Materials prepared by Ph . D. Zofia Krokosz-Krynke Faculty of Computer Science and Management

1. MANAGEMENT ACCOUNTINGTheActivity-BasedCosting Systembased on John G. Burch, Cost and Management Accounting Materials prepared by Ph. D. Zofia Krokosz-Krynke Faculty of Computer Science and Management

2. DEFINITIONS • Activity-basedcosting (ABC) - collection of financial and nonfinancial data about an entreprise’sactivities • Activityanalysis- proces of defining and describingactivities and correspondingcostdrivers • Activity-based management (ABM) - using ABC information to supportcost management 2

3. COMPONENTS OF ABC SYSTEMS • Resource categories • First-stage resource drivers • Activities and activity cost pools • Second-stage activity drivers • Cost objects • Direct cost inputs 3

4. Cost Management Activities and activity costs pools Performance Information for Management Activity Analysis Directcostinputs Cost objects Costing system Resource categories Resource drivers Activity drivers 4

5. Resourcecategories • Material handling & storage resources • Office space and furniture • Equipment (machines, transport, information technology) • Utilities • Salaries & benefits • Buildings • Accounting • Engineering • Insurance, licences, taxes 5

6. Cost objects • Jobs • Projects • Customers • Customer groups • Distribution channels • Sales territories Products Services Units Batches Contracts Cases 6

7. Assignment of costs to costobjects • cost object = costs assigned from activity cost pools • cost object = direct materials + costs assigned from activity cost pools • cost object = direct materials + direct labor + costs assigned from activity cost pools • cost object = direct materials + direct labor + direct technology + costs assigned from activity cost pools 7

8. Direct cost inputs • Direct materials • Direct labor • Direct technology (or equipment) 8

9. Volume-Based Costing System Overhead costs applied according to: • Direct labor hours (DLhr) • Direct labor dollars • Machine hours (Mhr) • Materials dollars 9

10. HowtheCosting System InfluencesDecisionMaking Reduce selling price (to enable it to compete better) Raise the price or … discontinue the product altogether 10

11. ABC is appropriate if: • Competition is high. • Product mix is diverse in batch size, physical sizes, degree of complexity, and raw material characteristics. • Product life cycles are short (3 years or less) • Collection and manipulation of data are performed by an integrated computer-based information system (ICBIS). 11

12. Strategic goals of ABC systems • Appropriate pricing decisions based on good cost information. • Appropriate product mix decisions based on good profitability information. • Good cost management by focusing on activities and cost drivers. 12

13. ABC systems development life cycle • Phase one: Plan the system. • Phase two: Analyze and define resource categories. • Phase three: Analyze and define activities. • Phase four: Determine first-stage resource drivers and establish activity cost pools. • Phase five: Determine second-stage activity drivers and assign costs to cost objects. 13

14. Phase one: Plan the system The ABC Systems Development Life Cycle start here • Understanding purposes of ABC system: • costing of cost objects • providing information for daily operational management, continous improvement, and business reengineering • The system project team can include : • management accountant • engineering representative • production representative • marketing representative • logistics representative • financial accounting representative Phase five: Determine second-stage activity drivers and assign costs to cost objects Phase one: Plan the system Phase two: Analyse and define resource categories Phase four: Determine first-stage resource drivers and establish activity cost pools Phase three: Analyze and define activities 14

15. Phasetwo: Analyze and defineresourcecategories - example. Budgeted Costs of Service and Production Resources 15

16. Phase three: Analyze and define activities • activity flow diagram • fishbone diagram • aggregation and decomposition processes 16

17. Design of ActivitiesUsingTheActivityFlow Diagram(flow diagram modelsthepurchasing, inspecting, receiving, accounting, machining, and settingupactivitiesat a firm) Vendor Invoice Payment Purchase order copy Purchase order Receiving report Purchase materials activity Account for materials activity Vendor Source or destination Notify Bill of lading and materials Purchase request Inspection report and materials Receiving report and materials Inspect materials activity Store materials activity Receive materials activity Materials Machine materials activity Products Finished goods Materials requisition Activity that transforms inputs to outputs Setup requisition Setup completed Input and output flows Shop floor Setup machine activity 17

18. Phase four: Determine first-stage resource drivers and establish activity cost pools service production 18

19. Phase five: Determinesecond-stageactivitydrivers and assigncosts to costobjects. Activity-Based Costing Model Showing Activity Cost Pools Service resources $1.500.000 Production resources $3.320.000 First-stage resource drivers 9 employees 100 000 cubic feet 10 employees 90% 10% 6 employees 5 employees Inspect materials $150.000 Purchase materials $300 000 Receive materials $270.000 Store materials $600.000 Account for materials $180.000 Setup machine $332.000 Machine materials $2.988.000 Number of receiving reports Number of purchase orders Number of inspections Number of parts stored Number of payments Number of setups Number of machine hours Products A and B Second-stage activity drivers Direct materials Direct labor 19

