Activity-Based Costing and Activity-Based Management
Activity-Based Costing and Activity-Based Management ACC
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This 9 page Class Notes was uploaded by Shannon Panagopoulos on Monday January 11, 2016. The Class Notes belongs to ACC at DePaul University taught by Nancy Hill in Winter 2016. Since its upload, it has received 7 views.
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Date Created: 01/11/16
Ch. 5: ActivityBased Costing and ActivityBased Management Broad Averaging and Its Consequences historically, companies produced a limited variety of products therefore they used fewer overhead resources for operations, so indirect/overhead costs were a small percentage of total costs used simple costing systems to allocate overhead costs broadly in an easy and cheap, but reasonably accurate manner NOW product diversity and indirect costs have increased, and broad averaging has become an inaccurate way of product costing *b/c simple peanutbutter costing broadly averages/spreads the cost of resources uniformly to cost objects (products/services) when these products and services do not actually use these resources uniformly Undercosting and Overcosting Product overcosting: a product consumes a high level of resources per unit but is reported to have a low cost per unit *Overcosted products will be overpriced, causing them to lose market share to competitors with similar products Product undercosting= a product consumes a low level of resources per unit but is reported to have a high cost per unit *Undercosted products will be underpriced may lead to sales that result in losses because the sale brings in less revenue than the cost of resources used If prices are determined by the market based on the consumer demand and competition among many companies: product over and undercosting causes managers to focus on the wrong products managers give more attention to overcosted products that show low profits, when in fact costs and profits from these products are perfectly reasonable managers give less attention to undercosted items because they think they are highly profitable, but in fact these products consume large amounts of resources and are much less profitable than they appear ProductCost CrossSubsidization ProductCost CrossSubsidization= if a company undercosts one of its products, it will overcost at least one of its other products *Viceversa Is very common when a cost is uniformly spread (broadly averaged) across multiple products without managers recognizing the amount of resources each product consumes Simple Costing System Using a Single IndirectCost Pool 1) Identify the products that are chosen cost objects 2) Identify the direct costs of the products a. DM, DML 3) Select the costallocation bases to use for allocating indirect/overhead costs to the products a. Supervisor salaries, engineers, manufacturing support, maintenance 4) Identify the indirect costs associated with each cost allocation base 5) Compute the rate per unit of each costallocation base Budgeted indirect cost rate = (budgeted total costs in indirectcost pool) / (budgeted total quantity of costallocation base) 6) Compute the indirect costs allocated to the products 7) Compute the total cost of the products by adding all direct and indirect costs assigned to the products 5Step DecisionMaking Process 1) Identify the problems and uncertainties 2) Obtain information 3) Make predictions about the future 4) Make decisions by choosing among alternatives 5) Implement the decision, evaluate performance, and learn Refining a Costing System Refined costing system reduces the use of broad averages for assigning the costs of resources to cost objects; provides a better measurement of the cost of indirect resources used by different cost objects, no matter how differently various cost objects use indirect resources *helps managers make better decisions about how to allocate resources and which products to produce Reasons for Refining a Costing System 1. Increase in product diversity a. Growing demand for customized products has led managers to increase the variety of products and services offered 2. Increase in direct costs a. The use of product and process technology has led to an increase in indirect costs and a decrease in direct costs (particularly DML costs) b. Ie CIM= computer integrated manufacturing; FMS= flexible management systems computers on the manufacturing floor instruct equipment to set up and run quickly and automatically managing complex technology and producing such diverse products also requires additional support function resources for activities such as production scheduling, product and process design, c. Since DML isn’t a cost driver of these costs, allocating indirect costs on the basics of DML does not accurately measure how resources are being used by different products 3. Competition in the markets a. Managers feel the need to obtain more accurate cost information to help them make important strategic decisions b. Making correct decisions about pricing and product is critical in competitive markets because competitors quickly capitalize on a manager’s mistake(s) Guidelines for Refining a Costing System 1. Directcost tracing a. Identify as many direct costs as is economically feasible b. aims to reduce the amount of costs classified as indirect, therefore minimizing the extent to which costs have to be allocated rather than traced 2. Indirectcost pools a. Expand the number of indirectcost pools until each pool is more homogenous b. All costs in a homogenous cost pool have the same or a similar causeandeffect relationship with a single cost driver that is used as the allocation base c. EX: 1 cost pool with both indirect machinehours and indirect distribution costs= not homogenous because machine hours are one cost driver but not both; making them two separate indirect cost pools, they would become homogenous 3. Costallocation base a. Whenever possible, managers should use the cost driver (cause of indirect costs) as the allocation base for each homogenous indirect cost pool (the effect) ActivityBased Costing Systems ABC costing= refines a costing system by identifying individual activities as the fundamental cost objects Activity= an event, task, or unit of work with a specified purpose *verbs: things a firm DOES ABC systems identify activities in all functions of the value chain, calculate costs of individual activities, and assign costs to costs objects such as products and services on the basis of the mix of activities needed to produce each product or service* Logic of ABC systems is twofold: 1) When managers structure activity cost pools more finely with cost drivers for each activity cost pool as the cost allocation base, it leads to more accurate costing of activities 2) Allocating these costs to products by measuring the costallocation bases of different activities used by different producs leads to more accurate product costs Cost Hierarchies cost hierarchy categorizes various activity cost pools on the basis of the different types of cost drivers, costallocation bases, or different degrees of difficulty in determining the cause and effect relationships *ABC systems commonly use a cost hierarchy with four levels to identify costallocation bases that are cost drivers of the activity cost pools 1. Output unitlevel costs a. The costs of activities performed on each