Overview managerial accounting chapter 08

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Chapter Activity-Based Costing– A Tool to Aid Decision Making Learning Objectives LO1 LO2 LO3 LO4 LO5 LO6 LO7 Understand activity-based costing and how it differs from a traditional costing system Assign costs to cost pools using a first-stage allocation Compute activity rates for cost pools Assign costs to a cost object using a second-stage allocation Prepare a report showing activity-based costing margins from an activity view Compare product costs computed using traditional and activity-based costing methods (Appendix 8A) Prepare an action analysis report using activity-based costing data and interpret the report New in this Edition • New In Business boxes have been added • Many new exercises have been added to the end of chapter materials Chapter Overview A Background for the Instructor A few general comments will help set the stage for the chapter ABC and GAAP Some ABC systems are used for external as well as for internal financial reports However, in most cases, a company’s ABC system is not integrated with the company’s regular costing system We agree with experts who argue against integrating the two systems because of their very different purposes We have chosen to emphasize the use of activity-based costing as a decision-making tool, although a number of exercises and problems at the end of the chapter permit an instructor to explore the use of ABC as an alternative to traditional costing systems for external reporting The ABC approach taken in the chapter In practice activity-based costing comes in many variations We have consciously combined the best elements from practice and have added some innovations of our own As a consequence, the material in the chapter should be regarded as ABC as it should be rather than a description of ABC as it is commonly implemented in practice B Differences Between ABC and Traditional Costing (Exercise 8-16) The product costs computed in this chapter differ in major ways from the product costs in Chapters 2, 3, and that describe traditional costing systems 448 Manufacturing costs in ABC In the ABC system described in the chapter, some manufacturing costs are excluded from product costs This treatment follows recommendations by Cooper and Kaplan and others a The chapter advocates excluding the costs of idle capacity from product costs, but without getting into the details of how this is done It would be helpful, but not absolutely necessary, for your students to have read Appendix 3A, which goes into this subject in greater depth b We also exclude organization-sustaining costs from activity-based costing product costs These costs will be discussed in more detail below Basically, organizationsustaining costs are excluded from product costs because they are not caused by individual products and are not relevant in decisions concerning those products Non-manufacturing costs in ABC Strictly speaking, non-manufacturing costs are excluded from product costs under GAAP However, to the extent that these costs are caused by specific products, excluding them results in misleading information for making decisions It is true that these non-manufacturing costs can be deducted from product revenues in addition to unit product costs when decisions are made, but this is not always done It is probably safer to build these costs right into product costs, which is the approach taken in this chapter (Remember, these costs are to be used for making decisions, not valuing inventory and cost of goods sold.) Multiple overhead cost pools in ABC Traditional overhead costing systems are described in Chapters 2, 3, and In these traditional systems, an entire plant may have a single overhead cost pool or each production department may have a separate overhead cost pool In nearly all cases, overhead costs are applied to products using either direct labor-hours, direct labor cost, or machine-hours In activity-based costing, each major activity has its own separate overhead cost pool An activity is any event that causes the consumption of resources The activities tracked in the ABC system may cut across many departments and the measures of activity (i.e., allocation bases) may be quite different from the traditional allocation bases C Cost Hierarchy in Activity-Based Costing (Exercises 8-8, 8-13, and 8-15.) Thousands of activities are carried out in most organizations It would not be practical to track all of them in an activity-based costing system A great deal of simplification is necessary Activities and their costs must be combined to reduce complexity and record-keeping requirements One way to simplify is to group activities into a hierarchy Activities, and their costs, can be combined within each level of the hierarchy into activity cost pools—hopefully with minimal loss in accuracy