Description
Activity-based costing (ABC) is a costing methodology that identifies activities in an organization and assigns the cost of each activity with resources to all products and services according to the actual consumption by each.
ABC-ACTIVITY BASED COSTING
Activity Based Costing (ABC)
• Historical development • Traditionally cost accountants had arbitrarily added a broad percentage of expenses onto the direct costs to allow for the indirect costs. • However as the percentages of indirect or overhead costs had risen, this technique became increasingly inaccurate because the indirect costs were not caused equally by all the products. For example, one product might take more time in one expensive machine than another product, but since the amount of direct labor and materials might be the same, the additional cost for the use of the machine would not be recognised when the same broad 'on-cost' percentage is added to all products. Consequently, when multiple products share common costs, there is a danger of one product subsidizing another.
2
SUMMARY OF COST DISTORTIONS THAT TEND TO OCCUR IN TRADITIONAL COST SYSTEMS
TYPE OF DIVERSITY PRODUCT TYPE OR CHARACTERISTIC TYPE OF COST DISTORTION THAT TENDS TO OCCUR IN TRADITIONAL COST SYSTEMS Undercost, i.e., too little overhead is allocated to these products. Overcost, i.e., too much overhead is allocated to these products. Undercost Overcost Undercost Overcost Undercost Overcost Undercost
Production volume
Low Volume specialty High Volume main line
Product Size
Small Large
Product Complexity
Complex design Simple design
Product Materials requirements
Requires many, or unique parts, i.e., only used on a single product. Requires few, or common parts, i.e., same part used on many products.
Product Machine setup requirements
Requires many, long or complex machine setups.
Requires few, short or simple machine setups.
Overcost
3
• The concepts of ABC were developed in the manufacturing sector of the United States during the 1970s and 1980s. During this time, the Consortium for Advanced Manufacturing-International, now known simply as CAM-I, provided a formative role for studying and formalizing the principles that have become more formally known as Activity-Based Costing.[1] • Robin Cooper and Robert Kaplan, proponent of the Balanced Scorecard, brought notice to these concepts in a number of articles published in Harvard Business Review beginning in 1988. Cooper and Kaplan described ABC as an approach to solve the problems of traditional cost management systems. These traditional costing systems are often unable to determine accurately the actual costs of production and of the costs of related services. Consequently managers were making decisions based on inaccurate data especially where there are multiple products. • Activity-based costing (ABC) is a method of allocating costs to products and services. It is generally used as a tool for planning and control. This is a necessary tool for doing value chain analysis. • This extended use of ABC to financial institutions was presented in 1990 in an article appearing in the Journal of Bank Cost and Management Accounting (Volume 3, Number 2) by Richard Sapp, David Crawford and Steven Rebishcke. There was also a subsequent article in 1991 in the same Journal (Volume 4, Number 1).
4
The 1970s and 1980s
• Instead of using broad arbitrary percentages to allocate costs, ABC seeks to identify cause and effect relationships to objectively assign costs. Once costs of the activities have been identified, the cost of each activity is attributed to each product to the extent that the product uses the activity. In this way ABC often identifies areas of high overhead costs per unit and so directs attention to finding ways to reduce the costs or to charge more for costly products.
5
• Like manufacturing industries, financial institutions also have diverse products and customers which can cause cross-product cross-customer subsidies. Since personnel expenses represent the largest single component of non-interest expense in financial institutions, these costs must also be attributed more accurately to products and customers. Activity based costing, even though originally developed for manufacturing, may even be a more useful tool for doing this
6
What is ABC
• Activity based costing (ABC) assigns manufacturing overhead costs to products in a more logical manner than the traditional approach of simply allocating costs on the basis of machine hours/ direct labour hours. Activity based costing first assigns costs to the activities that are the real cause of the overhead. It then assigns the cost of those activities only to the products that are actually demanding the activities.
– Product 124 is a low volume item which requires certain activities such as special engineering, additional testing, and many machine setups because it is ordered in small quantities. A similar product, Product 366, is a high volume product—running continuously—and requires little attention and no special activities. Product 124 is a low volume item which requires certain activities such as special engineering, additional testing, and many machine setups because it is ordered in small quantities. A similar product, Product 366, is a high volume product—running continuously—and requires little attention and no special activities.
