Ma 6e PPT CH 07 Se New

CORNERSTONES
of Managerial Accounting, 6e
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CHAPTER 7: ACTIVITY-BASED
COSTING AND MANAGEMENT
Cornerstones of Managerial
Accounting, 6e
Limitations of Functional-Based
Cost Accounting Systems
 Plant-wide and departmental rates based on
direct labor hours, machine hours, or other
volume-based measures are used successfully
by many organizations.
 However this approach to costing is equivalent to an
averaging approach and may produce distorted, or
inaccurate costs.
LO-1
Cost Accounting Systems (continued)
Product cost
distortions can be Continuous
Improvement Total Quality
damaging, Management
particularly for those
firms whose
business
environment is
characterized by :
LO-1
Cost Accounting Systems (continued)
 The need for more accurate product costs has
forced many companies to take a look at their
costing procedures.
 Two major factors impair the ability of unit-based
plant-wide and departmental rates to assign
overhead costs accurately:
 The proportion of nonunit-related overhead costs to
total overhead costs is large.
 The degree of product diversity is great.
LO-1
Categorizing Costs under ABC
LO-1
Product Diversity
 The presence of product diversity is also
necessary for product cost distortion to occur.
 Product diversity means that products consume
overhead activities in systematically different
proportions.
 This may occur for several reasons, including
differences in:
 product size
 product complexity
 setup time
 size of batches
LO-1
Product Diversity and Product
Costing Accuracy
 For unit-level overhead rates to fail, products
must consume the non-unit-level activities in
proportions significantly different than the unit
 In a diverse product environment, activity-based
costing promises greater accuracy.
LO-1
Activity-Based Product Costing
 Functional-based overhead costing involves two
major stages:
 Overhead costs are assigned to an organizational unit
(plant or department).
 Overhead costs are then assigned to cost objects.
LO-2
Activity Dictionary
 Interview-derived data is used to prepare an
activity dictionary, which lists the activities in an
organization along with activity attributes.
 Examples: Financial and nonfinancial information
items that describe individual activities.
LO-2
Activity Dictionary (cont.)
 Examples include:
 types of resources consumed
 amount (percentage) of time spent on an activity by
workers
 cost objects that consume the activity output (reason for
performing the activity)
 measure of the activity output (activity driver)
 activity name
LO-2
Assigning Costs to Activities
 The next task is to determine how much it costs
to perform each activity.
 Requires identification of the resources being
consumed by each activity.
 The cost of labor, energy, materials, and capital is
found in the general ledger, but the money spent
on each activity is not.
LO-2
Assigning Costs to Activities (cont.)
 A work distribution matrix is developed which
identifies the amount of labor consumed by each
activity and is derived from the interview process
(or a written survey).
 Here is an example:
LO-2
Assigning Costs to Products
 Activity costs are assigned to products by
multiplying a predetermined activity rate by the
usage of the activity, as measured by activity
drivers.
 To calculate an activity rate, the practical capacity
of each activity must be determined.
 To assign costs, the amount of each activity
consumed by each product must also be known.
LO-2
Activity-Based Customer Costing
and Activity-Based Supplier Costing
 ABC systems originally became popular for their
ability to improve product-costing accuracy by
tracing activity costs to the products that
consume the activities.
 ABC has expanded into areas upstream (i.e., before the
production section of the value chain—research and
development, prototyping, etc.) and downstream (i.e.,
after the production section of the value chain—
marketing, distribution, customer service, etc.) from
production.
LO-3
Activity-Based Customer Costing
and Activity-Based Supplier Costing
 ABC often is used to more accurately determine
the upstream costs of suppliers and the
downstream costs of customers.
 Knowing the costs of suppliers and customers can be
vital information for improving a company’s profitability.
LO-3
Process Value Analysis
 Process-value analysis is fundamental to activity-
based management.
 Activity-based management is a system-wide,
integrated approach that focuses management’s
attention on activities with the objective of improving
customer value and profit achieved by providing this
value.
 Process value analysis focuses on cost reduction
instead of cost assignment and emphasizes the
maximization of system-wide performance.
LO-4
Driver Analysis:
The Search for Root Causes
 Managing activities requires an understanding of
what causes activity costs. Every activity has
inputs and outputs.
 Activity inputs are the resources consumed by
the activity in producing its output.
 Activity output is the result or product of an
activity.
LO-4
Driver Analysis: The Search for Root
Causes (cont.)
 An activity output measure is the number of
times the activity is performed. It is the
quantifiable measure of the output.
 Driver analysis is the effort expended to identify
those factors that are the root causes of activity
costs.
LO-4
Activity Analysis: Identifying and
Assessing Value Content
 The heart of process-value analysis is activity
analysis.
 Activity analysis is the process of identifying,
describing, and evaluating the activities that an
organization performs.
LO-4
Activity Analysis: Identifying and
Assessing Value Content (cont.)
 Activity analysis produces four outcomes:
 what activities are done
 how many people perform the activities
 the time and resources required to perform the activities
 an assessment of the value of the activities to the
organization, including a recommendation to select and
keep only those that add value.
 Activities can be classified as value-added or
nonvalue-added.
LO-4
Activity Management
Reduces Costs in Four Ways
* Activity elimination * Activity selection involves

choosing among different sets
focuses on nonvalue-added
of activities that are caused
activities.
by competing strategies.
* Activity reduction * Activity sharing

decreases the time and increases the efficiency of
resources required by an necessary activities by using
activity. economies of scale.
LO-4
Quality Cost Management
 Activity-based management also is useful for
understanding how quality costs can be
managed.
 Quality costs can be substantial in size and a
source of significant savings if managed
effectively.
LO-4
Quality Cost Management (cont.)
 Improving quality can produce significant
improvements in profitability and overall
efficiency.
 Quality improvement can increase profitability in
two ways:
 by increasing customer demand and thus sales
revenues
 by decreasing costs
LO-4
Quality Related Activities
 Quality-linked activities are those activities
performed because poor quality may or does
exist.
 The costs of performing these activities are
referred to as costs of quality.
LO-4
Quality Related Activities (cont.)
 The definitions of quality-related activities imply
four categories of quality costs:
 prevention costs
 appraisal costs
 internal failure costs
 external failure costs
 Costs of quality are associated with two subcategories
of quality-related activities: control activities and
failure activities.
LO-4
Environmental Cost Management
 Management of environmental costs is becoming
a matter of high priority and a significant
competitive issue.
 Environmental costs are associated with the
creation, detection, remediation, and prevention
of environmental degradation.
 Environmental costs are classified into the same four
categories as quality costs.
LO-4

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CORNERSTONES

* Activity elimination * Activity selection involves

* Activity reduction * Activity sharing

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