The cost hierarchy used in the text is not the only scheme that could be used, but it is reasonably comprehensive The levels in the hierarchy are as follows: Unit-level activities These activities are performed each time a unit is produced For example, providing power to run processing equipment is likely to be a unit-level activity Batch-level activities These activities are performed each time a batch is handled or processed, regardless of how many units are in the batch For example, tasks such as placing purchase orders, setting up equipment, and arranging for shipments to customers are batch-level activities 449 Product-level activities These activities relate to specific products and must be carried out regardless of how many batches or units of product are produced or sold For example, designing a product, advertising a product, and maintaining a product manager and staff are all product-level activities Customer-level activities These activities relate to specific customers and include sales calls, catalog mailings, and general technical support not tied to any specific product Organization-sustaining activities These activities are carried out regardless of which products are produced, how many batches are run, or how many units are made This category of activities includes cleaning executive offices, providing a computer network, arranging for loans, preparing annual reports to shareholders, and so on D Mechanics of Activity-Based Costing (Exercises 8-9, 8-10, 8-11, 8-18, 8-20, and 816.) Exhibit 8-6 is a useful Exhibit for summarizing the mechanics of activity-based costing You may want to refer to it frequently as you walk students through the steps of assigning costs using ABC Overview Once the activity cost pools and their activity measures have been defined, costs are allocated to the activity cost pools The costs in the activity cost pools are then divided by their activity measures to determine activity rates (Activity rates are like the overhead rates of Chapter 3.) The activity rates are then used to assign costs to cost objects such as products and customers For example, if a customer generates five orders and the activity rate for orders is $15 per order, then the customer would be assigned $75 in order costs The mechanics are fundamentally no different from the mechanics covered in Chapter for applying overhead to products The main difference is that instead of one predetermined overhead rate, many activity rates are used First-stage allocations (Exhibits 8-13, 8-15, and 8-9.) The first stage in the allocation process is based on a table showing the distribution of resource consumption across activities for each category of cost in the company’s bookkeeping system For example, if indirect factory wages is one of the accounts in the company’s bookkeeping system, the table would show what percentage of indirect wages is attributable to each of the activities in the company’s ABC system The text describes how interviews can be used to elicit these percentage distributions, but these percentage distributions are always given in all examples and problems The first-stage allocation is accomplished by multiplying the total cost of each account by the percentages in its row in the table showing the distribution of resource consumption across activities For example, if the table shows that 20% of indirect factory wages are attributable to processing batches, then 20% of the cost of indirect factory wages would be allocated to that activity cost pool The end product of the first stage of the allocation process is a table showing how each cost such as indirect factory wages is divided up among activity cost pools The “Other” activity cost pool In the text one activity cost pool is usually labeled “Other.” Costs are allocated to this activity cost pool in the first stage of the allocation process but they are not subsequently allocated to products, customers, or other cost objects This activity cost pool is supposed to capture costs of idle capacity and organization-sustaining costs that should not be allocated to cost objects because they are not caused by the cost objects In practice, these costs are almost always allocated to cost 450 objects—the costs of idle capacity and organization-sustaining costs are seldom segregated from other costs Computation of activity rates (Exhibit 8-5.) The total cost assigned to an activity cost pool in the first-stage allocation is divided by the total amount of activity for the cost pool to determine the activity rate for that cost pool Each activity cost pool has its own activity rate Second-stage allocations of costs to cost objects (Exhibit 8-8.) The activity rates can be used to assign costs to any cost object The activity rate is simply multiplied by the amount of activity for the cost object Product and customer margins—activity view (Exhibit 