125,000
?Assign Costs to Activity Cost Pools
Factory equipment depreciation $300,000 Percent consumed by customer orders 20% $ 60,000
?Assign Costs to Activity Cost Pools
?Calculate Activity Rates
The ABC team determines that Classic Brass will have these total activities for each activity cost pool . . .
– – – – 1,000 customer orders, 200 new designs, 20,000 machine-hours, 100 customer relations activities.
Now the team can compute the individual activity rates by dividing the total cost for each activity by the total activity levels.
?Calculate Activity Rates
Activity-Based Costing at Classic Brass
Direct Materials Direct Labor Shipping Costs Overhead Costs
Traced
Traced
Traced
Cost Objects:
Products, Customer Orders, Customers
Activity-Based Costing at Classic Brass
Direct Materials Direct Labor Shipping Costs Overhead Costs
First-Stage Allocation
Order Size
Customer Orders
Product Design
Customer Relations
Other
Cost Objects:
Products, Customer Orders, Customers
Activity-Based Costing at Classic Brass
Direct Materials Direct Labor Shipping Costs Overhead Costs
First-Stage Allocation
Order Size
Customer Orders
Product Design
Customer Relations
Other
Second-Stage Allocations
$/MH $/Order $/Design $/Customer
Cost Objects:
Products, Customer Orders, Customers
Unallocated
?Assigning Costs to Cost Objects
Let’s take a look at how our system works for just one customer – Windward Yachts.
Standard Stanchions (no design required) 1. 400 units ordered with 2 separate orders. 2. Each stanchion required 0.5 machine-hours. 3. Selling price is $34 each. 4. Direct materials total $2,110. 5. Direct labor totals $1,850. 6. Shipping costs total $180. Custom Compass Housing (requires new design) 1. One order during the year. 2. Each housing required 4 machine-hours. 3. Selling price is $650 each. 4. Direct materials total $13. 5. Direct labor totals $50. 6. Shipping costs total $25.
?Assigning Costs to Cost Objects
The customer-level cost is assigned to customers directly; it is not assigned to products.
?Prepare Management Reports
Standard Stanchions Sales Cost: Direct materials Direct labor Shipping costs Customer orders Product design Order size Product margin $ $ 2,110 1,850 180 630 3,800 $ 13,600
8,570 5,030
Custom Compass Housing Sales Cost: Direct materials Direct labor Shipping costs Customer orders Product design Order size Product margin
$ $ 13 50 25 315 1,285 76
650
1,764 $ (1,114)
?Prepare Management Reports
Customer Profitability Analysis
Product Margins
Traditional Cost Accounting System
400 units x 0.5 MH/unit x $50/MH = $10,000
Predetermined manufacturing = overhead rate
$1,000,000 20,000 MH
= $50/MH
Differences Between ABC and Traditional Product Costs
Product margins are different for four reasons:
?Traditional costing assigns design costs to both products
based on machine hours. ABC assigns product design costs to a product only if product design work is required.
? Traditional costing assigns customer order costs, a batchlevel cost, using a unit-level allocation base, machine hours. ABC assigns these batch-level costs using a batch-level activity measure.
?Traditional costing assigns only manufacturing costs to
products. ABC also assigns nonmanufacturing costs to products.
? Traditional costing assigns all manufacturing costs to
products. The ABC system does not assign organizationsustaining manufacturing costs to the products.
Differences Between ABC and Traditional Product Costs
When batch-level and product-level costs are present, ABC will usually shift costs from high volume products, produced in large batches, to low volume products produced in small batches.
This cost shifting will usually have its greatest impact on the per unit cost of the low volume products.
Targeting Process Improvement
Activity-based management is used in conjunction with ABC to identify areas that would benefit from process improvements.
While the theory of constraints approach discussed in Chapter 1 is a powerful tool for targeting improvement efforts, activity rates can also provide valuable clues on where to focus improvement efforts.
Activity-Based Costing and External Reporting
Most companies do not use ABC for external reporting because . . .
1. External reports are less detailed than internal reports. 2. It may be difficult to make changes to the company’s accounting system. 3. ABC does not conform to GAAP. 4. Auditors may be suspect of the subjective allocation process based on interviews with employees.
ABC Limitations
Substantial resources required to implement and maintain. Resistance to unfamiliar numbers and reports.
Desire to fully allocate all costs to products.
Potential misinterpretation of unfamiliar numbers.
