ACCT 4A&B: Cost Accounting & Cost Management

Chapter 4: Activity based Management and Activity based Costing

& Service Department Cost Allocations
Two types of overhead costs:
1) Directly related to the operating activities (primary revenue
generating)
2) Indirectly related to the operating activities

Support departments include both service and administrative

departments.
o Service department an organizational unit that performs functional
tasks for other internal units.
o Administrative department perform management activities that
benefit the entire organization.

METHODS OF ALLOCATING SERVICE DEPARTMENT COSTS

1) Direct method assigns support department costs only to producing
departments.
- the simplest allocation method.
- No consideration is given to service performed by one
service department for another service department.

Service Dept. 1
Producing Dept. 1

Service Dept. 2
Producing Dept. 2

2) Step method allows a partial recognition of the effects of interaction

among support departments.
- No cost is assigned to service departments whose costs
have already been allocated.

Service Dept. 1
Producing Dept. 1

Service Dept. 2
Producing Dept. 2

1
Benefits-provided ranking begins with the support department providing
the most service to all other support areas and ends with the support
department providing the least service to all other support areas.
o Those of the service department that provides the highest percentage
of its total services to other service departments.
o Another is to begin with the costs of the service department providing
services to the greatest number of other service departments.
o Another is to begin with the service department having the greatest
peso cost of services provided to other service departments.

3) Algebraic method considers all departmental interrelationships and

reflects these relationships in simultaneous equations.
- the most complex of all the allocation techniques but it is
the most theoretically correct and provides the most
accurate and reliable allocations.

Service Dept. 1
Producing Dept. 1

Service Dept. 2
Producing Dept. 2

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Activity based management a business process model focusing on the

control of production or performance of activities so that they improve
customer value and enhance profitability.

Value-added activity (VA) increases the worth of a product or service to a

customer and is one for which the customer is willing to pay.

Non-value-added activity (NVA) increases the time spent on a product or

service but does not increase its worth and is viewed as unnecessary from
the customers perspective.

Business-value-added activity activities that are essential to business

operations but for which customers would not willingly choose to pay.

Total cycle time = Value added time+ NonValue added time

2
 Total value added time
Manufacturing cycle efficiency = total cycle time

Total actual service time

Service cycle efficiency = Total cycle time

Activity-based costing a cost accounting system that focuses on an

organizations activities, collects costs on the basis of the underlying nature
and extent of those activities, and uses the gathered information to
determine product/service cost accumulation and assess the appropriateness
of activity elimination.

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