Activity-Based Costing (ABC) and Activity-Based Management by 0jsPsqI4

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									Activity-Based Costing (ABC) and
  Activity-Based Management
              Chapter 5


 ABC – used to produce a refined costing
system where job costing is not appropriate



                                              5-1
Learning Objective 1

Explain undercosting
  and overcosting of
products and services.


                         5-2
    Undercosting and
   Overcosting Example

   Jose, Roberta, and Nancy order
       separate items for lunch.
Jose’s order amounts to          $14
Roberta consumed                  30
Nancy’s order is                  16
Total                            $60
 What is the average cost per lunch?
                                       5-3
       Undercosting and
      Overcosting Example

              $60 ÷ 3 = $20



Jose and Nancy                 Roberta is
are overcosted.               undercosted.



                                             5-4
     Existing Single Indirect-
    Cost Pool System Example

Kole Corporation manufactures a normal lens
       (NL) and a complex lens (CL).
Kole currently uses a single indirect-cost rate
             job costing system.
 Cost objects: 80,000 (NL) and 20,000 (CL).


                                                  5-5
      Existing Single Indirect-
     Cost Pool System Example

              Normal Lenses (NL)
Direct materials                 $1,520,000
Direct mfg. labor                   800,000
Total direct costs               $2,320,000
Direct cost per unit: $2,320,000 ÷ 80,000 = $29



                                                  5-6
      Existing Single Indirect-
     Cost Pool System Example

             Complex Lenses (CL)
Direct materials                 $ 920,000
Direct mfg. labor                   260,000
Total direct costs               $1,180,000
Direct cost per unit: $1,180,000 ÷ 20,000 = $59



                                                  5-7
      Existing Single Indirect-
     Cost Pool System Example
INDIRECT-COST       All Indirect Costs
POOL                    $2,900,000



INDIRECT             50,000 Direct
COST-ALLOCATION      Manufacturing
BASE                 Labor-Hours

                     $58 per Direct
                     Manufacturing
                      Labor-Hour


                                         5-8
      Existing Single Indirect-
     Cost Pool System Example

COST OBJECT:               Indirect Costs
NL AND CL
LENSES                     Direct Costs




DIRECT
COSTS
                                             Direct
                Direct
                                          Manufacturing
               Materials                     Labor

                                                          5-9
   Existing Single Indirect-
  Cost Pool System Example

  Kole uses 36,000 direct manufacturing
labor-hours to make NL and 14,000 direct
 manufacturing labor-hours to make CL.
  How much indirect costs are allocated
             to each product?



                                           5 - 10
  Existing Single Indirect-
 Cost Pool System Example
    NL: 36,000 × $58 = $2,088,000
     CL: 14,000 × $58 = $812,000
What is the total cost of normal lenses?
       Direct costs $2,320,000 +
Allocated costs $2,088,000 = $4,408,000
       What is the cost per unit?
     $4,408,000 ÷ 80,000 = $55.10
                                           5 - 11
   Existing Single Indirect-
  Cost Pool System Example

What is the total cost of complex lenses?
Direct costs $1,180,000 + Allocated costs
         $812,000 = $1,992,000
        What is the cost per unit?
     $1,992,000 ÷ 20,000 = $99.60


                                            5 - 12
 Existing Single Indirect-
Cost Pool System Example

 Normal lenses sell for $60 each and
   complex lenses for $142 each.
               Normal Complex
Revenue         $60.00      $142.00
Cost             55.10        99.60
Income          $ 4.90      $ 42.40
Margin             8.2%       29.9%

                                       5 - 13
   Learning Objective 2

Present three guidelines for
 refining a costing system.




                               5 - 14
       Refining a Costing System

  More             Direct-cost tracing


   Smaller              Indirect-cost pools

Better cause & effect
                                Cost-allocation basis
    relationship
                                                    5 - 15
 Learning Objective 3

Distinguish between the
  traditional and the
 activity-based costing
approaches to designing
   a costing system.
                          5 - 16
 Activity-Based Costing System
  Fundamental         Assignment to Other
  Cost Objects           Cost Objects
    Activities          Cost of:
                        • Product
                        • Service
Costs of Activities     • Customer


                                            5 - 17
  Refining a Costing System

   1. Design of Products and Process
The Design Department designs the molds
 and defines processes needed (details of
     the manufacturing operations).




                                            5 - 18
Refining a Costing System

  2. Manufacturing Operations
   Lenses are molded, finished,
      cleaned, and inspected.
   3. Shipping and Distribution
  Finished lenses are packed and
  sent to the various customers.

                                   5 - 19
Activity-Based Costing System

     A cross-functional team at Kole
   Corporation identified key activities:
    1. Design products and processes.
       2. Set up molding machine.
3. Operate machines to manufacture lenses.
     4. Maintain and clean the molds.

