University:
California State University, Northridge
Course:
ACCT 230 | Introduction to Managerial Accounting
Academic year:

2024
Views:

356

Pages:

19
Author:

sizwakalev84

Chapter 7: Activity-Based Costing and Management Part 1 Learning Objectives 1. Explain why functional (or volume)-based costing approaches may produce distorted costs. 2. Explain how an activity-based costing system works for product costing. 3. Describe activity-based customer costing and activity-based supplier costing. 4. Explain how activity-based management can be used for cost reduction. Limitations of Functional-Based Cost Accounting Systems 1 ►Plantwide and departmental rates based on direct labor hours, machine hours, or other volume-based measures have been used for decades to assign overhead costs to products and continue to be used successfully by many organizations. ► However, for many settings, this approach to costing is equivalent to an averaging approach and may produce distorted, or inaccurate, costs. 1 Limitations of Functional-Based Cost Accounting Systems (continued) Product cost distortions can be damaging, particularly for those firms whose business environment is characterized by : Continuous Improvement Total Quality Management 1 Limitations of Functional-Based Cost Accounting Systems (continued) ►The need for more accurate product costs has forced many companies to take a serious look at their costing procedures. ►Two major factors impair the ability of unitbased plant-wide and departmental rates to assign overhead costs accurately: 1. The proportion of nonunit-related overhead costs to total overhead costs is large. 2. The degree of product diversity is great. 1 Nonunit-Related Overhead Costs ►The use of either plantwide rates or departmental rates assumes that a product’s consumption of overhead resources is related strictly to the units produced. ►For unit-level activities (or activities that are performed each time a unit is produced), this assumption makes sense. ► But if there are nonunit-level activities (or activities that are not performed each time a unit of product is produced), the costs associated with these nonunit-level activities are unlikely to vary (i.e., increase or decrease) with units produced. 1 Categorizing Costs under ABC 1 Activity Drivers and the Consumption of Activities ►Nonunit-level activity drivers (i.e., batch, productsustaining, and facility-sustaining) are factors that measure the consumption of nonunit-level activities by products and other cost objects, whereas unitlevel activity drivers measure the consumption of unit-level activities. ►Activity drivers are factors that measure the consumption of activities by products and other cost objects and can be classified as either unit-level or nonunit-level. 1 Distorted Product Costs ►Using only unit-based activity drivers to assign nonunit-related overhead costs can create distorted product costs. ►The severity of this distortion depends on what proportion of total overhead costs these nonunit-based costs represent. ►If nonunit- based overhead costs are only a small percentage of total overhead costs, then the distortion of product costs will be quite small. ►In such a case, using unit-based activity drivers to assign overhead costs is acceptable. 1 Product Diversity ►The presence of product diversity is also necessary for product cost distortion to occur. ►Product diversity means that products consume overhead activities in systematically different proportions. ►This may occur for several reasons, including differences in: 1. product size 2. product complexity 3. setup time 4. size of batches 1 Consumption Ratio ►Regardless of the nature of the product diversity, product cost will be distorted whenever the quantity of unit-based overhead that a product consumes does not vary in direct proportion to the quantity consumed of nonunit-based overhead. ►The proportion of each activity consumed by a product is defined as the consumption ratio and is calculated as: Amount of Activity Driver per Product Total Driver Quantity 1 Cornerstone 7-1 Calculating Consumption Ratios 1 Cornerstone 7-1 Calculating Consumption Ratios (continued) 1 Cornerstone 7-2 Calculating Activity Rates 1 Cornerstone 7-3 Calculating Activity-Based Unit Costs 1 Cornerstone 7-3 Calculating Activity-Based Unit Costs (continued) 1 Comparison of Functional-Based and Activity-Based Product Costs ►A plantwide rate based on direct labor hours is calculated as follows: ►The activity-based cost assignment reflects the pattern of overhead consumption and is, therefore, the most accurate. ►Activity-based product costing reveals that functionalbased costing undercosts the low volume deluxe models and overcosts the high volume regular models. 1 Product Diversity and Product Costing Accuracy ►For unit-level overhead rates to fail, products must consume the non-unit-level activities in proportions significantly different than the unit-level activities. ►The key message of the relationship analysis is that in a diverse product environment, activity-based costing promises greater accuracy. Given the importance of making decisions based on accurate facts, a detailed look at activity-based costing is certainly merited. Product Diversity and Product 1 Costing Accuracy