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Activity Based Costing

Activity Based Costing. Class Announcements. Assignment #3 due today Assignment #4 due October 10th Midterm in-class Thursday October 24th Trudy Eagan Women in Business Speakers’ Series and Awards Presentation Location SCHW Auditorium (SCHW 110) 2:15pm Thursday October 10, 2012

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Activity Based Costing

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  1. Activity Based Costing

  2. Class Announcements • Assignment #3 due today • Assignment #4 due October 10th • Midterm in-class Thursday October 24th • Trudy Eagan Women in Business Speakers’ Series and Awards Presentation • Location SCHW Auditorium (SCHW 110) • 2:15pm Thursday October 10, 2012 • Guest Speaker: Mary Lou O’Reilly, IBC • Sign in at door

  3. Class Objectives • Activity Based Costing as an approach to refined manufacturing overhead allocation • The context for understanding successful ABC allocation

  4. Activity Based Costing Process • “ A system that first accumulates overhead costs for each of the activities of an organization and then assigns the costs of activities to the products, services or other cost objects that caused that activity.” p. 147 • Rationale for Selection: • Increase in product diversity • Increase in indirect costs • Advances in information technology • Competition in foreign markets

  5. Allocation of Overhead: Activity-Based Costing Overhead Costs ActivityCenter 1 ActivityCenter 2 ActivityCenter 3 Product 1 Product 2

  6. ABC: Contexts for its Use • Significant overhead costs allocated using one or two cost pools • Most or all overhead is considered unit-level • Products that consume different amounts of resources • Products that a firm should successfully make and sell consistently show small profits • Operations staff disagreeing with accounting over manufacturing and marketing costs

  7. ABC: Advantages • More accurate and informative product costs lead to better pricing decisions. • The activities driving costs are more accurately measured. • Managers gain easier access to the relevant costs.

  8. ABC: Limitations Expensive: Substantial Resources required to implement and maintain. Resistance tounfamiliar numbersand reports. Desire to fullyallocate all coststo products. Potentialmisinterpretation ofunfamiliar numbers. Does not conform toGAAP. Two costingsystems may be needed.

  9. Highland Instruments Co. • Highlander makes custom tools on special orders for its customers • To be competitive it is essential that the firm measure the cost of each product. • Questioning the accuracy of the profit generate by each product • President Chisholm has focused on overhead allocation as a potential problem

  10. Highlander Instruments Co. • The company has used a plant wide allocation rate based on direct labour • Knowledge that the changes in costs are more easily affected by machine hours in machining and by direct labour costs in finishing • Costing Approaches: • 1) plant wide rate based on direct-labour costs • 2) plant wide rate based on machine hours • 3) machine based on machine hours and finished based on direct-labour costs

  11. Highlander Instruments Co. • Calculate: • 1) plant wide rate based on direct-labour costs • 2) plant wide rate based on machine hours • 3) machine based on machine hours and finished based on direct-labour costs

  12. Highlander Instruments Co.

  13. Highlander Instruments Co. • Calculate: • Cost of NX12 and NX13 using • 1) plant wide rate based on direct-labour costs

  14. Highlander Instruments Co.

  15. Highlander Instruments Co. • Calculate: • Cost of NX12 and NX13 using • 2) plant wide rate based on machine hours

  16. Highlander Instruments Co.

  17. Highlander Instruments Co. • Calculate: • Cost of NX12 and NX13 using • 3) machine based on machine hours and finished based on direct-labour costs

  18. Highlander Instruments Co.

  19. Highlander Instruments Co. • Calculate: • Pricing of NX12 and NX13 using all three rates • 1) plant wide rate based on direct-labour costs • 2) plant wide rate based on machine hours • 3) machine based on machine hours and finished based on direct-labour costs • Pricing differentials of NX12 and NX13 using all three rates • 1) plant wide rate based on direct-labour costs • 2) plant wide rate based on machine hours • 3) machine based on machine hours and finished based on direct-labour costs

  20. Highlander Instruments Co.

  21. Highlander Instruments Co. • Plant wide rates do not distinguish between different jobs whose requirement for direct labour or machine hours differ • Management understands cost behaviour is affected by both machine hours and direct labour costs • Costing information impact decision making including pricing, profitability, competition, product line, etc.

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