8-9) Margins for products, customers, and other cost objects can be easily constructed using the costs in Exhibit 8-8 These costs are combined with whatever costs are directly traced to the cost object (for example, direct materials), and deducted from the sales attributable to the cost object This is the conventional approach in activity-based costing E Activity Rates and Activity-Based Management (Exercise 8-10.) Activity rates (i.e., the cost per unit of activity) can be useful to managers in targeting business process improvements If activity rates are available from other organizations, an unusually high cost for carrying out a particular activity can signal room for improvement Also, if similar activities are carried out at different locations within the same organization, activity rates can help identify which locations are most efficient The methods used at the most efficient locations can then be applied to other locations F The Impact on Product Costs of Adopting an ABC System (Exercise 8-21.) Unit product costs are different under activity-based costing and traditional cost systems for a number of reasons First, some manufacturing costs (i.e., the costs of idle capacity and organizationsustaining costs) are excluded from product costs under the activity-based costing approach described in the text Second, some non-manufacturing costs are included in product costs under activity-based costing These two differences affect the total amount of cost allocated to products However, even if these differences are ignored or suppressed, the unit product costs will still differ between activity-based costing and traditional costing systems For example, if a company switches to activity-based costing for external financial reports, the total costs allocated to products will remain the same, but the pattern of allocation will differ The biggest changes in product costs from switching to an ABC system occur when the ABC system includes batch or product-level costs In this case, costs ordinarily shift from highvolume products to low-volume products Consequently, the total and per unit costs of the highvolume products decrease and the total and per unit costs of the low-volume products increase When overhead costs are shifted from one product to another, a given dollar amount is implicitly subtracted from the total cost of one product and added to the total cost of the other product Since the total cost of all products remains the same, what is taken away from one product must be added to another product However, the effects on unit costs are not symmetrical The perunit costs of the low-volume products must go up more than the per-unit costs of the highvolume products go down G Appendix 8A: ABC Action Analysis (Exercises 8-12, 8-19, and 8-21) The conventional ABC analysis discussed in the chapter has some important drawbacks for decision-making Most importantly, with a product margin analysis such as the one shown 451 in Exhibit 8-9, it is unclear who is actually responsible for a cost For example, if a product is dropped because of a negative margin, it is unclear who would be responsible for actually carrying out reductions in costs An activity cost pool may contain costs from many departments If a product is dropped, the activities associated with the product will presumably disappear, but will the costs? If it is unclear who would be responsible for reducing the costs, no one may actually take any action This is particularly true for personnel costs What manager will voluntarily give up personnel if there is no accountability? Be sure to reinforce the idea that the costs assigned to a product, customer, or whatever in an activity-based costing system are relevant in a decision only if the costs would actually change if the decision were taken For example, in a product drop decision, the costs of resources are relevant only if spending would decrease as a result of the decision or the resources would be redeployed to more profitable uses In the latter case, this means that the resources would have to be redeployed to the constraint An action analysis report makes it much clearer what costs are likely to be relevant in a decision and who in the organization would be responsible for the cost if an action is taken Unfortunately, preparing an action analysis report requires considerably more work than the more conventional analysis Activity rates (Exhibit 8A-2) The action analysis approach differs from the conventional ABC approach beginning with the computation of the activity rates In the conventional analysis, a single activity rate is computed for each activity cost pool In an action analysis, a rate is computed for each cost category within an activity cost pool Looking at Exhibit 8A-2, only the rates at the bottom of the Exhibit would be computed in a conventional analysis In an action