Does not conform to GAAP. Two costing systems may be needed.
Appendix 8A: ABC Action Analysis
Conventional ABC analysis does not identify potentially relevant costs. An action analysis report helps because it: • Shows what costs have been assigned to a cost object.
• Indicates how difficult it would be to adjust those costs in response to changes in the level of activity.
Appendix 8A: ABC Action Analysis
Constructing an action analysis report begins with the first-stage allocation process. In addition to computing an overall activity rate for each activity cost pool, an activity rate is computed for each type of overhead cost that is consumed supporting a given activity. Let’s revisit the stage-one allocations from the Classic Brass example that we discussed earlier.
Appendix 8A: ABC Action Analysis
$125,000 ÷ 1,000 orders = $125 per order Other entries in the table are computed similarly.
Appendix 8A: ABC Action Analysis
$125 per order × 2 orders = $250 Other entries in the table are computed similarly.
Appendix 8A: ABC Action Analysis
$125 per order × 1 orders = $125 Other entries in the table are computed similarly.
Appendix 8A: ABC Action Analysis
Next, label each cost using an ease of adjustment code: • Green costs adjust more or less automatically to changes in activity level without any action by managers. • Yellow costs can be adjusted to changes in activity level, but it would require management action to realize the change in cost.
• Red costs can be adjusted to changes in activity level only with a great deal difficulty and with management intervention.
Appendix 8A: ABC Action Analysis
Action Analysis of Custom Compass Housing Sales Green costs Direct materials Shipping costs Green margin Yellow costs Direct labor Indirect factory wages Factory utilities Administrative wages and salaries Office equipment depreciation Marketing wages and salaries Selling expenses Yellow margin Red costs Factory equipment depreciation Factory building lease Administrative building lease Red margin $ 13 25 $ 50 1,145 72 168 15 175 5 $ 650 38 612
1,630 $ (1,018)
96 -
96 $ (1,114)
End of Chapter 8
doc_375661874.ppt
This is a PPT about how costs are treated under activity based costing, designing abc system, difference between ABC and traditional product costs, ABC limitations.
ACTIVITY BASED COSTING (ABC)
Activity-Based Costing: A Tool to Aid Decision Making
Activity Based Costing (ABC)
ABC is designed to provide managers with cost information for strategic and other decisions that potentially affect capacity and therefore affect fixed as well as variable costs.
ABC is a good supplement to our traditional cost system
I agree!
How Costs are Treated Under Activity–Based Costing
“Best practice” ABC differs from traditional costing in five ways.
Manufacturing costs Nonmanufacturing costs
Traditional product costing
ABC product costing
? ABC assigns both types of costs to products.
How Costs are Treated Under Activity–Based Costing
“Best practice” ABC differs from traditional costing in five ways.
Manufacturing costs All Nonmanufacturing costs Some
Traditional product costing
ABC product costing
? ABC does not assign all manufacturing costs to products.
How Costs are Treated Under Activity–Based Costing
“Best practice” ABC differs from traditional costing in five ways.
Level of complexity
Activity–Based Costing Departmental Overhead Rates Plantwide Overhead Rate
Number of cost pools ?ABC uses more cost pools.
How Costs are Treated Under Activity–Based Costing
“Best practice” ABC differs from traditional costing in five ways.
Volume measures plus other bases.
Number of Allocation Bases
Bases usually rely solely on volume measures.
Traditional Costing ABC ? ABC uses more allocation bases.
How Costs are Treated Under Activity–Based Costing
“Best practice” ABC differs from traditional costing in five ways.
The most commonly used allocation base in traditional costing is direct labor hours.
Direct labor hours work well when overhead increases as direct labor hours increase.
? ABC uses more allocation bases.
How Costs are Treated Under Activity–Based Costing
“Best practice” ABC differs from traditional costing in five ways.
The most commonly used allocation base in traditional costing is direct labor hours. Problems: ?In many processes, overhead is increasing while direct labor is decreasing. ? Variety and complexity of products is increasing.
? ABC uses more allocation bases.
How Costs are Treated Under Activity–Based Costing
“Best practice” ABC differs from traditional costing in five ways.
ABC uses volume as well as other allocation bases not related to the volume of production.
All overhead costs are not related to volume measures like direct labor hours.
? ABC uses more allocation bases.
How Costs are Treated Under Activity–Based Costing
“Best practice” ABC differs from traditional costing in five ways.
