Chapter 5 Activity Based Costing.docx

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Accounting & Financial Management
AFM 102
Tom Vance

05 – Activity-BasedCosting Chapter 5: Activity-Based Costing  activity-based costing (ABC): a costing method based on activities that is designed to provide managers with cost information for strategic and other decisions that potentially affect capacity and therefore fixed costs How Costs AreTreated Under Activity-Based Costing  ABC is designed for use in internal decision making  non-manufacturing and manufacturing costs may be assigned to products, on a cause-and-effect basis  some manufacturing costs may be excluded from product costs  numerous overhead cost pools are used, each of which is allocated to products and other cost objects using its own unique measure of activity  overhead rates, may be based on the level of activity at capacity rather than on the budgeted level of activity Non-Manufacturing Costs and Activity-Based Costing  traditional cost accounting: selling, general and admin expenses are period expenses -> not assigned to products  overhead = non-manufacturing costs and indirect manufacturing costs  products are assigned all of the overhead costs that they can reasonably be supposed to have caused Manufacturing Costs and Activity-Based Costing  cost is assigned to a product only if there is a good reason to believe that the cost would be affected by decisions concerning the product  costs that are unaffected by product-related decisions are treated as period expenses Cost Pools,Allocation Bases,and Activity-Based Costing  activity: any event that causes the consumption of overhead resources  activity cost pool: a ‘bucket’ in which costs are accumulated that relate to a single activity measure in the ABC system  activity measure: an allocation base in an activity-based costing system  aka cost driver -> activity measure ‘drives’ the cost being allocated  common types: transaction drivers, duration drivers  transaction driver : a simple count of the number of times an activity occurs  used more in practice because it takes less effort to record  duration driver: a measure of the amount of time required to perform an activity  more accurate than transaction drivers but take more effort to record  addresses five levels of activity: 1. unit-level activities: result of the total volume of goods and services produced and performed each time a unit is produced 2. batch-level activities: performed each time a batch of goods is handled/processed (regardless of the # of units); the about of resources consumed depends on the # of batches, not the # of units in each batch 3. product-level activities: relate to specific products that must be carried out regardless of how many units produced and sold or batches run 4. customer-level activities: carried out to support customers but that are not related to any specific product 5. organization-sustaining activities: carried out regardless of which customers are served, which produces are produced, and how many batches are run how many units are made The Cost of Idle Capacityin Activity-Based Costing  costs of idle capacity are not charged to products page 1 of 5 05 – Activity-BasedCosting  result: more stable unit of costs, consist with the objective of assigning only those costs to products that are actually caused by the products  these costs are considered period costs and flow through to the income statement as an expense of the current period Designing an Activity-Based Costing System  initiative to implement ABC must be strongly supported by top management  managers might not see a reason to change without leadership from top management  if top management doesn’t support then, subordinates will quickly get the message that ABC is not important and will abandon its  design and implementation of an ABC system should be the responsibility of cross-functional team (not the accounting dept)  cost object: the specific product or service to be costed Cost objects Consumption (products and Activities of Resources Cost customers)  implementation process: 1. identify and define activities, activity cost pools, and activity measures 2. assign overhead costs to activity cost pools 3. calculate activity rates 4. assign overhead costs to cost objects using the activity rates and activity measures 5. prepare management reports Step 1:Identify and Define Activities,ActivityCost pools,and ActivityMeasures  activities should be grouped together at the appropriate level  ex - batch-level and unit-level activities shouldn’t be grouped together Activity Cost Pools Activity Cost Pool Activity Measure Customer order # of customer orders Product design # of product designs Order size Machine-hours Customer relations # of active customers Other N/A  customer orders cost: assigned all costs of resources that are consumed by taking and processing customer orders  processing paper work, setting up machines for specific order, etc  batch-level activity (order generates work that occurs and doesn’t depend on the # of units ordered)  product design: assigned all costs of resources consumed in designing products  product-level activity (amount of work doesn’t depend on the # of units or # of batches)  order size: assigned all costs of resources consumed as a consequence of the # of units produced  includes costs of miscellaneous factory supplies, power to run machines, etc  unit-level activity  customer relations: assigned all costs associated with maintaining relations with customers  costs of sales calls, entertaining customers, etc  customer-level activity  other: assigned all other overhead costs that are not associated with the pools described above  will not be assigned to products page 2 of 5 05 – Activity-BasedCosting The Mechanics of Activity-Based Costing Direct Costs (materials, labour, other) cost objects: products, customer Overhead Costs activity cost pools orders, customers (manufacturing and
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