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Activity Based Cost System

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Overview of Activity Based Costing ... rate for each activity 3.Calculate a cost-driver rate for each activity 4.Assigning the activity cost to the product ABC VS. – PowerPoint PPT presentation

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Title: Activity Based Cost System


1
Activity Based Cost System
  • Overview of Activity Based Costing
  • History of Activity Based Costing
  • Contrasts between ABC and Traditional system
  • Steps to implement ABC
  • Exercise and solutions to ABC

2
Overview of ABC
A process of identifying activities that cause
indirect costs and choosing cost drivers to apply
those indirect costs to different products and
activities.
Activity-Based Management The management
processes that use activity-based costing
information to improve firm performance by
eliminating non-value-added activities, making
better pricing and product-mix decisions,
improving manufacturing and administrative
processes, and designing better products
3
Todays businesses are working in an increasingly
complex environment.
Use of Advanced Technology
Product Life Cycle
Product Complexity
Channels of Distribution
Quality Requirements
Product Diversity
4
(No Transcript)
5
Cooper and Kaplan described.
6
Cooper and Kaplan described
7
When Is Activity-Based Costing Appropriate?
  • ABC is used most effectively in complex
    companies that are not entirely service-based. it
    is most helpful when the costing information is
    difficult to understand or evaluate.
  • It can be a very powerful management tool
  • It can be very expensive to start
  • It does not always conform to generally accepted
    accounting principles
  • If using an ABC system a company may have to
    keep a separate system to track costs in a manner
    that does conform to GAAP.

8
Steps in ABC cost accounting
  • 1. Identifying activities
  • 2. Assigning costs to activity cost centers
  • 3. Calculate a cost-driver rate for each activity
  • 4. Assigning the cost of the activities to
    products.

9
1. Identifying activities
  • Examples
  • machine-related activities
  • Direct labor-related activities
  • Support activities
  • Ordering
  • Receiving

10
1. Identifying activities
  • ACTIVITY ANALYSIS
  • Examine the physical plan of the workplace
  • Payroll listing

11
1. Identifying activities(Approaches)
  • Top-Down approach
  • Recycling approach
  • Interviews or participative approach

12
2.Assigning costs to activity cost centers
  • Activity costs center
  • After the activities have been identified the
    cost of resources consumed over a specified
    period must be assigned to each activity.
  • Practical capacity Vs. Unused capacity

13
2.Assigning costs to activity cost centers
  • Resources can be
  • Directly attributable
  • Indirectly attributable
  • Cause-and-effect cost drivers
  • Interviews

14
3. Calculate a cost-driver rate for each activity
  • Activity cost drivers
  • Conditions for choosing cost drivers
  • It should provide a good explanation of costs in
    each activity cost pool.
  • Cost driver must be easily measurable.

15
3. Calculate a cost-driver rate for each activity
  • Activity cost drivers consists of
  • Transaction drivers
  • Number of customer orders performed
  • Number of inspections performed
  • Number of set-ups undertaken
  • Duration drivers
  • Inspection hours
  • Set-up hours

16
3.Calculate a cost-driver rate for each activity
  • Ex Mr. X Owns a customer service center where
    customers can call and ask questions. They pay a
    fixed fee for each call they make to the service
    center. It costs the owner 1,260,000 a year to
    operate the center. The center receive 120,000
    calls per year and also the center handles
    1,000,000 minutes of calls.
  • What is the cost-driver rate?
  • Answer
  • 1,260,000 120,000 10.5 per call

17
4.Assigning the activity cost to the product
  • At the final stage, the cost driver rates are
    applied to the products
  • Note the cost driver must be measurable in a way
    that enables it to be identified with individual
    products.

18
ABC VS. Traditional costing system
  • ABC costing system
  • Traditional Costing system

19
Product Costs Distortion
20
Cost Hierarchy
21
Unit Level
  • Manufacturing Operations Costs
  • Costs of Energy
  • Machine depreciation
  • Machine hours as cost driver

22
Batch Level
  • Set Up Costs
  • Procurement Cost
  • Quality Assurance Costs

23
Product Level
  • Design Costs
  • complexity of the product

24
Facility Level
  • General Administration Costs
  • Plant depreciation
  • Plant management salaries
  • Plant maintenance and insurance
  • Difficulty in finding a good cost driver
  • Allocating to products and deducting from
    operating income
  • Using direct manufacturing labor hours to
    allocate them to products

25
Exercise
  • The Tracy Corporation has a machining facility
    specializing in jobs for the aircraft components
    market. The previous job costing system had two
    direct cost categories (direct materials and
    direct manufacturing labor) and a single indirect
    cost pool (manufacturing overhead allocated using
    direct manufacturing labor hours). The indirect
    cost allocation rate of the previous system for
    2004 would have been 115 per direct
    manufacturing labor hour

26
Exercise (contd)
  • Recently a team with members from product design,
    manufacturing, and accounting used an ABC
    approach to refine its job costing system. The
    two direct cost categories were retained. The
    team decided to replace the single indirect cost
    pool with five indirect cost pools. The cost
    pools represent five activity areas at the
    facility, each with its own supervisor and budget
    responsibility. Pertinent data are as follows

27
Exercise (contd)
Activity Area Cost Allocation Base Cost Allocation Rate
Material Handling Parts 0.40
Lathe Work Lathe Turns 0.20
Milling Machine Hours 20.00
Grinding Parts 0.80
Testing Units Tested 15.00
28
Exercise (contd)
  • Information gathering technology has advanced to
    the point at which the data necessary for
    budgeting in these five activity areas are
    collected automatically.
  • Two representative jobs processed under the ABC
    system at the facility in the most recent period
    has the following characteristics

29
Exercise (contd)
Job 410 Job 411
Direct materials 9700 59900
Direct Manufacturing labor 750 11250
Number of direct manufacturing labor hours 25 375
Parts 500 2000
Lathe turns 20000 60000
Machining hours 150 1050
Units (all units are tested) 10 200
30
Exercise (contd)
  • Compute the manufacturing costs per unit for each
    job under the previous job costing system?
  •  Compute the manufacturing costs per unit for
    each job under the ABC system?
  •  Show which product is undercosted or overcosted
    under pervious costing system?

31
Solution
32
previous job costing system
33
Activity Based Cost System
34
Traditional job costing system Vs. ABC System
Job Order 410 Job Order 411
Number of units in job 10 200
Costs per unit with prior costing system 1332.5 571.38
Cost per unit with activity based costing 1820 547.75
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