activity based cost
TRANSCRIPT
7/30/2019 Activity Based Cost
http://slidepdf.com/reader/full/activity-based-cost 1/26
Management Accounting
2010
Second semesterTakayuki Asada
1
7/30/2019 Activity Based Cost
http://slidepdf.com/reader/full/activity-based-cost 2/26
Chapter4 Activity-Based Cost Systems
After reading this chapter,you will be able to:1)Understand how volume-based cost systems dostort product
and customer costs.
2)Describe why companies producing a more varied and complex
mix of products have higher costs than companies producingonly a narrow range of products.
3)Design a traditional activity-based cost system that links
resource costs to the activities the organization performs and
then from the activities to cost objects,such as products andcustomers.
4)Use the information from an activity-based cost system to
improve operations and to make better decisions about
products and customers. 2
7/30/2019 Activity Based Cost
http://slidepdf.com/reader/full/activity-based-cost 3/26
5)Understand the importance of measuring the practical capacity of resources and the cost of unused capacity.
6)Build a time-driven activity-based cost system that is simpler and thatcaptures more complexity than a traditional activity-based cost system.
7)Assign marketing ,distribution,and selling expeses to customers
8)Analyze and manage customer profitability.
9)Appreciate the role for activity-based cost systems for service companies.
10)Discuss the barriers for implementing activity-based cost systems and howthese might be overcome.
3
7/30/2019 Activity Based Cost
http://slidepdf.com/reader/full/activity-based-cost 4/26
Short caseJonathan Kellogg,ower and chief executive officer
1) He(Owner) was concerned about the recent decline of profitability of hisdelershop.
2) Booth Motors(his company) was a major Ford dealer in the Midwest.
3) Many car models are stocked and stayed in his lot for months.
4) His company had four related lines of business:used cars,parts,service,and
finance and insurance.
6) He still wondered how much each of these business lines contributed to
dealership profitability.
7) He wanted to understand much better the “economic facts” about delershop.
8)It(his accounting systems) reported the revenues for each of the five productlines and assigned the $48 million in directly attributed costs to each line.
9)The $5.4million of operating expense was allocated to each department on
the basis of sales
4
7/30/2019 Activity Based Cost
http://slidepdf.com/reader/full/activity-based-cost 5/26
1.Traditional Manufactuirng Costing Systems
5
An example of the problems of simple cost accounting systems,consider themanufactuirng plant of the Ericson Ice Cream Company.
Exhibit 4-1 Total and product profitability ,Ericson Ice Cream
.
Vanilla Chocolate Strawberry Mocha-
Almond
Total
Production and sales
volume(000)
Unit selling Price
Sales(000)
Material costs(000)
Direct labor(000)
Overhead at 300%Total factory expenses
Gross margin
Gross Margin(%)
Marketing,selling,
Distribution Adm.
Operating profit(loss)
500
$ 4.50
$2,250
750
300
9001,950
$309
13.3%
400
$4.50
$1,800
600
240
7201,560
$240
13.3%
90
$4.65
$418.5
140.4
54
162356.4
$62.1
14.8%
10
$4.95
$49.5
16.5
6
1840.5
$9
18.2%
1,000
$4,518
1,506.9
600
1,8003,906.9
$611.1
13.5%
$ 900.0
($288.9)
7/30/2019 Activity Based Cost
http://slidepdf.com/reader/full/activity-based-cost 6/26
Production process of Ice cream products:Ice cream production at the Ericson factory involved preparing
and mixing the ingredients for each flavor in large vats. In a
subsequent stage ,the ice cream mix was packaged into
containers using semiautomatic machines. A final package and
shipping stage was performed manually.
Problem of caluculating overhead:
Ericson’s indirect expenses(about $1.8 million per quarter)were
comprised of the following:
The plant’s indirect expenses($1.8million) were allocated into
products on the basis of each product ‘s direct labor cost.
