Activity-Based Costing: A Tool to Aid Decision Making

Activity-Based Costing: A Tool to Aid Decision Making

1. Different from traditional absorption costing

   • Costs may only be assigned to products on a cause-and-effect basis
   • Some manufacturing costs may be excluded from product costs
   • Numerous overhead cost pools are used that are allocated to products using a specific measure of activity

2. Two types of nonmanufacturing costs that ABC systems assign to products

   • Direct nonmanufacturing costs
     • Commissions paid to salespersons
     • Shipping costs
     • Warranty repair costs
   • Indirect nonmanufacturing costs
     • Products have presumably cause the costs to be incurred

3. Manufacturing costs

   • Products are charged only for the cost of the capacity they use

4. Activity

   • Any event that causes the consumption of overhead recources
   • Activity cost pool
     • A "bucket" in which costs are accumulated that relate to a single activity measure in the ABC system

5. Five levels of activity that do not relate to the volume of units produced

   • Unit-level activities
   • Batch-level activities
   • Product-level activities
   • Customer-level activities
   • Organization-sustaining activities

6. Three characteristics of a successful activity-based costing implementation

   • Top managers must ssupport the ABC implementation to motivate employees to embrace the need to change
   • Managers should ensure that ABC data is linked to how people are evaluated and rewarded to show that it is important
   • A cross-functional team should be created to design and implement the ABC system

7. Steps for Implementing activity-based costing

   • 1. Define activities, activity cost pools, and activity measures
   • 2. Assign overhead costs to activity cost pools
     • First-stage allocation
   • 3. Calculate activity rates
     • Computed by dividing the total cost for each activity by its total activity
   • 4. Assign overhead costs to cost objects
     • Second-stage allocation
   • 5. Prepare management reports
     • Product and customer profitability reports

8. Activity-based management

   • Focusing on activities to eliminate waste, decrease processing time, and reduce defects

9. Generally not used for external reports

   • External reports are less detailed than internal reports prepared for decision making
   • Individual product costs are not reported on external reports
   • Cost of goods sold are not broken down by product

10. Limitations

    • More costly to implement and maintain than a traditional costing system
    • Activity-based costing by cause resistance because management is aften accustomed to traditional costing systems
    • Can be easily misinterpreted