Cost Behavior, CST Driver and Activity Based Costing System

CHAPTER 7:
ACTIVITY-BASED COSTING AND

MANAGEMENT
Cornerstones of Managerial
Accounting, 6e
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Learning Objectives
1. Explain why functional (or volume)-based
costing approaches may produce distorted
costs.
2. Explain how an activity-based costing system
works for product costing.
3. Describe activity-based customer costing and
activity-based supplier costing.
Limitations of Functional-Based
Cost Accounting Systems
 Plantwide and departmental rates based on direct
labor hours, machine hours, or other volume-
based measures have been used for decades to
assign overhead costs to products and continue
to be used successfully by many organizations.
 However, for many settings, this approach to costing is
equivalent to an averaging approach and may produce
distorted, or inaccurate, costs.
LO-1
Cost Accounting Systems (cont.)
Product cost
distortions can be Continuous Total Quality
Improvement Management
damaging,
particularly for those
firms whose Small profit Total Customer
business margins Satisfaction
environment is
characterized by : Sophisticated
-Increasing
competitive Technology
pressures Intense worldwid
e
competition
LO-1
Cost Accounting Systems (cont.)
 The need for more accurate product costs has
forced many companies to take a serious 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
Nonunit-Related Overhead Costs
 The use of either plantwide rates or departmental
rates assumes that a product’s consumption of
overhead resources is related strictly to the units
produced.
 For unit-level activities (or activities that are performed each
time a unit is produced), this assumption makes sense.
 If there are nonunit-level activities (or activities that
are not performed each time a unit of product is
produced), the costs associated with these nonunit-
level activities are unlikely to vary (i.e., increase or
decrease) with units produced.
LO-1
Categorizing Costs under ABC
LO-1
Activity Drivers and the
Consumption of Activities
 Nonunit-level activity drivers (i.e., batch,
product-sustaining, and facility-sustaining) are
factors that measure the consumption of nonunit-
level activities by products and other cost objects.
 Unit-level activity drivers measure the
consumption of unit-level activities.
 Activity drivers are factors that measure the
consumption of activities by products and other
cost objects and can be classified as either unit-
level or nonunit-level.
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
Consumption Ratio
 Regardless of the nature of the product diversity,
product cost will be distorted whenever the
quantity of unit-based overhead that a product
consumes does not vary in direct proportion to the
quantity consumed of nonunit-based overhead.
 The proportion of each activity consumed by a
product is defined as the consumption ratio and
is calculated as:
Amount of Activity Driver per Product
Total Driver Quantity
LO-1
Cornerstone 7.1
Calculating Consumption Ratios
LO-1
Cornerstone 7.2
Calculating Activity Rates
LO-1
Cornerstone 7.3
Calculating Activity-Based Unit Costs
LO-1
Cornerstone 7.3
Calculating Activity-Based Unit Costs
LO-1
Comparison of Functional-Based and Activity-Based
Product Costs
 A plantwide rate based on direct labor hours is
calculated as follows:
 The activity-based cost assignment reflects the

pattern of overhead consumption and is the most
accurate.
 Activity-based product costing reveals that
functional-based costing undercosts the low volume
deluxe models and overcosts the high volume regular
models. LO-1
Activity-Based Product Costing
LO-2
Identifying Activities and
Their Attributes
 An activity is action taken or work performed by
equipment or people for other people.
 Identifying activities usually is accomplished by
interviewing managers or representatives of
functional work areas (departments).
LO-2
Activity Dictionary Example
for a Credit Card Department
LO-2
Assigning Costs to Activities
 Thus, 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
Resource Drivers
 Both direct tracing and driver tracing are used to
assign resource costs to activities.
 If the resource is shared by several activities (as is
the case of the clerical resource), then the
assignment is driver tracing, and the drivers are
called resource drivers, which are factors that
measure the consumption of resources by
activities.
 Once resource drivers are identified, then the costs
of the resource can be assigned to the activity.
LO-2
Activity-Based Customer Costing and Activity-Based
Supplier Costing (cont.)
 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
Activity-Based Customer Costing
 Customers are cost objects of fundamental interest.
 Knowing how much it costs to service different
customers can be vital information for the following
purposes:
 setting pricing
 determining customer mix
 improving profitability
 Furthermore, because of diversity of customers,
multiple drivers are needed to trace costs
accurately.
LO-3
Cornerstone 7.5
Calculating Activity-Based Customer Costs
LO-3
Cornerstone 7.5
Calculating Activity-Based Customer Costs
LO-3
Cornerstone 7.6
Calculating Activity-Based Supplier Costs
LO-3
Cornerstone 7.6
LO-3
Cornerstone 7.6
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
Process Value Analysis Model
 Process-Value Analysis is concerned with:
 Driver analysis
 Activity analysis
 Performance measurement
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
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
Nonvalue-Added Costs
 Costs that are caused either by nonvalue-added
activities or the inefficient performance of valued-
added activities.
 For nonvalue-added activities, the nonvalue-added
cost is the cost of the activity itself.
 For inefficient value-added activities, the activity cost
must be broken into its value-added and nonvalue-
added components.
 The value-added component is the waste-free
component of the value-added activity and is,
therefore, the value-added standard. LO-4
Examples of Nonvalue-Added
Activities
 In the manufacturing operation, the following
major activities are often cited as wasteful and
unnecessary:
 Scheduling: An activity that uses time and resources to
determine when different products have access to
processes
 Moving: An activity that uses time and resources to
move raw materials, work in process, and finished
goods from one department to another.
LO-4
Examples of Nonvalue-Added
Activities (cont.)
 Waiting: An activity in which raw materials or work in
process use time and resources by waiting on the next
process.
 Inspecting: An activity in which time and resources are
spent ensuring that the product meets specifications.
 Storing: An activity that uses time and resources while
a good or raw material is held in inventory.
LO-4
Thank You
ขอบคุณ
Terima Kasih

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CHAPTER 7:

ACTIVITY-BASED COSTING AND

 The activity-based cost assignment reflects the

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