20. Phase five: Determinesecond-stageactivitydrivers and assigncosts to costobjects. Activity-Based Costing Model Showing Activity Cost Pools Included in Activity Centers Service resources $1.500.000 Production resources $3.320.000 First-stage resouce drivers 9 employees 100 000 cubic feet 10 employees 6 employees 5 employees 90% 10% Materials handling Accounting Production Inspect materials $150.000 Purchase materials $300 000 Receive materials $270.000 Store materials $600.000 Account for materials $180.000 Setup machine $332.000 Machine materials $2.988.000 Number of receiving reports Number of purchase orders Number of inspectio ns Number of parts stored Number of payments Number of setups Number of machine hours Products A and B Second-stage activity drivers Direct materials Direct labor 20

21. Costing Cost Objects Theproject team created an activitycostpool for eachactivity and selected an activitydrivers for eachactivitycostpool. Theactivity driver isused to applythecosts of theactivitycostpool to eachproductaccording to theamount of activitycostsconsumed. Thecostsconsumedareassigned to thecostsobjectthrough a bill of activities. Thecost per unit for direct materials isdeterminedfromthebill of materials. Theamount of direct materials usedcomesfrom materials requisitions. Calculatethecost per unit of products A and B under fourdifferentcosting systems: Activity-basedcosting Activity-basedcosting system usingthreedirectcostelements:direct materials, directlabor, and direct technology Traditionalvolume-basedcosting system using a plantwidepredeterminedoverheadrate (POR) based on directlaborhours Treaditionalvolume-basedcosting system usingtwopredeterminedoverheadrates (PORs) based on materials dollars and machinehours. 21

22. Bill of Activities for Product-Driven Activities Bill of Activities , Products A and B For the Period Ended December 31, 200X 22

23. Direct cost inputs Bill Of Materials (BOM) Product A Total cost = $60 per unit A1 2 parts x $15 = $30 A2 4 parts x $5 = $20 A3 1 part x $10 = $10 A3.1 1 component x $5 = $5 A3.2 1component x $3 = $3 A3.3 1 component x $2 = $2 A1.1 3 components x $3 = $9 A1.2 2 components x $3 = $6 Product B Total cost = $ 50 per unit B2 1 part x $20 = $20 B1 1 part x $30 = $30 23

24. Activity-based costing Activity-based costing with direct technology as a cost element Machine (Direct technology): A: $2 988 000 x 1/3 = $996 000/ 50 000 units = $19,92 per unit B: $2 988 000 x 2/3 = $1 992 000/ 100 000 units = $19,92 per unit Activities without the machine materials activity Product AProduct B Purchase Materials 240 000 60 000 Receive materials 225 000 45 000 Inspect materials 125 000 25 000 Store materials 400 000 200 000 Account for materials 108 000 72 000 Setup machine 298 800 33 200 Total activity costs 1 396 800435 200 A: $ 1 396 800/ 50 000 units = $27,94 per unit B: $ 435 200/ 100 000 units = $4,35 per unit 24

25. Traditional volume-based costing using a plantwide predetermined overhead rate based on direct labor hours Calculation of plantwidepredeterminedoverheadratebased on directlaborhours : A: Directlaborbudgeted 20 000 B: Directlaborbudgeted40 000 Total directlaborhoursbudgeted60 000 Total resouces: Service resources $1 500 000 Production resources 3 320 000 Total resources budgeted$ 4 820 000 $ 4 820 000/ 60 000 DLhr = $ 80,33 per DLhr 25

26. Traditional volume-based costing using two predetermined overhead rates based on direct materials dollars and machine hours Predeterminedoverheadratebased on direct materials dollars : Service resouces: A: ($60 x 50 000 units) = $ 3 000 000 (3/8) B: ($50 x 100 000 units) = 5 000 000 (5/8) Total direct materials = $ 8 000 000(8/8) A: $ 1 500 000 x 3/8 = $ 562 500 / 50 000 units = $ 11,25 per unit B: $ 1 500 000 x 5/8 = $ 937 500 / 100 000 units = $ 9,38 per unit Predeterminedoverheadratebased on machinehours : Production resources: A: Machinehoursbudgeted 1 000 (1/3) B: Machinehoursbudgeted2 000 (2/3) Total machinehoursbudgeted 3 000 (3/3) A: $ 3 320 000 x 1/3 = $ 1 106 667 / 50 000 units = $ 22,13 per unit B: $ 3 320 000 x 2/3 = $ 2 213 333 / 100 000 units = $ 22,13 per unit 26

27. Results comparison 27

28. the end the end