Traditional Costing
The predetermined overhead rate is based on budgeted activity. This results in applying all overhead costs including unused, or idle capacity costs to products.
ABC
Products are charged for the costs of capacity they use – not for the costs of capacity they don’t use. Unused capacity costs are treated as period expenses.
? ABC bases level of activity on capacity.
Characteristics of Successful ABC Implementations
Strong top management support
Link to evaluations and rewards
Cross-functional involvement
Designing an ABC System
Cost Objects (e.g., products and customers)
Activities
Consumption of Resources
Cost
Designing an ABC System
Steps for Implementing ABC
?Identify and define activities and activity cost pools. ?Trace costs to activities and cost objects. ?Assign costs to activity cost pools. ?Calculate activity rates. ?Assign costs to cost objects. ?Prepare management reports.
?Identify and Define Activities and Activity Cost Pools
Unit-Level Activity Batch-Level Activity
Manufacturing companies typically combine their activities into five classifications.
Product-Level Activity
Organizationsustaining Activity
Customer-Level Activity
?Identify and Define Activities and Activity Cost Pools
Activities should only be combined within a level if they are highly correlated. When combining activities, they should be grouped together only at the appropriate level.
?Identify and Define Activities and Activity Cost Pools
An Activity Cost
Pool is a “bucket” in which costs are accumulated that relate to a single activity measure in the ABC system.
$$ $ $ $ $
?Identify and Define Activities and Activity Cost Pools
Two types of activity measures: Transaction driver
Simple count of the number of times an activity occurs.
Duration driver
A measure of the amount of time needed for an activity.
?Identify and Define Activities and Activity Cost Pools
At Classic Brass, the ABC team, selected the following activity cost pools and activity measures:
?Identify and Define Activities and Activity Cost Pools
• Customer Orders - assigned all costs of resources that are consumed by taking and processing customer orders. • Product Designs - assigned all costs of resources consumed by designing products. • Order Size - assigned all costs of resources consumed as a consequence of the number of units produced. • Customer Relations – assigned all costs associated with maintaining relations with customers. • Other – assigned all overhead costs that are not associated with the other cost pools.
?When Possible, Directly Trace Overhead
Costs to Activities and Cost Objects
?Assign Costs to Activity Cost Pools
At Classic Brass the following distribution of resource consumption across activity cost pools is determined.
**Not included because they are directly traced to customer orders.
?Assign Costs to Activity Cost Pools
Indirect factory wages $500,000 Percent consumed by customer orders 25% $125,000
?Assign Costs to Activity Cost Pools
Factory equipment depreciation $300,000 Percent consumed by customer orders 20% $ 60,000
?Assign Costs to Activity Cost Pools
?Calculate Activity Rates
The ABC team determines that Classic Brass will have these total activities for each activity cost pool . . .
– – – – 1,000 customer orders, 200 new designs, 20,000 machine-hours, 100 customer relations activities.
Now the team can compute the individual activity rates by dividing the total cost for each activity by the total activity levels.
?Calculate Activity Rates
Activity-Based Costing at Classic Brass
Direct Materials Direct Labor Shipping Costs Overhead Costs
Traced
Traced
Traced
Cost Objects:
Products, Customer Orders, Customers
Activity-Based Costing at Classic Brass
Direct Materials Direct Labor Shipping Costs Overhead Costs
First-Stage Allocation
Order Size
Customer Orders
Product Design
Customer Relations
Other
Cost Objects:
Products, Customer Orders, Customers
Activity-Based Costing at Classic Brass
Direct Materials Direct Labor Shipping Costs Overhead Costs
First-Stage Allocation
Order Size
Customer Orders
Product Design
Customer Relations
Other
Second-Stage Allocations
$/MH $/Order $/Design $/Customer
Cost Objects:
Products, Customer Orders, Customers
Unallocated
?Assigning Costs to Cost Objects
Let’s take a look at how our system works for just one customer – Windward Yachts.
Standard Stanchions (no design required) 1. 400 units ordered with 2 separate orders. 2. Each stanchion required 0.5 machine-hours. 3. Selling price is $34 each. 4. Direct materials total $2,110. 5. Direct labor totals $1,850. 6. Shipping costs total $180. Custom Compass Housing (requires new design) 1. One order during the year. 2. Each housing required 4 machine-hours. 3. Selling price is $650 each. 4. Direct materials total $13. 5. Direct labor totals $50. 6. Shipping costs total $25.
