BMGT 221 STUDY SHEET 2 Chapter 7 OVERVIEW OF ABC ABC is different from traditional cost accounting because 1 Nonmanufacturing as well as manufacturing costs might be assigned to products but only on a cause and effect basis 2 Some manufacturing costs may be excluded form product costs 3 Numerous overhead cost pools are used each of which is allocated to products and other cost objects using its own unique measure of activity ABC costing method that is designed to provide managers with cost info for strategic and other decisions that potentially affect capacity and therefore fixed as well as variable costs First stage allocations the process of assigning functionally organized overhead costs derived from a company s general ledger to the activity cost pools Usually based on results of interviews with employees who have first hand knowledge of the activities Second stage allocations activity rates are used to apply overhead costs to products and customers Product margins profit from a product Customer margins ABC steps Step 1 Compute activity rates for cost pools Step 2 Assign costs to cost pools using first stage allocation Step 3 Compute activity rates for cost pools Step 4 Assign costs to a cost object using a second stage allocation Step 5 Use activity based costing to compute product and customer margins Differences between ABC and Traditional product costs 1 Traditional costing allocates all manufacturing overhead to products ABC costing only assigns manufacturing overhead costs consumed by products to those products 2 Traditional costing allocates all manufacturing overhead costs using a volume related allocation base ABC costing uses non volume related allocation bases 3 Traditional costing disregards SG A expenses because they are assumed to be period expenses ABC costing directly traces shipping costs to products and includes nonmanufacturing overhead costs caused by products in the activity cost pools that are assigned to products ABC Limitations Substantial resources required to implement Desire to fully allocate costs to products Doesn t conform to GAAP Two costing systems may be needed Resistance to unfamiliar numbers and reports Potential misinterpretation of unfamiliar numbers Chapter vocab Activity any event that causes the consumption of overhead resources Activity cost pool bucket where costs are accumulated that relate to a single activity measure in the ABC system Activity measure allocation base in an ABC system also referred to as cost driver Transaction drivers simple counts of the number of times an activity occurs such as the number of bills sent out to customers Duration drivers measure the amount of time required to perform an activity such as the time spent preparing individual bills for customers more accurate measures of resource consumption than transaction drivers but they take more effort to record Unit level activities performed each time a unit is produced Costs of activities should be proportional to the number of unites produced Ex providing power to run equipment because power is consumed in proportion to number of units produced Batch level activities performed each time a batch is handled or processed despite how many units are in the batch Ex tasks like placing purchase orders setting up equipment arranging for shipments to customers These are incurred once for each batch or customer order Cost depends on number of batches processed not on number of units produced sold or other measures of volume Product level activities Relate to specific products and typically must be carried out despite how many batches are run or units of product are produced or sold Ex Designing a product advertising a product and maintaining a product manager and staff Customer level activities Relate to specific customers and include activities like sales calls catalog mailings and general tech support that are not tied to an specific product Organization sustaining activities carried out despite what customers are served which products are produced how many batches are run or how many units are made ex heating the factory cleaning exec offices producing computer network arranging for loans and preparing annual reports to shareholders Action analysis report provides more detail about costs and how they might adjust to changes in activity than the ABC analysis presents Activity based management involves focusing on activities to eliminate waste decrease processing time and reduce defects Benchmarking systematic approach to identifying the activities with the greatest room for improvement Desired units of ending finished goods inventory desired ending inventory Budgeted Unit sales Budgeted COGS Units of beginning finished goods inventory beginning merchandise inventory Required production in units required purchases in dollars Production Total needs Chapter 8 Budgets Sales Budgeted Unit Sales X Selling price per unit Total sales DM Budget Required production in units X units of raw materials needed per unit Units of raw materials needed to meet production Desired ending inventory of raw materials Total units of raw materials needed Units of beginning raw materials inventory Units of raw materials to be purchased X Cost of raw materials per pound Cost of raw materials to be purchased Direct Labor Budget Required production in units X Direct Labor Hours per unit Total Direct labor hours needed X Direct labor cost per hour Total direct labor cost Manufacturing OH Budgeted direct labor hours X Variable MOH rate Variable manufacturing overhead Fixed manufacturing overhead Total manufacturing overhead Depreciation Cash disbursements for MOH Ending finished goods inventory budget Budgeted finished goods inventory X Unit production cost Ending finished goods inventory in Selling administrative Budgeted unit sales X Variable SG A expense per unit Variable SG A expense includes DEPRECIATION Fixed SG A expenses Total SG A expenses Depreciation Cash disbursements for SG A expenses Excess deficiency of cash available over disbursements Cash Budget Beginning cash balance Cash receipts Total cash available Cash disbursements Budgeted income statement Sales COGS Gross Margin SG A expenses Net operating income Interest expense Net income Budget detailed quantitative plan for acquiring and using financial and other resources over a specified future time period Budgetary control use of budgets to control an organization s activities Planning developing objectives and preparing various
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