bg management accounting chapter 4 3607

CHAPTER 4: Activity-Based Costing 4.1 Activity- Based Costing: An overview 4.2.Designing an Activity-Based Costing system 4.3 The limitation of Activity -Based Costing 4.1 Activity- Based Costing: An overview Activity-based costing (ABC) is a costing method that is designed to provide managers with cost information for strategic and other decisions that potentially affect capacity and therefore “fixed” as well as variable costs Most organizations that use activity-based costing have two costing systems —the official costing system that is used for preparing external financial reports and the activity-based costing system that is used for managing activities 4.1 Activity- Based Costing: An overview In activity-based costing, many nonmanufacturing costs relate to selling, distributing, and servicing specific products First, ABC systems trace all direct nonmanufacturing costs to products Second, ABC systems allocate indirect nonmanufacturing costs to products whenever the products have presumably caused the costs to be incurred 4.1 Activity based costing – an overview Manufacturing costs Nonmanufacturing costs Traditional product costing ABC product costing ABC assigns both types of costs to products 4.1 Activity based costing – an overview Traditional product costing some All Non manufacturing costs ABC product costing ABC does not assign all manufacturing costs to products 4.1 Activity based costing – an overview The most commonly used allocation base in traditional costing is direct labor hours Direct labor hours work well when overhead increases as direct labor hours increase Problems: Œ In many processes, overhead is increasing while direct labor is decreasing  Variety and complexity of products is increasing 4.1 Activity based costing – an overview An activity is any event that causes the consumption of overhead resources An activity cost pool is a “bucket” in which costs are accumulated that relate to a single activity measure in the ABC system An activity measure is an allocation base in an activity-based costing system A Cost driver is also used to refer to an activity measure because the activity measure should “drive” the cost being allocated Exh 1-2 4.1 Activity based costing – an overview ABC uses more allocation bases 4.2 Designing an Activity-Based Costing system There are three essential characteristics of a successful activitybased costing implementation First, top managers must strongly support the ABC implementation Second, top managers should ensure that ABC data is linked to how people are evaluated and rewarded Third, a cross-functional team should be created to design and implement the ABC system 4.2 Designing an Activity-Based Costing system Steps for Implementing ABC ŒIdentify and define activities and activity cost pools Trace costs to activities and cost objects ŽAssign costs to activity cost pools Calculate activity rates Assign costs to cost objects ‘Prepare management reports 4.2 Designing an Activity-Based Costing system Unit-Level Activity Batch-Level Activity Manufacturing companies typically combine their activities into five classifications Product-Level Activity Organizationsustaining Activity Customer-Level Activity 4.2.Designing an Activity-Based Costing system Activities should only be combined within a level if they are highly correlated When combining activities, they should be grouped together only at the appropriate level 4.2 Designing an Activity-Based Costing system An Activity Cost Pool is a “bucket” in which costs are accumulated that relate to a single activity measure in the ABC system Two types of activity measures: Transaction driver Simple count of the number of times an activity occurs Duration driver A measure of the amount of time needed for an activity 4.2 Designing an Activity-Based Costing system Direct Materials Traced Direct Labor Shipping Costs Traced Traced Cost Objects: Products, Customer Orders, Customers Overhead Costs 4.3 The limitation of Activity - Based Costing Substantial resources required to implement and maintain Resistance to unfamiliar numbers and reports Desire to fully allocate all costs to products Potential misinterpretation of unfamiliar numbers Does not conform to GAAP Two costing systems may be needed  ... incurred 4. 1 Activity based costing – an overview Manufacturing costs Nonmanufacturing costs Traditional product costing ABC product costing ABC assigns both types of costs to products 4. 1 Activity... activity measure should “drive” the cost being allocated Exh 1-2 4. 1 Activity based costing – an overview ABC uses more allocation bases 4. 2 Designing an Activity-Based Costing system There are three... activity cost pools Calculate activity rates Assign costs to cost objects ‘Prepare management reports 4. 2 Designing an Activity-Based Costing system Unit-Level Activity Batch-Level Activity