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Activity-Based Costing
McGraw-Hill/Irwin
Copyright 2008 by The McGraw-Hill Companies, Inc. All
Traditional costing system 1. Direct and indirect costs are allocated to process centres or major departments
ABC System 1. The direct and indirect costs are allocated to activities like Purchases, Material handling, Producing the goods, machine set ups, Supervising production workers, Inspecting finished
goods, Dispatching good to customers 2. Cost driver as base for allocation of overheads is not based on cause and effect
relationship
2.Cost driver as base for allocation of overheads is based on cause and effect relationship between overheads and the overhead allocation base (the cost driver) Stores deptt Labour hours or machine hours or units produced 3. There are many allocation bases as per activity chosen and cause
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Direct materials Direct labor (hr/board) Setup time (hr/run) Machine time (hr/board)
$3,894,000 118,000
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With these product costs, Aerotech established target selling prices (Cost 125%).
209.00 x 1.25
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I agree!
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Stage One Identify significant activities and assign overhead costs to each activity in proportion to resources used.
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Stage Two Identify cost drivers appropriate to each activity and allocate overhead to the products.
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ABC System
1. Identify major activities
activity consists of aggregation of tasks having common characteristics) e.g. Activity: purchase of materials : Tasks: receiving a purchase request, inviting quotations, selecting supplier, placing orders, receiving material
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There must be a cause - effect relationship between the overheads to be allocated and the allocation base otherwise inaccurate allocation of overheads will occur. For an example, it would be wrong to allocate overheads of stores dept. on the basis of labor hours. It should be more appropriately based on number of units handled or used in production process.
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1. Labor cost of employees working in 2. Handling materials and purchase dept. Parts 2. Labor cost of stores, depreciation of machines used for 3. Inspection of material and moving materials parts purchased 3. Labor cost of inspection team, Depr. Of testing 4. Setting up production equipments procedures 4. Labor cost of works involved in setups and depr. of set up equipments
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Associated costs
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Cost Drivers
A characteristic of an event or activity that results in the incurrence of costs. In selecting a cost driver, we must consider . . .
Degree of Correlation Cost of Measurement
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Behavioral Effects
Activity-Based Costing Activity-Based Costing An effort is made to An effort is made to account for as many account for as many costs as possible as costs as possible as direct costs of direct costs of production. production.
Indirect Costs
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Storyboarding
A procedure used to develop a detailed process flow chart, which visually represents activities and the relationships among activities.
Step Step 1 1 Step Step 2 2 Step Step 3 3 Step Step 4 4 These are the steps we These are the steps we follow to build a follow to build a memory board. memory board.
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Overhead Costs
Activity must be done on each unit produced. Total budgeted cost = $3,894,000
Unit Level
Machinery cost pool $1,212,600
Activity performed on each batch produced.
Batch Level
Setup cost pool $3,000
ProductSustaining Level
Engineering cost pool $700,000
Facility Level
Facility cost pool $507,400
Batch Level Setup cost pool $3,000 Receiving/Inspection cost pool $200,000 Material-Handling cost pool $600,000 Quality-Assurance cost pool $421,000 Packaging/Shipping cost pool $250,000
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STAGE ONE
Various overhead costs related to machinery
Maintenance Depreciation Computer Support Lubrication Electricity Calibration
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STAGE TWO
Calculate the pool rate
Budgeted Machinery Costs = $1,212,600 Budgeted Machine Hours 43,000 = $28.20/hour
Cost Assignment
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STAGE ONE
Calculation of total setup cost
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STAGE TWO
Calculate the pool rate
Budgeted Setup Costs = $3,000 Planned Production Runs 15 runs = $200 per run
Cost Assignment
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STAGE ONE
Various overhead costs related to engineering
Engineering salaries Engineering supplies Engineering software Depreciation
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STAGE TWO
Allocate based on engineering transactions
Cost Assignment
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STAGE ONE
Various overhead costs related to general operations
Plant depr. Plant mgmt. Plant maint. Property taxes Insurance Security
Exh. 5-9
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STAGE TWO
Calculate the pool rate
Budgeted Facilities Cost = $507,400 Budgeted Direct-Labor Hours 118,000 = $4.30/hour
Exh. 5-9
Cost Assignment
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$14.82
Board Mode I Mode II Mode II I Overhead $ 421,000 421,000 421,000
% 7% 30% 63%
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The selling price of Mode I and II are reduced and the selling price for Mode III is increased.
[$209.00 1.25] [$183.44 1.25]
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Marketing does not Marketing does not use costs reports for use costs reports for pricing decisions pricing decisions
Activity-based costing establishes relationships between overhead costs and activities so that we can better allocate overhead costs. Activity-based management focuses on managing activities to reduce costs.
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Activities
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Activities
Activities
Activities
Necessary
Continually Evaluate and Improve
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1. Identify Activities. 2. Identify Non-Value-Added Activities. 3. Understand Activity Linkages, Root Causes,
and Triggers.
Select Select vendor vendor
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Process time
Inspection time
Storage time
Move time
Waiting time
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Customer profitability analysis uses activity-based costing to determine the activities, costs, and profit associated with serving particular customers.
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Orders frequently.