• Under ABC, the company will calculate the cost of the resources used in each of these activities. Next, the cost of each of these activities will be assigned only to the products that demanded the activities. the manufacturing overhead costs no longer correlate with the productive machine hours or direct labor hours,
7
• ABC is an alternative to the traditional way of accounting. Instead of using broad arbitrary percentages to allocate costs, ABC seeks to identify cause and effect relationships to objectively assign costs • ABC is an accounting methodology that assigns costs to activities rather than products or services. This enables resource and overhead costs to be more accurately assigned to the products and the services that utilize the resources. ABC is a method of allocating costs to products and services. • In order to correctly associate costs with products and services ABC assigns cost to activities based on their use of resources. It then assigns cost to cost objects, such as products or customers, based on their use of resources/activities. This information assists in making decisions about pricing, outsourcing, capital expenditures and operational efficiency. • It is possible to draw the relationship between products/services (cost objects) and the resources that are utilized by the product or service. • ABC is a costing model that identifies the cost pools, or activity centres, in an organisation and assigns costs to products and services (cost drivers),customers based on the number of events or transactions involved in the process of providing a product or service or servicing customers.
ABC Explained
8
•
• • • • • • • •
Usefulness of ABC ABC is generally used as a tool for planning and control. This is a necessary
•
tool for doing value chain analysis ABC assigns manufacturing overhead costs to products in a more logical manner than the traditional approach In order to correctly associate costs with products and services, ABC assigns cost to activities based on their use of resources. It then assigns cost to cost objects, such as products or customers, based on their use of activities This information assists in making decisions about pricing, outsourcing, capital expenditures and operational efficiency. Knowing your “winners” from your “losers” is critical. It’s not getting any easier out there—you have to remain competitive. Flat shop rates don’t provide a true cost picture. ABC provides a simple approach to analyze true cost and is now being applied even to small job shops. Also, ABC allows managers to see how to maximise performance and implement sound profit-growth strategies. Once costs of the activities have been identified, the cost of each activity is attributed to each product to the extent that the product uses the activity. In this way ABC often identifies areas of high overhead costs per unit and so directs attention to finding ways to reduce the costs or to charge more for costly products.
9
Benefits/Advantages of ABC
• • • • • • • • • Typical benefits of ABC include: Identifying the most and least profitable customers, products and channels Determine the true contributors to- and detractors from financial performance. Accurately predict costs, profits and resource requirements associated with changes in production volumes, organizational structure and resource costs. Easily identify the root causes of poor financial performance. Track costs of activities and work processes. Equip managers with cost intelligence to drive improvements. Facilitate better Marketing Mix Enhance the bargaining power with the customer. Achieve better Positioning of products.
10
Benefits of ABC
• • ABC implementation can help make employees to understand the various costs involved, which will in turn enable them to analyze the cost, identify the Value Added and Non Value Added Activities, implement the improvements and realize the benefits. ABC has helped enterprises in answering the market need of better quality products at competitive prices. Analyzing the product profitability and customer profitability, the ABC method has contributed effectively for the top management’s decision making process. With ABC, enterprises are able to improve their efficiency and reduce the cost without sacrificing the value for the customer. Many companies also use ABC as a basis for a balanced scorecard. Overall, ABC is a dynamic method for continuous improvement. With ABC, any enterprise will have a built in competitive cost advantage and can continuously add value to both its stakeholders and customers.
• • • •
11
Cost Driver, Resource Cost Driver, An Activity Cost Driver
• Direct labor and materials are relatively easy to trace directly to products, but it is more difficult to directly allocate indirect costs to products. Where products use common resources differently, some sort of weighting is needed in the cost allocation process. The measure of the use of a shared activity by each of the products is known as the cost driver. For example, the cost of the activity of bank tellers can be ascribed to each product by measuring how long each product's transactions takes at the counter and then by measuring the number of each type of transaction. • Cost pools are assigned to products using cost drivers. The cost drivers measure the number of individual activities undertaken or performed to produce products or provide services, used as a basis for allocating.
12
Cost Driver, Resource Cost Driver, An Activity Cost Driver cond.