The cost system’s current overhead rate was 300% of direct labor
cost.
6
7/30/2019 Activity Based Cost
http://slidepdf.com/reader/full/activity-based-cost 7/26
2.Limitations of Ericson’s Traditional Cost
systems
But ,the Eriricson production environment has
changed.Because of automation,direct labor costs
have decreased and indirect expenses increased.
Erricson ‘s traditional cost sytem is adequate
for the financial for the financial reporting
role of inventory evaluation.
7
7/30/2019 Activity Based Cost
http://slidepdf.com/reader/full/activity-based-cost 8/26
3. Vanilla Factory and Multiflavor Factory
1) In an Environment of high production variety,
the exclusive use of unit-level drivers
allocates overhead costs leads to product
cost distortion.
2) In a typical year, the multi-flavor factory
produces about 2,500 different
SKUs(Stockkeeping Units),ranging fromspeciality flavors and packages,with annual
production volumes as low as a50 to 100
gallons per year. 8
7/30/2019 Activity Based Cost
http://slidepdf.com/reader/full/activity-based-cost 9/26
3) If possible ,you would use the traditonal costing
systems,you could not make clear that the variety of multi-products and the low-volume effects for
production costs are not able to be traced into each
products cost.
9
7/30/2019 Activity Based Cost
http://slidepdf.com/reader/full/activity-based-cost 10/26
.
10
4.Activity –based Cost systems1) Activity-based cost(ABC) systems typically use a simple two-stageapproach similar to but more general than traditional costing system.
2) ABC systems use, instead of using cost centers, activites foraccumulating costs. The design of an ABC system starts by asking whatActivities are being performed by a department’s resources.
Tracing Costs to Activities(p.139)
3)The employees in charge of indirect labor are doing three kinds of activities.Handle production runs:50% of such labor hours are involved in
scheduling productions orders.Set-up machine:40% of these are the physical handle production runs.Support products:10% of these hours are maintained records on the four
flavors
4)Laura Tunney ,controller made the first two steps of designing ABC.1: Develop the activity dictionary
2:Obtain the sufficient information to assign resource expenses to eachactivity.
7/30/2019 Activity Based Cost
http://slidepdf.com/reader/full/activity-based-cost 11/26
5)The remaining overhead costs is:
Expenses----computer system, machine
depreciation, machine maintenance, the
energy to operate the machines
Tunny noted the three different level of the
manufacturing cost hierarchy.
P.140
11
Activity Cost Hierarchy
Run MachinesHandle production run
Set up machines
Support products
unit levelBatch level
Batch level
Product sustaining
7/30/2019 Activity Based Cost
http://slidepdf.com/reader/full/activity-based-cost 12/26
Finding at least one activity for each hierarchy level
gave her(Controller) confidence that the complexity
of the manufacturing process could be representedwell enough by the activity-based cost system.
12
Handle
Production
runs
St-up
machines
Support
Products
Run
Machines
Total
expense
Indirect labor
(plus 40% fringe
benefits)
Computer
expense
Machinedepreciation
Maintenace
Energy
Activity
Expense
50%
80%
660,000
40%
336,000
10%
20%
144,000
100%
100%
100%
420,000
840,000
300,000
240,000
120,000
60,000
1,560,000
7/30/2019 Activity Based Cost
http://slidepdf.com/reader/full/activity-based-cost 13/26
6)Now she saw only categories of expenses ,such as the
company’s spending on computers,energy,and
indirect labor.
In the past: industrial engineers have studied labor andmaterials usages
In the present: we try to focus the activities of handlingproduction runs and setting up machine.
13
7/30/2019 Activity Based Cost
http://slidepdf.com/reader/full/activity-based-cost 14/26
Tracing Costs from activities to Products(p.141)
1)Now she try to see the quantity required of eachactivity by each of the four products.
2)This knowledge would permit her to relate the
activity costs to each flavor(each product).
3)Activity cost drives:represent the quantity of
activities used to produce individual products.