analysis, the entire table is filled out Second-stage allocations (Exhibit 8A-3) In an action analysis, an entire matrix of costs is computed rather than just a total cost for each activity cost pool Looking at Exhibit 8A-3, only the costs at the bottom of the Exhibit would be computed in a conventional analysis In an action analysis, the entire table is filled out by multiplying activities by the activity rates in each cell The conventional activity analysis From the action analysis cost matrix in Exhibit 8A-3, it is easy to construct the conventional activity analysis report showing product margins Just take the totals from the bottom of the cost matrix Note that these costs are identical to the costs computed earlier in the chapter in Exhibit 8-8 However, using the row totals from Exhibit 8A-3, it is possible to look at the margins of products and other cost objects from a different perspective Instead of abstract labels like “order processing costs” for the various activity cost pools, the costs are labeled using the account titles from the company’s bookkeeping system This makes it clear what the costs actually consist of and who in the organization would be responsible for taking action if a decision is made Ease of adjustment codes (Exhibit 8A-4) Some costs, such as direct materials, are much easier to adjust than other costs, such as the total wages of experienced supervisors As a consequence, some costs are more likely to be relevant in a decision than others The ease of adjustment codes provide a way of assisting managers in making these distinctions a Green These costs adjust automatically to changes in activity without any management action Examples include direct materials and the cost of power to run machines 452 b Yellow These costs could, in principle, be adjusted to changes in activity, but management action would be required Direct labor is usually such a cost, as are many discretionary expenses c Red These costs would be very difficult to adjust to changes in activity and management action would be required Examples include time-based depreciation and many salaries Action analysis report (Exhibit 8A-5) The action analysis report combines the cost information from the row totals in Exhibit 8A-3 with the ease of adjustment codes in Exhibit 8A-4 This report makes it much clearer where costs would need to be adjusted in the organization as the result of an action, who would be responsible for the change in costs, and which costs are likely to be relevant and which costs are likely to be irrelevant in decisions Such an action analysis report is not the final step in the decision-making process Further analysis, such as illustrated in Chapter 13, would be necessary before making any major decision 453 Assignment Materials Assignment Exercise 8-1 Exercise 8-2 Exercise 8-3 Exercise 8-4 Exercise 8-5 Exercise 8-6 Exercise 8-7 Exercise 8-8 Exercise 8-9 Exercise 8-10 Exercise 8-11 Exercise 8-12 Exercise 8-13 Exercise 8-14 Exercise 8-15 Exercise 8-16 Exercise 8-17 Exercise 8-18 Exercise 8-19 Exercise 8-20 Exercise 8-21 Problem 8-22 Problem 8-23 Problem 8-24 Problem 8-25 Problem 8-26 Problem 8-27 Problem 8-28 Problem 8-29 Problem 8-30 Case 8-31 Case 8-32 Case 8-33 Case 8-34 Level of Topic Difficulty ABC cost hierarchy Basic First-stage allocation Basic Compute activity rates Basic Compute ABC product costs Basic Product and customer profitability analysis Basic Contrasting traditional and ABC product costs Basic (Appendix 8A) Preparing an action analysis report Basic Cost hierarchy Basic First-stage allocations Basic Computing and interpreting activity rates Basic Second-stage allocation to an order Basic (Appendix 8A) Second-stage allocation to an order using the action analysis approach Basic Activity measures Basic Computing ABC product costs Basic Cost hierarchy and activity measures Basic Calculating and interpreting activity-based costing data Basic Activity-based costing as an alternative to traditional product costing Basic Second-stage allocation and margin calculations Basic (Appendix 8A) Second-stage allocation and margin calculations using the action analysis approach Basic Comprehensive activity-based costing exercise Basic (Appendix 8A) Comprehensive activity-based costing exercise Basic Activity-based costing as an alternative to traditional product costing Medium (Appendix 8A) Activity rates and activity-based management Medium Evaluating the profitability of services Medium (Appendix 8A) Evaluating the profitability of services using an action analysis approach Medium Activity-based costing as an alternative to traditional product costing Medium Activity-based costing and bidding on jobs Medium Second-stage allocations and product margins Medium (Appendix 8A) Second-stage allocations and product margins Medium Activity-based costing as an alternative to traditional product