Post on 07-Aug-2018
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Activity Based Costing
(ABC)Cost & Management Accounting
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Traditional Costing Systems
• Product Costs
– Direct labor
– Direct materials
– Factory Overead
• Period Costs
– Administrative e!"ense
– Sales e!"ense
A""ear on teincome statement#en goods aresold$ "rior to tattime tey are
stored on tebalance seet asinventory%A""ear on teincome statementin te "eriodincurred%
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Traditional Costing Systems
• Product Costs
– Direct labor
– Direct materials
– Factory Overead
• Period Costs
– Administrative e!"ense
– Sales e!"ense
Direct labor anddirect materials areeasy to trace to"roducts%
Te "roblem
comes #itactory overead%
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Traditional Costing Systems
• Ty"ically used one rate to allocateoveread to "roducts%
•
Tis rate #as oten based on directlabor dollars or direct labor ours%
• Tis made sense$ as direct labor #asa ma'or cost driver in earlymanuacturing "lants%
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Problems #it TraditionalCosting Systems
• Manuacturing "rocesses and te"roducts tey "roduce are no# morecom"le!%
• Tis results in overcosting or undercosting%
– Com"le! "roducts are not allocated an
adeuate amount o overead costs%
– Sim"le "roducts get too muc%
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Today*s ManuacturingPlants
• Are more com"le!
• Are oten automated
•
Oten ma+e more tan one "roduct• ,se "ro"ortionately smaller amount
o direct labor ma+ing direct labor a
"oor allocation base or actoryoveread%
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-en te manuacturing"rocess is more com"le!.
• Ten multi"le allocation basessould be used to allocateoveread e!"ense%
• /n suc situations$ managersneed to consider using activitybased costing (ABC)%
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ABC De0nitions
• Activity based costing is an a""roacor allocating overead costs%
• An activity is an event tat incurscosts%
• A cost driver is any actor or activitytat as a direct cause and e1ectrelationsi" #it te resourcesconsumed%
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ABC Ste"s
• Overead cost drivers aredetermined%
• Activity cost "ools are created%
– A activity cost "ool is a "ool o individualcosts tat all ave te same cost driver%
• All overead costs are ten allocatedto one o te activity cost "ools%
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ABC Ste"s2
• An overead rate is ten calculatedor eac cost "ool using te ollo#ingormula.
– Costs in activity cost "ool3base
– Te base is$ o course$ te cost driver
• Overead costs are ten allocated to
eac "roduct according to o# muco eac base te "roduct uses%
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Let’s work an example . . .
• Assume tat a com"any ma+es#idgets
• Management decides to install anABC system
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Overhead Cost Drivers areDetermined:
• Management decides tat alloveread costs only ave tree costdrivers4sometimes called activities
(obviously a sim"li0cation o te real#orld)
– Direct labor ours
– Macine ours
– 5umber o "urcase orders
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All overhead costs are then allocated toone of the activity cost pools.
Direct 6abor
Macine 7ours
8 o Purcase Orders
General LedgerPayroll taxes $1,000
Machinemaintenance
$500
Purchasing Dept.
labor
$,000
!ringe bene"ts $#,000
Purchasing Dept.upplies
$#50
%&uipment
depreciation
$'50
%lectricity $1,#50
(nemploymentinsurance
$1,500Which overhead costs do you think are driven y
direct laor hours!
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All overhead costs are then allocated toone of the activity cost pools.
Direct 6abor
Macine 7ours
8 o Purcase Orders
General LedgerPayroll taxes $1,000
Machinemaintenance
$500
Purchasing Dept.
labor
$,000
!ringe bene"ts $#,000
Purchasing Dept.upplies
$#50
%&uipment
depreciation
$'50
%lectricity $1,#50
(nemploymentinsurance
$1,500
9:$;;; $=;;
Overhead driver y directlaor hours
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All overhead costs are then allocated toone of the activity cost pools.