14
Activity Activity cost driver
Handle production runs
Set up machines
Support products
Run Machines
Production runs
Setup hours
Number of products
Machine Hours
7/30/2019 Activity Based Cost
http://slidepdf.com/reader/full/activity-based-cost 15/26
15
Activity cost
drivers
vanila chocolate strawberry Mocha Total
Directlabor/unit
Machine
hour/unit
Productions
runs
Setup time/run
Total setup time
Number of
products
0.012
0.012
700
4
2,800
1
0.02
0.012
650
2.4
1,560
1
0.02
0.012
500
5
2,500
1
0.02
0.012
150
7.6
1,140
1
20,000
12,000
2,000
8,000
4
Exhibit 4-4 Activity cost dirives
E hibit 4 7 ti it b d ti
7/30/2019 Activity Based Cost
http://slidepdf.com/reader/full/activity-based-cost 16/26
16
Exhibit 4-7 activity-based costingproduct profitability report(000)
Vanilla Chocolate Strawberry Mocha total
Sales
Material costs
Direct labor
Contribution
Margin
40% fringe
on direct
Labor
Handle
production run
Set up
machines
Supportproducts
Run machine
Total overhead
Gross margin
(%)gross margin
MSDAOperating profit
2,250
750
300
1,200
120
231
117.6
36
210
714.6
485.4
21.6%
1,800
600
240
960
96
214.5
65.52
36
168
580.02
379.98
21.1%
418.5
140.4
54
224.1
21.6
165
105
36
37.8
365.4
(141.3)
(33.8%)
49.5
16.5
6
27
2.4
49.5
47.88
36
4.2
139.8
(112.98)
(228.2)%
4,518
1506.9
600
2,411.1
240
660
336
144
420
1,800
611.1
13.5%
900.0(288.9(
7/30/2019 Activity Based Cost
http://slidepdf.com/reader/full/activity-based-cost 17/26
17
Exhibit4-8a and b
7/30/2019 Activity Based Cost
http://slidepdf.com/reader/full/activity-based-cost 18/26
18
The result from the ABC system were quite different from the results usingthe Traditional cost system shown in Exhibit 4-1. Tunny(controller) now understood why the profitability of Ericson had
deteriorated in recent years. The two speciality products, which the previouscost system had reported as the most profitable were in fact the mostuprofutable and were losing lots of money.
Activity-Based Management
Activity based management refers to the actions managers take,onthe basis of an ABC study,to improve the efficiency of the activities andthe profitability of products.1) Pricing change for unprofitable products2) Making more efficiency in the process of set-up and handling of
products.
3) Designing changes of some products4) Change of minimum order size of unprofitable runs
7/30/2019 Activity Based Cost
http://slidepdf.com/reader/full/activity-based-cost 19/26
19
Time-Driven Activity-Based Costing
The common approach to activity-based costing, assigns many resourceexpenses to activities on the basis of interviews and surveys, As noted
earlier,this approach is time consuming,expensive ,often inaccurate,and difficultto update. The time-diriven activity –based costing requires that only twoparameters be estimated:
1. The unit cost of supplying capacity for each department or process2. The consumption of capacity (unit times) by each transaction or product
Unit cost estimate The cost of resources that supply capacity The Practical capacity of the resources suppliedcase :Indirect labor costs and resource
indirect labor cost per hour= $840,000/ 20,000 hours = $42 per hourUnit time estimate
The second piece of new information is an estimate of the time used on aresource when an activity is performed.
7/30/2019 Activity Based Cost
http://slidepdf.com/reader/full/activity-based-cost 20/26
20
At the first glance, it may be difficult to appreciate the difference betweentraditional and time-driven ABC. But, in the time-driven approach,theABCproject team directly observes the quantity of time required to schedule aproduction run and to set up machines for different products.1) Further advantage of TDABC, the ease of updating a time-dirivenABC
model to reflect changes in operating conditions.