• A Cost Driver- it is a factor that causes a change in cost of an activity; there are 2 categories of cost driver – A Resource Cost Driver (the activities that consume the company's resources,)- It is a measure of quantity of resources consumed by an activity. It is used to assign cost of resources to an activity or cost pool. Resource drivers that keep track of how the subsequent activity level affects the resource consumption. The process requires the assignment of cost from general ledger accounts to activities using resource drivers. E.g. area occupied by a purchase department. An Activity Cost Driver – It is a measure of frequency & intensity of demand, placed on activities by cost object. It is used to assign activity costs to cost object. Activity drivers that keep track of how cost object behaviour influences activity levels, i.e., the level of activity for each activity. e.g. number of purchase orders placed. Activity Cost Drivers consists of • Transaction Drivers (number of purchase orders , number of customer orders, number of inspection performed, number of set ups required) & • Duration Drivers. (time required to perform the activity, set up hours, inspection hours
13
HEIRARCHY OF ACTIVITIES
1. 2. 3. 4. 5. UNIT LEVEL ACTIVITIES BATCH LEVEL ACTIVITIES PRODUCT LEVEL ACTIVITIES FACILITY LEVEL ACTVITIES CUSTOMER LEVEL ACTIVITIES
• UNIT LEVEL ACTIVITIES (Unit level drivers are triggered for every unit that is being produced. For example, for a man and a machine that produces one unit at a time, the associated direct labor will be a unit level cost driver. This is therefore a volume related driver similar to the traditional allocation bases.) – Use of indirect material , Inspection or testing every item produced r say every 100th item produced, Indirect consumables, providing power to run processing equipment. • BATCH LEVEL ACTIVITIES (Batch level drivers are triggered for every batch produced. A good example of that is production planning, because the planning is done for each and every batch regardless of the size of the batch. Here, number of batches can be a good driver. ) – materials ordering, Machine set up costs, Inspection of product on sample basis, arranging for deliveries to customers
14
HEIRARCHY OF ACTIVITIES contd
• PRODUCT LEVEL (Product level drivers are triggered for every product regardless of the number of units and batches produced. These drivers occur by the sole existence of a product. A good example of a driver is the number of product development hours per product so that the more product development hours a product triggers, the more product development costs should be assigned to that product. – Designing , modifying the product, Producing parts to certain specifications, Advertising costs, if advertisement is for individual product, Managing inventory • FACILITY LEVEL (Facility level driver are drivers that are not related to the products at all. Costs that are traced by such drivers will therefore be allocated to products and not traced. The difference between allocation and tracing is that allocation is quite arbitrary whereas tracing is based on 'cause and effect' relations. ) – Maintenance of building & plant, Plant security, Production manager’s salaries, Advertising campaign the company, managing factory, heating factory, providing factory safety and security, maintaining general-purpose equipment, cleaning executive offices, arranging for loans, closing books each month, preparing annual reports to shareholders, providing a computer network, etc. • CUSTOMER LEVEL – IT-support, sales calls, sales visits, catalog mailings, etc) 15
Some cost drivers
Machine-hours used Labour-hours or labour cost incurred Pounds of material handled Computer time used Number of items produced or sold Customers served
Pages typed Machine setups
Purchased orders completed Quality inspections performed Number of parts installed in a product
Flight hours completed Surgeries performed
Scrap/rework orders completed Hours of testing time spent Number of different customers served
Type of Business Manufacturing Restaurant Taxi Hotel Printing company Hospital
Cost Direct Materials Payroll Fuel Housekeeping costs Paper Food cost
Cost Driver Number of units produced Number of hours worked Number of miles driven Number of rooms occupied Number of pages printed 16 Number of patients served
Limitations
• Even in activity-based costing, some overhead costs are difficult to assign to products and customers, for example the chief executive's salary. These costs are termed 'business sustaining' and are not assigned to products and customers because there is no meaningful method. This lump of unallocated overhead costs must nevertheless be met by contributions from each of the products, but it is not as large as the overhead costs before ABC is employed. • ABC must be tailored for each organisation in the light of its intentions and particular requirements, using a degree of analysis that is affordable and realistic. • ABC will never be a panacea for inefficiency or incompetence . • Although some may argue that costs untraceable to activities should be "arbitrarily allocated" to products, it is important to realize that the only purpose of ABC is to provide information to management. Therefore, there is no reason to assign any cost in an arbitrary manner
17
When to switch to ABC
• Switch to ABC when...
