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Activity Based Costing (ABC)

Activity Based Costing (ABC). Trad. Costing Limits. Overall purpose: accounting values Volume Size Complexity. Activity Based Costing. Benefits More accurate costs More accurate operating information Better access to relevant costs Limits Allocations are still used Cost omission

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Activity Based Costing (ABC)

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  1. Activity Based Costing (ABC) STRATEGIC COST MANAGEMENT - BA122B - Spring 2006 Slide 3-1

  2. Trad. Costing Limits • Overall purpose: accounting values • Volume • Size • Complexity STRATEGIC COST MANAGEMENT - BA122B - Spring 2006 Slide 3-2

  3. Activity Based Costing • Benefits • More accurate costs • More accurate operating information • Better access to relevant costs • Limits • Allocations are still used • Cost omission • Time and expense STRATEGIC COST MANAGEMENT - BA122B - Spring 2006 Slide 3-3

  4. Contemporary Advantages • Comprehensive cost information • Emphasis on operations and activities • Costs are attached to activities • Provides driver visibility STRATEGIC COST MANAGEMENT - BA122B - Spring 2006 Slide 3-4

  5. Ansari: MOA • Strategic Implications • Info @ the cost of value-added features • Info @ the overall cost of the product • Reflects time considerations in the attribution process STRATEGIC COST MANAGEMENT - BA122B - Spring 2006 Slide 3-5

  6. MOA, cont. • Attribute Implications • Technical • Provides decision relevant information • Enhances process understanding • Behavioral • Cost structure visibility • Facilitates communication • Empowers employees • Risk of “failed expectations” re: “true” cost • Cultural • Supports process focus • Encourages cross-functional participation STRATEGIC COST MANAGEMENT - BA122B - Spring 2006 Slide 3-6

  7. ABC Implementation • Select an area • Identify primary activities (5-10) • Cost each activity • Determine one driver for each activity • Apply the costs to the final cost objectives on the basis of the drivers. STRATEGIC COST MANAGEMENT - BA122B - Spring 2006 Slide 3-7

  8. Remember... • ABC does NOT yield “true” costs! STRATEGIC COST MANAGEMENT - BA122B - Spring 2006 Slide 3-8

  9. ABC/ABM Case-Gulfstream Recreation Gulf Stream Recreation, a major sporting goods firm in California has two major products--the Bobcat Racer and the Snidley Whiplash Cruiser. For the current year, overhead was planned at $850K. Overhead is applied on the basis of machine hours. Each racer uses 2 machine hours and each cruiser uses 1 machine hour. GSR planned to build 10K racers and 50K cruisers. The cost structure for each product is as follows: Racer Cruiser Direct Material $35 $50 Direct Labor 25 13 Machine Hours 2 1 GSR is considering some type of activity based costing system. Sandra Jones, the cost accounting manager, suggested the following drivers: Driver Relationship to FCO DriverTotal Activity CostTotalRacerCruiserActivity P.O.'s (#) $300K 2000 1250 750 Purchasing Rework Hrs. (Hrs) $200 450 200 250 Quality Control Invoices (#) $200 600 150 450 Billing Change Orders (#) $150 300 150 150 Mfg. Eng. 1. Calculate the unit costs of each product under the traditional method. 2. Calculate the unit costs of each product under activity based costing. 3. What pricing implications are inherent in this example. STRATEGIC COST MANAGEMENT - BA122B - Spring 2006 Slide 3-9

  10. Gulfstream Recreation Solution Standard Overhead Rate: $850K/70K Mhrs. = $12.14 per machine hour Traditional Cost Structure: Racer Cruiser Direct materials $35 $50 Direct labor $25 $13 Overhead $24 $12 Total $84 $75 STRATEGIC COST MANAGEMENT - BA122B - Spring 2006 Slide 3-10

  11. Gulfstream Solution, continued ABC Overhead Rate: Racer Cruiser Purchasing $187.5 $112.5 Quality control $ 88.9 $111.1 Billing $ 50.0 $150.0 Mfg. Engineering $ 75.0 $ 75.0 Total $401.4 $448.6 Per unit $40.10 $ 8.97 ABC Cost Structure: Racer Cruiser Direct materials $35 $50 Direct labor $25 $13 Overhead $40 $ 9 Total $100 $72 STRATEGIC COST MANAGEMENT - BA122B - Spring 2006 Slide 3-11

  12. Implementation Strategy • Involve management and employees • Parallel system approach • Find a winner • KISS • Incentivize • Education users STRATEGIC COST MANAGEMENT - BA122B - Spring 2006 Slide 3-12

  13. Activity Based Management (ABM) STRATEGIC COST MANAGEMENT - BA122B - Spring 2006 Slide 3-13

  14. Ansari: ABM • Strategic Implications • Visibility on the efficiency & effectiveness (the quality) of activities • Visibility of costs for process redesign • Insight into timing consideration of actions STRATEGIC COST MANAGEMENT - BA122B - Spring 2006 Slide 3-14

  15. ABM, cont. • Attribute Implications • Technical • Greater focus on work • Provides cross-functional cost impact • Highlights operational interdependencies • Behavioral • Heightens importance of process knowledge • Reinforces continuous improvement • Empowers employees--be careful of “non-value” terminology • Cultural • Reorients focus on process not people • Challenges current thinking • May add cultural conflict STRATEGIC COST MANAGEMENT - BA122B - Spring 2006 Slide 3-15

  16. ABM, cont. • ABM Process • Obtain existing cost information • Determine the major processes • Identify process inputs and outputs • Determine the specific activities • Identify the resources used • Define output measures (what we measure) • Define performance measures (how we measure it) • Assess performance through benchmarking • Brainstorm improvements STRATEGIC COST MANAGEMENT - BA122B - Spring 2006 Slide 3-16

  17. ABC, ABM & Strategic Cost Applications • Comparison of cost structure to competition • Pricing, design and other operational impact • Mass customization impact • Behavioral impact of common components • Changes in the production process • Changes in the distribution system • Changes in source and types of supplies/suppliers • Profitability impact • Identification and elimination of non-value added activities • Quality and time implications STRATEGIC COST MANAGEMENT - BA122B - Spring 2006 Slide 3-17

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