Direct 6abor
Macine 7ours
8 o Purcase Orders
General LedgerPayroll taxes $1,000
Machinemaintenance
$500
Purchasing Dept.
labor
$,000
!ringe bene"ts $#,000
Purchasing Dept.upplies
$#50
%&uipment
depreciation
$'50
%lectricity $1,#50
(nemploymentinsurance
$1,500
9:$;;; $=;;
Which overhead costsare driven y machinehours!
9 =;; ?=; :$
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All overhead costs are then allocated toone of the activity cost pools.
Direct 6abor
Macine 7ours
8 o Purcase Orders
General LedgerPayroll taxes $1,000
Machinemaintenance
$500
Purchasing Dept.
labor
$,000
!ringe bene"ts $#,000
Purchasing Dept.upplies
$#50
%&uipment
depreciation
$'50
%lectricity $1,#50
(nemploymentinsurance
$1,500
9:$;;; $=;;
And "nally# whichoverhead costs aredriven y $ of purchase
orders!
9 =;; ?=; :$
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An overhead rate is then calculated foreach cost pool:
Direct 6abor
Macine 7ours
8 o Purcase Orders
9:$;;; $=;;
9 =;; ?=; :$
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Overhead costs are then allocated toeach product accordin& to how much of
each ase the product uses.
$,500/1,000 = $!50 "er directlabor hour $2,500/250 = $10 "er #achine hour
$,250/100 = $2!50 "er "urchase order
-he )/ rates are+
Lets assume the company maes to products,idget ) and idget +Let2s also assume that each product uses the *olloing &uo* o3erhead cost dri3ers+
ase idget ) idget -otalDirect laborhours 00 00 1,000
Machine hours 100 150 #50
Purchaseorders 50 50 100
6oticethatall baseunitsareaccounte
d *or.
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'ow let’s allocate overhead toWid&et A:
ase ) 7ate )llocated
Direct laborhours 00
$.50
$1,800.00
9ust lie e learned in )ccounting #0#0, ethe base used by the rate.
:n this case, 00 hours used to mae idgemultiplied by the rate o* $.50. -his gi3es t
applied *or this acti3ity cost pool o* $1,800idget ).
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Continuin& the calculation:
idget ) ase 7ate )llocated
Direct labor
hours 00
$
.50
$
1,800.00
Machine hours 100 $
10.00$
1,000.00
Purchaseorders 50
$#.50
$#,1#5.00
-otal
$
,;#5.00
Let2s do the same thing *or the other to rates, to get theo* o3erhead applied to idget )+
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5o# let*s allocate overead to-idget B.
6et*s do te same ting or te oter t#o rates$ to get te total ao overead a""lied%
idget ase 7ate )llocated
Direct laborhours @;;
9>%=; 9
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Same Problems TraditionalMetod
• O+ay$ so #at i #e ad allocated teoveread in tis com"any usingtraditional cost accounting allocation%
• 6et*s assume te base is direct laborours%
• -at #ould be te amount allocatedto eac "roduct
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Calculation
General LedgerPayroll taxes $1,000
Machinemaintenance
$500
Purchasing Dept.
labor
$,000
!ringe bene"ts $#,000
Purchasing Dept.upplies
$#50
%&uipment
depreciation
$'50
%lectricity $1,#50
(nemploymentinsurance
$1,500
Tis is te totaloveread #e#ere given$ tetotal amount is
9::$
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Calculation
• Te rate #ould be.
– O7 Gate Overead3Direct 6abor 7ours
– 9::$
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Com"arison
idget ) idget -otal-raditionalMethod
$,500 $,'50 $11,#50
)cti3ity ased/osting
$,;#5 $,$#5 $#5 >0>
&hich is #ore accurate!
)/ /ostingH
6ote these are total costs. -o get per>unit costs e ould
number o* units produced.
