Presentation on theme: "Activity Based Costing: A Tool to Aid Decision Making"— Presentation transcript:
1 Activity Based Costing: A Tool to Aid Decision Making
2 Activity Based Costing (ABC) Both manufacturingand nonmanufacturingcosts may beassigned toproducts.A numberof cost pools each allocated to a productor cost object.Some manufacturingcosts may be excludedfrom productcosts.Allocation bases oftendiffer fromtraditional costingsystems.Overhead rates maybe based on activityat capacity.
3 How Costs are Treated Under Activity-Based Costing DepartmentalOverheadRatesLevel of ComplexityPlantwideOverheadRateOverhead Allocation
4 Cost of Idle Capacity Activity Based Costing Traditional Cost AccountingThe predetermined overhead rate is based on budgeted activity. This results in applying overhead costs of unused, or idle, capacity.Activity Based CostingProducts are charged for the costs of capacity they use – not for the costs of capacity they don’t use.
5 Difference Between ABC and Traditional Product Costs Batch-level or product-level costs will ordinarily shift overhead costs from high-volume products produced in large batches to low-volume products produced in small batches.Under ABC both manufacturing and nonmanufacturing costs may be assigned to products. Organization-sustaining costs and the costs of idle capacity are not assigned to products.
6 Designing an ABC System Cost Objects(e.g., productsand customers)ActivitiesConsumptionof ResourcesCost
7 Designing of an ABC System Steps for Implementing ABCIdentify and define activities and activity cost pools.Trace costs to activities and cost objects.Assign costs to activity cost pools.Calculate activity rates.Assign costs to cost objects.
8 Identify and Define Activities and Activity Cost Pools A part of the productionprocess for which managementwants a separate reporting of thecosts of the activity involved.Unit-LevelActivityBatch-LevelProduct-LevelCustomer-LevelOrganization- sustaining
9 Identify and Define Activities and Activity Cost Pools $Activity Cost Pool is a “bucket” in which costs are accumulated that relate to a single activity measure in the ABC system.
11 Assign Costs to Activity Cost Pools At Classic Brass the following distribution of resource consumption across activity cost pools is determined.**Not included because they are directly traced to customer orders.
12 Assign Costs to Activity Cost Pools Indirect factory wages $500,000Percent consumed by customer orders %$125,000
14 Calculate Activity Rates The ABC team determines that Classic Brass will have these total activities for each activity cost pool . . .1,000 customer orders200 new designs20,000 machine-hours100 customer relations activitiesNow the team can compute the individual activity rates by dividing the total cost for each activity by the total activity levels.
18 Assigning Costs to Cost Objects Let’s take a look at how our system works for just one customer – Windward Yachts.Standard Stanchions (no design required)units ordered with 2 separate orders.2. Each stanchion required 0.5 machine-hours .3. Selling price is $34 each.4. Direct materials total $2,110.5. Direct labor totals $1,850.6. Shipping costs total $180.Custom Compass Housing (requires new design)1. One order during the year.2. Each housing required 4 machine-hours .3. Selling price is $650 each.4. Direct materials total $13.5. Direct labor totals $50.6. Shipping costs total $25.
19 Assigning Costs to Cost Objects The customer-level cost is assigned to customers directly; it is not assigned to products.
20 Limitations of ABCABC produces numbers, like product margins, that are at odds with numbers produced by traditional costing system. Some managers find it difficult to adjust to this change.ABC systems are a major project requiring substantial resources. The benefits of increased accuracy must outweigh these additional costs.ABC data can be misinterpreted and must be used with care when making decisions.