Key Topics:

1
Chapter 7Activity-Based Costing and Management

• Key Topics
• Traditional versus ABC systems
• Activities and their identification
• Cost hierarchy
• ABC procedures
• ABM
• Benefits and costs of ABC and ABM
• Uncertainties

2
Traditional Overhead CostAllocation System
3
ABC Cost Allocation System
4
What Are Activities, and How Are They Identified?

• Activity
• Type of task or function performed in an
  organization
• Activity Identification
• Tracking the use of resources
• Using the cost hierarchy
• Grouping homogeneous costs

5
Cost Hierarchy

• Organization-sustaining activities
• Activities and costs associated with overall
  organization (lease of headquarters office space,
  salary of CEO)
• Facility-sustaining activities
• Activities and costs associated with single
  manufacturing plant or service facility (property
  taxes, plant manager salary)
• Customer-sustaining activities
• Activities and costs associated with a single
  customer (costs of ordering and delivery)

6
Cost Hierarchy

• Product-sustaining activities
• Activities or costs associated with product line
  or one single product (advertising, depreciation)
• Batch-level activities
• Activities or costs associated with each batch of
  product (set-up costs, electricity)
• Unit-level activities
• Activities or costs associated with each unit
  (indirect materials, indirect labor)

7
ABC Procedures

• 1. Identify the relevant cost object
• 2. Identify activities
• 3. Assign (trace and allocate) costs to activity
  based cost pools
• 4. For each ABC cost pool, choose a cost driver

8
ABC Procedures

• 5. For each ABC cost pool, calculate an
  allocation rate
• Allocation Rate Activity Cost/Volume of Cost
  Driver
• 6. For each ABC cost pool, allocate activity
  costs to the cost object
• Allocation Allocation Rate Actual Volume of
  Activity

9
Using ABC

• 7.21 Palmer Company uses an activity based
  costing system. It has the following
  manufacturing activity areas and has chosen
  related cost drivers.
• Activity Cost Driver
• Machine setup Number of setups
• Material handling Number of parts
• Machining Machine hours
• Assembly Direct labor hours
• Inspection Number of finished units

10
Develop allocation rate(not shown in textbook
problem)

• Activity
• Machine setup 200,000
• Material handling 320,000
• Machining 208,000
• Assembly 66,000
• Inspection 264,000
• Cost Driver
• Number of setups 4,000
• Number of parts 640,000
• Machine hours 8,000
• Direct labor hours 3,000
• Number of finished units 22,000

11
Cost allocation rates
12
Product information
13

Developing ABC unit cost
14
Selection of Cost Drivers

• Need cause and effect relationship between cost
  driver and activity costs
• Requires judgment in choosing and evaluating
  potential cost drivers
• Examples

15
What Is Activity Based Management (ABM)?

• The process of using ABC information to evaluate
  the costs and benefits of production and internal
  support activities and to identify and implement
  opportunities for improvements in profitability,
  efficiency, and quality within an organization

16
ABM Applied

• Customer profitability
• Product and process design
• Focus resources on value-added activities
• Reduce or eliminate non-value- added
  activities
• Target and kaizen costing

17
ABM Applied

• Environmental costs
• Quality
• Prevention activities
• Appraisal activities
• Production activities
• Post-sales activities
• Constrained resources

18
Benefits

• Increase awareness of cause and effect
  relationships
• Promote performance improvements
• Identify non-value-added activities
• Motivate cost reduction
• Reduce arbitrariness in cost measurement
• Optimize use of constrained resources

19
Costs

• System design
• Accounting system modifications
• Employee training
• Higher costs when
• There are more activities
• Activities are complex
• ABC system is complex

20
Uncertainties in ABC and ABM Implementation

• Choice of activities
• Choice of cost drivers
• Inability to foresee all possible uses of
  information
• Choice of denominator in allocation rate