– Products differ greatly in volume and manufacturing complexity – Products lines are
• numerous • diverse • require differing degrees of support services
– Overhead costs constitute a significant portion of total costs – The manufacturing process or number of products has changed significantly
18
ABC DEFINITIONS
• An activity is an event/transaction that incurs costs. • A cost driver is any factor or activity that has a direct cause and effect relationship with resource consumed. • A activity cost pool is a pool of individual costs that all have the same cost driver.
19
The Four Steps to ABC Implementation
1. Identify activities—perform an in-depth analysis of the operating processes of each responsibility segment. Each process may consist of one or more activities required by outputs.
20
The Four Steps to ABC Implementation
Step 2. Assign resource costs to activities • this is sometimes called "tracing." Traceability refers to tracing costs to cost objects to determine why costs were incurred. DoD categorizes costs in three ways: – Direct—costs that can be traced directly to one output. Example: the material costs (varnish, wood, paint) to build a chair. – Indirect—costs that cannot be allocated to an individual output; in other words, they benefit two or more outputs, but not all outputs. Examples: maintenance costs for the saws that cut the wood, storage costs, other construction materials, and quality assurance.) • General & Administrative—costs that cannot reasonably be associated with any particular product or service produced (overhead). These costs would remain the same no matter what output the activity produced. Examples: salaries of personnel in purchasing department, depreciation on equipment, and plant security
21
The Four Steps to ABC Implementation
Step 3 Identify outputs • Identify all of the outputs for which an activity segment performs activities and consumes resources. Outputs can be products, services, or customers (persons or entities to whom a federal agency is required to provide goods or services Step 4 Assign activity costs to outputs Activity costs to outputs using activity drivers. Activity drivers assign activity costs to outputs based on individual outputs’ consumption or demand for activities. For example, a driver may be the number of times an activity is performed (transaction driver) or the length of time an activity is performed (duration driver).
22
• Activity-Based Costing encourages managers to identify which activities are value-added— those that will best accomplish a mission, deliver a service, or meet a customer demand. It improves operational efficiency and enhances decision-making through better, more meaningful cost information
23
24
doc_733659865.pptx
Activity-based costing (ABC) is a costing methodology that identifies activities in an organization and assigns the cost of each activity with resources to all products and services according to the actual consumption by each.
ABC-ACTIVITY BASED COSTING
Activity Based Costing (ABC)
• Historical development • Traditionally cost accountants had arbitrarily added a broad percentage of expenses onto the direct costs to allow for the indirect costs. • However as the percentages of indirect or overhead costs had risen, this technique became increasingly inaccurate because the indirect costs were not caused equally by all the products. For example, one product might take more time in one expensive machine than another product, but since the amount of direct labor and materials might be the same, the additional cost for the use of the machine would not be recognised when the same broad 'on-cost' percentage is added to all products. Consequently, when multiple products share common costs, there is a danger of one product subsidizing another.
2
SUMMARY OF COST DISTORTIONS THAT TEND TO OCCUR IN TRADITIONAL COST SYSTEMS
TYPE OF DIVERSITY PRODUCT TYPE OR CHARACTERISTIC TYPE OF COST DISTORTION THAT TENDS TO OCCUR IN TRADITIONAL COST SYSTEMS Undercost, i.e., too little overhead is allocated to these products. Overcost, i.e., too much overhead is allocated to these products. Undercost Overcost Undercost Overcost Undercost Overcost Undercost
Production volume
Low Volume specialty High Volume main line
Product Size
Small Large
Product Complexity
Complex design Simple design
Product Materials requirements
Requires many, or unique parts, i.e., only used on a single product. Requires few, or common parts, i.e., same part used on many products.
Product Machine setup requirements
Requires many, long or complex machine setups.
Requires few, short or simple machine setups.