individual unit of a product or service i. Machine operations costs related to the activity of running the automated molding machines are outputlevel unit because, over time, the cost of this activity increases with additional units of output produced (or machinehours used) 2. Batchlevel costs a. The costs of activities related to a group of units of a product/service rather than each individual product/service i. Ex materialhandling and qualityinspection costs associated with batches (not the quantities) of products produced and the costs of placing purchase orders, receiving materials, and paying invoices related to the number of purchase orders placed rather than the quantity or value of materials purchased 3. ProductSustaining costs/ Servicesustaining costs a. Costs of activities undertaken to support individual products or services regardless of the number of units or batches in which the units are produced i. Over time, design costs depend largely on the time designers spend on designing and modifying the product, the mold, and the process 1. These design costs are a function of the complexity of the mold, measured by the number of parts in the mold by the area over which the plastic must flow Other examples: research and development costs, costs of making engineering changes, and marketing to launch new products 4. FacilitySustaining costs a. The costs of activities that managers cannot trace to individual products/services but that support the organization as a whole i. Is usually difficult to find a good causeandeffect relationship between these costs and the costallocation base, so some companies deduct facilitysustaining costs as a separate lump sum from operating income rather than allocating them to products 1. They must set prices that are much greater than the allocated costs to recover some of the unallocated facilitysustaining costs i. Allocating all costs to products/services ensures that managers have taken into account all costs when making decisions based on costs, such as pricing Considerations in Implementing ABC Systems managers choose the level of detail to use in a costing system by evaluating the expected costs of the system against the expected benefits that result from better decisions Benefits & Costs of ABC Systems Signs of benefits: significant amounts of indirect costs are allocated using only one or two cost pools all or most indirect costs are identified as outputlevel costs (few indirect costs are described any other way) products make diverse demands on resources because of differences in volume, process steps, batch size, or complexity operations staff has substantial disagreement with the reported costs of manufacturing and marketing products and services *When managers decide to implement ABC, they must make important choices about the level of detail to use main costs and limitations of an ABC system are the measurements necessary to implement it requires managers to estimate costs of activity pools and to identify and measure cost drivers for these pools to serve as costallocation bases even basic ABC systems require many calculations to determine costs of products and services; these measures are often costly; activity cost rates also need to be updated regularly *more detail and more cost pools created= more allocations necessary to calculate activity costs for each period, which increases the chances of misidentifying the costs for each cost pool sometimes mangers are forced to use allocation bases for which data are readily available, instead of the allocation bases they would have liked to use when incorrect allocation costallocation bases are used, activitycost information can be misleading Behavioral Issues in Implementing ABC Systems to successfully implement ABC systems requires more than an understanding of the technical details; ABC implementation often represents a significant change in the costing system requires a manager to choose how to define activities and the level of detail ?? Behavioral issues a manager and management accountant must be sensitive to?? 1. Gaining support of top management and creating a sense of urgency for the ABC effort 2. Creating a guiding coalition of managers throughout the value chain for the ABC effort 3. Educating and training employees in ABC as a basis for employee empowerment 4. Seeking small shortrun success as proof that ABC implementation is yielding results 5. Recognizing that ABC information is not perfect because it balances the need for better information against the costs of creating a complex system that few managers and employees can understand ActivityBased Management ABM= a method of management decision making that uses ABC information to improve customer satisfaction and profitability broadly defined to include decisions about pricing and product mid, cost reduction, process improvement, and product and process design Pricing and ProductMix Decisions an ABC system gives manages information about the costs of making and selling diverse products Managers can then make pricing and productmix decisions Cost Reduction and Process Improvement Decisions Managers use ABC systems to focus on how and where to reduce costs set cost reduction targets for the cost per unit of the costallocation base in different activity areas *goal is to reduce these costs (distribution labor, warehouse rental costs) by improving the way work is done without compromising customer service or the actual or perceived value (usefulness) customers obtain from the product/service *Supervisor will attempt to take out only those costs that are nonvalue added Design Decisions ABC systems help managers to evaluate the effect of current products and process designs on activities and costs and to identify new designs to reduce costs Planning and Managing Activities most managers implementing ABC systems for the first time start by analyzing actual costs to identify activitycost pools and activitycost rates managers then calculate a budgeted rate that they use for planning, making decisions, and managing activities at year end, managers compare budgeted costs and actual costs to evaluate how well activities were managed management accountants make adjustments for underallocated or overallocated indirect costs for each activity (using method from ch 4) as activities and processes change, managers calculate new activitycost rates ABC and Department Costing Systems companies often use costing systems with features of ABC systems, such as multiple cost pools and multiple cost allocation bases, but do not emphasize individual activities Many companies have evolved their costing systems from using a single indirect cost rate system to using separate indirect cst rates for each department or subdepartment that can represent broad tasks *ABC systems are a further refinement of department costing systems ABC in Service and Merchandising Companies originated in manufacturing, but can be used in service and merchandising companies widespread use of ABC systems in service and merchandising companies reinforces the idea that ABC systems are used by managers for strategic decisions rather than for inventory valuation (inventory valuation is fairly straightforward in merchandising activities) service companies find great value in ABC because a vast majority of their cost structure is composed of indirect costs
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