Chapter 5 Activity-Based Costing (ABC) and Activity-based Management

How does broad averaging under cost and over cost product or services

Under the traditional costing systems the Broad-Averaging “Peanut-Butter Spreading”: allocate (aggregated), indirect costs across products according to volume-related measures. Ex: Direct Labour Hours

Product Undercosting

The cost measurement system reports a cost for a product that is below the cost of the resources the product consumes.

Product Overcosting

Is the cost measurement system reports a cost for a product that is below the cost of the resources the product consumes.

Present the three guidelines for refining a costing system. How to refine our costing method

1). Trace more costs: the most costs we can directly trace to products, the more accurate the costs of the products will be

2). Develop various indirect cost pools until each pool is homogeneous. The more homogenous an indirect cost pool is the more feasible

3). Identify Relevant Cost Drivers: A relevant allocation base for each pool allows us to accurately allocate indirect cost pools.

Under simple (traditional costing systems) in which indirect costs are allocated simply according to volume (or a volume-related measure).

High-volume, simple-to-produce products may unfairly bear te costs of low-volume, comples-to-produce products

Under Activity-based costing (ABC) are more accurately assign costs to products for better decision-making in pricing product mix (ch 15), outsourcing decisions (ch 12), etc.

Benefits include understanding the “profitability for correct performance evaluation, an control costs through activity-based management

Who are most likely to benefit from ABC (activity-based costing) system?

Firms with diverse products vs Firms with few product lines

Firms with a large amount of indirect (overhead) costs

Describe the four-part cost hierarchy

1. Facility level (ex: maintaining plants)

2. Product-line level (ex: designing different colored pens)

3. Batch-;evel costs (ex: setting up each production)

4. Unit-level line cost (ex: led (units) for pens)

Cost products or services using activity-based costing steps to implement ABC (Seven step approach) to costing and the three guidelines for refining costing systems (trace more)

Step 1: Identify the Products that are the chosen cost objects

Step 2: Identify the Direct Costs of the products

Step 3: Select the Activities and cost-allocation Base to use for allocating Indirect costs to the products

Step 4: Identify the indirect costs associated with each cost-allocation base

Step 5: Compute the Rate per unit of each cost-allocation base

Step 6: Compute the indirect costs allocated to the individual products

Step 7: Compute the total costs of the products by adding all direct and indirect costs assigned to the products