...Activity-based Costing Activity-based costing, is a system that follows a two-stage procedure to assign overhead costs to products. It identifies activities in a company and assigns the cost of each activity resource to all products and services according to the actual consumption by each. As revealed in the article, this costing method had both pros and cons. The article favored the advantages of the ABC method although the satisfaction scores were below the average for all tools used. For those companies that disfavored ABC method, the most common complain was that it took too much money and time using this method, and the method might not capture the complexity of their operations. In fact, ABC method is not production-specified. For production costs, standard costing was still “kill of the hill” with a usage rate of 42% according to the article. However, it is inaccurate to say that ABC method is increasingly being abandoned, only four out of 141 organizations previously used ABC but no longer use it according to the survey. In addition, the survey revealed that around sixteen percent companies considered ABC but chose not to implement it. The main concerns of managers of those companies regarding which cost-measurement system to choose were that they were not sure if it was a better way to allocate cost, if it accurately reflected how resources were used, if the information was timely, and if updating the system was difficult. Having said about the disadvantages and...
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...Chapter 8 Activity-based costing Problems with conventional product costing systems General features of conventional product costing systems Direct material and direct labour costs are traced to products Manufacturing overhead costs are allocated to products using a predetermined overhead rate Manufacturing overhead rate is calculated using some measure of production volume Non-manufacturing costs are not assigned to products Problems with conventional product costing systems Failure to adapt to the changing business environment Increasing levels of non-volume-driven manufacturing overhead costs Increasing proportion of non-manufacturing costs Causes of changes in costs Changing product structures and increased product diversity 5 Indicators of problems with a product costing system Product costing systems are likely to result in inaccurate product costs when … Proportion of direct labour costs decreases Proportion of manufacturing overhead costs increases Proportion of manufacturing overhead costs, not related directly to production volume, increases Non-manufacturing costs that are product-related become substantial Product diversity increases Problems with costing in service businesses Service firms...
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...INTRODUCTION TO COST MANAGEMENT Activity-Based Costing and Management After studying this chapter, you should be able to . . . 1. Explain the strategic role of activity-based costing 2. Describe activity-based costing (ABC), the steps in developing an ABC system, and the benefits and limitations of an ABC system 3. Determine product costs under both the volume-based method and the activity-based method and contrast the two 4. Explain activity-based management (ABM) PART I 5. Describe how ABC/M is used in manufacturing companies, service companies, and governmental organizations 6. Use an activity-based approach to analyze customer profitability 7. Identify key factors for successful ABC/M implementation Beware of little expenses. A small leak will sink a great ship. Benjamin Franklin This chapter has a lot to do with implementing the spirit of Benjamin Franklin’s observation—in cost management terms—that it really does matter how accurately you calculate a cost. Why? Having accurate costs is important for a variety of reasons: a company might find that it has a difficult time determining which of its products is most profitable. Alternatively, it finds its sales increasing but profits declining and cannot understand why. Perhaps the company keeps losing competitive bids for products and services and does not understand why. In many cases, accurate cost information is the answer to these questions. Accurate cost information provides a competitive advantage...
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...Cooper was designed the activity based costing (ABC) method in 1988. It was felt that there was a need for more accurate and up-to-date information and a more proactive approach to planning and managing the costs. ABC is a process to identify the costs of all activities and allocating, applying, assigning or tracing costs to products. Activity based costing is a costing technique, tool, system, mechanism or approach. It may be used in addition to the current traditional system or used in place of it. This will enable the new system to be applied consistently so that the opportunity to revert to old ways is limited. Activity based costing is aims to cost the products independent of output volume and to apply overheads on the basis of causes and effect. Besides that, it is also aim to trace all the costs to products. The underlying assumption of ABC is that a product causes activities, activities cause costs and therefore activity is related to product costs. In other words, since activities consume assigned resources and products consume activities, the costs of products are the cost of resources. Its main focus is on the relationship between activity, cost driver, cost, cost pool and cost object. Traditional cost accounting is inadequate so that become activity based costing more relevant. Activity based costing gained support because of the limitations of traditional cost accounting. It is focuses on departments, cost centres or divisions and not an activity. For example, the production...
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...|The ratio of adopting ABC | | |system |use of data of different |How do firms consider ABC system | |Activity based costing in |Earlier experience of ABC system |survey |CIMA research on ABC system | |manufacturing: |ABC implementation case studies |Journals |Detail case study of two | |two case studies |comparison & conventional costing |articles |companies | | |system |Different case studies | | |Year 1998 | | | | |Page 137-147 | | | | |2. "Activity-Based Costing." |The structure of ABC and its pit |Study of research magazine & |Potential pitfalls of activity | |Encyclopedia of Small Business. Ed. |falls |article |based costing. | |Kevin Hillstrom and Laurie Collier | | | | |Hillstrom. Gale...
