Title: Activity Based Cost System
1Activity 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
2Overview 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
3Todays 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)
5Cooper and Kaplan described.
6Cooper and Kaplan described
7When 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.
8Steps 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.
91. Identifying activities
- Examples
- machine-related activities
- Direct labor-related activities
- Support activities
- Ordering
- Receiving
101. Identifying activities
- ACTIVITY ANALYSIS
- Examine the physical plan of the workplace
- Payroll listing
111. Identifying activities(Approaches)
- Top-Down approach
- Recycling approach
- Interviews or participative approach
-
122.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
132.Assigning costs to activity cost centers
- Resources can be
- Directly attributable
- Indirectly attributable
- Cause-and-effect cost drivers
- Interviews
143. 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.
153. 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
163.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
174.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.
18ABC VS. Traditional costing system
- Traditional Costing system
19Product Costs Distortion
20Cost Hierarchy
21Unit Level
- Manufacturing Operations Costs
- Costs of Energy
- Machine depreciation
- Machine hours as cost driver
22Batch Level
- Set Up Costs
- Procurement Cost
- Quality Assurance Costs
23Product Level
- Design Costs
- complexity of the product
24Facility 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
25Exercise
- 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
26Exercise (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
27Exercise (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
28Exercise (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
29Exercise (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
30Exercise (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?
31Solution
32previous job costing system
33Activity Based Cost System
34Traditional 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