ACC200 term 2 2019 Assignment

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ACC200Lecture7chapter8-Activitybasedcosting.ppt

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Chapter 8
Activity-based management
and activity-based costing

PowerPoint to accompany:

Horngren’s Cost Accounting, 3rd Edition

Learning objectives

Identify and explain the reasons why the managers of an organisation might need a sophisticated costing system.
Explain and apply activity-based management.
Explain and apply activity-based costing.
Compare activity-based costing with traditional costing.
Given the context, design an activity-based costing system.
Given the context, evaluate an activity-based costing system.

Why might the managers of an organisation need a sophisticated costing system?

If a reasonably experienced management accountant were to evaluate a traditional costing system, the following symptoms might be detected:
The amount of indirect costs relative to total costs is significant.
There are only one or two cost drivers in the costing system to allocate indirect costs to cost objects.
Outputs make diverse demands on resources because they exhibit differences in volume, process steps, batch size or complexity.
All or most of the indirect costs are treated as output-unit-level costs.
Outputs that the organisation is well-suited to produce and sell show small profits, whereas those to which it is less suited show large profits.

Why might the managers of an organisation need a sophisticated costing system? (cont’d)

Managers and workers who work closely with processes and outputs perceive that the reported costs of outputs differ markedly from the costs that they might expect.
From the symptoms noted on the previous slide, three criteria for an ABC system emerge:
a high level of overhead costs relative to total costs
diversity of processes and outputs
a relatively high level of competition.

Managing activities

Activity-based management (ABM) focuses on observing and analysing activities as a basis for making a range of decisions, including:
pricing outputs
deciding on output mix
how to reduce costs
how to improve processes
product design
profitability
customer satisfaction.

Estimating the costs of activities

Activity-based costing (ABC) gives managers information about the costs of making and selling diverse outputs.
ABC systems include all resources consumed by cost objects, irrespective of whether the costs are variable or fixed in the short run.
Management accountants express the acquired resources in dollar terms and identify the cost objects that consume those resources, either direct cost objects or the activities that are required to produce the outputs.
They then trace the cost of resources consumed to the cost object or activity, or allocate them according to their nature to either resource-cost pools or activity-cost pools.

Estimating the costs of activities (cont’d)

They then allocate the costs in the resource-cost pools to the activity-cost pools using resource-cost drivers.
And finally, they allocate costs from the activity-cost pools to the cost objects using activity-cost drivers.

Estimating the costs of activities (cont’d)

Hierarchies of activities

Output-unit level activities are performed on each individual unit of output.
Batch-level activities relate to a group of units of outputs rather than to each individual unit of output.
Output-sustaining activities are undertaken to support categories of outputs, irrespective of the number of units or batches in which the units are produced.
Organisation-sustaining activities support the organisation as a whole but do not have a cause-and–effect relationship with any cost object.

Estimating the costs of activities (cont’d)

Comparing activity-based costing with traditional costing

Most traditional costing systems collect indirect costs into a single cost pool and allocate them to cost objects using a single cost-driver rate.
Traditional systems like these are capable of producing reasonably accurate costs, but only under certain conditions:
Where a single activity accounts for a sizeable proportion of a department’s indirect costs; or
Where significant costs are incurred on different activities within a department but the same cost driver applies to all the activities in the department.

Designing an activity-based costing system

Level of detail:
Should there be many finely specified activities, cost drivers, and cost pools?
If different activities use resources in the same way, one driver might be adequate to capture the resources used.
Cost drivers (cause-and-effect relationships) and homogeneity of cost pools:
Focused and homogeneous cost pools aid in identifying resource-cost and activity-cost drivers that better reflect cause-and-effect relationships and facilitate better decisions.
In a homogeneous cost-pool, all of the costs have the same or a similar cause-and-effect relationship with a single cost driver.

Designing an activity-based costing system (cont’d)

Analysing benefits and costs:
the main costs of an ABC system are the collection and measurement of data
the effort and cost of collecting data also depends on their availability.
Budgeted rates:
to be useful for planning, control and making decisions, managers specify budgeted costs for activities and use budgeted cost-driver rates to estimate the cost of outputs.
Unused capacity:
a well-designed ABC system allows managers to identify unused capacity in each major activity and to estimate its cost.

Designing an activity-based costing system (cont’d)

Behavioural issues

Gain support of top management and create a sense of urgency for the ABC effort.
Create a guiding coalition of managers throughout the value chain for the ABC effort.
Educate and train employees in ABC as a basis for employee empowerment.
Seek small short-run successes as proof that the ABC system is yielding results.
Recognise that ABC information is not perfect because it balances the need for better information against the costs of creating a complex system that many find difficult to understand fully.

Evaluating an activity-based costing system

Before one is able to evaluate an ABC system, one must review all facets of the design, application, and context of that system:
Examine the context and establish whether the criteria that call for an ABC system have been met.
Examine the system and observe the way in which all who use it can use ABC-information to identify symptoms of a failing system.
Examine the design and application of the system to assess whether all cost drivers and cost pools have been accurately identified.
Analyse the potential and actual benefits and costs associated with the system.

Case: Plaslenz Ltd

Simple costing system - design, manufacturing and

distribution processes

Plaslenz Ltd manufactures two types of lenses: a complex lens, CX5; and a simple lens, SX3, for vehicle tail lights
Design department – modifies the designs of the moulds and specifies the processes needed to produce the lenses
Manufacturing department – moulds, finishes, cleans and inspects the lenses
Distribution department – packs the lenses and sends them to customers

Case: Plaslenz Ltd (cont’d)

Simple costing system using a single indirect-cost pool

There are seven steps:

Identify the products that are the chosen cost objects.

Identify the direct costs of the products.

Select the cost-allocation bases to use for allocating indirect (or overhead) costs to the products.

Identify the indirect costs associated with each cost-allocation base.

Calculate the rate per unit of each cost-allocation base.

Calculate the indirect costs allocated to the products.

Calculate the total cost of the products by adding all direct and indirect costs assigned to the products.

Case: Plaslenz Ltd (cont’d)

Implementing activity-based costing at Plaslenz Ltd

Figures 8.5 to 8.7 illustrate the following seven steps:

Identify the outputs that are the chosen cost objects.

Identify the direct costs of the outputs.

Select the activities and cost-allocation bases to use for allocating indirect costs to the outputs.

Identify the indirect costs associated with each cost-allocation base.

Calculate the rate per unit of each cost-allocation base.

Calculate the indirect costs allocated to the outputs.

Calculate the total cost of the outputs by adding all direct and indirect costs assigned to the outputs.

Case: Plaslenz Ltd (cont’d)