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Activity Based Costing 2

The document discusses activity-based management and costing systems, which focus on identifying value-added and non-value-added activities to improve profitability. It explains how activity-based costing uses cost drivers and allocates costs through multiple cost pools to more accurately assign costs to products and services. The document also introduces attribute-based costing as an extension of activity-based costing to calculate the cost of product attributes valued by customers.

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72 views

Activity Based Costing 2

The document discusses activity-based management and costing systems, which focus on identifying value-added and non-value-added activities to improve profitability. It explains how activity-based costing uses cost drivers and allocates costs through multiple cost pools to more accurately assign costs to products and services. The document also introduces attribute-based costing as an extension of activity-based costing to calculate the cost of product attributes valued by customers.

Uploaded by

Maricon Berja
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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Activity-Based Cost Systems

for Management
Learning Objectives (1 of 2)
• Identify the focus of activity-based
management
• Explain why non-value-added activities
cause costs to increase unnecessarily
• Explain why cost drivers are designated in
activity-based costing
• Contrast activity-based costing to the
traditional cost accounting system
Learning Objectives (2 of 2)
• Describe how activity-based costing
systems affect behavior
• Describe attribute-based costing and explain
how it extends activity-based costing
Activity-Based Management
• Focuses on activities during production and
performance process
• Improves the value received by customers
• Improves profitability
Activity-Based Management

Activity analysis Continuous improvement


Cost driver analysis Operational control
Activity-based costing Performance evaluation
Business process
reengineering
ABM
Activity Analysis
Non-value-added activity
Value-added activity • Increases time spent on
product or service but does
• Increases worth of not increase worth
product or service to a
customer • Unnecessary from customer
perspective
• Customer is willing to pay
for • Some can be eliminated
without affecting market
value or quality
• Business-value-added
activities are essential
Activity Analysis

•Create a Process Map for each process


•Identify each step
•Create Value Chart
•Identify stages and time spent in stages

Value-Added Non-Value-Added
Processing Time Inspection Time
Service Time Transfer Time
Idle Time
Cycle Time

Cycle Value- Non-


Time = Added + Value-Added
Activities Activities
Manufacturing Cycle Efficiency
Manufacturing Value-Added
Cycle = Processing Time
Efficiency Total Cycle Time

• 100% efficiency unrealistic


• Reducing non-value-added activities will
increase Manufacturing Cycle Efficiency
• Value-added activity usually represents
about 10% of total cycle time
Non-Value-Added Activities

• Attributed to following factors


• Systemic
• Physical
• Human
• Eliminate non-value-added activities that create the most costs
ABM
Cost Driver Analysis

• Cost drivers are factors that have a direct cause-effect relationship


to a cost
• Limit number of cost drivers
• Cost of measurement should not exceed benefit of using the cost driver
• Easy to understand
• Directly related to activity being performed
• Appropriate for measurement
Cost Driver Analysis
• Unit-level costs
– direct material, direct labor
• Batch-level costs
– setup, inspection
• Product/process-level costs
– engineering changes, product development
• Organizational or facility costs
– building depreciation, plant manager’s salary
Product Cost

Unit-Level Allocate over number


Cost per unit
Costs of units produced

Batch-Level Allocate over number Cost per unit


Costs of units in batch in batch

Allocate over number


Product/Process- of units produced in Cost per unit
Level Costs related product line in product line
Product and Company
For each
Profitability
product line
Total product revenue
<Total product cost>
Net product margin
<Organizational/facility-level costs>
Company profit or loss

Not
GAAP
ABM
Activity-Based Costing

• Recognizes several levels of costs


• Accumulates costs into related cost pools
• Uses multiple cost drivers to assign costs to products and services
Use ABC When ….
• Wide variety of products or services
• High overhead costs not proportional to the unit volume of
individual products
• Automation makes it difficult to assign overhead to products using
direct labor or machine hours
• Profit margins are difficult to explain
• Hard-to-make products show big profits and easy-to-make products
show losses
Two-Step Allocation

• Collect costs in general ledger and subsidiary accounts


• Identify activity centers
• Accumulate costs into activity center cost pools
• cost driver
• Allocate costs to products and services
• activity driver
Choosing an Activity Center

• Geographical proximity of equipment


• Centers of managerial responsibility
• Magnitude of product costs
• Manageable number of activity centers
Activity-Based Costing

• Important assumptions about activity center cost pools


• Costs in each cost pool are
• Driven by homogenous activities, and
• Strictly proportional to the activity
Activity-Based Costing

Record Activity
Costs in GL Driver

Accumulate in
Activity Center
Cost Cost Pool
Driver

Cost
Objects
Traditional vs. ABC Costing

• When ABC implemented


• Cost reduced for high volume, standard products
• Cost increased for low-volume, complex specialty products
Long-Term Variable Costs
• Cost drivers
• Product variety
• Product complexity
Attribute-Based Costing (ABC II)
• Identify customer needs
• reliability
• durability
• responsiveness
• Calculate cost of incremental improvements to obtain these
attributes
• Uses planned costs
• Focuses on development stage of product life cycle
When to Use ABC

• Product Variety and Process Complexity


• Caused by mass customization
• too many choices, opportunity for errors
• Pareto principle
• Reduced by
• Simultaneous engineering
When to Use ABC
• Lack of Commonality in Overhead Costs
– Some products/services use substantially more
overhead than others
• Problems with Current Cost Allocations
– Significant changes in process with no change
in cost allocations
• Changes in Business Environment
– Increase in competition
Criticisms of ABC

• Significant amount of time and cost to implement


• Must overcome barriers to change
• Does not conform to GAAP
• Does not promote total quality management
Questions
• What are the differences between activity-
based costing and traditional cost
accounting?
• What are cost drivers?
• How does attribute-based costing extend
activity-based costing?
References:
Cost Accounting by Cecily Raiborn, Michael R. Kinney

Cost Accounting Traditions and Innovations by Barfield,


Raiborn, Kinney

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