abc - from managerial accounting weygandt, kimmel et kieso
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The NavigatorLearning ObjectivesAfter studying this chapter, you should be able to:
1 Recognize the difference between traditional costing and activity-based costing.
2 Identify the steps in the development of an activity-based costing system.
3 Know how companies identify the activity cost pools used in activity-based costing.
4 Know how companies identify and use cost drivers in activity-based costing.
5 Understand the benefi ts and limitations of activity-based costing.
6 Differentiate between value-added and nonvalue-added activities.
7 Understand the value of using activity levels in activity-based costing.
8 Apply activity-based costing to service industries.
Precor Is on Your SideDo you feel like the whole world is
conspiring against your efforts to get
in shape? Is it humanly possible to
resist the constant barrage of adver-
tisements and fast-food servers who
pleasantly encourage us to supersize
it? Lest we think that we have no allies
in our battle against the bulge,
Ever since it made the fi rst ergonomi-
cally sound rowing machine in 1980,
Precors sole mission has been to
provide exercise equipment. It makes
elliptical trainers, exercise bikes,
rowing machines, treadmills, multi-
station strength systems, and many
other forms of equipment designed
to erase the cumulative effects of a
fast-food nation. Its equipment is
widely used in Hilton hotels, Golds
Gym franchises, and even in Madonnas
Hard Candy fi tness center in Moscow.
Building high-quality fi tness equipment
requires sizable investments by Precor
in buildings and machinery. For
example, Precor recently moved its
facilities from Valencia, California, to
Greensboro, North Carolina. In order
to reduce costs and minimize environ-
mental impact, the company installed
low-fl ow water fi xtures, high-effi ciency
heating and cooling systems, and
state-of-the-art lighting in its $26
million, 230,000-square-foot facility.
As a result of these efforts, Precors
new facility received a Leadership in
Energy and Effi cient Design (LEED) CI
Gold Certifi cation.
Scan Learning Objectives
Read Feature Story
Read Text and answer p. 149 p. 153 p. 158 p. 161
Work Using the Decision Toolkit p. 164
Review Summary of Learning Objectives
Work Comprehensive p. 169
Answer Self-Test Questions
Go to WileyPLUS for practice and tutorials
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Because of its huge investments in property, plant, and
equipment, overhead costs represent a large percentage of
the cost of Precors exercise equipment. The
combination of high overhead costs and a
wide variety of products means that it is
important that Precor allocates its overhead
accurately to its various products. Without
accurate cost information, Precor would not
know whether its elliptical trainers and
recumbent bicycles are making money,
whether its AMT 100i adaptive motion
trainer is priced high enough to cover its
costs, or if its 240i Stretchtrainer is losing
money. To increase the accuracy of its costs,
Precor uses a method of overhead allocation
that focuses on identifying the types of activities that cause
the company to incur costs. It then assigns more overhead
to those products that rely most heavily
on cost-incurring activities. By doing this,
the allocation of overhead is less arbitrary
than traditional overhead allocation methods.
In short, before it can help us burn off the
pounds, Precor needs to understand what
drives its overhead costs.
Watch the Precor video in WileyPLUS to
learn more about activity-based costing
in the real world.
As indicated in the Feature Story about Precor, the traditional costing systems described in earlier chapters are not the best answer for every company. Because Precor suspected that the traditional system was masking signifi cant differences in its real cost structure, it sought a new method of assigning costs. Similar searches by other companies for ways to improve operations and gather more accurate data for decision-making have resulted in the development of powerful new management tools, including activity-based costing (ABC). The primary objective of this chapter is to explain and illustrate this concept.
The content and organization of this chapter are as follows.
Preview of Chapter 4
Traditional costing Need for a new
approach Activity-based costing
Traditional Costing and ABC
Identify activities and allocate to cost pools
Identify cost drivers Compute overhead
rates Assign overhead costs
to products Compare unit costs
Example of ABC versus Traditional Costing
Benefi ts Limitations When to use ABC Value-added versus
Classifi cation of activity levels
ABC: A Closer Look Traditional costing
example ABC example
ABC in Service Industries
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146 4 Activity-Based Costing
Traditional Costing Systems
It is probably impossible to determine the exact cost of a product or service. However, in order to achieve improved management decisions, companies strive to provide decision-makers with the most accurate cost estimates they can. The most accurate estimate of product cost occurs when the costs are traceable di-rectly to the product produced or the service provided. Direct material and direct labor costs are the easiest to trace directly to the product through the use of mate-rial requisition forms and payroll time sheets. Overhead costs, on the other hand, are an indirect or common cost that generally cannot be easily or directly traced to individual products or services. Instead, companies use estimates to assign overhead costs to products and services.
Often the most diffi cult part of computing accurate unit costs is determining the proper amount of overhead cost to assign to each product, service, or job. In our coverage of job order costing in Chapter 2 and of process costing in Chapter 3, we used a single or plantwide overhead rate throughout the year for the entire factory operation. That rate was called the predetermined overhead rate. For job order costing, we assumed that direct labor cost was the relevant activity base for assigning all overhead costs to jobs. For process costing, we assumed that machine hours was the relevant activity base for assigning all overhead to the process or department.
The use of direct labor as the activity base made sense when overhead cost allocation systems were fi rst developed. At that time, direct labor made up a large portion of total manufacturing cost. Therefore, it was widely accepted that there was a high correlation between direct labor and the incurrence of overhead cost. As a result, direct labor became the most popular basis for allocating overhead.
Even in todays increasingly automated environment, direct labor is some-times the appropriate basis for assigning overhead cost to products. It is appro-priate to use direct labor when (a) direct labor constitutes a signifi cant part of total product cost, and (b) a high correlation exists between direct labor and changes in the amount of overhead costs. Illustration 4-1 displays a simplifi ed (one-stage) traditional costing system relying on direct labor to assign overhead.
The Need for a New Approach
In recent years, manufacturers and service providers have experienced tremen-dous change. Advances in computerized systems, technological innovation, global competition, and automation have changed the manufacturing environment dras-tically. As a result, the amount of direct labor used in many industries has greatly decreased, and total overhead costs resulting from depreciation on expensive equipment and machinery, utilities, repairs, and maintenance have signifi cantly increased. When there is not a correlation between direct labor and overhead, it is inappropriate to use plantwide predetermined overhead rates based on direct labor. Companies that use overhead rates based on direct labor when this correla-tion does not exist experience signifi cant product-cost distortions.
To avoid such distortions, many companies now use machine hours as the basis on which to allocate overhead in an automated manufacturing environ-ment. But even machine hours may not suffi ce as the only plantwide basis for allocating all overhead. If the manufacturing process is complex, then only mul-tiple allocation bases can result in more accurate product-cost computations. In such situations, managers need to consider an overhead cost allocation method that uses multiple bases. That method is activity-based costing.
Traditional Costing and Activity-Based Costing
Illustration 4-1Traditional one-stage costing system