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Learn how Activity-Based Costing (ABC) provides managers with cost information for strategic decisions that impact capacity and fixed costs. Understand the differences between ABC and traditional cost accounting methods.
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Activity-Based Costing:A Tool to Aid Decision Making Chapter 7
ABC is designed to provide managers with cost information for strategic and other decisions that potentially affect capacity, and therefore, affect “fixed”as well as variable costs. Activity–Based Costing (ABC) ABC is a good supplement to our traditional cost system I agree!
How Costs are Treated UnderActivity–Based Costing ABC differs from traditional cost accounting in three ways. Manufacturingcosts Nonmanufacturingcosts Traditionalproduct costing ABCproduct costing ABC assigns both types of costs to products.
How Costs are Treated UnderActivity–Based Costing ABC differs from traditional cost accounting in three ways. Manufacturingcosts Nonmanufacturingcosts Most, butnot all Some All Traditionalproduct costing ABCproduct costing • ABC does not assign all manufacturing costs to products.
How Costs are Treated UnderActivity–Based Costing ABC differs from traditional cost accounting in three ways. Activity–Based Costing Departmental Overhead Rates Level of complexity Plantwide Overhead Rate Number of cost pools • ABC uses more cost pools.
How Costs are Treated UnderActivity–Based Costing ABC differs from traditional cost accounting in three ways. Each ABC cost pool has itsown unique measure of activity. Traditional cost systems usually relyon volume measures such as direct laborhours and/or machine hours to allocateall overhead costs to products. • ABC uses more cost pools.
How Costs are Treated UnderActivity–Based Costing An event that causes the consumption of overhead resources. Activity A “cost bucket” in which costs related to a single activity measure are accumulated. Activity Cost Pool $ $ $ $ $ $
The term cost driver is also used to refer to an activity measure. Activity Measure An allocation basein an activity-basedcosting system. How Costs are Treated UnderActivity–Based Costing
Transactiondriver Durationdriver Simple countof the number oftimes an activityoccurs. A measureof the amountof time neededfor an activity. How Costs are Treated UnderActivity–Based Costing Two common types of activity measures:
How Costs are Treated UnderActivity–Based Costing ABC definesfive levels of activitythat largely do not relateto the volume of unitsproduced. Traditional cost systems usually rely on volumemeasures such as direct labor hours and/or machinehours to allocate all overhead costs to products.
Unit-Level Activity Batch-Level Activity Manufacturingcompanies typically combinetheir activities into fiveclassifications. Product-Level Activity Customer-Level Activity Organization-sustaining Activity How Costs are Treated UnderActivity–Based Costing
Link to evaluationsand rewards Characteristics of Successful ABC Implementations Strong topmanagement support Cross-functionalinvolvement
Differences Between ABC and Traditional Product Costs There are three reasons why thereported product margins for the twocosting systems differ from one another. Traditional costing allocates all manufacturing overhead to products. ABC costing only assigns manufacturing overhead costs consumed by products to those products.
Differences Between ABC and Traditional Product Costs There are three reasons why thereported product margins for the twocosting systems differ from one another. Traditional costing allocates all manufacturing overhead costs using a volume-related allocation base. ABC costing also uses non-volume related allocation bases.
Differences Between ABC and Traditional Product Costs There are three reasons why thereported product margins for the twocosting systems differ from one another. Traditional costing disregards selling and administrative expenses because they are assumed to be period expenses. ABC costing directly traces shipping costs to products and includes nonmanufacturing overhead costs caused by products in the activity cost pools that are assigned to products.
Targeting Process Improvement Activity-based management is used in conjunction with ABC to identify areas that would benefit from process improvements by focusing on activities to eliminate waste, decrease processing time, and reduce defects. ABC activity rates can also provide valuable clues concerning where there is waste and the opportunity for improvement. Benchmarking can be used to compare activity cost information with standards of performance achieved by other organizations.
Activity-Based Costing and External Reporting Most companies do not use ABCfor external reporting because . . . • External reports are less detailed than internal reports. • It may be difficult to make changes to the company’s accounting system. • ABC does not conform to GAAP. • Auditors may be suspect of the subjective allocation process based on interviews with employees.
ABC Limitations Substantial resourcesrequired to implementand maintain. Resistance tounfamiliar numbersand reports. Desire to fullyallocate all coststo products. Potentialmisinterpretation ofunfamiliar numbers. Does not conform toGAAP. Two costingsystems may be needed.
