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Chapter 5. Activity-Based Costing. 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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chapter 5

Chapter 5

Activity-Based Costing

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 system1
Traditional, Volume-Based Product-Costing System

Additional information includes:

Manufacturing overhead is determined as follows

traditional volume based product costing system3
Traditional, Volume-Based Product-Costing System

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

209.00 x 1.25

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 abc1
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 abc2
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.

slide9

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

Batch

Level

Facility

Level

Unit

Level

Machinery

cost pool

$1,212,600

Setup

cost pool

$3,000

Engineering

cost pool

$700,000

Facility

cost pool

$507,400

slide10

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

slide11

Maintenance

Lubrication

Depreciation

Electricity

Computer Support

Calibration

STAGE ONE

Various overhead

costs related

to machinery

Activity

cost

pool

Machinery Cost Pool

Total budgeted cost = $1,212,600

slide12

STAGE TWO

Calculate

the pool

rate

Budgeted Machinery Costs$1,212,600

Budgeted Machine Hours 43,000

$28.20/hour

=

=

Cost

Assignment

slide13

STAGE ONE

Calculation of

total setup cost

Activity

cost

pool

Setup Cost Pool

Total budgeted cost = $3,000

slide14

STAGE TWO

Calculate

the pool

rate

Budgeted Setup Costs $3,000

Planned Production Runs 15 runs

$200 per run

=

=

Cost

Assignment

slide15

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

slide16

STAGE TWO

Engineering Cost Pool

Total budgeted cost = $700,000

Allocate based

on engineering

transactions

Cost

Assignment

slide17

Exh.

5-9

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

slide18

Exh.

5-9

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

These are the new product costs when Aerotech uses ABC.

distorted product costs
Distorted Product Costs

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]

slide22

Distorted Product Costs

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.

two key points
A large proportion of non-unit-level activities

A unit-level cost driver, such as direct labor, machine hours, or throughput, will not be able to assign the costs of non-unit-level activities accurately.

Product diversity

When the consumption ratios differ widely between activities, no single cost driver will accurately assign the resulting overhead costs.

Two Key Points
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

methods of data collection
Methods of Data Collection

Interview & Paper Trails:

The information for ABC systems initially comes from interviews with employees in the support departments and a review of each department’s records.

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

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

Exh.

5-13

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

chapter 6

Chapter 6

Activity-Based Management and Cost Management Tools

activity based management

The use

Of ABCinformationto helpmanagementmake decisions

Activity-Based Management

Activity-based costingestablishes relationshipsbetween overhead costs and activities so thatwe can better allocate overhead costs.

Activity-based managementfocuses on managing activities to reduce costs.

two dimensional abc and activity based management

Cost Assignment View

Resource costs

Process View

Activity Analysis

Activity Evaluation

Performance

Measures

Root

Causes

Activity

Triggers

Activities

Cost Objects

Two-Dimensional ABC and Activity-Based Management
elimination of non value added costs
Elimination of Non-Value-Added Costs

Activities

Nonvalue-added activities

Unnecessary

Necessary

Reduce orEliminate

Continually Evaluate and Improve

using abm to eliminate non value added activities and costs
Using ABM to Eliminate Non-Value-Added Activities and Costs
  • Identify Activities.
  • Identify Non-Value-Added Activities.
  • Understand Activity Linkages, Root Causes, and Triggers.
  • Establish Performance Measures.
  • Report Non-Value-Added Costs.

Specify

parts

Select

vendor

Receive

parts

Produce

goods

Inspect

finished

goods

Rework

defective

products

using abm to eliminate non value added activities and costs1
Using ABM to Eliminate Non-Value-Added Activities and Costs

Process time

Storage time

Inspection time

Move time

Waiting time

achieving cost reduction
Achieving Cost Reduction

Activity

Reduction

Activity

Selection

Reduce

Non-Value-Added

Costs

Activity

Sharing

Activity

Elimination

customer profitability analysis
Customer Profitability Analysis

Customer profitability analysis uses ABC to determine

the activities, costs, and profit associated with serving particular customers.

Requiredspecialpackaging.

Orderssmallquantities.

Demandfastservice.

Oftenchangesorders.

Ordersfrequently.

A costly customer

customer profitability analysis1
Customer Profitability Analysis

A company may use these customerrelated costs to help determine theprofitability of each customer.

target costing
Target Costing

Design a product, and the manufacturing process, so that the product can be manufactured at a cost that will enable the firm to make a profit when the product is sold at an estimated market-driven price.

Value engineering is used to achieve a product design that meets the target cost.

Number of parts

Quality of materials

Change methods

Change components

kaizen costing
Kaizen Costing
  • The process of cost reduction during the manufacturing phase of an existing product
  • Kaizen cost goal is established to help achieve continuous cost reduction.

Product cost

.

Kaizen goal

cost-reduction

amount.

}

.

3/31/x1

3/31/x2

benchmarking
Benchmarking

The continual search for the most effective method of accomplishing a task, by comparing existing methods and performance levels with those of other organizations.

Here are

the best

practices

in our

industry. . .

re engineering
Re-engineering

The complete redesign of a process, with an emphasis on finding creative new ways to accomplish an objective.

theory of constraints
Theory of Constraints

A management approach seeking to maximize long-run profit through proper management of organizational bottlenecks or constrained resources.

just in time inventory and production management
Just-in-Time Inventory and Production Management

No materials are purchased and no products are manufactured until they are needed.

The primary goal of a

JIT production system is

to reduce or eliminate

inventories at every

stage of production.

key features of the jit approach
Key Features of the JIT Approach

Smooth, uniform production rate

Pull method of production

Purchase is small lot sizes

Quick, inexpensive setups

High quality materials

Effective preventive maintenance

Teamwork

Multiskilled workers

jit purchasing
JIT Purchasing

Long-term

contracts with

suppliers.

Parts delivered

in small lots.

Only a few

suppliers.

Grouped

payments to

vendor.

Minimal

inspection of

materials.