ACC406 Chapter 7.doc

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21 Apr 2012
ACC406Chapter 7
Limitations of Functional-Based Cost Accounting Systems
oTwo major factors that impair the ability of unit-based plantwide and
departmental rates to assign overhead costs accurately
1. Proportion of nonunit-related overhead costs to total overhead
costs is large
2. Degree of product diversity is great
Nonunit-Related Overhead Costs
oUnit-level activities = activites that are preformed each time a unit is
oThe use of either plantwide rates or departmental rates assumes that a
product’s consumption of overhead resources is related strictly to the
units produced
oProponents of activity-based costing (ABC) refer to the ABC cost
hierarchy that categorizes costs either as unit-level (e.g., vary with
output volume), batch-level (e.g., vary with the number of
groups or batches that are run), product-sustaining (e.g., vary
with the diversity of the product or service line), facility-
sustaining (e.g., do no vary with any factor but are necessary in
operating the plant)
oNonunit-level activity drivers (e.g., batch-level, product-sustaining, and
facility-sustaining) are factors that measure the consumption of nonunit-
level activities by products and other cost objects.
oUnit-level activity drivers measure the consumption of unit-level
oActivity drivers are factors that measure the consumption of activities by
products and other cost objects and can be classified as either unit-
level or nonunit-level
Product Diversity
oProducts consume overhead activities in systematically different
oProportion of each activity consumed by a product is known as the
consumption ratio
Activity-Based Product Costing: Detailed Description
oFunctional-based overhead costing involves two major stages:
1. Overhead costs are assigned to an organizational unit (plant or
2. Overhead costs are then assigned to cost objects.
oAn Activity-Based Costing (ABC) system:
1. Traces costs to activities, and then to cost objects.
Activities consume resources, and cost objects, in turn,
consume activities
Two-stage process
Emphasizes direct tracing and driver tracing (exploiting cause-
and-effect relationships)
Identifying Activities
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oActivity Dictionary = list of activities in an organization along with some
critical activity attributes
oActivity Attributes = financial and nonfinancial information items that
describe individual activities
Assigning Costs to Activities
oResource Drivers = factors that measure the consumption of resources
by activities
Activity-Based Customer Costing and Activity-Based Supplier Costing
oABC is used to more accurately determine the upstream costs of
suppliers and the downstream costs of customers
oCustomers to the left of the peak increase the company’s profitability
Customers to the right decrease the company’s profitability.
Process-Value Analysis
oFundamental to Activity-Based Management
oFocuses on cost reduction instead of cost assignment and emphasizes
the maximization of systemwide performance
Driver Analysis: The Search for Root Causes
oActivity Inputs = Resources consumed by the activity in producing its
oActivity Outputs = Result or product of an activity
oActivity Output Measure = Number of times the activity is performed
oThe effort expended to identify those factors that are the root causes of
activity costs
Activity Analysis: Identifying and Assessing Value Content
oThe process of identifying, describing, and evaluating the activities that
an organization performs
oShould produce four outcomes:
1. What activities are done
2. How many people perform the activities
3. The time and resources required to perform the activities
4. An assessment of the value of the activities to the organization,
including a recommendation to select and keep only those that
add value.
oActivities can be classified as value-added or nonvalue-added
Value-added: activities necessary to remain in business
Value-added costs = costs to perform value-added
activities with perfect efficiency
Nonvalue-added: all activities other than those that are
absolutely essential to remain in business (unnecessary)
Nonvalue-added costs = costs that are caused either by
nonvalue-added activities or the inefficient performance of
value-added activities
Can exist anywhere in the organization
oIn manufacturing, 5 major activities are often cited
as unnecessary:
1. Scheduling
2. Moving
3. Waiting
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