Chapter 4- Activity based costing systems Flashcards
Traditional costing systems
- were created when manufacturing processes were labor intensive
- a single company-wide overhead rate based on direct labor hours may be used to allocate overhead to products in these labor intensive processes
Have led to under-costing and over-costing because it doesn’t reflect reality
Activity based costing
A costing method that identifies the activities performed within the organization as it delivers its goods and services.
- direct labor hours
- process setups
- design time
- machine hours
- customer contact
Steps for ABC
- Identify and classify the activities related to the company’s products or services
- Estimate the cost of each activity identified in 1.
- Calculate a cost-driver rate for each activity
- Assign activity costs to products using the cost-driver rate
ABC vs traditional costing
Traditional:
Resource costs –> Directly traced or allocated –> Cost pools: Plants or departments –> Predetermined overhead rate –> Cost objects
ABC:
Resource costs –> Directly traced or allocated –> Cost pools: Activities or activity centers–> Cost driver rates for each activity–> Cost objects
Classify activities
- Unit-level activities
- Batch- level activities
- Product-level activities
- Customer-level activities
- Facility-level activities
Unit-level activities
Resources acquired and activities performed for individual units of product
Batch-level activities
Resources acquired and activities performed for a group or batch of similar products or services
Product-level activities
Resources acquired and activities performed to produce and sell a specific product or service
Customer-level activities
Resources acquired and activities performed to serve specific customers
Facility-level activities
Resources acquired and activities performed to provide general capacity to produce goods or services
Methods for identifying and classifying activities
- Top down approach
- Recycling approach
- Interview or participative approach
Top down approach
ABC teams of people from top levels of management generate the activity dictionary.
Recycling approach
Reuses documentation of processes used for other purposes
Interview or participative approach
ABC teams include or interview operating employees
Cost driver rate =
Activity cost + activity volume
ABC profitability measures
Now that we havemeasured productcosts accurately,we see how profitableeach product really is.
Activity-based analysis canbe used to track the costsof serving customers andthose customers’contribution to company profits.
When to use ABC?
- Indirect costs are significant in proportion to direct costs.
- Goods are complex, requiring many inputs and processes.
- Complex, low-volume products are profitable while standard, high-volume products are not.
- Different departments believe costs are assigned inaccurately.
- The company loses bids it thought were low, and wins bids it thought were high.
- Operations have changed significantly, but the costing system has not changed.
- Introduction of new models result in higher sales, apparent profits per unit, but an overall income decline.