Overcost
3
• The concepts of ABC were developed in the manufacturing sector of the United States during the 1970s and 1980s. During this time, the Consortium for Advanced Manufacturing-International, now known simply as CAM-I, provided a formative role for studying and formalizing the principles that have become more formally known as Activity-Based Costing.[1] • Robin Cooper and Robert Kaplan, proponent of the Balanced Scorecard, brought notice to these concepts in a number of articles published in Harvard Business Review beginning in 1988. Cooper and Kaplan described ABC as an approach to solve the problems of traditional cost management systems. These traditional costing systems are often unable to determine accurately the actual costs of production and of the costs of related services. Consequently managers were making decisions based on inaccurate data especially where there are multiple products. • Activity-based costing (ABC) is a method of allocating costs to products and services. It is generally used as a tool for planning and control. This is a necessary tool for doing value chain analysis. • This extended use of ABC to financial institutions was presented in 1990 in an article appearing in the Journal of Bank Cost and Management Accounting (Volume 3, Number 2) by Richard Sapp, David Crawford and Steven Rebishcke. There was also a subsequent article in 1991 in the same Journal (Volume 4, Number 1).
4
The 1970s and 1980s
• Instead of using broad arbitrary percentages to allocate costs, ABC seeks to identify cause and effect relationships to objectively assign costs. Once costs of the activities have been identified, the cost of each activity is attributed to each product to the extent that the product uses the activity. In this way ABC often identifies areas of high overhead costs per unit and so directs attention to finding ways to reduce the costs or to charge more for costly products.
5
• Like manufacturing industries, financial institutions also have diverse products and customers which can cause cross-product cross-customer subsidies. Since personnel expenses represent the largest single component of non-interest expense in financial institutions, these costs must also be attributed more accurately to products and customers. Activity based costing, even though originally developed for manufacturing, may even be a more useful tool for doing this
6
What is ABC
• Activity based costing (ABC) assigns manufacturing overhead costs to products in a more logical manner than the traditional approach of simply allocating costs on the basis of machine hours/ direct labour hours. Activity based costing first assigns costs to the activities that are the real cause of the overhead. It then assigns the cost of those activities only to the products that are actually demanding the activities.
– Product 124 is a low volume item which requires certain activities such as special engineering, additional testing, and many machine setups because it is ordered in small quantities. A similar product, Product 366, is a high volume product—running continuously—and requires little attention and no special activities. Product 124 is a low volume item which requires certain activities such as special engineering, additional testing, and many machine setups because it is ordered in small quantities. A similar product, Product 366, is a high volume product—running continuously—and requires little attention and no special activities.
• Under ABC, the company will calculate the cost of the resources used in each of these activities. Next, the cost of each of these activities will be assigned only to the products that demanded the activities. the manufacturing overhead costs no longer correlate with the productive machine hours or direct labor hours,
7
• ABC is an alternative to the traditional way of accounting. Instead of using broad arbitrary percentages to allocate costs, ABC seeks to identify cause and effect relationships to objectively assign costs • ABC is an accounting methodology that assigns costs to activities rather than products or services. This enables resource and overhead costs to be more accurately assigned to the products and the services that utilize the resources. ABC is a method of allocating costs to products and services. • In order to correctly associate costs with products and services ABC assigns cost to activities based on their use of resources. It then assigns cost to cost objects, such as products or customers, based on their use of resources/activities. This information assists in making decisions about pricing, outsourcing, capital expenditures and operational efficiency. • It is possible to draw the relationship between products/services (cost objects) and the resources that are utilized by the product or service. • ABC is a costing model that identifies the cost pools, or activity centres, in an organisation and assigns costs to products and services (cost drivers),customers based on the number of events or transactions involved in the process of providing a product or service or servicing customers.
ABC Explained
8
•
• • • • • • • •
Usefulness of ABC ABC is generally used as a tool for planning and control. This is a necessary
•
tool for doing value chain analysis ABC assigns manufacturing overhead costs to products in a more logical manner than the traditional approach In order to correctly associate costs with products and services, ABC assigns cost to activities based on their use of resources. It then assigns cost to cost objects, such as products or customers, based on their use of activities This information assists in making decisions about pricing, outsourcing, capital expenditures and operational efficiency. Knowing your “winners” from your “losers” is critical. It’s not getting any easier out there—you have to remain competitive. Flat shop rates don’t provide a true cost picture. ABC provides a simple approach to analyze true cost and is now being applied even to small job shops. Also, ABC allows managers to see how to maximise performance and implement sound profit-growth strategies. Once costs of the activities have been identified, the cost of each activity is attributed to each product to the extent that the product uses the activity. In this way ABC often identifies areas of high overhead costs per unit and so directs attention to finding ways to reduce the costs or to charge more for costly products.
