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ACC406 - Chapter 7.docx

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Ryerson University
ACC 406
All Accounting410

C HAPTER 7: ACTIVITY -BASED C OSTING AND M ANAGEMENT Non-Unit Related Overhead Costs Unit-Level Activities are activities that are performed each time a unit is produced. They increase or decrease in proportion to the levels of unit activities. Non-Unit Level Activities These costs are unlikely to vary with units produced.  Batch Level varies with the number of batches produced.  Product Sustaining Varies with the number of product lines  Facility Sustaining Necessary to operate the plant facility but does not vary with units, batches or product lines Product re-engineering activity authorized by document called engineering work order. Activity Drivers factors that measure the consumption of activities by product and other cost objects and can be classified as unit-level or non-unit level  Non-Unit Level Activity Drivers are factors that measure the consumption of non-unit level activities by products and other cost objects  Unit-Level Activity Drivers measure the consumption of unit-level activities Product Diversity is the products consume overhead activities in systematically different proportions. Cost will be distorted whenever the quantity of unit-based overhead that a product consumes does not vary in direct proportion to the non-unit-based overhead.  The proportion of each activity consumed by a product is Consumption Ratio Activity Based Costing (ABC) accumulates overhead costs for each of the organization’s activities and then assigns the cost of activities to the products, services or other cost objects that caused those activities. Because labor-related costs in an automated system is only a small percentage companies are using machine hours as they are best related to the cause of most overhead Activity-based cost assignment consists of the following three-steps: 1. Identify and define activities using interviews and surveys Build list of activities (Activity Dictionary). Lists Activity Attributes a. Primary Activity (Activity consumed by a product or consumer) b. Secondary Activity (Consumed by another primary or secondary activities) 2. Assign Costs to Activities Determine the cost of resources (materials, labor and capital) a. If resource is exclusive to activity (material) use direct tracing b. If resource is shared by several activities, use drivers to trace and measure the consumption of resources by each activity c. Cost of secondary activities are ultimately assigned to primary activities using activity drivers 1 C HAPTER 7: ACTIVITY-B ASED C OSTING AND M ANAGEMENT 3. Assign Costs to Products After the cost of primary activities is calculated; assign the cost of these activities to products based on usage of the activity as measured by activity drivers. Cost assigned to product = Predetermined activity rate x Actual usage of activity Problems with ABC: 1. Does not conform to GAAP so can only be used for internal use. 2. Substantial time is needed to properly identify / analyze activities so ABC is costly to implement. 3. ABC requires a lot of support throughout the firm. Cost Drivers factor that drives or causes costs. Usually more than one cost driver causes costs, so the one that has the greatest impact on costs is chosen. Value-Added Activities and Non-Value-Added Activities Value-Added Activity increases the value of a product or service to a customer and is one for which the customer is willing to pay. Value added activities result in more efficient production methods, continuous operating improvements and better operational control and reduced time for completing the operation cycle.  Activities needed to comply with the law (reporting, legalities) are valued added by mandate  Discretionary activities are classified as value-added provided it simultaneously satisfied three conditions: 1. Produces a change of state 2. Change of state was not achievable by preceding activities 3. Activity enables other activities to be performed  Value-Added Costs are the costs to perform value-added activities with perfect efficiency Non-Value Added Activity increases the time / cost without increasing its worth. May be necessary from a business perspective but not from a customers. (Scheduling, moving, waiting, inspecting and storing)  Can be attributed to systematic, physical and human factors.  Zero-based budgeting perspective is the best way to determine the value of an activity.  Time it takes to perform necessary functions to manufacture a product / service is processing or service time this time adds value.  NVA includes: Idle Time (waiting) Transfer Time (Moving inventories / products around) Inspection Time (performing quality control)  Non-Value Added Costs are the costs that are caused either by non-value added activities or by the inefficient performance of value-added activities. 2 C HAPTER 7: ACTIVITY -BASED C OSTING AND M ANAGEMENT Cost Reduction occurs in four ways: 1. Activity Elimination Once activities that fail to add value are identified, the organization should get rid of these activities. 2. Activity Selection involves choosing different sets of activities of competing strategies. Different strategies cause different activities. Lower-cost activities should be chosen. 3. Activity Reduction Decreases the time and resources required by an activity. Aimed at improving the efficiency of necessary activities. (Finding ways to reduce set-up time) 4. Activity Sharing increases efficiency of necessary activities by using economies of scale. Lowers per-unit cost of the cost driver and amount of cost traceable to the products that consume the activity. Cycle Time The length of time from ordering to selling an item in retail environment  In service company cycle time refers to the time between service order and service completion. Assigning Costs to Activities Most difficult task is to determine how much it costs to perform each activity. Becomes necessary to assign resource costs to activities by using direct and driver tracing.  Work Distribution Matrix identifies the amount of labor consumed by each activity and is derived from the interview process.  Resource Drivers are factors that measure the consumption of resources by activities. Once these are identified, then cost of the resource can be assigned to activity. Activity-Based Customer Costing and Activity Based Supplier Costing ABC is used to more accurately determine the upstream of costs of suppliers and the downstream of costs of customers.  10% of customers were responsible for 90% of its profits. Actually losing profit on 50% of its customers.  Whale Curve customers to the left of the peak increase company’s profitability while customers to the right decrease the profitability. Customers can consume customer-driven activities in different proportions sources of customer diversity include: Order frequency, delivery frequency, geographic distance, sales and promotional support and engineering support requirements Customer Costing vs. Product Costing Assigning costs of customer service to customers is the same as assigning manufacturing costs to products.  The smaller customers cost more, attribute to smaller, more frequent orders and the evident need for the sales force to engage in more nego
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