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-en do #e use ABCcosting
• When one or more of the followin&conditions are present:
• Product lines di1er in volume and
manuacturing com"le!ity%
• Product lines are numerous and diverse$and tey reuire di1erent degrees o
su""ort services%• Overead costs constitute a signi0cant
"ortion o total costs%
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-en do #e use ABCcosting
• Te manuacturing "rocess or numbero "roducts as canged signi0cantly4or e!am"le$ rom labor intensive to
ca"ital intensive automation%• Production or mar+eting managers are
ignoring data "rovided by te e!istingsystem and are instead using
IbootlegJ costing data or oteralternative data #en "ricing orma+ing oter "roduct decisions%
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Additional ,ses o ABC
• Activity Based Management (ABM)
– K!tends te use o ABC rom "roductcosting to a com"reensive management
tool tat ocuses on reducing costs andim"roving "rocesses and decision ma+ing%
– ,ses ABC inormation to su""ortorganiLational strategy$ im"rove
o"erations$ and manage costs%
– K%g% -%S% /ndustries
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ABM
• ABM classi0es all activities as valueadded or nonvalueadded%
– alueadded activities increase te #ort
o a "roduct or service to te customer%• K!am"le. Addition o a sun roo to an
automobile%
– 5onvalue added activities don*t%
• K!am"le. Te cost o moving or storing te"roduct "rior to sale%
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Te Ob'ective o ABM % % %
• To reduce or eliminate nonvaluerelated activities (and tereorecosts)%
• Attention to ABM is a "art ocontinuous im"rovement oo"erations and activities%
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Possible Cost Drivers
• Macine ours
• Direct labor ours
•
5umber o setu"s• 5umber o "roducts
• 5umber o "urcase orders
• 5umber o em"loyees• 5umber o suare eet
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Common Classi0cationSystem
• ,nitlevel activities% Activities "erormedor eac unit o "roduction%
• Batclevel activities% Activities
"erormed or eac o bat o "roducts%• Productlevel activities% Activities
"erormed in su""ort o an entire
"roduct line%• Facilitylevel activities% Activities reuired
to sustain an entire "roduction "rocess%
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Common Classi0cationSystem
• Tis system "rovides a structured#ay o tin+ing about relationsi"bet#een activities and te resources
tey consume%
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Facility Sustaining Activities
• 7ave no good cost driver
• May or may not be allocated to"roducts de"ending u"on te"ur"ose or #ic te inormation isto be used
• K!am"les
– 7ouse+ee"ing
– Factory yard maintenance
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Manuacturing Systems
• Traditional
– INustinCase%J
• /nventories o ra# materials are maintained
'ust in case some items are o "oor uality or+ey su""liers don*t delivery on time%
– Pus a""roac manuacturing%
• Materials are "used troug te
manuacturing "rocess% – Based on standard costs% Once a
standard is reaced im"rovement ceases%
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Manuacturing Systems
• Progressive
– INust in Time%J
• Ga# materials arrive 'ust in time or use in
"roduction%• Finised goods are manuactured 'ust in time
to meet customer needs%
– Pull a""roac manuacturing%
• Ga# materials are not "ut into te "rocessuntil te ne!t de"artment reuests tem%
– Continuous uality im"rovement%
Tree im"ortant elements
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Tree im"ortant elementsmust e!ist or N/T systems to
#or+.• De"endable su""liers #o candelivery on sort notice%
• Multis+illed #or+orce #o can #or+in #or+ cells or #or+ stations%
– One #or+er may o"erate several +indso macines%
• Total uality management% Ob'ectiveis no deects%
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Ob'ectives o N/T
• Geduction or elimination oinventories
• Knanced "roduction uality
• Geduction or elimination o re#or+costs
•
Production cost savings romim"roved o# o goods troug te"rocess%
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ABC in Service /ndustry
• Similar to tat in manuacturing industry
• T#ostage costing model.
– Assign te resource costs to activity cost "ools
– ,se cost drivers to assign te costs in tese
"ools• To various services "rovided and customers served%
• K!%. 7ealtcare services cos%$ Ban+ing$BPOs
• ABC and ABM systems
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Tan+sH