                                             5 - 20
  Activity-Based Costing System

5. Set up batches of finished lenses for shipment.
        6. Distribute lenses to customers.
    7. Administer and manage all processes.




                                                 5 - 21
       Activity-Based Costing System
Activity
Indirect Cost   Design    Setup    Shipping
Pool


Cost             Parts-   No. of
                Square    Setup      No. of
Allocation                         Shipments
Base              feet    Hours




Product         Lenses    Lenses    Lenses
Cost
Objects          NL        CL       Other

                                               5 - 22
  Activity-Based Costing System

                               NL          CL
Quantity produced            80,000      20,000
No. produced/batch              250          50
Number of batches               320         400
Setup time per batch         2 hours     5 hours
Total setup-hours               640       2,000
         Total setup costs are $409,200.

                                                   5 - 23
Activity-Based Costing System

 What is the setup cost per setup-hour?
    $409,200 ÷ 2,640 hours = $155
       What is the setup cost per
   direct manufacturing labor-hour?
     $409,200 ÷ 50,000 = $8.184


                                          5 - 24
Activity-Based Costing System
  Allocation using direct labor-hours:
  NL: $8.184 × 36,000 = $294,624
  CL: $8.184 × 14,000 = $114,576
  Total                     $409,200
    Allocation using setup-hours:
  NL: $155 × 640       = $ 99,200
  CL: $155 × 2,000     = $310,000
  Total                   $409,200
                                         5 - 25
Learning Objective 4

Describe a four-part
  cost hierarchy.




                       5 - 26
          Cost Hierarchies

A cost hierarchy is a categorization of costs
into different cost pools, based on……
   •Cost drivers bases (cost-allocation bases)
  •Degrees of difficulty in determining
  cause-and-effect relationships


                                                 5 - 27
     Cost Hierarchies
 ABC systems commonly use a
   four-part cost hierarchy to
 identify cost-allocation bases:
1. Output unit-level costs
2.   Batch-level costs
3.   Product-sustaining costs
4.   Facility-sustaining costs
                                   5 - 28
    1. Output Unit-Level Costs

   These are resources sacrificed
  on activities performed on each
individual unit of product or service.
               Energy
                                          Vary
       Machine depreciation               with
                                         Output
               Repairs

                                             5 - 29
        2. Batch-Level Costs

 These are resources sacrificed on
activities that are related to a group
 of units of product(s) or service(s)
 rather than to each individual unit
        of product or service.
                                          Vary
             Setup-hours                 with #
                                           of
         Procurement costs               setups
                                           etc

                                             5 - 30
 3. Product-Sustaining Costs

These are often called service-sustaining
 costs and are resources sacrificed on
    activities undertaken to support
    individual products or services.
              Design costs
           Engineering costs

                                            5 - 31
   4. Facility-Sustaining Costs

  These are resources sacrificed on
  activities that cannot be traced to
 individual products or services but
support the organization as a whole.
      General administration            “True”
                                        indirect
  – rent       – building security        costs



                                            5 - 32
    Learning Objective 5

Cost products or services using
    activity-based costing.




                                  5 - 33
             Implementing
         Activity-Based Costing
       Step 1                     Step 2
Identify cost objects.   Identify the direct costs
                             of the products.

         NL                 Direct material
         CL                  Direct labor
                           Mold cleaning and
                              maintenance
                                                 5 - 34
       Implementing
   Activity-Based Costing

  Cleaning and maintenance costs of
 $360,000 are direct batch-level costs.
                Why?
Because these costs consist of workers’
 wages for cleaning molds after each
        batch of lenses is run.

                                          5 - 35
           Implementing
       Activity-Based Costing

                Normal Lenses (NL)
                   Cost Hierarchy
  Description        Category
Direct materials     Unit-level    $1,520,000
Direct mfg. labor    Unit-level       800,000
Cleaning and maint. Batch-level       160,000
Total direct costs                 $2,480,000

                                            5 - 36
           Implementing
       Activity-Based Costing

                Complex Lenses (CL)
                   Cost Hierarchy
  Description        Category
Direct materials     Unit-level    $ 920,000
Direct mfg. labor    Unit-level       260,000
Cleaning and maint. Batch-level       200,000
Total direct costs                 $1,380,000

                                            5 - 37
            Implementing
        Activity-Based Costing
                      Step 3
    Select the cost-allocation bases to use for
     allocating indirect costs to the products.
   (1)                (2)                    (3)
Activity        Cost Hierarchy          Total Costs
Design        Product-sustaining         $450,000
Setups         Batch-level               $409,200
Operations Unit-level                    $637,500
                                                  5 - 38
         Implementing
     Activity-Based Costing
                   Step 4
    Identify the indirect costs associated
       with each cost-allocation base.
   Overhead costs incurred are assigned
   to activities, to the extent possible, on
the basis of a cause-and-effect relationship.