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...Nowadays, global competition is driving the business towards restoration in order to strengthen their position in the global economy. The attention focuses on product quality, processes for the production, and improving workforce. However, many companies are still using the same traditional costing systems, Cooper and Kaplan (1991).The absorption costing paved way due to the lack of visibility for indirect costs so the ABC has been adopted by many organizations rapidly. According to Krajnc et al. (2011), the main difference of ABC to absorption costing lies on how they treat indirect production costs (overheads) and sales. The fundamental goal of ABC is to identify as much as possible direct relationships between products and resources consumed through activities conducted from production to disposal. The ABC system is based on the assumption that the support activities such as activities and sales, the cost of which traditional systems characterized as overheads, offer opportunities for the implementation of activities, and thus are not just for sharing costs. In an absorption costing when the volume of overheads is larger, the likelihood of distortions in reported costs is also greater. In general, overheads that exceed 15 percent of the total cost can cause inaccuracies, Turney (1996). Many companies had major problems by these inaccuracies and so they started using ABC. The traditional approach to cost allocation consists of three steps: Concentration of costs in the productive...
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...Characteristics of an organization contributing to the use of activity based techniques Activity Based Costing (ABC) is a costing methodology used to trace overhead costs directly to cost objects, i.e. products, processes, services, or customers. Costs are assigned to specific activities (e.g. engineering, manufacturing or purchasing) based on their use of resources and costs are assigned to cost objects based on their use of activities. ABC recognizes the causal relationship of cost drivers to activities. ABC techniques enable a business to decide which products, services, and resources are increasing their profitability, and which are contributing to losses. Certain organizations appear to be more successful in implementing ABC than others. ABC helps the managers in these organizations to make the right decisions regarding product mix, pricing, process improvements and product designs. Closer look reveals characteristics of an organization such as structure, product range or environment contributing to these successes. Cost Structure Where overhead costs comprises major portion of product costs as compared to direct costs such as direct labour and direct materials, correctly attributes overhead costs to product is highly important. In modern business, service departments plays a more and more important role than in the past in which production department is mainly responsible for key manufacturing activities. Overall product and service costs are more influenced by...
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...ACTIVITY-BASED COSTING McGraw-Hill/Irwin Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. ACTIVITY BASED COSTING Traditional costing system 1. Direct and indirect costs are allocated to process centres or major departments ABC System 1. The direct and indirect costs are allocated to activities like Purchases, Material handling, Producing the goods, machine set ups, Supervising production workers, Inspecting finished goods, Dispatching good to customers 2.Cost driver as base for allocation of overheads is based on cause and effect relationship between overheads and the overhead allocation base (the cost driver) Stores deptt – Labour hours or machine hours or units produced 3. There are many allocation bases as per activity chosen and cause and effect base relationship 1-2 2. Cost driver as base for allocation of overheads is not based on cause and effect relationship 3. There is only one cost driver Or OH allocation Traditional, Volume-Based Product-Costing System • Aerotech produces three complex printed circuit boards referred to as Mode I, Mode II, and Mode III. • The following information is obtained from company records: Mode I Production: Units Runs 10,000 1 run of 10,000 units Mode II 20,000 4 runs of 5,000 units Mode III 4,000 10 runs of 400 units 1-3 Traditional, Volume-Based Product-Costing System Additional information includes: Direct materials Direct labor Mode I Mode II Mode III $ 50.00 $ 90.00 $ 20...
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...DBS Consulting Services, using the Activity-Based Costing system (ABC) and the conventional costing system based on computing hours. ABC provides more detailed and accurate information than the conventional costing system because ABC is based on consumption of resources by production of a product or service line and focuses on the activities that drive costs, recognising that activities consume resources. The conventional method allocates overhead costs based on hours consumed (in this case computing hours), which may not represent the actual consumption of indirect resources expended by the service. A costing system should provide information to help minimise waste, but should not be wasteful in it-self . The resources required to design, implement and maintain a costing system should be less than the benefit derived from the use of the system. This report is to compare the conventional costing system against an ABC System for DBS Consulting Services and will discuss the following: 1. ABC improving costing accuracy 2. Profitability of DBS Consulting Service using conventional costing procedures and ABC 3. Recommendation of the adoption of ABC based the results conventional costing and ABC 4. Aggressive expansion? 5. Factors to be taken into account when implementing ABC 6. How to encourage positive reactions. 1. ABC IMPROVING COSTING ACCURACY ABC is said to improve costing accuracy when compared with conventional costing procedures. ABC is a managerial accounting...
