Manerial accounting 11e garrison noreen brewer chap008

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11th Edition Chapter McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc Activity-Based Costing: A Tool to Aid Decision Making Chapter Eight McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc Activity Based Costing (ABC) ABC is designed to provide managers with cost information for strategic and other decisions that potentially affect capacity and therefore affect fixed as well as variable costs McGraw-Hill/Irwin ABC is a good supplement to our traditional cost system I agree! Copyright © 2006, The McGraw-Hill Companies, Inc How Costs are Treated Under Activity–Based Costing “Best “Best practice” practice” ABC ABC differs differs from from traditional traditional costing costing in in five five ways ways Manufacturing costs Nonmanufacturing costs Traditional product costing ABC product costing  ABC assigns both types of costs to products McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc How Costs are Treated Under Activity–Based Costing “Best “Best practice” practice” ABC ABC differs differs from from traditional traditional costing costing in in five five ways ways Traditional product costing Nonmanufacturing costs Mo st, b ut not all Some All Manufacturing costs ABC product costing  ABC does not assign all manufacturing costs to products McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc How Costs are Treated Under Activity–Based Costing Level of complexity “Best “Best practice” practice” ABC ABC differs differs from from traditional traditional costing costing in in five five ways ways Activity–Based Activity–Based Costing Costing Departmental Departmental Overhead Overhead Rates Rates Plantwide Plantwide Overhead Overhead Rate Rate Number of cost pools  ABC uses more cost pools McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc How Costs are Treated Under Activity–Based Costing Number of Allocation Bases “Best “Best practice” practice” ABC ABC differs differs from from traditional traditional costing costing in in five five ways ways Volume measures plus other bases Bases usually rely solely on volume measures Traditional Costing ABC  ABC uses more allocation bases McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc How Costs are Treated Under Activity–Based Costing “Best “Best practice” practice” ABC ABC differs differs from from traditional traditional costing costing in in five five ways ways The The most most commonly commonly used used allocation allocation base base in in traditional traditional costing costing is is direct direct labor labor hours hours Direct labor hours work well when overhead increases as direct labor hours increase  ABC uses more allocation bases McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc How Costs are Treated Under Activity–Based Costing “Best “Best practice” practice” ABC ABC differs differs from from traditional traditional costing costing in in five five ways ways The The most most commonly commonly used used allocation allocation base base in in traditional traditional costing costing is is direct direct labor labor hours hours Problems:  In many processes, overhead is increasing while direct labor is decreasing  Variety and complexity of products is increasing  ABC uses more allocation bases McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc How Costs are Treated Under Activity–Based Costing “Best “Best practice” practice” ABC ABC differs differs from from traditional traditional costing costing in in five five ways ways All overhead costs are not related to volume measures like direct labor hours ABC uses volume as well as other allocation bases not related to the volume of production  ABC uses more allocation bases McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc  Prepare Management Reports Customer Profitability Analysis Windward Windward Yachts Yachts Product Product margins: margins: Standard Standard stanchion stanchion Custom Custom compass compass housing housing Total Total product product margin margin Less: Less: Customer Customer relations relations Customer Customer margin margin McGraw-Hill/Irwin $$5,030 5,030 (1,114) (1,114) 3,916 3,916 3,675 3,675 $$ 241 241 Copyright © 2006, The McGraw-Hill Companies, Inc Product Margins Traditional Cost Accounting System Sales Costs Direct materials Direct labor Manufacturing overhead Product margin Standard Stanchions $ 13,600 $ (2,110) (1,850) (10,000) (360) Compass Housing $ 650 $ (13) (50) (200) 387 400 400 units units xx 0.5 0.5 MH/unit MH/unit xx $50/MH $50/MH == $10,000 $10,000 Predetermined manufacturing = overhead rate McGraw-Hill/Irwin $1,000,000 20,000 MH = $50/MH Copyright © 2006, The McGraw-Hill Companies, Inc Differences Between ABC and Traditional Product Costs Product margins are different for four reasons:  Traditional costing assigns design costs to both products based on machine hours ABC assigns product design costs to a product only if product design work is required  Traditional costing assigns customer order costs, a batch- level cost, using a unit-level allocation base, machine hours ABC assigns these batch-level costs using a batch-level activity measure  Traditional costing assigns only manufacturing costs to products ABC also assigns nonmanufacturing costs to products  Traditional costing assigns all manufacturing costs to products The ABC system does not assign organizationsustaining manufacturing costs to the products McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc Differences Between ABC and Traditional Product Costs When batch-level and product-level costs are present, ABC will usually shift costs from high volume products, produced in large batches, to low volume products produced in small batches This cost shifting will usually have its greatest impact on the per unit cost of the low volume products McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc Targeting Process Improvement Activity-based management is used in conjunction with ABC to identify areas that would benefit from process improvements While the theory of constraints approach discussed in Chapter is a powerful tool for targeting improvement efforts, activity rates can also provide valuable clues on where to focus improvement efforts McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc Activity-Based Costing and External Reporting Most companies not use ABC for external reporting because 1 External External reports reports are are less less detailed detailed than than internal