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activity-based costing

activity-based costing

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Published by Priya Vinodan

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Published by: Priya Vinodan on Feb 06, 2011
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Activity-Based Costing

Better Costing for Better Decisions


Indirect Costs 

Not easily and conveniently traceable to cost objects
Cost element is shared among cost objects Physically impossible to trace Not cost effective to trace


Indirect Costs  Need for allocation Estimate product or activity cost  What does it really cost? Increase awareness of indirect costs  Activities are not free Plan more cost efficient operations  Now that we know what it costs. what should we do? 3 .

Allocation of Indirect Costs  Typical allocation methods Ability to bear Fairness or equity Benefits received Cause and effect 4 .

usually labor hours $10.Traditional Allocation Method  Indirect costs allocated to cost object based on the cost object¶s consumption of some measure of activity.000 total indirect cost 400.000.000 total labor hours = $25 per hour rate A product consuming 6 labor hours would be charged $150 of indirect costs 5 .

not cause of costs 6 . not process focus Focus on costs incurred.Criticisms of Traditional Overhead Allocation   Assumes all overhead is volume-related Factory-wide or departmental rates All related to single activity measure   Departmental focus.

Activity-Based Costing  Purpose Allocation of indirect costs based on causal activities  Attempts to identify ³direct´ link between cost and cost object Results in better allocation Does not provide ³true´ cost 7 .

Activity-Based Costing  Traditional allocation method Costs Products  Activity-based allocation method Costs First stage Activities Products Second stage 8 .

Overview of ABC  Identifies activities required to produce the product or service Determines the cost of the activities Allocates costs to the cost object based on the object¶s consumption of activities   9 .

Levels of Cost Incurrence  Not all costs are volume-related Unit level Batch level Product level Facility level 10 .

Operation of an ABC System  Assign costs to activity pools First stage allocation Identify the costs incurred to perform various activities  Determine the measure of activity best related to each cost pool Cost drivers 11 .

Operation of an ABC System   Determine rate per unit of activity Assign costs to products/services based on consumption of activities Second stage allocation  Indirect costs are converted to direct costs 12 .

Implementing ABC  Step 1 ± Plan the system What are the goals?   Inventory valuation Process improvement Foster active involvement Assemble cross-functional team  Functional specialists 13 .

analyze activities and resources Decompose organization into elemental activities  Who does what. and why? Interview employees Determine resources Determine inputs and outputs 14 .Implementing ABC  Step 2 ± Define.

duration.Implementing ABC Gather statistics on activities    Inputs and outputs Transaction. intensity For possible use as second-stage cost drivers 15 .

etc. square footage.Implementing ABC  Step 3 ± Establish activity cost pools and determine first stage allocation First stage allocations assign costs to cost pools  Requires costs to be re-categorized according to why they are incurred. not by type Drivers may be employee time.  16 .

times handled. units. Amount assigned to the cost object is the amount of activity consumed times the rate per unit of the activity 17 . machine hours. etc.Implementing ABC  Step 4 ± Determine second stage drivers and assign costs to cost objects Outputs of activity analysis may be second stage drivers  Distance moved.

When is ABC Most Useful?      High amounts of overhead cost Multiple products Complex products Complex production system Significant variation in volume between high and low volume products 18 .

When is ABC Most Useful?  Different products place different demands on resources Problems with current cost allocations due to changes in products or processes Better cost information is needed   19 .

Activity-Based Management  Natural extension of ABC Why are activities performed?   Are they necessary? Are they consistent with organizational goals? How are they performed?   Are they performed efficiently? Can they be redesigned or eliminated? 20 .

ABM for Process Improvement   Focus on problems. opportunities Prioritize opportunities for improvement Most critical Greatest potential for cost savings 21 .

ABM for Process Improvement  Determine and explain causes for problems and opportunities Cannot improve the system without first understanding it  Select specific improvement projects 22 .

ABM for Process Improvement  Use ABC/ABM data to test potential impact of changes Make changes Iterate Process of continual improvement   23 .

measuring and controlling complexity Promotes understanding of why costs are incurred Provides better cost allocation information 24    .Implications of ABC/ABM  Shifts focus from managing costs to managing activities Aids in recognizing.

Implications of ABC/ABM    Useful for planning future operations Fosters continuous improvement Likely to meet with substantial resistance Analysis of why and how activities are performed 25 .

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