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Chapter 5 Outline

Activity-Based Costing and Cost Management Systems

 

  1. The Changing Manufacturing Environment
    1. Environment changed: The manufacturing environment has changed as a result of ever-increasing international competition, technological innovations, and use of computers.
    2. Volume-based costing used widely: Many companies still use traditional volume-based product-costing systems.
    1. Single cost driver usually labor: These systems generally group overhead into one cost pool and apply overhead to products based on direct labor, with labor being a measure of volume.
    2. Traditionally correlation between labor and overhead: In the past, accountants felt there was a high correlation between overhead and labor; however, with increasing factory computerization and automation (and the reduction of hands-on labor, this is not always the case today.
    1. Organizations changing to ABC: Many organizations are change to a new activity-based costing (ABC) system. This system improves product costing and management decision making.
  1. ABC Product-Costing Systems
    1. Generally: In activity-based costing systems, the costs of an organizationís significant activities are isolated into cost pools. The next step involves identification of a cost driver for each pool. The system then assigns overhead costs by using the cost drivers and assessing the relative proportion of the activity consumed by a product (sometimes called transaction-based costing).
    2. Cost Pool Categories
    1. Unit level: These activities must be done for each level of production.
    2. Batch level: These activities must be performed for each batch of product (e.g., setup, quality-assurance, receiving).
    3. Product-sustaining level: These activities support an entire production line (e.g., engineering).
    4. Facility level: These activities are required for the entire manufacturing process to occur (e.g., plant management, plant maintenance, depreciation).
    1. ABC improves accuracy: Costing is improved under ABC, as the system identifies products that were overcosted or undercosted by traditional methods. ABC uses multiple drivers in recognition of the fact that more than one item drives an organizationís costs.
    1. ABC uses multiple drivers: ABC uses multiple drivers in recognition of the fact that more than one item drives the costs of an organization.
    2. ABC not limited to unit level: Additionally, not all activities are unit-level in nature, and ABC allows a user to recognize batchó, product-sustaining, and facility-level activities.
    3. Elimination of averaging: The result is elimination of an averaging procedure that often occurs when many of ABCís pools are combined and allocated by using a single base.
    1. Costing improved on diverse products: Costing is further improved especially in the case of diverse products (and widely varying consumption ratios).
    1. Single cost drivers not accurate: No single cost driver can accurately assign overhead when products use activities differently and consume costs accordingly.
    1. ABC requires more information and cost: The activity-based costing system calls for enormous amounts of information tracking; thus, there is a large cost involved in supporting the system.
    1. Example: The text discusses the decision criteria for changing to an ABC system and gives a detailed list of change indicators on pages 174-5.
  1. Key Issues in Activity-Based Systems
    1. Degree of correlation significant: The degree of correlation between activity consumption and consumption of the driver has a significant impact on the accuracy of the ABC-costing effort.
    2. Homogeneity important indicator: In deciding the number of cost pools, an analyst, should look at the homogeneity of each potential pool.
    1. Cost consumed proportionality: The cost should be consumed in roughly the same proportion by each product line, allowing a given pool to be allocated by a single cost driver.
    1. Flow charts organize data: Many companies prepare detailed process flow charts showing the activities and relationships among activities.
    1. Storyboarding: The procedure to do this, called storyboarding, is needed to collect and organize the data in an ABC project.
    1. ABC multidisciplinary: A typical ABC project involves multidisciplinary project teams.
    2. ABC classifies more direct costs: ABC-systems strive to increase the number of costs that can be classified as direct costs of production. Thus, increasing accuracy.
    1. Traditional systems classify these as indirect costs: Many of these costs under a traditional volume-based system are classified as indirect, requiring an allocation procedure to cost the product.
  1. Cost Management Systems
    1. Generally: Managerial accounting does more than assist in product costing. It is viewed as a much broader cost management system (CMS) that helps support strategic management decision such as pricing and long-term acquisitions.
    2. Planning & control system: More specifically, a CMS is a planning and control system that strives to:
    1. Measures costs: The system attempts to measure the cost of resources consumed in performing the organizationís significant activities.
    2. Eliminate waste: It also attempts to identify and eliminate non-value-added costs (e.g., costs of storage, moving time, inspection time, and waiting time).
    3. Evaluate major activities: The system seeks to determine the efficiency and effectiveness of all major activities performed by the enterprise.
    4. Seek new activities: The system tries to identify and evaluate new activities that can improve the future performance of the organization.
  1. Activity-Based Management
    1. Generally: Activity-based management (ABM) involves using activity-based costing to improve organizational operations. As managers attempt to establish cost pools and accumulate the costs of activities, the activities are evaluated in an effort to reduce or eliminate any unnecessary ones.
    2. Equally useful for service & manufacturing: Both ABC and ABM can be used by manufacturers as well as firms involved in the service sector.

 

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