Transcript Document 7450640

Chapter 4
Product Costing for Management
Decisions: Activity-Based Costing
and Activity-Based Management
Topics to be Discussed
Introduction
Activity-Based Costing
Choosing Cost Drivers
to Motivate Behavior
Introduction
Overhead costs have soared to 60
percent or more of total product costs
in heavily automated manufacturing
environments.
As overhead costs increase and make
up a larger portion of the total costs of
products, accuracy in overhead
application has become much more
important.
Activity-Based Costing
Overhead Allocation Methods
Using Volume-Based Cost Drivers
Using Activity-Based Cost Drivers
Types of Overhead Costs
Unit-level costs are incurred each time a
unit is produced. Examples:
Supplies for factory
Depreciation on factory machinery
Energy costs for factory machinery
Repairs and maintenance of factory machinery
Types of Overhead Costs
Batch-level costs are incurred each time
a batch of goods is produced. Examples:
Salaries related to purchasing and receiving
Salaries related to moving material
Quality control costs
Depreciation of setup equipment
Types of Overhead Costs
Product-level costs are incurred as
needed to support the production of
each different type of product.
Examples:
Salaries of engineers
Depreciation of engineering equipment
Product development costs (testing)
Quality control costs
Types of Overhead Costs
Facility-level costs simply sustain a
facility’s general manufacturing
process. Examples:
Depreciation of factory building or rent
Salary of plant manager
Insurance, taxes, etc.
Training
Activity-Based Costing (ABC)
Key Concept
Overhead costs are assigned to products in
an ABC system in two stages:
Stage 1: Activities are identified and
overhead costs are traced to each activity
Stage 2: Cost drivers are determined for
each activity and costs are assigned to
products
Activities and Cost Drivers:
Unit Level
Activity
Potential Cost Driver
Machining
Machine hours, labor
hours or number of units
Maintenance
of machines
Machine hours
Activities and Cost Drivers:
Batch Level
Activity
Potential Cost Driver
Purchasing
Number of purchase
orders or number of parts
Receiving
Amount of material or
number of receipts
Machine setups
Number of setups
Customer orders
Number of orders, number
of customers
Activities and Cost Drivers:
Product Level
Activity
Potential Cost Driver
Product
Testing
Number of change orders,
number of tests, hours of
testing time
Supervision
Number of supervision
hours
Activities and Cost Drivers:
Facility Level
Activity
Potential Cost Driver
Plant Occupancy
Square footage, number
of employees, labor hours,
machine hours
Choosing Cost Drivers to Motivate Behavior
Cost drivers should generally be chosen
based on a cause-and-effect relationship
between the driver and the specific cost
being considered.
However, cost drivers may have
motivational effects that must be
considered as well. Example: Taking
customers’ orders by phone.
Choosing Cost Drivers to Motivate Behavior
Step 2: Identify Objectives
Minimize cost, thus spending
as little time on the phone as
possible or increase sales,
thus spending more time on
the call to make the sale
Choosing Cost Drivers to Motivate Behavior
Step 3: Identify and Analyze
Available Options
If less time is spent per call,
perhaps employees will answer
more calls or by not cutting a
call short, perhaps customers
will be more satisfied and more
sales will occur.
Traditional Overhead Allocation
and ABC - An Example
Beach Housing
Contractor
Builds standard houses
and custom houses
Estimated Overhead Costs
for 2002
Overhead Item
Indirect Materials
Construction Supervisors
Estimated Cost
$180,000
130,000
Office Staff
30,000
Part-time Workers
30,000
Office Expenses
48,000
Tools
15,000
Trucks and Other Equipment
40,000
Rent on Construction Trailers
12,000
Total
$485,000
Stage 1: Identification of
Activities
Activity
Estimated Cost
Inspections
$50,000
Purchasing
30,000
Supervision
100,000
Material delivery & handling
225,000
Processing change orders
Total
80,000
$485,000
Stage 2: Identification of Cost
Drivers & Allocation of Costs
Activity
Cost Driver
Inspections
Number of inspections
Purchasing
Number of purchase
orders
Supervision
Hours of supervisor time
Material delivery &
handling
Number of deliveries
Change orders
Number of change orders
Estimated Cost Driver Activity
Cost Driver
Standard Custom
Houses Houses
Totals
Number of Houses
(20)
(10)
Number of inspections
400
1,000
1,400
Number of purchase orders
600
600
1,200
2,500
1,500
4,000
Number of deliveries
600
600
1,200
Number of change orders
200
300
500
48,000
40,000
88,000
Supervision hours
Direct Labor Hours
Traditional Volume Based Costing
Activity
Cost / Cost Driver
= POR
Total Overhead
$485,000 / 88,000
= $5,51/DLH
Activity-Based Costing
Activity
Inspections
Purchasing
Cost / Cost Driver = PDR
$50,000 / 1400 = $35.71/inspection
30,000 / 1200 = $25/order
Supervision
100,000 / 4000 = $25/hour
Material delivery & handling
225,000 / 1200 = $187.50/delivery
Processing change orders
Total Overhead
80,000 / 500 = $160/order
$485,000
Standard House
Cost
ABC
Vol-Based
$75,000
$75,000
Direct labor
60,000
60,000
Inspections
714
Purchasing
750
overhead
Supervision
3,125
13,224
Material H&D
5,625
Processing change orders
1,600
Direct materials
Total Costs
$146,814
$148,224
Custom House
Cost
ABC
Vol-Based
$112,500
$112,500
Direct labor
100,000
100,000
Inspections
3,571
Purchasig
1,500
overhead
Supervision
3,750
22,040
Direct materials
Material H&D
Processing change orders
Total Costs
11,250
4,800
$237,371
$234,540
ABC
Allocating overhead costs using and
activity-based costing system results in
greater allocations of overhead to the
custom house because it consumes
more of the purchasing, inspection,
supervision, material handling, and
processing change order activities than
the standard house.
