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Chapter 5
Activity-Based
Cost Management
Systems

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Activity-BasedCosting
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Chapter 5 objectives:
To be able to:
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.

Understand how traditional cost systems, using only unit-level drivers, distort product and customer costs.
Describe why factories producing a more varied and complex mix of products have higher costs than factories
producing only a narrow range of products.
Design an activity-based cost system by linking resource costs to the activities performed and then to cost
objects, such as products and customers.
Appreciate the role for choosing appropriate activity cost drivers when tracing activity costs to products and
customers.
Use the information from a well-designed activity-based cost system to improve operations and make better
decisions about products and customers.
Understand the importance of measuring the practical capacity of resources and the cost of unused capacity.
Assign marketing, distribution and selling expenses to customers.
Analyze customer profitability.
Appreciate the role for activity-based cost systems for service companies.
Discuss the barriers for implementing activity-based cost systems and how these might be overcome.
Understand how ABC-costing works in the organizational structure of Arla Foods Amba

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Traditional Manufacturing Costing Systems

Tends to underestimate resources required for specialty


low -volume costs

Tends to overestimate the resource cost of high volume


standard products

Exhibit 5-1, pages 160-162

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Activity-Based Cost Management Systems


Definition:
System based on activities that links organizational spending on
resources to the products and services produced and delivered to
customers

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Activity-Based Cost Management Systems


Tracing costs to activities
Tracing costs from activities to products
Selecting activity cost drivers

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Tracing costs to activities


Step 1

Develop activity dictionary = the list of major


activities performed by the plants resources
(use verb action words as handle, perform and
support to describe activities)

Step 2

Map resource expenses to activities in dictionary

Exhibit 5-2, page 166


Exhibit 5-3, page 166
Exhibit 5-4, page 167

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Tracing costs to activities


The process of identifying the link between expenses and activities
provide knowledge/insight about
1.

The cost of performing a specific activity

2.

Transforming focus from what the money was being spent


on to what the resources acquired by the spending were
actually doing (exhibit 5-4, page 167)

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Tracing costs to activities


Operational activity-based management:
The process of using information collected by the ABC-system at
the activity level to identify promising opportunities for reducing
costs in indirect and support activities.

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Tracing costs from activities to products


Purpose:
The activity expenses should be related in some way to the
demands for the activities by individual products.
Activity cost drivers:
Measures that identify the linkage between activities and cost
objects. They serve as quantitative measures of the output of
activities.
Activity cost driver rate:
The amount determined by dividing the activity expense by the
total quantity of the activity cost driver.
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Tracing costs from activities to products


Establishing activity cost drivers:
Exhibit 5-5, page 169
Exhibit 5-6, page 169
Calculationg activity cost driver rates:
=

activity expense
total quantity of activity cost driver

example
Cost driver = handle production runs
Cost driver rate =
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$66.000
Number of runs

66.000
150 = $440

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Tracing costs from activities to products


Assigning activity expenses to products:
Exhibit 5-7, page 170
Creating a full Activity-Based Costing Product Profitability Report:
Exhibit 5-8, page 170
Bill of activities:
The set of activities and costs associated with individual products
or customers.

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Tracing costs from activities to products


Activity-based management (ABM):
An approach to operations control that involves the five-step
process of

identifying the process objectives


charting activities
clasifying activities
continuously improving processes
eliminating activities whose costs exceed their value.

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Selecting activity cost drivers


Accuracy versus the cost of measurement
3 different categories of activity cost drivers:
Transaction drivers:

Used to count the frequency of an activity, the number of times an activity is


performed.
Example - cost per customer (assumes all customers cost the same).

Duration drivers:

Represent the amount of time required to perform an activity.


Example - cost per customer hour (assume different customers use different
amounts of sales resource time, but each hour of support time costs the same).

Intensity drivers:

Used to directly charge for the resources used each time an activity is performed.
Example - actual cost per customer (actual or estimated time and specific
resources, including travel committed to specific customers).

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Measuring the Cost of Resource Capacity


Practical capacity:

The amount of work that can be performed by resources supplied for


production or service.

Cost of unused capacity:

An expense determined by the amount of resources unused during


production.

Example:
Capacity 176 production runs
Actual is 150 production runs

Amount = $66.000
Amount = $66.000

cost driver = $375


cost driver = $440

The rate of $440 contains a cost of unused capacity in the amount of $65.
Where to assign the cost related to unused capacity? Case: Arla Foods Amba overhead and capacity.
capacity

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Marketing, Selling and Distribution Expenses:


Tracing costs to Customers
Many of the MSDE costs do not relate to individual products or product lines, but are
rather associated with individual customers, market segments and distribution
channels.
The Anders Wire Company, page 177-179

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Managing Customer Profitability


Exhibit 5-10, page 180
Discussing types of customers and what can be done to make profits
acceptable.

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Service Companies and Activity-Based Costing


ABC is highly relevant for service companies since they typically generate
indirect and overall fixed costs. Consequently there are no direct product or
customer costs to serve as convenient allocation bases.
Exhibit 5-11, page 184

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Implementation Issues
Lack of clear business purpose
Lac of senior management commitment
Delegating the project to consultants
Poor ABC model design
Individual and organizational resistance to change

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