MSE608C%20

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MSE608C Engineering and Financial Cost Analysis

• Activity Based Costing (ABC)

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Activity Based Costing (ABC)

• The purpose of ABC is to better associate
  Overhead costs with the product that incur them.
  It accomplishes this by
• defining a number of specific processes with a
  number of associated activities for each
  department
• measuring the indirect resource costs for each of
  these activities
• determining a cost driver, or output for each
  process
• allocating the costs based on the proportion used
  by each product.

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ABC vs. Traditional Costing Methods

• ABC allocates Overhead more closely aligned with
  each products consumption of resources.
• Traditional Methods will tend to over-cost
• Products with fewer parts
• Larger products
• Products built in larger lots
• Products with less demanding performance
  specifications
• Standard products.
• ABC, though, will require more effort and costs
  to administer and is unfamiliar to most
  businesses.
• It can be used in specific Managerial accounting
  applications for analyzing product costs and
  improving marketing and sales strategies.

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Implementing ABC (cont)

• Step 1 Identify processes and activities
• Perform an in-depth analysis of the conversion
  processes for each department and define
  activities for these processes.
• These processes and activities must be clearly
  defined so raw cost data can be accurately
  measured.

Activity A
Process X
Activity B
Activity C
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Implementing ABC (cont)

• Step 2 Assign costs to activities
• Indirect resource costs are assigned to the
  activities.
• Costs will include
• Direct labor
• Direct material
• utilities
• rent
• depreciation

Resource Cost
Resource Cost
Activity A
Resource Cost
Process X
Activity B
Resource Cost
Activity C
Resource Cost
Resource Cost
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Implementing ABC (cont)

• Step 3. Define outputs (cost drivers)
• Define what the output is for each process in
  each department. The output will depend on the
  process. Examples will include
• Number of machine setups
• Machine or labor hours
• Number of purchase orders placed
• Number of parts (product complexity)
• Number of Engineering Change Orders (ECO)

Resource Cost
Resource Cost
Activity A
Resource Cost
Output
Process X
Activity A
Resource Cost
Activity A
Resource Cost
Resource Cost
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Implementing ABC (cont)

• Step 4. Calculate Unit Cost
• Unit Cost Total (budgeted) Activity
  Costs/Total (budgeted) Cost Driver
• Used to calculate budgeted Overhead costs
• Used to apply Overhead costs to process output.

Resource Cost
Resource Cost
Activity A
Resource Cost
Output
Process X
Activity A
Resource Cost
Activity A
Resource Cost
Resource Cost
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Assessment

• What are the benefits of ABC?
• Traditional methods of cost accounting tend to
  over-cost _______ ?
• Is ABC allowed to be used for financial reports?