9
Benefits/Advantages of ABC
• • • • • • • • • Typical benefits of ABC include: Identifying the most and least profitable customers, products and channels Determine the true contributors to- and detractors from financial performance. Accurately predict costs, profits and resource requirements associated with changes in production volumes, organizational structure and resource costs. Easily identify the root causes of poor financial performance. Track costs of activities and work processes. Equip managers with cost intelligence to drive improvements. Facilitate better Marketing Mix Enhance the bargaining power with the customer. Achieve better Positioning of products.
10
Benefits of ABC
• • ABC implementation can help make employees to understand the various costs involved, which will in turn enable them to analyze the cost, identify the Value Added and Non Value Added Activities, implement the improvements and realize the benefits. ABC has helped enterprises in answering the market need of better quality products at competitive prices. Analyzing the product profitability and customer profitability, the ABC method has contributed effectively for the top management’s decision making process. With ABC, enterprises are able to improve their efficiency and reduce the cost without sacrificing the value for the customer. Many companies also use ABC as a basis for a balanced scorecard. Overall, ABC is a dynamic method for continuous improvement. With ABC, any enterprise will have a built in competitive cost advantage and can continuously add value to both its stakeholders and customers.
• • • •
11
Cost Driver, Resource Cost Driver, An Activity Cost Driver
• Direct labor and materials are relatively easy to trace directly to products, but it is more difficult to directly allocate indirect costs to products. Where products use common resources differently, some sort of weighting is needed in the cost allocation process. The measure of the use of a shared activity by each of the products is known as the cost driver. For example, the cost of the activity of bank tellers can be ascribed to each product by measuring how long each product's transactions takes at the counter and then by measuring the number of each type of transaction. • Cost pools are assigned to products using cost drivers. The cost drivers measure the number of individual activities undertaken or performed to produce products or provide services, used as a basis for allocating.
12
Cost Driver, Resource Cost Driver, An Activity Cost Driver cond.
• A Cost Driver- it is a factor that causes a change in cost of an activity; there are 2 categories of cost driver – A Resource Cost Driver (the activities that consume the company's resources,)- It is a measure of quantity of resources consumed by an activity. It is used to assign cost of resources to an activity or cost pool. Resource drivers that keep track of how the subsequent activity level affects the resource consumption. The process requires the assignment of cost from general ledger accounts to activities using resource drivers. E.g. area occupied by a purchase department. An Activity Cost Driver – It is a measure of frequency & intensity of demand, placed on activities by cost object. It is used to assign activity costs to cost object. Activity drivers that keep track of how cost object behaviour influences activity levels, i.e., the level of activity for each activity. e.g. number of purchase orders placed. Activity Cost Drivers consists of • Transaction Drivers (number of purchase orders , number of customer orders, number of inspection performed, number of set ups required) & • Duration Drivers. (time required to perform the activity, set up hours, inspection hours
13
HEIRARCHY OF ACTIVITIES
1. 2. 3. 4. 5. UNIT LEVEL ACTIVITIES BATCH LEVEL ACTIVITIES PRODUCT LEVEL ACTIVITIES FACILITY LEVEL ACTVITIES CUSTOMER LEVEL ACTIVITIES
• UNIT LEVEL ACTIVITIES (Unit level drivers are triggered for every unit that is being produced. For example, for a man and a machine that produces one unit at a time, the associated direct labor will be a unit level cost driver. This is therefore a volume related driver similar to the traditional allocation bases.) – Use of indirect material , Inspection or testing every item produced r say every 100th item produced, Indirect consumables, providing power to run processing equipment. • BATCH LEVEL ACTIVITIES (Batch level drivers are triggered for every batch produced. A good example of that is production planning, because the planning is done for each and every batch regardless of the size of the batch. Here, number of batches can be a good driver. ) – materials ordering, Machine set up costs, Inspection of product on sample basis, arranging for deliveries to customers
14
HEIRARCHY OF ACTIVITIES contd