costing Medium Activity-based costing and pricing Difficult Contrasting activity-based costing and traditional costing Difficult (Appendix 8A) Comprehensive activity-based costing case Difficult Activity-based costing as an alternative to traditional product costing Difficult 454 Suggested Time 10 15 10 10 30 30 20 10 10 20 10 30 10 20 15 30 45 15 45 30 60 60 45 45 75 60 45 20 30 45 90 90 120 90 Essential Problems: Problem 8-22 or Problem 8-26, Problem 8-24, Problem 8-27, Problem 8-28 Supplementary Problems: Problem 8-30, Case 8-31, Case 8-32, Case 8-34 Linked Exercises: Exercise 8-10 should be assigned only if Exercise 8-9 is also assigned Exercise 8-12 should only be assigned if Exercise 8-11 is assigned Appendix 8A Essential Problems: Problem 8-23, Problem 8-25, Problem 8-29 Appendix 8A Supplementary Problems: Case 8-33 455 456 Chapter Lecture Notes Helpful Hint: Before beginning the lecture, show students the seventh and eighth segments from the second tape of the McGraw-Hill/Irwin Managerial/Cost Accounting video library These segments introduce students to many of the concepts discussed in chapter The lecture notes reinforce the concepts in the video Chapter theme: This chapter introduces students to activity-based costing (ABC) which is a tool that has been embraced by a wide variety of service, manufacturing, and non-profit organizations ABC is a costing method that is designed to provide managers with cost information for strategic and other decisions that potentially affect capacity and therefore “fixed” as well as variable costs It is ordinarily used as a supplement to, rather than as a replacement for, the company’s usual costing system I How costs are treated under activity-based costing A “Best practice” ABC differs from traditional cost accounting in five ways: i ABC assigns both manufacturing and nonmanufacturing costs to products Traditional cost systems only assign manufacturing costs to products For example, ABC systems can assign sales commissions, shipping costs, and warranty repair costs to specific products 457 TM 8-9 THE CLASSIC BRASS EXAMPLE (cont’d) Exhibit 8-3 Results of Interviews Production Department: Indirect factory wages Factory equipment depreciation Factory utilities Factory building lease Customer Orders Activity Cost Pools Product Customer Design Order Size Relations Other Total 25% 20% 0% 0% 40% 0% 10% 0% 20% 60% 50% 0% 10% 0% 0% 0% 5% 20% 40% 100% 100% 100% 100% 100% General Administrative Department: Administrative wages and salaries Office equipment depreciation Administrative building lease 15% 30% 0% 5% 0% 0% 10% 0% 0% 30% 25% 0% 40% 100% 45% 100% 100% 100% Marketing Department: Marketing wages and salaries Selling expenses 20% 10% 10% 0% 0% 0% 60% 70% 10% 100% 20% 100% Shipping costs* *Shipping costs are directly traced to customer orders © The McGraw-Hill Companies, Inc., 2006 All rights reserved TM 8-10 THE CLASSIC BRASS EXAMPLE (cont’d) Exhibit 8-4 First-Stage Allocations to Activity Cost Pools Activity Cost Pools Customer Product Order Customer Orders Design Size Relations Production Department: Indirect factory wages $125,000 $200,000 $100,000 Factory equipment depreciation 60,000 180,000 Factory utilities 12,000 60,000 Factory building lease 0 Other Total $50,000 0 $25,000 60,000 48,000 80,000 $500,000 300,000 120,000 80,000 120,000 12,500 160,000 22,500 60,000 400,000 50,000 60,000 Shipping costs* General Administrative Department: Administrative wages and salaries Office equipment depreciation Administrative building lease 60,000 15,000 20,000 0 40,000 0 Marketing Department: Marketing wages and salaries 50,000 25,000 150,000 25,000 250,000 Selling expenses 0 35,000 10,000 50,000 5,000 Total $315,000 $257,000 $380,000 $367,500 $490,500 $1,810,000 *Shipping costs are directly traced to customer orders © The McGraw-Hill Companies, Inc., 2006 All rights reserved TM 8-11 THE CLASSIC BRASS EXAMPLE (cont’d) Exhibit 8-5 Computation of Activity Rates Activity Cost Pools Customer orders Product design Order size Customer relations Other (a) Total Cost (b) Total Activity (a) ÷ (b) Activity Rate $315,000 1,000 orders $315 per order $257,000 200 designs $1,285 per design $380,000 20,000 MHs $19 per MH $367,500 100 customers $3,675 per customer Not applicable $490,500 Not applicable © The McGraw-Hill Companies, Inc., 2006 All rights reserved TM 8-12 THE CLASSIC BRASS EXAMPLE (cont’d) Exhibit 8–7 Data Concerning the Products Ordered by Windward Yachts Standard Stanchions This is a standard design that does not require any new design resources Four hundred units were ordered during the year, comprising two separate orders Each stanchion required 0.5 machine-hour, for a total of 200 machine-hours The selling price per unit was $34, for a total of $13,600 Direct materials for 400 units totaled $2,110 Direct labor for 400 units totaled $1,850 Shipping costs for