2) Managers can also easily update the cost dirves rates.
3) The cost driver rates change when there has been a shift in the efficiency of
the activity,such as when employees get more edfficientat scheduling orperformaingchageovers.
7/30/2019 Activity Based Cost
http://slidepdf.com/reader/full/activity-based-cost 21/26
21
Time equations
Time Driven ABC accomodates the complexity of real-world operationswith time equations,a new feature that enables the modelto reflect how particular order and activity characteristicscause processing times to vary.
Rather than the standard 5 hours for all the activitiesrequired to scheduleand excute a production run,the ABC project team mightestimate the following tme equation fot the activity handleproduction runs on the basisof how the order was received.
Indirect labor time to handle production runs= 4 hours+2 hours(of telephone order)+1 hour(if fax order)+0.2 hours (if electric order)
7/30/2019 Activity Based Cost
http://slidepdf.com/reader/full/activity-based-cost 22/26
5. Marketing ,Selling ,Distribution ,and Adminnistrative
Expenses : Tracing Costs to CustomersExhibit 4-9 Marketing,sales,technical ,and Administrative Activities
22
Activity Activity expenses Activity Cost Driver
Provide marketing and
technical support
Travel to customers
Service customers
Handle customer orders
Ship to customers
salaries and benefits of marketing and
technical support personnel
Salesperson salaries;travel and
entertainment expendituresSalaries and benefits of customer
service representatiives
Salaries and benefits of
adminisitarative and customer
support staffs to receive orders and
coordinate production to schedule
deliveries
Costs of shipping finished goods to
customers;some customers requsired
immediate,overnight delivery;others
could be seviced using low-cost
common carriers
Estimated proportion
of time spent on
each customer
Actual expenditures
Estimated quantity of
time spent on each
customer
Time equation
Combination of time
equation and actual
shipping records
7/30/2019 Activity Based Cost
http://slidepdf.com/reader/full/activity-based-cost 23/26
23
6. Managing Customer Profitablity
The output from an ABC customer analysis is oftenportrayed as a whale Curve,a plot of cumulativeprofitability versus the number of customers wherecustomers are ranked on the horizontal axis from most
profitable to least profitable. While cumulative salesfollow the usual 20-80 rule—20% of the customersprovide 80% of the sales—the whale curve forcumulative profitability typically reveals that the mostproftable 20% of customers generate between 150%
and 300% of total profits.
7/30/2019 Activity Based Cost
http://slidepdf.com/reader/full/activity-based-cost 24/26
7.Service Companises
24
Although ABC had its origins in manufactuirng companies,today many
services organizations are obtaining great benefits from this approach.
In practices,the actual construction of an ABC model is nearly identicalfor both types of companies.
7/30/2019 Activity Based Cost
http://slidepdf.com/reader/full/activity-based-cost 25/26
8.Implementation Issues
Lack of clear business purpose
Lack of senior Management commitment
Delagating the Project to cunsultantsPoor ABC model design
Individual and organizational resistance to
changePeople feel threatened
25
7/30/2019 Activity Based Cost
http://slidepdf.com/reader/full/activity-based-cost 26/26
Summary
26
This Chapter introduced activity-based cost systems for manufacturingand service companies. ABC systems drive the cost of indirect and supportresources-manufacturing resources in factories and marketing,selling,distribution,and administrative resources-to the activities ,they perform and
then to the cost objects.
To develop an ABC model, management accountants should estimateactivity cos driver rates using the practical capacity of the resourcessupplied. They should also make appropriate tradeoffs in the design of themodel,balancing the cost of more accurate measurment for more complex
Models with the benefits from the greater accuracy.
Despite the apparent attraction of increased accuracy and managerilarelevance from ABC individual and organizational resistance can arise toblock the effective use of these systems. Management accountants mustbe sensitive to the conditions that cause such resistance to arise and
devise good contermeasuress to overcome them.