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Module 18

Module 18. Activity-Based Costing, Customer Profitability, and Activity-Based Management. Traditional Product Costing. Overhead Costs allocated to Products By direct labor or machine hours Traditional results will be inaccurate when Products differ on use of resources, like

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Module 18

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  1. Module 18 Activity-Based Costing, Customer Profitability, and Activity-Based Management

  2. Traditional Product Costing • Overhead Costs allocated to Products • By direct labor or machine hours • Traditional results will be inaccurate when • Products differ on use of resources, like • Frequent design changes • Specialized equipment • Complex setups • Difficult customer specifications

  3. Activity-Based Costing (ABC) Resources are assigned to activity costs, which are then assigned to objectives by cost drivers. *Based on units of activity utilized by the cost objective For example, consider purchasing and receiving:

  4. Example Activity CostsPurchasing Interviews determined that 15% of the time, receiving room employees verified purchase orders, and 85% of their time was spent unloading, unpacking, and inspecting. Supervisors were found to spend 30% of their receiving time on verifying issues, with the other 70% on unloading, unpacking, and inspecting issues.

  5. Cost per Unit of Activity • Each activity results in a different rate • Rates are used to apply costs to cost objectives Assume direct materials totaling $120,000 are to be acquired during the month with 300 purchase orders.

  6. Assigning Activity Costs to Cost Objectives Assigning costs to a purchase order which has a materials cost of $1,600 for 500 parts.

  7. ABC Implementation • ABC is expensive to implement • After switching to ABC, companies may find that only 10 to 15% of their products are profitable • Causes management to alter the product mix by minimizing unprofitable products which causes profits to increase

  8. Customer Profitability • ABC may be used for customer profitability analysis. • Customer costs to be analyzed • Cost incurred to sell the goods or services • Cost incurred to provide service • Actions possible from analysis • Convert customers to profitability or increase profitability • Seek to terminate unprofitable customer relationships

  9. Continued ABC Customer Profitability Analysis Example What activities are required to serve customers? Customer activity costs for Haskell Construction:

  10. ABC Customer Profitability Analysis Example Customer profitability ratio: $13,970 ÷ $79,000 = 17.7% Customers found to generate losses should be flagged and efforts made to correct the situation or terminate the customer.

  11. Activity-Based Management • Identification and selection of activities to maximize the value of activities while minimizing their cost from the perspective of the final consumer • From the perspective of the final customer, what adds value to the product?

  12. Activity-Based Management • Value Added: Required activities to produce a product and serve customers. • Examples: Produce product, fill customer order • Non-Value Added: Not required to produce a product or serve customers well. • Examples: Inspections, waiting, customer returns, storage, downtime for repairs, redoing anything

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