the two orders totaled $180 Custom Compass Housing This is a custom product that requires new design resources There was only one order for a single unit during the year The compass housing required machine-hours The selling price was $650 Direct materials were $13 Direct labor was $50 Shipping costs were $25 © The McGraw-Hill Companies, Inc., 2006 All rights reserved TM 8-13 THE CLASSIC BRASS EXAMPLE (cont’d) Exhibit 8-8 Computation of Overhead Costs Activity Cost Pools (a) Activity Rate Standard Stanchions Customer orders $315 Product design $1,285 Order size $19 Customer relations $3,675 (b) Activity (a) × (b) ABC Cost per per per per order design MH customer orders designs 200 MHs Not applicable $630 $0 $3,800 Custom Compass Housing Customer orders $315 per Product design $1,285 per Order size $19 per Customer relations $3,675 per order design MH customer order design MHs Not applicable $315 $1,285 $76 © The McGraw-Hill Companies, Inc., 2006 All rights reserved TM 8-14 THE CLASSIC BRASS EXAMPLE (cont’d) Exhibit 8-9 Product Profitability Analysis Standard Stanchions Custom Compass Housing Sales (from Exhibit 8-7) $13,600 $ 650 Costs: Direct materials (from Exhibit 8-7) $2,110 $ 13 Direct labor (from Exhibit 8-7) 1,850 50 Shipping costs (from Exhibit 8-7) 180 25 Customer orders (from Exhibit 8-8) 630 315 Product design (from Exhibit 8-8) 1,285 Order size (from Exhibit 8-8) 3,800 8,570 76 1,764 Product margin $ 5,030 $(1,114) Customer Profitability Analysis—Windward Yachts Product margins of products ordered by Windward Yachts: Standard stanchion product margin (see above) Custom compass housing product margin (see above) Total product margins Less: Customer relations overhead (from Exhibit 8-5) Customer margin © The McGraw-Hill Companies, Inc., 2006 All rights reserved $5,030 (1,114) 3,916 3,675 $ 241 TM 8-15 THE CLASSIC BRASS EXAMPLE (cont’d) Exhibit 8-10 Standard Stanchions Sales (from Exhibit 8-7) $13,600 Cost: Direct materials (from Exhibit 8-7) $ 2,110 Direct labor (from Exhibit 8-7) 1,850 Manufacturing overhead (see below) 10,000 13,960 Product margin* $ (360) Custom Compass Housing $650 $ 13 50 200 263 $387 In the traditional costing system used at Classic Brass, manufacturing overhead is applied based on machine-hours The predetermined rate is $50 per machine-hour, determined as follows: Predetermined manufacturing = Total estimated manufacturing overhead overhead rate Total estimated machine-hours = $1,000,000 20,000 machine-hours = $50 per machine-hour Referring back to Exhibit 7, the standard stanchions require 200 machinehours in total and the custom compass housing requires machine-hours Therefore, $10,000 (= 200 machine-hours × $50 per machine-hour) of manufacturing overhead would be charged to the standard stanchions and $200 (= machine-hours × $50 per machine-hour) to the custom compass housing *In a traditional costing system, the product margins not include any nonmanufacturing costs such as shipping costs © The McGraw-Hill Companies, Inc., 2006 All rights reserved TM 8-16 CONTRASTING ACTIVITY-BASED COSTING AND TRADITIONAL COSTING Exhibits 8-8 and 8-10 can be used to develop the following analysis: Stanchions: Direct materials Direct labor Manufacturing overhead* Nonmanufacturing overhead§ Shipping costs Total cost Number of units ordered Unit product cost Custom Compass Housing: Direct materials Direct labor Manufacturing overhead* Nonmanufacturing overhead§ Shipping costs Total cost Number of units ordered Average cost per unit Traditional ABC $ 2,110 1,850 10,000 $2,110 1,850 3,770 660 180 $8,570 ÷ 400 $21.43 $13,960 ÷ 400 $34.90 Traditional $ $ 13 50 200 263 ÷1 $263.00 $ ABC 13 50 1,313 363 25 $ 1,764 ÷1 $1,764.00 * Indirect factory wages, factory utilities, factory equipment depreciation, and factory building § Administrative wages and salaries, office equipment depreciation, marketing wages and salaries, selling expenses, and administrative building lease © The McGraw-Hill Companies, Inc., 2006 All rights reserved TM 8-17 TYPICAL IMPACT ON PRODUCT COSTS FROM IMPLEMENTING ABC • Adopting activity-based costing usually results in shifting manufacturing overhead costs from high-volume products (e.g., stanchions) to lowvolume products (e.g., custom compass housing) • The per unit costs of the low-volume products increase and the per unit costs of the high-volume products decrease because of better assignment of batch-level and product-level costs • The effects are not symmetrical—the dollar effect on the per unit costs of the low-volume products is usually larger Note: The product costs from the activity-based costing system described here would not be acceptable for external financial reports • Excludes some manufacturing costs (i.e., costs of idle capacity and organization-sustaining costs) • Includes some nonmanufacturing costs • Relies on subjective interview data © The