Ch 7 Summary.docx

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University of Waterloo
Accounting & Financial Management
AFM 481
Grant Russell

Chapter 7 – Activity-Based Costing (ABC) and Management Traditional Cost Accounting System - Ex: job costing, process costing → mfg production cost is assigned to individual products in inventory and COGS, but non-mfg costs are recognized as period costs on the I/S - Non-mfg costs are allocated for some types of contractual reporting - Trace direct costs and allocate overhead costs to each indiv. product - Two-stage process: group overhead costs to cost pool(s); then allocate using allocation base (DL cost/hrs; machine hrs, # of units) - Allocation base rarely reflects the flow of resources to products of diff. complexity - Fixed overhead costs are distributed equally – regardless of actual time by robotic machines - Costs of complex computers (requires more assembly time/machine setups) are understated - Costs of simple computers are overstated Activity-Based Costing Systems - Assign overhead costs to specific activities performed in a mfg or service delivery process - Try to trace costs more accurately to products or other cost objects - Activity is a type of task/function performed o Material handling o Engineering o Inspection o Customer support o Information systems - Direct costs are traced to indiv. products/services (same as traditional) - Overhead resources are traced/allocated to multiple cost pools - First assigned to activity cost pools, then allocated to indiv. products/services ABC Cost Hierarchy Organization sustaining - To oversee the entire entity; occurs no matter the number of facilities operated, customers served, products sold, batches processed or units produced - Admin salaries, amortization, etc. – fixed; no cause-and-effect relationship between costs and activities performed - Typically assigned to the entire org and not allocated to product lines, batches or units Facility sustaining - Overall operations of a facility and unaffected by the # of customers served or amount of products, batches or units - Facility janitorial services, retail store insurance/heating, mfg plant manager salary - Not allocated except when the org. Needs to allocate all product costs for a particular purpose Customer sustaining - Individuals or groups of past, current and future customers - Cust. sales rep. and tech support salaries, market research, tools for customer’s orders - Cost drivers: # of sales calls, hours of tech support, # of customers Product sustaining - For production and distribution of a single or line of product(s) - Production-line supervisor and product design engineer salaries, product advertising, amortization of equipment used for mfg - Cost drivers: # of engineer hours, # of ads, machine hours Batch level - For each batch of product – not related to the # of units in the batch - Labour cost for setting up each new batch - Shipping costs - Cost drivers: setup hours, # of batches, weight of orders shipped Unit level - To produce individual units of goods/services; proportional to the production or sales volume - Material handling wages, production workers pay (based on quantity produced), supplies used - Cost drivers: machine hours, units processed, materials quantity processed Assigning Costs using an ABC System - Two stage process: gather overhead costs into cost pools; then allocate to cost objects - Overhead costs are assigned to various activity-based cost pools and cost drivers are used as allocation bases 1. Identify the relevant cost object 2. Identify activities 3. Assign costs to ABC pools 4. For each ABC cost pool – choose a cost driver 5. – calculate an allocation rate: est. allocation rate = est. total cost / est. # of batches 6. – a
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