Chapter 8 (Garrison Text)
Dr. M.S. Bazaz
ABC is a costing method that is designed to provide managers with cost information for strategic and other decisions that potentially affect capacity and therefore “fixed” costs.
In the traditional cost accounting system, the objective is to properly value inventories and cost of goods sold for external financial reports. In activity-based costing, the objective is to understand overhead and the profitability of products and customers. The major differences are:
In traditional cost accounting, only mfg. costs are assigned to products. Selling, general, and administrative expenses are treated as period expenses and are not assigned to products. Under ABC, however, nonmanufacturing costs such as commissions, paid to salespersons, shipping costs, and warranty repair costs, which can easily traced to individual products are included in the product costs. On the other hand and despite the traditional cost accounting, some manufacturing costs that are not caused by the products (i.e., security guard’s wage), do not participate in product costing under ABC. A cost is assigned to a product only if there is good reason to believe that the cost would be affected by decisions concerning the product.
In Traditional cost accounting, predetermined overhead rates are computed by dividing budgeted overhead costs by a measure of budgeted activity such as budgeted direct labor-hours. This practice results in applying the costs of unused, or idle, capacity to products, and it results in unstable unit product costs. In ABC, however, products are charged for the costs of capacity they use. In other words, the costs of idle capacity are not charged to products. This results in more stable unit costs and is consistent with the objective of assigning only those costs to products that are actually caused by the products.
Basic steps that often should be taken by the ABC team to implement activity based costing:
An activity cost pool is a “bucket” in which costs are accumulated that relate to a single activity in the ABC system.
Process of cost allocation:
The first-stage allocation in an ABC system is the process by which overhead costs are assigned to activity cost pools.
The second-stage allocation in an ABC system is to relate overhead costs to ultimate cost objects (products, customer orders, and customers). In this stage activity rates are used to apply costs to products and customers.
Activity-based management (ABM) focuses on managing activities as a way of eliminating waste and reducing delays and defects. In this regard, powerful tools such as TQM, process reengineering, and/or benchmarking can be used which provide a systematic approach to identifying the activities with greatest room for improvement.
Implementing activity-based costing often will typically shift costs from high-volume to low-volume products, but the effects will be much more dramatic on unit costs of the low-volume products. The unit costs of the low-volume products will increase far more than the unit costs of the high-volume products will decrease.
A vital part of activity-based analysis of product or customer profitability is an action analysis that identifies who is ultimately responsible for each cost and the ease with which the cost can be adjusted. In this regard, the action analysis and using colors to code how easily costs can be adjusted are suggested, see, Journal of Cost Management, fall 1993, pp. 44-52.
ABC and External Reporting:
ABC often are not used for external reporting for the following reasons:
Web site to visit: http://www.sba.oakland.edu
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