• PRODUCT LEVEL (Product level drivers are triggered for every product regardless of the number of units and batches produced. These drivers occur by the sole existence of a product. A good example of a driver is the number of product development hours per product so that the more product development hours a product triggers, the more product development costs should be assigned to that product. – Designing , modifying the product, Producing parts to certain specifications, Advertising costs, if advertisement is for individual product, Managing inventory • FACILITY LEVEL (Facility level driver are drivers that are not related to the products at all. Costs that are traced by such drivers will therefore be allocated to products and not traced. The difference between allocation and tracing is that allocation is quite arbitrary whereas tracing is based on 'cause and effect' relations. ) – Maintenance of building & plant, Plant security, Production manager’s salaries, Advertising campaign the company, managing factory, heating factory, providing factory safety and security, maintaining general-purpose equipment, cleaning executive offices, arranging for loans, closing books each month, preparing annual reports to shareholders, providing a computer network, etc. • CUSTOMER LEVEL – IT-support, sales calls, sales visits, catalog mailings, etc) 15
Some cost drivers
Machine-hours used Labour-hours or labour cost incurred Pounds of material handled Computer time used Number of items produced or sold Customers served
Pages typed Machine setups
Purchased orders completed Quality inspections performed Number of parts installed in a product
Flight hours completed Surgeries performed
Scrap/rework orders completed Hours of testing time spent Number of different customers served
Type of Business Manufacturing Restaurant Taxi Hotel Printing company Hospital
Cost Direct Materials Payroll Fuel Housekeeping costs Paper Food cost
Cost Driver Number of units produced Number of hours worked Number of miles driven Number of rooms occupied Number of pages printed 16 Number of patients served
Limitations
• Even in activity-based costing, some overhead costs are difficult to assign to products and customers, for example the chief executive's salary. These costs are termed 'business sustaining' and are not assigned to products and customers because there is no meaningful method. This lump of unallocated overhead costs must nevertheless be met by contributions from each of the products, but it is not as large as the overhead costs before ABC is employed. • ABC must be tailored for each organisation in the light of its intentions and particular requirements, using a degree of analysis that is affordable and realistic. • ABC will never be a panacea for inefficiency or incompetence . • Although some may argue that costs untraceable to activities should be "arbitrarily allocated" to products, it is important to realize that the only purpose of ABC is to provide information to management. Therefore, there is no reason to assign any cost in an arbitrary manner
17
When to switch to ABC
• Switch to ABC when...
– Products differ greatly in volume and manufacturing complexity – Products lines are
• numerous • diverse • require differing degrees of support services
– Overhead costs constitute a significant portion of total costs – The manufacturing process or number of products has changed significantly
18
ABC DEFINITIONS
• An activity is an event/transaction that incurs costs. • A cost driver is any factor or activity that has a direct cause and effect relationship with resource consumed. • A activity cost pool is a pool of individual costs that all have the same cost driver.
19
The Four Steps to ABC Implementation
1. Identify activities—perform an in-depth analysis of the operating processes of each responsibility segment. Each process may consist of one or more activities required by outputs.
20
The Four Steps to ABC Implementation
Step 2. Assign resource costs to activities • this is sometimes called "tracing." Traceability refers to tracing costs to cost objects to determine why costs were incurred. DoD categorizes costs in three ways: – Direct—costs that can be traced directly to one output. Example: the material costs (varnish, wood, paint) to build a chair. – Indirect—costs that cannot be allocated to an individual output; in other words, they benefit two or more outputs, but not all outputs. Examples: maintenance costs for the saws that cut the wood, storage costs, other construction materials, and quality assurance.) • General & Administrative—costs that cannot reasonably be associated with any particular product or service produced (overhead). These costs would remain the same no matter what output the activity produced. Examples: salaries of personnel in purchasing department, depreciation on equipment, and plant security
21
The Four Steps to ABC Implementation
Step 3 Identify outputs • Identify all of the outputs for which an activity segment performs activities and consumes resources. Outputs can be products, services, or customers (persons or entities to whom a federal agency is required to provide goods or services Step 4 Assign activity costs to outputs Activity costs to outputs using activity drivers. Activity drivers assign activity costs to outputs based on individual outputs’ consumption or demand for activities. For example, a driver may be the number of times an activity is performed (transaction driver) or the length of time an activity is performed (duration driver).
22
• Activity-Based Costing encourages managers to identify which activities are value-added— those that will best accomplish a mission, deliver a service, or meet a customer demand. It improves operational efficiency and enhances decision-making through better, more meaningful cost information
23
24
doc_733659865.pptx