internal reports reports 2 ItIt may may be be difficult difficult to to make make changes changes to to the the company’s company’s accounting accounting system system 3 ABC ABC does does not not conform conform to to GAAP GAAP 4 Auditors Auditors may may be be suspect suspect of of the the subjective subjective allocation allocation process process based based on on interviews interviews with with employees employees McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc ABC Limitations Substantial resources required to implement and maintain Resistance to unfamiliar numbers and reports Desire to fully allocate all costs to products Potential misinterpretation of unfamiliar numbers Does not conform to GAAP Two costing systems may be needed McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc Appendix 8A: ABC Action Analysis Conventional Conventional ABC ABC analysis analysis does does not not identify identify potentially potentially relevant relevant costs costs An An action action analysis analysis report report helps helps because because it: it: •• Shows Shows what what costs costs have have been been assigned assigned to to aa cost cost object object •• Indicates Indicates how how difficult difficult itit would would be be to to adjust adjust those those costs costs in in response response to to changes changes in in the the level level of of activity activity McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc Appendix 8A: ABC Action Analysis Constructing an action analysis report begins with the first-stage allocation process In addition to computing an overall activity rate for each activity cost pool, an activity rate is computed for each type of overhead cost that is consumed supporting a given activity Let’s revisit the stage-one allocations from the Classic Brass example that we discussed earlier McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc Appendix 8A: ABC Action Analysis Activity Cost Pools Customer Product Order Customer Orders Design Size Relations Other Total Activity Customer Orders Production Department Indirect factory wages Factory equipment depreciation Factory utilities Factory building lease General Administrative Department Administrative wages and salaries Office equipment depreciation Administrative building lease Marketing Department Marketing wages and salaries Selling expenses Total $ 125,000 60,000 60,000 15,000 - 1,000 200 20,000 Production Department Indirect factory wages $ 125 $ 1,000 $ $ FactoryActivity equipmentCost depreciation 60 Pools Factory utilities 60 Product Order Customer Factory building lease Design Size Relations Other General Administrative Department Administrative wages and salaries 60 100 Office equipment depreciation 15 $ 200,000 $ 100,000 $ 50,000 $ 25,000 $ Administrative building lease 180,000 60,000 Marketing Department Marketing salaries 125 12,000 wages and 60,000 - 50 48,000Selling- expenses 80,000Total $ 315 $ 1,285 $ 19 $ 20,000 - 40,000 - 120,000 12,500 - 160,000 22,500 60,000 100 N/A 500 - Total 1,200 125 500,000 - 300,000 1,500 120,000 350 80,000 3,675 400,000 50,000 60,000 50,000 25,000 150,000 25,000 250,000 5,000 35,000 10,000 50,000 $ 315,000 $ 257,000 $ 380,000 $ 367,500 $ 490,500 $ 1,810,000 $125,000 ÷ 1,000 orders = $125 per order Other entries in the table are computed similarly McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc Appendix 8A: ABC Action Analysis Action Analysis Cost Matrix for Standard Stanchions Activity Cost Pools Customer Product Orders Design Total activity for stanchions Production Department Indirect factory wages Factory equipment depreciation Factory utilities Factory building lease General Administrative Department Administrative wages and salaries Office equipment depreciation Administrative building lease Marketing Department Marketing wages and salaries Selling expenses Total $ 250 $ 120 120 30 - $ 100 10 630 $ Order Customer Size Relations - 200 $ 1,000 1,800 600 400 $ 3,800 Total N/A $ 1,250 1,920 600 520 30 100 10 $ 4,430 $125 per order × orders = $250 Other entries in the table are computed similarly McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc Appendix 8A: ABC Action Analysis Action Analysis Cost Matrix for Custom Compass Housing Activity Cost Pools Customer Product Orders Design Total activity for compass housing Production Department Indirect factory wages Factory equipment depreciation Factory utilities Factory building lease General Administrative Department Administrative wages and salaries Office equipment depreciation Administrative building lease Marketing Department Marketing wages and salaries Selling expenses Total $ $ Order Customer Size Relations 125 $ 1,000 $ 60 60 60 100 15 50 125 315 $ 1,285 $ 20 36 12 76 Total N/A $ 1,145 96 72 168 15 175 $ 1,676 $125 per order × orders = $125 Other entries in the table are computed similarly McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc Appendix 8A: ABC Action Analysis Next, Next, label label each each cost cost using using an an ease ease of of adjustment adjustment code: code: •• Green Green costs costs adjust adjust more more or or less less automatically automatically to to changes changes in in activity activity level level without without any any action action by by managers managers •• Yellow Yellow costs costs can can be be adjusted adjusted to to changes changes in in activity activity level, level, but but itit would would require require management management action action to to realize realize the the change change in in cost cost •• Red Red costs costs can can be be adjusted adjusted to to changes changes in in activity activity level level only only with with aa great great deal deal difficulty difficulty and and with with management management intervention intervention McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc Appendix 8A: ABC Action Analysis Action Analysis of Custom Compass Housing Sales Green costs Direct materials Shipping costs Green margin Yellow costs Direct labor Indirect factory wages Factory utilities Administrative wages and salaries Office equipment depreciation Marketing wages and salaries Selling expenses Yellow margin Red costs Factory equipment depreciation Factory building lease Administrative building lease Red margin McGraw-Hill/Irwin $ $ 650 $ 38 612 13 25 50 1,145 72 168 15 175 96 - 1,630 $ (1,018) 96 $ (1,114) Copyright © 2006, The McGraw-Hill Companies, Inc End of Chapter McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc
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