activity_based_costing power point presentation

Learning Objectives
• Explain under-costing and over-costing of products
or services
• Distinguish between the traditional and the activity-
based costing approaches to designing a costing
system
• Present three guidelines for refining a costing system
• Describe a four-part cost hierarchy
• Cost products or services using activity-based costing
• Compare activity-based costing systems and simple
costing system
• Activity-Based Management

Cost Smoothing
(Peanut butter costing)
The term cost smoothing describes a
particular costing approach that uses broad
averages for assigning the cost of resources
uniformly to cost objects when the
products/services use those resources in a
non-uniform way
Cost smoothing can lead to ---------------------or
--------------------------of product and services

Over & Undercosting
• Overcosting –
• Undercosting –

Under costing and Over costing Example
Jose. Rob, and Naney order separate items for lunch
Jose’s order amounts to $14
Rob Consumed 30
Naney’s order is 16
Total $ 60
What is the average cost per lunch?

Cross – Subsidization
• Means that if a company undercosts one of
its products, then it will overcost at least one
of its other products.
• Similarly, if a company overcosts one of its
products, it will undercost at least one of its
other products.
• It occurs when a cost is----------------------------
--------------------------------------------------------------
-------------------------------------------------------------

Product costing with single indirect
cost pool system
Use seven step process
1) Identify the product that are the chosen cost objects
2) Identify the direct costs of the products
3) Select the cost allocation bases to use for allocating indirect
costs to the products
4) Identify the indirect costs associated with each allocation
base
5) Compute the rate per unit of each allocation base used to
allocate indirect costs to the products
6) Compute the indirect costs allocated to the products
7) Compute the total cost of the products by adding all direct
and indirect costs assigned to the products

Refining a costing system
• A refined costing system reduces the use of
broad averages for assigning the cost of
resources to cost objects and
• Provides the better measurement of the costs
of indirect resources used by different cost
objects

Rationale for selecting a more
refined costing system
The Past
•
•
The Present
•
•
•
•
•

• The promoters of ABC;
Robert Kaplan and his colleagues from HBS

ABC as a powerful programme of cost management
• In 1980s’; American Goods were
Struggling in the Global Market But
• Japanese were successful in
–Cost reduction
–Quality improvement
• their products became very competitive in the
global market
17

• several waves of developing ABC
• In the first wave,
• In the second,
• In the third wave,
18

Deficiencies and misconceptions of traditional costing
• Cost centre managers’ mistaken belief on
profitability improvement.
• The traditional cost allocation system could prompt
managers to make unwise decisions.
• Not flexible
• Problem of timeliness
19

• The above deficiencies led to the new programme of
cost management initiated by Harvard business
School academics and allied professional journals.
• The 1987 historical analysis of the ‘ relevance lost’
thesis became a turning point in the history of
management accounting, and the birth of
subsequent cost management techniques.
20

Cost Hierarchies
• A cost hierarchy categorizes various activity
cost pools on the basis of
–Different types of cost drivers/cost-
allocation bases or
–Different degrees of difficulty in
determining cause and effect relationship

Cost Hierarchies
1. Unit-level (output-level)
2. Batch-level
3. Product-sustaining-level
4. Facility-sustaining-level

Output Unit-Level Costs
These are resources sacrificed on activities performed on
each individual unit of product or service.
Examples: Energy. Machine deprecation, Repairs
Batch - Level Costs
These are resources sacrificed on activities that are related to
a group of units of product(s) or service(s) rather than to each
individual unit of product or service.
Examples: Setup hours, Procurement costs

These are often called service-sustaining costs and are
resources sacrificed on activities undertaken to support
individual products or services. Example: Design costs
Engineering costs, overtime
There are resources sacrificed on activities that cannot be
traced to individual products or services but support the
organization as a whole. Example: General Administration.
rent. building security
Facility – Sustaining Costs
Product-Sustaining Costs

QUIZ
Advertising of a specific product is an example of
• unit-level costs.
• batch-level costs.
• product-sustaining costs.
• facility-sustaining costs.

QUIZ
The allocation of indirect costs in an activity-based
costing system
• may require other costs to be allocated to activities
before the costs of the activities can be allocated to
the products.
• is simplified because more costs are identified as
direct costs.
• requires the use of heterogeneous cost pools.
• is simplified because a limited number of activities
are identified as cost objects.

Comparison between Simple
Costing System vs ABC System

Conclusions
• Each method is mathematically correct
• Each method is acceptable
• Each method yields a different cost figure, which will
lead to different Gross Margin calculations
• Only Overhead is involved. Total Costs for the entire
firm remain the same – they are just allocated to
different cost objects within the firm
• Selection of the appropriate method and drivers
should be based on experience, industry practices, as
well as a cost-benefit analysis of each option under
consideration

A Cautionary Tale
• A number of critical decisions can be made
using this information;
– Should one product be “pushed” over another?
– Should one product be dropped?
• Accounting for overhead costs is an imprecise
science. Accordingly, best efforts should be
put forward to arrive at a cost that is fair and
reasonable.

ABC vs. Simple Costing Schemes
• ABC is generally perceived to produce superior
costing figures due to the use of multiple
drivers across multiple levels
• ABC is only as good as the drivers selected,
and their actual relationship to costs. Poorly
chosen drivers will produce inaccurate costs,
even with ABC

Limitations of ABC Systems
• Numerous measurements are required to
implement the system
• Required to estimate the costs of activity
pools and to identify and measure cost drivers
for those pools
• Activity-cost rates need to be updated
regularly.
• Costly to operate and difficult to understand

Activity Based Management (ABM)

activity_based_costing power point presentation

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