ABC
Key Concept
Volume-based costing systems
often result in overcosting highvolume products and undercosting
low-volume products.
This cross subsidy is eliminated by
the use of ABC.
More ABC Topics
ABC Systems in Service Industries
ABC and Selling Administrative Activities
ABC and JIT
Cost Flows and ABC
Benefits and Limitations of ABC
The ABM Life Cycle
ABC Systems in Service Industries
Although ABC was developed for
use primarily be manufacturing
companies, it has gained
widespread acceptance in the
service sector.
ABC Systems in Service Industries
Problems
Type of work tends to be
non-repetitive
Activities differ greatly for
each customer or service
Have proportionately more
facility-level costs
ABC Systems and Administrative
Activities
ABC is used to determine
the cost of providing a
selling or administrative
service. Example: The U.S.
Post Office used ABC to
help determine the costs
and benefits of allowing
customers to pay using
debit and credit cards.
ABC and Just in Time
Since factories are typically redesigned
in a JIT environment so that all
machinery and equipment needed to
make a product is available in one area,
overhead costs are more likely to be
traced to products as unit-level, batchlevel, or product-level costs.
Cost Flows and ABC
The flow of costs from raw materials
to work in process to finished goods
and cost of goods sold is not affected
by the implementation of ABC.
Benefits of ABC
Using ABC in the budgeting process provides
more accurate estimates of resources
Provides more accuracy of cost information for
day-to-day decision making
Costs that appeared to be indirect using
volume-based costing systems are now traced
to specific activities using cost drivers
Limitations of ABC
High measurement costs are significant
limitations.
The higher the potential for cost distortions,
the more likely the company will benefit from
ABC. Distortions result from diverse
products.
Diverse products: products that consume
resources in different proportions
Diverse Products
Pause and Reflect:
Are the standard houses and custom
houses built by TopSail Construction
diverse products?
Activity-Based Management Topics
Activity-Based Management and ABC
ABM and the Value Chain
Value-Added and Non-Value-Added
Activities
Successful Implementation of ABC
and ABM
Activity-Based Management Topics
Key Concept
Activity-based management
focuses on managing activities
to reduce costs and make
better decisions.
ABM and the Value Chain
1. Research and Development: The creation
and development of ideas that lead to new
products and services
2. Design: The detailed development of the
research and development ideas that results in
new products and services
3. Production: The use of resources to
produce a product or provide a service
ABM and the Value Chain
4. Marketing: Providing potential customers
with information about the attributes of products
or services available that results in customers
purchasing the products or services
5. Distribution: The actual delivery of products
or services to customers
6. Customer Service: Providing customers
with needed support and service during and
after the sale.
Value-Added and Non-Value-Added
Activities
Non-value-added activities don’t add value to
the finished product or service.
Storage of inventory
Moving of materials and parts from storage to
the factory
Idle time of employees while waiting for work
Value-Added and Non-Value-Added
Activities
Pause and Reflect:
Can you think of a situation in which you
would consider quality inspections to
increase the value of a product or service?
Successful Implementation of ABC and ABM
Utilize activity-based costing information
to reduce costs, eliminate non-valueadded activities, and manage more
effectively required the cooperation of all
functional areas of business organization
and top management.
Successful Implementation of ABC and ABM
Perhaps nowhere else is cooperation
among accountants, marketing managers,
production managers, human resource
managers, and finance managers more
critical than in the implementation of
activity-based costing and management
systems.
Successful Implementation of ABC and ABM
Key Concept
The successful implementation of ABC
and ABM requires a long-term
commitment by top management and
the cooperation of all functional areas
of business organization.
The ABM Life Cycle
Cost Focus
(1-2 years)
Performance Focus
(1-2 years)
Value-Added Focus
(ongoing)
End of Chapter 4
How do I allocate all
of this overhead?