Activity-Based Costing and Cost Management Systems
The Changing Manufacturing Environment
: The manufacturing
environment has changed as a result of ever-increasing international
competition, technological innovations, and use of computers.
Volume-based costing used widely
: Many companies still use traditional
volume-based product-costing systems.
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.
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.
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.
ABC Product-Costing Systems
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).
Cost Pool Categories
Unit level: These activities must be done for each level of
: These activities must be performed for each batch of
product (e.g., setup, quality-assurance, receiving).
: These activities support an entire
production line (e.g., engineering).
: These activities are required for the entire
manufacturing process to occur (e.g., plant management, plant
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.
ABC uses multiple drivers
: ABC uses multiple drivers in recognition
of the fact that more than one item drives the costs of an organization.
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.
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.
Costing improved on diverse products
: Costing is further improved
especially in the case of diverse products (and widely varying consumption
Single cost drivers not accurate
: No single cost driver can
accurately assign overhead when products use activities differently and
consume costs accordingly.
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.
: The text discusses the decision criteria for changing to an
ABC system and gives a detailed list of change indicators on pages 174-5.
Key Issues in Activity-Based Systems
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.
Homogeneity important indicator
: In deciding the number of cost
pools, an analyst, should look at the homogeneity of each potential
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.
Flow charts organize data
: Many companies prepare detailed process
flow charts showing the activities and relationships among activities.
: The procedure to do this, called storyboarding,
is needed to collect and organize the data in an ABC project.
: A typical ABC project involves
multidisciplinary project teams.
ABC classifies more direct costs
: ABC-systems strive to increase the
number of costs that can be classified as direct costs of production. Thus,
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.
Cost Management Systems
: 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
Planning & control system
: More specifically, a CMS is a planning
and control system that strives to:
: The system attempts to measure the cost of resources
consumed in performing the organizationís significant activities.
: It also attempts to identify and eliminate non-value-added
costs (e.g., costs of storage, moving time, inspection time, and
Evaluate major activities
: The system seeks to determine the
efficiency and effectiveness of all major activities performed by the
Seek new activities
: The system tries to identify and evaluate new
activities that can improve the future performance of the organization.
: 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
Equally useful for service & manufacturing
: Both ABC and ABM can
be used by manufacturers as well as firms involved in the service sector.