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5. Chapter Five. Activity-Based Costing and Cost Management Systems. Traditional, Volume-Based Product-Costing System. Aerotech produces three complex printed circuit boards referred to as Mode I, Mode II, and Mode III. The following information is obtained from company records:.

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activity based costing and cost management systems

5

Chapter Five

Activity-Based Costing and Cost Management Systems

traditional volume based product costing system
Traditional, Volume-Based Product-Costing System
  • Aerotech produces three complex printed circuit boards referred to as Mode I, Mode II, and Mode III.
  • The following information is obtained from company records:
traditional volume based product costing system3
Traditional, Volume-Based Product-Costing System

Additional information includes:

Manufacturing overhead is determined as follows

traditional volume based product costing system5
Traditional, Volume-Based Product-Costing System

With these product costs, Aerotech established target selling prices (Cost × 125%).

209.00 x 1.25

traditional volume based product costing system6
Traditional, Volume-Based Product-Costing System

Aerotech wishes to see what target selling prices would be suggested when using activity-based costing.

Let’s see how ABC works.

activity based costing system abc
Activity Based Costing System (ABC)

ABC systems follow a two-stage procedure to assign overhead costs to products.

Assigning

overhead to products is a

difficult process.

I agree!

activity based costing system abc8
Activity Based Costing System (ABC)

ABC systems follow a two-stage procedure to assign overhead costs to products.

Let’s begin

by identifying

our major activities.

Stage OneIdentify significant

activities and assign overhead

costs to each activity in

proportion to resources used.

activity based costing system abc9
Activity Based Costing System (ABC)

ABC systems follow a two-stage procedure to assign overhead costs to products.

Overhead assigned to activities are called “activity cost pools.”

Stage TwoIdentify cost drivers

appropriate to each activity

and allocate overhead to

the products.

slide10

Activity

must be

done on

each unit

produced.

Activity

performed

on each

batch

produced.

Activities needed to support

an entire product line

Activity required in order

for the production

process to occur.

Overhead Costs

Total budgeted cost = $3,894,000

Identification

of Activity

Cost Pools

Activity

Cost

Pools

Product-

Sustaining

Level

Unit

Level

Batch

Level

Facility

Level

Machinery

cost pool

$1,212,600

Setup

cost pool

$3,000

Engineering

cost pool

$700,000

Facility

cost pool

$507,400

slide11

Overhead Costs

Total budgeted cost = $3,894,000

Identification

of Activity

Cost Pools

Activity

Cost

Pools

Product-

Sustaining

Level

Unit

Level

Batch

Level

Facility

Level

Machinery

cost pool

$1,212,600

Setup

cost pool

$3,000

Engineering

cost pool

$700,000

Facility

cost pool

$507,400

More

Cost

Pools

slide12

Product-

Sustaining

Level

Unit

Level

Batch

Level

Facility

Level

Machinery

cost pool

$1,212,600

Setup

cost pool

$3,000

Engineering

cost pool

$700,000

Facility

cost pool

$507,400

Receiving/Inspection

cost pool $200,000

Material-Handling

cost pool $600,000

Quality-Assurance

cost pool $421,000

Packaging/Shipping

cost pool $250,000

slide13

STAGE ONE

Various overhead

costs related

to machinery

Maintenance

Lubrication

Depreciation

Electricity

Computer Support

Calibration

Activity

cost

pool

Machinery Cost Pool

Total budgeted cost = $1,212,600

slide14

STAGE TWO

Calculate

the pool

rate

Budgeted Machinery Costs$1,212,600

Budgeted Machine Hours 43,000

$28.20/hour

=

=

Cost

Assignment

slide15

STAGE ONE

Calculation of

total setup cost

Activity

cost

pool

Setup Cost Pool

Total budgeted cost = $3,000

slide16

STAGE TWO

Calculate

the pool

rate

Budgeted Setup Costs $3,000

Planned Production Runs 15 runs

$200 per run

=

=

Cost

Assignment

slide17

STAGE ONE

Various overhead

costs related

to engineering

Engineering salaries

Engineering software

Engineering supplies

Depreciation

Activity

cost

pool

Engineering Cost Pool

Total budgeted cost = $700,000

slide18

STAGE TWO

Engineering Cost Pool

Total budgeted cost = $700,000

Allocate based

on engineering

transactions

Cost

Assignment

slide19

STAGE ONE

Various overhead

costs related

to general

operations

Plant depr.

