03 27 2014 1 Activity Based Costing ABC Costing method designed to provide managers with cost information for strategic and other decisions that potentially affect capacity and therefore fixed as well as variable costs a Ordinarily used as a supplement to a company s usual costing system b Most organizations have two costing systems I The official costing system used for preparing external financial reports 1 All manufacturing costs are assigned to products even manufacturing costs that are not caused by the products 2 MOH include costs that aren t directly related to the product Security guard s wages cost of supplies used by manager s secretary Assigned to products in a traditional absorption costing system even though they are totally unaffected by which products are made during a period 3 Cost of unused idle capacity are assigned to products 4 Rely exclusively on the allocation bases that are driven by the volume of production II Activity based costing system that is used for internal decision making and for managing activities 1 Purposefully doesn t assign two types of manufacturing overhead costs to products 2 Do not arbitrarily assign organization sustaining costs to products Treats these costs as period expenses rather than product costs 3 Products are only charged for the costs of the capacity they use not for the costs of capacity they don t use a Provides more stable unit product costs and is consistent with the goal of assigning to products only the cost of the resources that they use 4 Uses more cost pools and unique measures of activity to better understand the costs of managing and sustaining product diversity a With the new changes of decrease labor and increase overhead continuing to rely on a limited number of overhead cost pools and traditional allocation bases posed the risk that reported unit product costs would be distorted and misleading when used for decision making purposes c Activity any event that causes the consumption of overhead resources I Activity cost pool bucket in which costs are accumulated that relate to a single activity measure in the ABC system II Activity Measure Cost Driver allocation base in an activity based costing system 1 Transaction Driver simple counts of the of times an activity occurs bills sent out to customers 2 Duration Drivers measure the amount of time required to preform an activity time spent preparing individual bills for customers 2 ABC Defines five levels of activity that don t relate to the volume of units produced a Unit Level Activities Preformed each time a unit is produced Cost should be proportional to the of units produced Providing power to run processing equipment b Batch Level Activities Preformed each time a batch is handled or processed regardless of how many units are in the batch Placing purchase orders setting up equipment arranging for shipments to customers Depend on of batches processed rather than on of units produced units sold or other measures of volume c Product Level Activities relate to specific products and typically must be carried out regardless of how many batches are run or units of products are produced or sold Designing a product advertising a product maintaining a product manager and staff d Customer Level Activities relate to specific customers that include activities such as sales calls catalog mailings and general technical support that are not tied to any specific product e Organization Sustaining Activities carried out regardless of which customers are served which products are produced how many batches are run or how many units are made Heating cleaning offices providing network arranging for loans preparing annual reports to shareholders 3 Designing an Activity Based Costing System I Need for representation 1 Top Managers must strongly Support the ABC implementation because their leadership is instrumental in properly motivating all employees to embrace the need to change 2 Top managers should ensure that ABC data is linked to how people are evaluated and rewarded 3 If employees continue to be evaluated and rewarded using traditional cost data they will quickly get the message that ABC is not important and they will abandon it 4 Cross functional team should be created to design and implement the ABC system a Should include representatives from each area that will use ABC data b c they possess intimate knowledge and because it will lessen their resistance to ABC b 1 DEFINE ACTIVITIES ACTIVITY COST POOLS AND ACTIVITY MEASURES I II Identify the activities that will form the foundation for the system The greater the number of activities tracked in the ABC system the more accurate the costs are likely to be III A complex system involving large numbers of activities is costly to design implement maintain and use IV When combining activities in an ABC system activities should be grouped together at the appropriate level V c 2 ASSIGN OVERHEAD COSTS TO ACTIVITY COST POOLS I First Stage Allocation process of assigning functionally organized overhead costs derived from a company s general ledger to the activity cost pools II Direct material direct labor and selling administrative costs are excluded because there is no need to incorporate direct costs into the activity based allocations of indirect costs 1 Usually based on the results of interviews with employees who have first hand knowledge of the activities III Amount needed x amount needed amount necessary for each department IV III d 3 CALCULATE ACTIVITY RATES I Activity Rate total cost total activity 1 Ex 300 000 annual cost 1000 customers 300 per customer order 2 These figures are the average figures II Activity rate isn t computed for the Other category because it consists of organization sustaining costs and costs of idle capacity that are not allocated to products and customers e 4 ASSIGN OVERHEAD COSTS TO COST OBJECTS I Second Degree Allocation activity rates are used to apply overhead costs to products and customers II How to Assign costs to products 1 Activity rate X Activity ABC Cost 2 Amount is less than the overhead costs in the ABC system because it doesn t include the customer relations customer level activity portion OR the other category to products Must add them later III How to assign costs to customers 1 Activity rate X Activity ABC costs IV f 5 PREPARE MANAGEMENT REPORTS I Most common management reports prepared with ABC data are product and customer profitability reports 1 These reports help companies channel their
View Full Document
Unlocking...