                                                5 - 39
       Implementing
   Activity-Based Costing
              Step 5
     Compute the rate per unit.
             (1)               (5)
             NL      CL       Total
Setup-hours: 640    2,000     2,640
      $409,200 ÷ 2,640 = $155


                                      5 - 40
         Implementing
     Activity-Based Costing
                 Step 6
   Compute the indirect costs allocated
            to the products.
NL: $155 × 640 =                 $ 99,200
CL: $155 × 2,000 =                310,000
Total                            $409,200



                                            5 - 41
         Implementing
     Activity-Based Costing
               Step 7
 Compute the costs of the products.
   NL and CL would show three
      direct cost categories.
1. Direct materials
2.    Direct manufacturing labor
3.    Cleaning and maintenance
                                      5 - 42
            Implementing
        Activity-Based Costing
 NL and CL would show six indirect cost pools.
1.        Design
2.        Molding machine setups
3.        Manufacturing operations
4.        Shipment setup
5.        Distribution
6.        Administration
                                                 5 - 43
   Learning Objective 6

     Use activity-based
     costing systems for
activity-based management.


                             5 - 44
      Activity-Based Management

   ABM describes management decisions that use
     activity-based costing information to satisfy
            customers and improve profits.
1. Product pricing and mix decisions
2. Cost reduction and process improvement decisions
3. Design decisions

                                                 5 - 45
           1.Product Pricing and
              Mix Decisions

   ABC gives management insight into the cost
structures for making and selling diverse products.
      It provides more accurate product cost
    information and more detailed information
on costs of activities and the drivers of those costs.



                                                    5 - 46
     2. Cost Reduction and Process
        Improvement Decisions

   Manufacturing and distribution personnel use
  ABC systems to focus on cost-reduction efforts.
   Managers set cost-reduction targets in terms of
reducing the cost per unit of the cost-allocation base.




                                                    5 - 47
            3. Design Decisions

Management can identify and evaluate new designs
to improve performance by evaluating how product
   and process designs affect activities and costs.
    Companies can work with their customers to
evaluate the costs and prices of alternative designs.



                                                   5 - 48
    Learning Objective 7

Compare activity-based costing
  systems and department-
       costing systems.


                                 5 - 49
     ABC and Department
      Indirect-Cost Rates

 Many companies have evolved their
  costing system from using a single
cost pool to using separate indirect-cost
       rates for each department:
                Design
            Manufacturing
              Distribution
                                            5 - 50
       ABC and Department
        Indirect-Cost Rates

                   Why?
Because the cost drivers of resources in each
department or sub-department differ from the
 single, company-wide, cost-allocation base.
  ABC systems are a further refinement of
         department costing systems.

                                                5 - 51
     Levels of refinement of Job Costing,
Department Costing and Activity-Based Costing

           Job Costing is…….. good

    Department Costing is ……..more refined


 Activity-Based Costing is…… even more refined


                                             5 - 52
    Learning Objective 8

Evaluate the costs and benefits
of implementing activity-based
        costing systems.


                                  5 - 53
Benefits of ABC Systems are likely
         to occur when…..
1. Significant amounts of indirect costs are
allocated using only one or two cost pools.
2. All or most costs are identified as output
unit-level costs.
3. Products make diverse demands on
resources because of differences in volume,
process steps, batch size, or complexity.

                                                5 - 54
Benefits of ABC Systems are likely
    to occur when…..(Cont’d)

4. Products that a company is well-suited to
make and sell show small profits while
products for which a company is less
suited show large profits.
5. Complex products appear to be very
profitable and simple products appear to
losing money.
                                               5 - 55
 Benefits of ABC Systems

Operations staff often have significant
  disagreements with the accounting
staff about the costs of manufacturing
and marketing products and services.




                                          5 - 56
Limitations of ABC Systems

 The main limitations of ABC are the
     measurements necessary to
        implement the system.
  ABC systems require management
  to estimate costs of activity pools
   and to identify and measure cost
        drivers for these pools.
                                        5 - 57
Limitations of ABC Systems

  Activity-cost rates also need to be
          updated regularly.
Very detailed ABC systems are costly
to operate and difficult to understand.




                                          5 - 58
     ABC In Service and
   Merchandising Companies

    The general approach to ABC in the
  service and merchandising areas is very
 similar to the approach in manufacturing.
 Costs are divided into homogeneous cost
  pools and classified as output unit-level,
batch-level, product- or service-sustaining,
        and facility-sustaining costs.
                                               5 - 59
     ABC In Service and
   Merchandising Companies

The cost pools correspond to key activities.
Costs are allocated to products or customers
  using activity drivers or cost-allocation
     bases that have a cause-and-effect
 relationship with the cost in the cost pool.



                                                5 - 60

								
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