Activity-Based Costing and Cost Management Systems

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5
Chapter Five

• Activity-Based Costing and Cost Management
  Systems

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Traditional, Volume-Based Product-Costing System

• Aerotech produces three complex printed circuit
  boards referred to as Mode I, Mode II, and Mode
  III.
• The following information is obtained from
  company records

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Traditional, Volume-Based Product-Costing System

• Additional information includes

Manufacturing overhead is determined as follows
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Traditional, Volume-Based Product-Costing System
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Traditional, Volume-Based Product-Costing System

• With these product costs, Aerotech established
  target selling prices (Cost 125).

209.00 x 1.25
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Traditional, Volume-Based Product-Costing System

• Aerotech wishes to see what target selling prices
  would be suggested when using activity-based
  costing.

Lets see how ABC works.
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Activity Based Costing System (ABC)

• ABC systems follow a two-stage procedure to
  assign overhead costs to products.

Assigning overhead to products is a difficult
process.
I agree!
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Activity Based Costing System (ABC)

• ABC systems follow a two-stage procedure to
  assign overhead costs to products.

Lets begin by identifying our major activities.
Stage OneIdentify significant activities and
assign overhead costs to each activity
in proportion to resources used.
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Activity Based Costing System (ABC)

• ABC systems follow a two-stage procedure to
  assign overhead costs to products.

Overhead assigned to activities are called
activity cost pools.
Stage TwoIdentify cost drivers appropriate to
each activity and allocate overhead to the
products.
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Overhead Costs Total budgeted cost 3,894,000
Identification of Activity Cost Pools
Activity Cost Pools
Product- Sustaining Level
Unit Level
Batch Level
Facility Level
Machinery cost pool 1,212,600
Setup cost pool 3,000
Engineering cost pool 700,000
Facility cost pool 507,400
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Overhead Costs Total budgeted cost 3,894,000
Identification of Activity Cost Pools
Activity Cost Pools
Product- Sustaining Level
Unit Level
Batch Level
Facility Level
Machinery cost pool 1,212,600
Setup cost pool 3,000
Engineering cost pool 700,000
Facility cost pool 507,400
More Cost Pools
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Product- Sustaining Level
Unit Level
Batch Level
Facility Level
Machinery cost pool 1,212,600
Setup cost pool 3,000
Engineering cost pool 700,000
Facility cost pool 507,400
Receiving/Inspection cost pool 200,000
Material-Handling cost pool 600,000
Quality-Assurance cost pool 421,000
Packaging/Shipping cost pool 250,000
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STAGE ONE
Various overhead costs related to machinery
Maintenance
Lubrication
Depreciation
Electricity
Computer Support
Calibration
Activity cost pool
Machinery Cost Pool Total budgeted cost
1,212,600
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STAGE TWO
Calculate the pool rate
Budgeted Machinery Costs 1,212,600
Budgeted Machine Hours 43,000

28.20/hour


Cost Assignment
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STAGE ONE
Calculation of total setup cost
Activity cost pool
Setup Cost Pool Total budgeted cost 3,000
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STAGE TWO
Calculate the pool rate
Budgeted Setup Costs 3,000 Planned
Production Runs 15 runs
200 per run


Cost Assignment
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STAGE ONE
Various overhead costs related to engineering
Engineering salaries
Engineering software
Engineering supplies
Depreciation
Activity cost pool
Engineering Cost Pool Total budgeted cost
700,000
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STAGE TWO
Engineering Cost Pool Total budgeted cost
700,000
Allocate based on engineering transactions
Cost Assignment
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STAGE ONE
Various overhead costs related to
general operations
Plant depr.
Property taxes
Plant mgmt.
Insurance
Plant maint.
Security
Activity cost pool
Facility Cost Pool Total budgeted cost 507,400
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STAGE TWO
Calculate the pool rate
Budgeted Facilities Cost
507,400 Budgeted Direct-Labor Hours
118,000
4.30/hour


Cost Assignment
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Product Cost from ABC

• Here are the new product costs so far . . .

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Other Overhead Costs
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Other Overhead Costs
14.82
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Product Cost from ABC

• These are the new product costs when Aerotech
  uses ABC.

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Product Diversity

• Both original and ABC target selling prices are
  based on (Cost 125).

The selling price of Mode I and II are
reduced and the selling price for Mode III is
increased.
209.00 1.25
183.44 1.25
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Product Diversity

• Can you identify any problems Aerotech is likely
  to face as a result of this distortion?

Traditional costing understates the cost of
complex, low volume products.
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ABC Some Key Issues

• The Past
• Small number of products which did not differ
  much in required manufacturing support.
• Labor was the dominant element in the cost
  structure.

• The Present
• Numerous products with more and complicated
  production requirements.
• Labor is becoming an ever smaller part component
  of total production costs.

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Cost Drivers

• A characteristic of an event or activity that
  results in the incurrence of costs. In selecting
  a cost driver, we must consider . . .

Degree of Correlation
Behavioral Effects
Cost of Measurement
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Homogeneous Activity Cost Pools

• A homogeneous cost pool is a grouping of overhead
  costs in which each cost component is consumed in
  roughly the same proportion by each product line.

A homogeneous cost pool uses a single cost driver.
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Transaction Costing
Transaction processing provides
a readily measurable gauge of departmental activit
y.
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Storyboarding

• A procedure used to develop a detailed process
  flow chart, which visually represents activities
  and the relationships among activities.

Step 1
These are the steps we follow to build a memory
board.
Step 2
Step 3
Step 4
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Direct versus Indirect Costs

• Volume-Based Costing
• All production costs except direct materials and
  direct labor are lumped together in one overhead
  cost pool.

• Activity-Based Costing
• An effort is made to account for as many costs
  as possible as direct costs of production.

Indirect Costs
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Indicators of Need for ABC
Product-line profit margins are hard to explain
Direct labor is a small percentage of total costs
Line managers do not believe the product costs
reports
Sales are increasing, but profits are declining.
Some products that have reported high profit
margins are not sold by competitors
Marketing does not use costs reports for pricing
decisions
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Optimal Product-Costing System
Cost
Total Cost
High
Cost of inferior decisions resulting from inaccura
te information.
Design, implementation and maintenance costs
Information System Accuracy
Low
High
Low
Optimal system
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Cost Management Systems
Objectives

• Measure the cost of resources consumed.
• Identify and eliminate non-value-added costs.
• Determine the efficiency and effectiveness of all
  major activities.
• Identify and evaluate new activities that can
  improve future performance.

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Non-Value-Added Costs
Suppose our production process looks like this
VA Valued-added activity NVA
Non-value-added activity
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Non-Value-Added Costs
Our goal is to reduce or eliminate the
non-value-added activities.
VA Valued-added activity NVA
Non-value-added activity
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ABC in the Service Industry
Activities tend to be nonrepetitive human tasks.
Implementation Problems
High proportion of facility-level costs
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End of Chapter 5
This is real value-added time!