Activity-Based

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Chapter 5 Activity-Based Cost Management
Systems
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Chapter 5 objectives To be able to 1.
Understand how traditional cost systems, using
only unit-level drivers, distort product and
customer costs. 2. Describe why factories
producing a more varied and complex mix of
products have higher costs than factories
producing only a narrow range of
products. 3. Design an activity-based cost system
by linking resource costs to the activities
performed and then to cost objects, such as
products and customers. 4. Appreciate the role
for choosing appropriate activity cost drivers
when tracing activity costs to products and
customers. 5. Use the information from a
well-designed activity-based cost system to
improve operations and make better decisions
about products and customers. 6. Understand the
importance of measuring the practical capacity of
resources and the cost of unused
capacity. 7. Assign marketing, distribution and
selling expenses to customers. 8. Analyze
customer profitability. 9. Appreciate the role
for activity-based cost systems for service
companies. 10. Discuss the barriers for
implementing activity-based cost systems and how
these might be overcome. 11. Understand how
ABC-costing works in the organizational structure
of Arla Foods Amba
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• Traditional Manufacturing Costing Systems
• Tends to underestimate required resources
  required for specialty low -volume costs
• Tends to overestimate the resource cost of high
  volume standard products
• Exhibit 5-1, pages 160-162

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• Activity-Based Cost Management Systems
• Definition
• System based on activities that links
  organizational spending on resources to the
  products and services produced and delivered to
  customers

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• Activity-Based Cost Management Systems
• Tracing costs to activities
• Tracing costs from activities to products
• Selecting activity cost drivers

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• Tracing costs to activities
• Step 1 Develop activity dictionary the list of
  major activities performed by the plants
  resources
• (use verb action words as handle, perform and
  support to describe activities)
• Step 2 Map resource expenses to activities in
  dictionary
• Exhibit 5-2, page 166
• Exhibit 5-3, page 166
• Exhibit 5-4, page 167

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Tracing costs to activities The process of
identifying the link between expenses and
activities provide knowledge/insight about 1.
The cost of performing a specific activity
2. Transforming focus from what the money was
being spent on to what the resources acquired by
the spending were actually doing (exhibit 5-4,
page 167)
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Tracing costs to activities Operational
activity-based management The process of using
information collected by the ABC-system at the
activity level to identify promising
opportunities for reducing costs in indirect and
support activities.
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Tracing costs from activities to
products Purpose The activity expenses should
be related in some way to the demands for the
activities by individual products. Activity cost
drivers Measures that identify the linkage
between activities and cost objects. They serve
as quantitative measures of the output of
activities. Activity cost driver rate The
amount determined by dividing the activity
expense by the total quantity of the activity
cost driver.
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Tracing costs from activities to
products Establishing activity cost
drivers Exhibit 5-5, page 169 Exhibit 5-6, page
169 Calculationg activity cost driver
rates activity expense total quantity of
activity cost driver example Cost driver
handle production runs 66.000 66.000 Cost
driver rate Number of runs 150 440
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Tracing costs from activities to
products Assigning activity expenses to
products Exhibit 5-7, page 170 Creating a full
Activity-Based Costing Product Profitability
Report Exhibit 5-8, page 170 Bill of
activities The set of activities and costs
associated with individual products or customers.
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• Tracing costs from activities to products
• Activity-based management (ABM)
• An approach to operations control that involves
  the five-step process of
• identifying the process objectives
• charting activities
• clasifying activities
• continuously improving processes
• eliminating activities whose costs exceed their
  value.

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Selecting activity cost drivers Accuracy versus
the cost of measurement 3 different categories
of activity cost drivers Transaction
drivers Used to count the frequency of an
activity, the number of times an activity is
performed. Example - cost per customer
(assumes all customers cost the same). Duration
drivers Represent the amount of time required to
perform an activity. Example - cost per
customer hour (assume different customers use
different amounts of sales resource time, but
each hour of support time costs the
same). Intensity drivers Used to directly
charge for the resources used each time an
activity is performed. Example - actual cost
per customer (actual or estimated time and
specific resources, including travel committed
to specific customers).
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Measuring the Cost of Resource Capacity Practical
capacity The amount of work that can be
performed by resources supplied for production
or service. Cost of unused capacity An expense
determined by the amount of resources unused
during production. Example Capacity 176
production runs Amount 66.000 cost driver
375 Actual is 150 production runs Amount
66.000 cost driver 440 The rate of 440
contains a cost of unused capacity in the amount
of 65. Where to assign the cost related to
unused capacity? Case Arla Foods Amba overhead
and capacity.
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Marketing, Selling and Distribution
Expenses Tracing costs to Customers Many of the
MSDE costs do not relate to individual products
or product lines, but are rather associated with
individual customers, market segments and
distribution channels. The Anders Wire
Company, page 177-179
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Managing Customer Profitability Exhibit 5-10,
page 180 Discussing types of customers and what
can be done to make profits acceptable.
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Service Companies and Activity-Based Costing ABC
is highly relevant for service companies since
they typically generate indirect and overall
fixed costs. Consequently there are no direct
product or customer costs to serve as convenient
allocation bases. Exhibit 5-11, page 184
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• Implementation Issues
• Lack of clear business purpose
• Lac of senior management commitment
• Delegating the project to consultants
• Poor ABC model design
• Individual and organizational resistance to
  change