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Chapter 4 Activity Based Cost Management PowerPoint Authors: Jon A. Booker, Ph.D., CPA, CIA Charles W. Caldwell, D.B.A., CMA Susan Coomer Galbreath, Ph.D.,

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Presentation on theme: "Chapter 4 Activity Based Cost Management PowerPoint Authors: Jon A. Booker, Ph.D., CPA, CIA Charles W. Caldwell, D.B.A., CMA Susan Coomer Galbreath, Ph.D.,"— Presentation transcript:

1 Chapter 4 Activity Based Cost Management PowerPoint Authors: Jon A. Booker, Ph.D., CPA, CIA Charles W. Caldwell, D.B.A., CMA Susan Coomer Galbreath, Ph.D., CPA Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

2 Traditional Volume-Based Cost Systems Because indirect costs cannot be directly traced to specific products or services, they must be assigned or allocated based on some other observable measure called an allocation base or cost driver. Indirect Costs $$ Cost Driver or Allocation Base Cost Driver or Allocation Base Individual Products or Services We have used units produced or direct labor hours to assign indirect manufacturing overhead costs to specific products. Units produced and direct labor hours are examples of a volume-based allocation measure. 4-2

3 Activity Based Costing (ABC) Activity Based Costing (ABC) is a method of assigning indirect costs to products and services based on the activities they require. 4-3

4 Stage 1: Assign Indirect Costs To Activities 4-4

5 Form Activity Pools and Assign Indirect Costs to Each Pool Machining and Installation Machine Setup Product Engineering and Design Quality Control TMMK Manufacturing Overhead Cost Pools TMMK has identified the following cost pools: 4-5

6 Form Activity Pools and Assign Indirect Costs to Each Pool Recall that the total manufacturing overhead cost in our Toyota example was $3,720,000 (in thousands). Now we must assign this total cost to one of the four activity cost pools. 4-6

7 Select an Activity Cost Driver for Each Cost Pool Machine hours will be used as the driver for the machining and installation activity. Number of set-ups will be used as the activity driver for the set-up activity. Engineering hours will be used as the driver to assign engineering and design costs. Inspection time will be used to assign quality control costs. 4-7

8 Activity Rate Method The activity rate method is very similar to the predetermined overhead rate computed earlier. Activity Rate Total Activity Cost Total Activity Driver = Total indirect costs assigned to the machining pool was $825,000, the total machine hours required by each of the three Toyota models is as follows: Activity Rate = $825,000 15,000 = $55 per machine hour 4-8

9 Activity Based Management Activity based management (ABM) includes all the actions that managers take to improve operations or reduce costs based on the ABC data. The first step in any improvement program is to target areas that need improvement. What Activities Are Performed? How Much Does it Cost to Perform Each Activity? Does the Activity Add Value to the Customer? 4-9

10 Life Cycle Cost Management In pursuing cost management, managers need to set their cost reduction goals across all stages of the product life cycle, including 1.product introduction, 2.growth, 3.maturity, and 4.eventual decline. Costs tend to be higher. Most revenue earned. In todays digital and technological age, product life cycles become increasingly short. 4-10

11 Total Quality Management The second highest cost assigned to the Camry-Hybrid was due to quality control. In managing quality costs, managers must balance four types of quality costs: 1.Prevention costs, 2.Appraisal or inspection costs, 3.Internal failure costs, and 4.External failure costs. 4-11

12 Target Costing The target cost would be computed by subtracting the target profit from the market price, as follows: Market Price $30,000 Target Profit (20% × $30,000) $6,000 Target Cost $24,000 ̶ = The $24,000 target cost is the most that can be spent on the product and still achieve the 20% return on sales (given a market sales price of $30,000). It is important to realize that the target cost includes more than just the manufacturing costs. 4-12

13 Target Costing Once the target cost is set, the next step is to determine whether it is feasible to design, develop, manufacture and deliver the product at this target cost. Target Cost Design Product Develop Process Estimate Cost Cost Reduction Goals Make Product ? ? Compare the estimated cost with the target cost to see if cost reduction is necessary. 4-13

14 Just-in-Time (JIT) Inventory In a JIT system, materials are purchased and units are made only as they are needed to satisfy customer demand. JIT is a "demand pull" system, where materials and products are pulled through the manufacturing system based on customer demand. In a traditional manufacturing setting where products are pushed through the system and often end up sitting in inventory. One advantage of a JIT system is that it eliminates problems in product costing associated with holding inventory. 4-14

15 End of Chapter 4 Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin


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