Managerial accounting by garrison noreen13th chap008

Activity-Based Costing:
A Tool to Aid Decision Making
Chapter 8

McGraw-Hill/Irwin

Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.


Activity–Based Costing (ABC)
ABC is designed to
provide managers with
cost information for
strategic and other
decisions that
potentially affect
capacity and therefore
affect “fixed”
as well as variable
costs.

ABC is a
good supplement
to our traditional
cost system

I agree!

8-2

How Costs are Treated Under
Activity–Based Costing
ABC
ABC differs
differs from
from traditional
traditional cost
cost accounting
accounting in
in three
three ways.
ways.
Manufacturing
costs

Nonmanufacturing
costs

Traditional
product costing

ABC
product costing

 ABC assigns both types of costs to products.
8-3


How Costs are Treated Under
Activity–Based Costing

ABC
ABC differs
differs from
from traditional
traditional cost
cost accounting
accounting in
in three
three ways.
ways.

Traditional
product costing

Nonmanufacturing
costs
Mo
st, b
ut
not
all

Some

All

Manufacturing
costs

ABC

product costing

 ABC does not assign all manufacturing costs to products.
8-4


How Costs are Treated Under
Activity–Based Costing
Level of complexity

ABC
ABC differs
differs from
from traditional
traditional cost
cost accounting
accounting in
in three
three ways.
ways.
Activity–Based
Activity–Based
Costing
Costing
Departmental
Departmental
Overhead
Overhead
Rates
Rates

Plantwide
Plantwide
Overhead
Overhead
Rate
Rate

Number of cost pools
 ABC uses more cost pools.
8-5


How Costs are Treated Under
Activity–Based Costing
ABC
ABC differs
differs from
from traditional
traditional cost
cost accounting
accounting in
in three
three ways.
ways.

Each
Each ABC cost
cost pool
pool has
has its

its
own
own unique
unique measure
measure of activity.
Traditional
Traditional cost
cost systems
systems usually
usually rely
rely
on
on volume
volume measures
measures such
such as
as direct
direct labor
labor
hours
hours and/or
and/or machine
machine hours
hours to
to allocate
allocate
all
all overhead
overhead costs
costs to

to products.
products.
 ABC uses more cost pools.
8-6


How Costs are Treated Under
Activity–Based Costing
Activity

An event that causes the
consumption of overhead
resources.

Activity
Cost Pool

A “cost bucket” in which
costs related to a single
activity measure are
accumulated.

$$
$
$ $
$

8-7

How Costs are Treated Under
Activity–Based Costing
Activity
Measure

The term cost driver is
also used to refer to
an activity measure.

An allocation base
in an activity-based
costing system.

8-8


How Costs are Treated Under
Activity–Based Costing
Two common types of activity measures:
Transaction
driver

Duration
driver

Simple count
of the number of
times an activity
occurs.

A measure
of the amount
of time needed
for an activity.
8-9


How Costs are Treated Under
Activity–Based Costing
ABC defines
five levels of activity
that largely do not relate
to the volume of units
produced.

Traditional
Traditional cost
cost systems
systems usually
usually rely
rely on
on volume
volume
measures
measures such
such as
as direct
direct labor
labor hours
hours and/or

and/or machine
machine
hours
hours to
to allocate
allocate all
all overhead
overhead costs
costs to
to products.
products.
8-10


How Costs are Treated Under
Activity–Based Costing
Unit-Level
Activity

Batch-Level
Activity

Manufacturing
companies typically combine
their activities into five
classifications.
Product-Level
Activity

Organizationsustaining

Activity

Customer-Level
Activity

8-11


Characteristics of Successful ABC
Implementations

Strong top
management support

Link to evaluations
evaluations
and rewards

Cross-functional
involvement
8-12


Targeting Process Improvement
Activity-based management is
used in conjunction with ABC to
identify areas that would benefit
from process improvements.
While the theory of constraints
approach discussed in Chapter 1

is a powerful tool for targeting
improvement efforts, activity rates
can also provide valuable clues on
where to focus improvement efforts.
Benchmarking
Benchmarking can
can be
be used
used to
to compare
compare activity
activity cost
cost
information
information with
with world-class
world-class standards
standards of
of performance
performance
achieved
achieved by
by other
other organizations.
organizations.
8-13


Activity-Based Costing and External Reporting
Most companies do not use ABC

for external reporting because . . .
1.
1. External
External reports
reports are
are less
less detailed
detailed than
than internal
internal
reports.
reports.
2.
2. ItIt may
may be
be difficult
difficult to
to make
make changes
changes to
to the
the company’s
company’s
accounting
accounting system.
system.
3.
3. ABC
ABC does
does not

not conform
conform to
to GAAP.
GAAP.
4.
4. Auditors
Auditors may
may be
be suspect
suspect of
of the
the subjective
subjective allocation
allocation
process
process based
based on
on interviews
interviews with
with employees.
employees.

8-14


ABC Limitations
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.
8-15


Appendix 8A: ABC Action Analysis
Conventional ABC analysis does not
identify potentially relevant costs. An
action analysis report helps because it:
• Shows what costs have been
assigned to a cost object.
• Indicates how difficult it would be to
adjust those costs in response to
changes in the level of activity.
8-16

Appendix 8B
A
A modified
modified form
form of
of activity-based
activity-based
costing
costing can
can be
be used
used to
to develop
develop product
product
costs
costs for external
external financial
financial reports.
reports.

ABC
ABC product
product costs:
costs:

•• Include
Include organization-sustaining
organization-sustaining costs
costs

and
and unused
unused capacity
capacity costs.
costs.
•• Exclude
Exclude nonmanufacturing
nonmanufacturing costs
costs even
even
ifif they
they are
are caused
caused by
by the
the products.
products.

8-17


End of Chapter 8

8-18