A costly
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Customer-Related Activities Order processing Sales contacts (phone calls, faxes, etc.) Sales visits Shipment processing Billing and collection Design/engineering change orders Special packaging Special handling
Cost Driver Base Purchase orders Contacts Visits Shipments Invoices Design changes Units packaged Units handled
A company may use these customer A company may use these customer related costs to help determine the related costs to help determine the profitability of each customer. profitability of each customer.
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No materials are purchased and no products are manufactured until they are needed.
The primary goal of a The primary goal of a JIT production system is JIT production system is to reduce or eliminate to reduce or eliminate inventories at every inventories at every stage of production. stage of production.
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Teamwork
Multiskilled workers
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Long-term Long-term contracts with contracts with suppliers. suppliers. Only a few Only a few suppliers. suppliers. Parts delivered Parts delivered in small lots. in small lots.
Activity based costing in service industry As useful as in mfg. industry Mangers want more detailed and accurate information about the cost of producing products and services they are selling Airlines, ins co, banks, hospitals, fin service firms, hotels railroads, Air France, American express, Bank of America, DHL, Fed Ex, US postal service
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ABC at service companies: Identifying Activities Activity cost pools Cost drivers Classification of activities at Unit level : batch level, product sustaining level, facility (general operations) level
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Bajaj Allianze General Insurance Co. Ltd Claims Department Classification of activities at Unit level : Entering initial claim into computer batch level: moving a batch of claims from one processing step to the next product sustaining level: maintenance of the medical service provider network ( physicians, hospitals ) facility (general operations) level: general administration of claims business unit
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ABC at Delaware medical centre (Primary Care UnitOPD) Appointment Patient routine extended complex New Continuing routine extended complex Every appointment needs Regd. nurse 1 : vital signs/preparing patient for Primary health care professional PHCP 1: physician / intern / resident doctor or nurse practitioner
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ABC team identified : Activities Physician time Practitioner nurse time Intern or resident time Regd. Nurse time Clerical time: new patients Clerical time : continuing Billing Facility
cost drivers Physician minutes with patient P-Nurse minutes with patient Intern minutes with patient Regd. Nurse minutes with patient New patient visits Continuiing patient visits Billing lines (items on a bill) Patient visits (both new and continuing)
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Activity : physician time Cost driver : physician minutes with patient Cost cost driver rate PV driver activity no. of activity pool qty Type qty cost visits cost /p 960000 240000 4 R 80000 320000 8000 $40 E 100000 400000 5000 $80 C 60000 240000 2000 $120
Activity Nurse Practitioner time Cost driver : NP minutes with patient Cost cost driver rate PV driver activity no. of activity pool qty Type qty cost visits cost /p 90000 30000 3 R 12000 36000 1200 $30 E 10000 30000 500 $60 C 8000 24000 320 $75
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Activity : intern or resident time Cost driver : intern or resident minutes with patient Cost cost driver rate PV driver activity no. of activity pool qty Type qty cost visits cost /p 412500 125000 3.30 R 40000 132000 4000 $33 E 50000 165000 2500 $66 C 35000 115500 1000 $115
Activity : Rgd. nurse time Cost driver : RN minutes with patient Cost cost driver rate PV driver activity no. of activity pool qty Type qty cost visits cost /p 281980 245200 1.15 R 132000 151800 13200 $11.50 E 80000 92000 8000 $11.50 C 33200 38180 3320 $11.50
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Activity : Clerical time new patients Cost driver : New patients number Cost cost driver rate PV driver activity no. of activity pool qty Type qty cost visits cost /p 135300 12300 11.00 R 7200 79200 7200 $11 E 3000 33000 3000 $11 C 2100 23100 2100 $11
Activity : Cleical time continuing patients Cost driver : cont. patients number Cost cost driver rate PV driver activity no. of activity pool qty Type qty cost visits cost /p 61100 12220 5.00 R 6000 30000 6000 $5 E 5000 25000 5000 $5 C 1220 6100 1220 $5
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Activity : Billing Cost driver : Billing lines on a bill Cost cost driver rate PV driver pool qty Type qty 38480 76960 0.50 R 26400 E 24000 C 26560
Activity : Facility Cost driver : number of new plus cont. patients visits Cost cost driver rate PV driver activity no. of activity pool qty Type qty cost visits cost /p 245200 24520 10.00 R 13200 132000 13200 $10 E 8000 80000 8000 $10 C 3320 33200 3320 $10
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Costing of service 1. Each patient sees either a physician or PN or intern or resident not all four 2. each patient is either a new patient or a continuing patient and not both. 3. to compute cost of particular appointment, we should select only one of primary health care professionals, and select one of the two clerical time categories new or continuing. 3.4. finally since every appointment involves RN , billing, and use of primary care unit facility, all of these activities must be included in the cost calculation.
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Cost of extended appointment for a new patient seeing a nurse practitioner Activity Cost Nurse practitioner time RN time Clerical time new patients Billing Facility
Total
94.00
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Cost of extended appointment for a new patient seeing a nurse practitioner Activity cost Nurse practitioner time 60.00 RN time 11.50 Clerical time new patients 11.00 Billing 1.50 Facility 10.00
Total
94.00
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End of Chapter 5
This is my kind of cost pool!
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