McGraw-Hill Companies, Inc., 2006 All rights reserved TM 8-18 APPENDIX 8A: ABC ACTION ANALYSIS • Many decisions involve changes in activity, for example: • If a product or customer is dropped, all of the activities associated with that product or customer can be avoided • Changes in prices affect sales volume, which in turn affects activity • Process improvements often result in decreases in redundant and nonvalue-added activities • A change in activity does not necessarily result in a change in cost Many costs (i.e., the costs of salaried employees) must be managed up or down as a result of a change in activity An action analysis report helps decision-makers by: • Distinguishing between costs that are easy to adjust to changes in activity and those that are difficult to adjust • Identifying where cost adjustments would have to be made in the organization © The McGraw-Hill Companies, Inc., 2006 All rights reserved TM 8-19 APPENDIX 8A: ABC ACTION ANALYSIS Exhibit 8A-2 Computation of the Activity Rates for the Action Analysis Report Activity Cost Pools Customer Product Order Customer Orders Design Size Relations Total activity 1,000 orders 200 20,000 100 product machine- active designs hours customers Production Department: Indirect factory wages Factory equipment depreciation Factory utilities Factory building lease $125 60 0 $1,000 60 $5 $500 0 General Administrative Department: Administrative wages and salaries Office equipment depreciation Administrative building lease 60 15 100 0 0 1,200 125 Marketing Department: Marketing wages and salaries Selling expenses 50 125 0 1,500 350 Total (conventional ABC analysis) $315 $1,285 $19 $3,675 Note: Activity rates are not computed for the Other cost pool because these are costs of idle capacity and organization-sustaining costs that are not allocated to products and other cost objects © The McGraw-Hill Companies, Inc., 2006 All rights reserved TM 8-20 APPENDIX 8A: ABC ACTION ANALYSIS Exhibit 8A-3 Action Analysis Cost Matrix for the Custom Compass Housing Activity Cost Pools Customer Product Order Orders Design Size Total activity Total order product machinedesign hours Production Department: Indirect factory wages Factory equipment depreciation Factory utilities Factory building lease $125 60 0 $1,000 60 $20 36 12 $1,145 96 72 General Administrative Department: Administrative wages and salaries Office equipment depreciation Administrative building lease 60 15 100 0 0 168 15 Marketing Department: Marketing wages and salaries Selling expenses 50 125 0 175 Total (conventional ABC analysis) $315 $1,285 $76 $1,676 Note: The activity rates for the Customer Relations cost pool are applied to customers, not products © The McGraw-Hill Companies, Inc., 2006 All rights reserved TM 8-21 APPENDIX 8A: ABC ACTION ANALYSIS © The McGraw-Hill Companies, Inc., 2006 All rights reserved TM 8-22 APPENDIX 8A: ABC ACTION ANALYSIS Exhibit 8A-5 Action Analysis of the Custom Compass Housing Sales (from Exhibit 8-7) Green costs: Direct materials (from Exhibit 8-7) $ Shipping costs (from Exhibit 8-7) Green margin $ 13 25 Yellow costs: Direct labor (from Exhibit 8-7) 50 Indirect factory wages (from Exhibit 8A-3) 1,145 Factory utilities (from Exhibit 8A-3) 72 Administrative wages and salaries (from Exhibit 8A-3) 168 Office equipment depreciation (from Exhibit 8A-3) 15 Marketing wages and salaries (from Exhibit 8A-3) 175 Selling expenses (from Exhibit 8A-3) Yellow margin Red costs: Factory equipment depreciation (from Exhibit 8A-3) Factory building lease (from Exhibit 8A-3) Administrative building lease (from Exhibit 8A-3) Red margin 96 0 650 38 612 1,630 (1,018) 96 $(1,114) Question: Do you think all of the above costs would be eliminated if jobs like the custom compass housing were no longer accepted? What impact would dropping such jobs have on follow-on sales and other sales from these customers? © The McGraw-Hill Companies, Inc., 2006 All rights reserved © The McGraw-Hill Companies, Inc., 2006 All rights reserved [...]... seen as unimportant 11 ii There should be cross-functional involvement 1 Since ABC affects people across departments, it should involve these people 467 11 12 468 and be fully supported by them If the accounting department alone attempts to impose ABC on others, skepticism and resistance are inevitable 2 A well designed ABC system requires intimate knowledge of many parts of an organization This knowledge... production order and the greater the amount of time devoted to preparing the production order, the greater the cost 12 13 The consumption of resources causes costs C Steps for implementing ABC (provide an overview of all five steps) i Identify and define activities and activity cost pools (The activities are often identified and defined by interviewing the employees that work in the respective overhead
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