ActivityBased Costing ABC and ActivityBased Management ABM

1
Activity-Based Costing (ABC) and Activity-Based
Management (ABM)
Chapter Five
2
Strategic Role of ABC

• Activity-based costing (ABC) vs. volume-based
  costing
• Volume-based costing is often inadequate because
  indirect costs do not always occur in proportion
  to output volume
• Volume-based costing generally causes miscosting
  of outputs (i.e., some products will be
  overcosted and others undercosted)
• Volume-based costing can create inappropriate
  incentives for managers (i.e., more volume
  equates to more overhead expense)
• Activity-based costing uses detailed information
  about the activities that make up indirect
  (support) costs so that outputs are charged only
  for resources consumed

3
Volume-Based Costing

• Although it is often inadequate, volume-based
  costing may be a good strategic choice for some
  firms
• This type of costing system is appropriate
  generally when direct costs are the major cost of
  the product or service and the activities
  supporting its production are relatively simple,
  low-cost, and homogeneous across different
  product lines
• Volume-based costing is often used by paper
  product manufacturers, producers of agricultural
  products, and professional service firms

4
ABC Terms

• An activity is a specific task or action of work
  done, such as production set-up
• A resource is an economic element needed or
  consumed in performing activities, such as
  salaries and supplies
• A cost driver is either a resource consumption
  cost driver or an activity consumption cost
  driver
• Resource consumption cost drivers measure the
  amount of resources consumed by an activity, such
  as the number of items in a purchase or sales
  order
• Activity consumption cost drivers measure the
  amount of activity performed for an object, such
  as the number of batches used to manufacture
  product Y

5
Cost Assignment

• The two-stage cost assignment approach for
  indirect (support) costs resource costs such as
  factory overhead are assigned to activity cost
  pools and then to cost objects (jobs, clients,
  products, patients, etc.)
• Volume-based systems assign factory overhead to a
  single plant or departmental cost pool first and
  then to products or services using a volume-based
  rate
• ABC systems assign factory overhead costs to
  activities or activity cost pools using resource
  consumption cost drivers and then assign these
  costs to cost objects using activity consumption
  cost drivers
• The use of cost drivers in each stage makes ABC
  generally more accurate than volume-based costing

6
Activity-Based Costing

• A costing approach that assigns resource costs
  to cost objects based on activities performed for
  the cost objects
• Costs of resources are assigned to activities
  based on the activities that use or consume
  resources (resource consumption drivers), and
  costs of activities are assigned to cost objects
  based on activities performed for the cost
  objects (activity consumption cost drivers)

7
Activity Analysis

• Through activity analysis, a firm identifies the
  work it performs to carry out its operations
• The process includes gathering data from existing
  documents and records, as well as collecting
  additional data using questionnaires,
  observations, or interviews of key personnel
• Sample questions include
• What work or activities do you do?
• How much time do you spend performing these
  activities?
• What resources are required to perform these
  activities?
• What value does the activity have or the product,
  service, customer, or organization?

8
Activity Analysis (continued)

• To identify resource costs for various
  activities, a firm classifies all activities
  according to the way in which the activities
  consume resources
• A unit-level activity is performed on each
  individual unit of product or service of the firm
  (e.g., direct materials)
• A batch-level activity is performed for each
  batch or group of units of products or services
  (e.g., setting up machines or placing purchase
  orders)
• A product-level activity supports the production
  of a specific product or service (e.g.,
  engineering changes to modify parts for a
  product)
• A facility-level activity supports operations in
  general (e.g., property taxes and insurance)

9
Developing an ABC System

• There are three steps in the development of an
  ABC system
• Identify resource costs and activities (Stage
  One)
• An activity analysis is performed to identify key
  activities and the way in which the activities
  consume resources
• Assign resource costs to activities (Stage One)
• Use resource consumption cost drivers based on
  cause-and-effect relationships, such as the
  number of labor hours, setups, moves,
  machine-hours, employees, or square feet to
  assign resource costs
• The assignment is made through either direct
  tracing or estimation
• Assign activity costs to cost objects (Stage Two)
• Use activity consumption cost drivers, such as
  purchase orders, receiving reports, parts stored,
  direct labor-hours, or manufacturing cycle time
  to assign activity costs