?Assigning Costs to Cost Objects
The customer-level cost is assigned to customers directly; it is not assigned to products.
?Prepare Management Reports
Standard Stanchions Sales Cost: Direct materials Direct labor Shipping costs Customer orders Product design Order size Product margin $ $ 2,110 1,850 180 630 3,800 $ 13,600
8,570 5,030
Custom Compass Housing Sales Cost: Direct materials Direct labor Shipping costs Customer orders Product design Order size Product margin
$ $ 13 50 25 315 1,285 76
650
1,764 $ (1,114)
?Prepare Management Reports
Customer Profitability Analysis
Product Margins
Traditional Cost Accounting System
400 units x 0.5 MH/unit x $50/MH = $10,000
Predetermined manufacturing = overhead rate
$1,000,000 20,000 MH
= $50/MH
Differences Between ABC and Traditional Product Costs
Product margins are different for four reasons:
?Traditional costing assigns design costs to both products
based on machine hours. ABC assigns product design costs to a product only if product design work is required.
? Traditional costing assigns customer order costs, a batchlevel cost, using a unit-level allocation base, machine hours. ABC assigns these batch-level costs using a batch-level activity measure.
?Traditional costing assigns only manufacturing costs to
products. ABC also assigns nonmanufacturing costs to products.
? Traditional costing assigns all manufacturing costs to
products. The ABC system does not assign organizationsustaining manufacturing costs to the products.
Differences Between ABC and Traditional Product Costs
When batch-level and product-level costs are present, ABC will usually shift costs from high volume products, produced in large batches, to low volume products produced in small batches.
This cost shifting will usually have its greatest impact on the per unit cost of the low volume products.
Targeting Process Improvement
Activity-based management is used in conjunction with ABC to identify areas that would benefit from process improvements.
While the theory of constraints approach discussed in Chapter 1 is a powerful tool for targeting improvement efforts, activity rates can also provide valuable clues on where to focus improvement efforts.
Activity-Based Costing and External Reporting
Most companies do not use ABC for external reporting because . . .
1. External reports are less detailed than internal reports. 2. It may be difficult to make changes to the company’s accounting system. 3. ABC does not conform to GAAP. 4. Auditors may be suspect of the subjective allocation process based on interviews with employees.
ABC Limitations
Substantial resources required to implement and maintain. Resistance to unfamiliar numbers and reports.
Desire to fully allocate all costs to products.
Potential misinterpretation of unfamiliar numbers.
Does not conform to GAAP. Two costing systems may be needed.
Appendix 8A: ABC Action Analysis
Conventional ABC analysis does not identify potentially relevant costs. An action analysis report helps because it: • Shows what costs have been assigned to a cost object.
• Indicates how difficult it would be to adjust those costs in response to changes in the level of activity.
Appendix 8A: ABC Action Analysis
Constructing an action analysis report begins with the first-stage allocation process. In addition to computing an overall activity rate for each activity cost pool, an activity rate is computed for each type of overhead cost that is consumed supporting a given activity. Let’s revisit the stage-one allocations from the Classic Brass example that we discussed earlier.
Appendix 8A: ABC Action Analysis
$125,000 ÷ 1,000 orders = $125 per order Other entries in the table are computed similarly.
Appendix 8A: ABC Action Analysis
$125 per order × 2 orders = $250 Other entries in the table are computed similarly.
Appendix 8A: ABC Action Analysis
$125 per order × 1 orders = $125 Other entries in the table are computed similarly.
Appendix 8A: ABC Action Analysis
Next, label each cost using an ease of adjustment code: • Green costs adjust more or less automatically to changes in activity level without any action by managers. • Yellow costs can be adjusted to changes in activity level, but it would require management action to realize the change in cost.
• Red costs can be adjusted to changes in activity level only with a great deal difficulty and with management intervention.
Appendix 8A: ABC Action Analysis
Action Analysis of Custom Compass Housing Sales Green costs Direct materials Shipping costs Green margin Yellow costs Direct labor Indirect factory wages Factory utilities Administrative wages and salaries Office equipment depreciation Marketing wages and salaries Selling expenses Yellow margin Red costs Factory equipment depreciation Factory building lease Administrative building lease Red margin $ 13 25 $ 50 1,145 72 168 15 175 5 $ 650 38 612
1,630 $ (1,018)
96 -
96 $ (1,114)
End of Chapter 8
doc_375661874.ppt