Property taxes

Plant mgmt.

Insurance

Plant maint.

Security

Activity

cost

pool

Facility Cost Pool

Total budgeted cost = $507,400

slide20

STAGE TWO

Calculate

the pool

rate

Budgeted Facilities Cost $507,400

Budgeted Direct-Labor Hours 118,000

$4.30/hour

=

=

Cost

Assignment

product cost from abc
Product Cost from ABC

Here are the new product costs so far . . .

product cost from abc24
Product Cost from ABC

These are the new product costs when Aerotech uses ABC.

product diversity
Product Diversity

Both original and ABC target selling prices are based on (Cost × 125%).

The selling price of Mode I and II are reduced

and the selling price for Mode III is increased.

[$209.00 × 1.25]

[$183.44 × 1.25]

product diversity26
Product Diversity

Can you identify any problems Aerotech is likely to face as a result of this distortion?

Traditional costing understates the cost

of complex, low volume products.

abc some key issues
The Past

Small number of products which did not differ much in required manufacturing support.

Labor was the dominant element in the cost structure.

The Present

Numerous products with more and complicated production requirements.

Labor is becoming an ever smaller part component of total production costs.

ABC: Some Key Issues
cost drivers
Cost Drivers

A characteristic of an event or activity that results in the incurrence of costs. In selecting a cost driver, we must consider . . .

Degree of

Correlation

Behavioral

Effects

Cost of

Measurement

homogeneous activity cost pools
Homogeneous Activity Cost Pools

A homogeneous cost pool is a grouping of overhead costs in which each cost component is consumed in roughly the same proportion by each product line.

A homogeneous cost pool

uses a single cost driver.

transaction costing

Usually

Result In

Activities

Paperwork

Transaction Costing

Transaction

processing

provides a

readily

measurable

gauge of

departmental

activity.

storyboarding
Storyboarding

A procedure used to develop a detailed process flow chart, which visually represents activities and the relationships among activities.

Step

1

These are the steps we

follow to build a

memory board.

Step

2

Step

3

Step

4

direct versus indirect costs
Volume-Based Costing

All production costs except direct materials and direct labor are lumped together in one overhead cost pool.

Activity-Based Costing

An effort is made to account for as many costs as possible as direct costs of production.

Direct versus Indirect Costs

Indirect

Costs

indicators of need for abc
Indicators of Need for ABC

Direct labor is a

small percentage

of total costs

Product-line profit

margins are hard

to explain

Line managers do not

believe the product

costs reports

Sales are increasing,

but profits are declining.

Some products that

have reported high

profit margins are not

sold by competitors

Marketing does not

use costs reports for

pricing decisions

optimal product costing system
Optimal Product-Costing System

Cost

Total Cost

High

Cost of

inferior

decisions

resulting

from

inaccurate

information.

Design, implementation

and maintenance costs

Information

System

Accuracy

Low

Low

High

Optimal

system

cost management systems
Cost Management Systems
  • Measure the cost of resources consumed.
  • Identify and eliminate non-value-added costs.
  • Determine the efficiency and effectiveness of all major activities.
  • Identify and evaluate new activities that can improve future performance.

Objectives

non value added costs

Storage

Time

Waiting

Time

Process

Time

Move

Time

Inspection

Time

NVA

NVA

VA

NVA

NVA

Non-Value-Added Costs

Suppose our production process looks like this:

VA = Valued-added activity

NVA = Non-value-added activity

non value added costs37

Storage

Time

Waiting

Time

Process

Time

Move

Time

Inspection

Time

NVA

NVA

VA

NVA

NVA

Non-Value-Added Costs

Our goal is to reduce or eliminate the non-value-added activities.

VA = Valued-added activity

NVA = Non-value-added activity

abc in the service industry
ABC in the Service Industry

Activities tend to

be nonrepetitive

human tasks.

Implementation

Problems

High proportion of

facility-level costs

end of chapter 5
End of Chapter 5

This is

real value-added

time!