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MGAB03H3 (55)
Lecture 6

Week 6 chapter notes

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Financial Accounting
Liang Chen

Chapter 7 Activity-Based Costing and Management Notes Activity-Based Costing (ABC) Traditional Cost Accounting Systems N traditional cost accounting systems, such as job costing and process costing, assign manufacturing production costs to individual products in inventory and COGS, while non-manufacturing costs are recognized as period costs on the income statement N traditional cost accounting methods are also used to allocate non-manufacturing costs for some types of contractual reporting Activity-Based Costing Systems N activity-based costing (ABC) process of assigning overhead costs to specific activities in a manufacturing or service delivery process; it attempts to trace costs more accurately to products or other cost objects N activity a type of task or function performed in an organization ABC Cost Hierarchy N accountants often use a cost hierarchy to help identify activities, and then assign costs to these activities N ABC developers identified a number of general categories for the cost hierarchy based on different levels of operations N these include: organization sustaining; facility sustaining; customer sustaining; product sustaining; batch level; and unit level N organization-sustaining activities tasks or functions undertaken to oversee the entire entity; these activities occur no matter how many facilities are operated, customers are served, products are sold, batches are processed, or units are produced N facility-sustaining activities tasks or functions undertaken to provide and manage an area, location, or property; these activities occur no matter how many customers are served, products are sold, batches are processed, or units are produced N customer-sustaining activities tasks or functions undertaken to service past, current, and future customers; those costs tend to vary with the needs of individual customers or groups of customers N product-sustaining activities tasks or functions undertaken to support the production and distribution of a single product or line of products; these activities are not related to units or batches, but to individual products or product lines N batch-level activities tasks or function undertaken for a collection of goods or services that are processed as a group; batch- level costs do not relate to the number of units in the batch, but instead to the number of batches processed N unit-level activities tasks or functions undertaken to produce individual units manufactured or services produced; need to be performed for every unit of good or service, and therefore the cost should be proportional to the number of units produced Assigning Costs Using an ABC System N in ABC system, the process of assigning costs is a 2-stage process similar to the process used in other cost accounting methods: (1) overhead costs are gathered into cost pools; and (2) allocated to the cost objects, such as product line, batch, or units N ABC differs from other cost accounting methods in that overhead costs are assigned to a larger number of activity-based cost pools, and cost drivers are used as allocation bases] N the following procedures are followed for the ABC method: (1) identify the relevant cost object; (2) identify activities; (3) assign costs to activity-based cost pools; (4) for each ABC cost pool, choose a cost driver; (5) for each ABC cost pool, calculate an allocation rate; and (6) for each ABC cost pool, allocate activity costs to the cost object Identify the Relevant Cost Object N the design of the system beings with identification of one or more cost objects that are relevant to managers Identify Activities N to identify the activities performed within the production process, the use of resources must be tracked, and in many cases, additional information must be gathered from employees
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