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ABC3
ABC3
by James Jiambalvo
Chapter 6:
Cost Allocation and
Activity-Based Costing
Steps include:
Identify the cost objectives
b. machine hours
2. Not all overhead costs vary in relation to
volume!
Activity-Based Costing
Activity-Based Costing (ABC) is a
relatively recent development in
management accounting.
The Problem of Using Only
Measures of Production
Volume to Allocate Overhead
1. Traditionally firms use labor hours or
machine hours as allocation bases for
assigning overhead to products.
2. This assumes that all costs are
proportional to production volume.
3. Setup costs are not proportional.
4. For example, a setup might work for a
400,000 unit production run just as well as
a 200,000 production run.
5. Low-volume items are undercosted and
high-volume items are overcosted.
The ABC Approach
1. Identify the major activities that cause
overhead costs to be incurred.
2. Group costs of activities into cost
pools.
3. Identify measures of activities (the cost
drivers)
4. Relate costs to products using the cost
drivers.
The ABC Approach
Examples of Activities
1. Processing purchase orders.
2. Handling materials and parts.
3. Inspecting incoming material and parts.
4. Setting up equipment.
5. Producing goods using manufacturing
equipment.
6. Supervising assembly workers.
7. Inspecting finished goods.
8. Packing customer orders.
Examples of Associated Costs
1. Various labor costs.
2. Depreciation.
Examples of Cost Drivers
1. Number of purchase orders processed.
2. Number of material requisitions.
3. Number of receipts.
4. Number of setups.
5. Number of machine hours.
6. Number of assembly labor hours.
7. Number of inspections.
8. Number of boxes shipped.
Pros and Cons of ABC
Benefits:
1. ABC is less likely than traditional costing to
Limitations:
1. Expensive relative to traditional system!
“You Get What You Measure”
Quick Review Question #1
1. The direct method of allocating costs:
a. Allocates service department costs
to other service departments.
b. Allocates only direct costs.
c. Allocates service department costs
to production departments only.
d. Both (b) & (c).
Quick Review Answer #1
1. The direct method of allocating costs:
a. Allocates service department costs
to other service departments.
b. Allocates only direct costs.
c. Allocates service department costs
to production departments only.
d. Both (b) & (c).
Quick Review Question #2
1. In the cost allocation process, the cost
objective is:
a. The allocation base used to
allocate the costs.
b. A grouping of individual costs
whose total is allocated using one
allocation base.
c. The product, service or department
that is to receive the allocation
d. None of these.
Quick Review Answer #2
1. In the cost allocation process, the cost
objective is:
a. The allocation base used to
allocate the costs.
b. A grouping of individual costs
whose total is allocated using one
allocation base.
c. The product, service or department
that is to receive the allocation.
d. None of these.
Quick Review Answer #2
2. Units produced = 2,000, units sold =
1,800, contribution margin ratio is 37%,
fixed S & A expenses are $90,000.
Fixed mfg. Expenses are $80,200 By
how much is net income greater under
full costing than variable costing?
a. $8,020
b. $80,200
c. $9,000
d. $17,020
Quick Review Question #3
3. The errant process of treating fixed
costs a variable, or a per-unit basis, is
called?
a. A cost driver.
b. A cost object.
c. Unitizing fixed costs.
d. An arbitrary allocation.
Quick Review Answer #3
3. The errant process of treating fixed
costs a variable, or a per-unit basis, is
called?
a. A cost driver.
b. A cost object.
c. Unitizing fixed costs.
d. An arbitrary allocation.
Quick Review Question #4
4. What does it mean to “Get
What You Measure?”
Quick Review Answer #4
Appendix: Activity-Based
Management (Four-Steps)
1. Determine major activities.
2. Identify resources used by each activity.
3. Evaluate the performance of the activities.
4. Identify ways to improve the effficiency
and/or effectiveness of the activities.
Step 1: Determine major
activities through interviews
and observations
a. Determine customer locations, determine
availability of stock, and prepare delivery
schedules.
b. Pick orders from warehouse.
c. Load trucks.
d. Deliver merchandise.
Step 1: Determine major
activities through interviews
and observations (continued)