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...CHAPTER 5 ACTIVITY-BASED COSTING AND ACTIVITY-BASED MANAGEMENT TRUE/FALSE 1. Companies that undercost products will most likely lose market share. 2. When refining a costing system, a company should classify as many costs as possible as indirect costs. 3. Indirect labor and distribution costs would most likely be in the same activity-cost pool. 4. Activity-based costing helps identify various activities that explain why costs are incurred. 5. Traditional systems are likely to undercost complex products with lower production volume. 6. For activity-based cost systems, activity costs are assigned to products in the proportion of the demand they place on activity resources. 7. Misleading cost numbers are larger when unit-level assignments and the alternative activity-cost-driver assignments are proportionately similar to each other. 8. Information derived from an ABC analysis might be used to eliminate nonvalue-added activities. 9. Department-costing systems are a further refinement of ABC systems. 10. Simply because activity-based costing systems employ more activity-cost drivers, they provide more accurate product costs than traditional systems. MULTIPLE CHOICE 11. Overcosting of a product is MOST likely to result from: a. misallocating direct labor costs b. overpricing the product c. undercosting another product d. understating total product costs 12. The use of a single indirect-cost rate is...
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... Discuss the limitations of using only unit-based drivers to assign costs. 2. Provide a detailed description of activity-based product costing. 3. Describe how homogeneous cost pools can be used to reduce the number of activity rates. 4. Describe activity-based system concepts including an ABC relational database and ABC software. chapter summary This chapter explains how activity-based costing systems produce more accurate product cost information than traditional costing systems that use unit-based drivers. Potential users of ABC systems are those companies that produce multiple products, have high degree of product diversity, and have a significant percentage of nonunit-level overhead costs. This chapter also outlines the essential steps in designing an ABC system in order for it to be implemented successfully. The chapter concludes by describing an ABC relational database and ABC software. Learning Objective #1 CHAPTER REVIEW I. Unit-Based Product Costing A. Functional-based costing uses only unit-based drivers to assign overhead costs to products. a. Functional-based costing first assigns overhead costs to a functional unit, creating plant or departmental cost pools. Next, these pooled costs are assigned to products using only unit-based drivers. b. Unit-based drivers are factors that cause changes in cost as the units produced change. n Functional-based costing uses only unit-based drivers because it assumes that overhead...
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...Introduction to Activity Based Costing (ABC) University of Pittsburgh Pittsburgh, PA Introduction to Activity Based Costing (ABC) Internet ABC Online Presentation This page and this presentation are created by Narcyz Roztocki. Click here to start Table of Contents Activity Based Costing (ABC) A typical situation in a small manufacturing firm Common beliefs Reality Why is a new cost management system needed? Why is the knowledge of the “true” cost of a product so important ? http://www.pitt.edu/~roztocki/abc/abctutor/index.htm (1 of 4)1/28/2005 5:20:20 AM Introduction to Activity Based Costing (ABC) Why is the knowledge of the “true” cost of a product so important ? (cont) Major factors for determination of market price Ways to determine object cost Total cost for a cost object Traditional Cost Accounting (TCA) TCA in a company TCA in a company (cont) Activity Based Costing (ABC) ABC Basic Premise When to use ABC ABC Steps ABC Illustration 1. Identify activities ABC Illustration 2. Determine activity cost ABC Illustration 3. Determine cost drivers ABC Illustration 4. Activity data ABC Illustration 5. Product cost calculation Product cost TCA vs. ABC Summary of ABC approach http://www.pitt.edu/~roztocki/abc/abctutor/index.htm (2 of 4)1/28/2005 5:20:20 AM Introduction to Activity Based Costing (ABC) If you want to improve the operation or quality of your business, or just learn more about ABC, Economic Value Added and...
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.... | Activity Based Costing | | | | | . | Executive Summary The success of any business that offers a product or service is greatly dependent on the ability of the products it offers to compete in a market. If a firm can determine its costs and the demand at each possible price offering it is likely to find the market price that maximizes profit. (Bakken, 2012). Hence, it is important that companies employ strategies that will ensure that cost allocation is accurate and gives management an accurate view of production cost. Having a full picture of every production step and their respective cost can help management make better pricing and sells decisions. This paper is aimed at exploring the process of cost allocation, specifically, the Activity Based Costing System (ABC). It examines how the ABC system diverges from the previous traditional accounting system. It highlights the advantages and disadvantages of the ABC model, and presents an alternate approach that tries to fix the loop holes that exist in the ABC system. This paper shows that the analysis of costs and resources used in the production of goods and services is the most important tool needed in determining business performance (Veres, 2011). Cost Allocation: Purpose and Process When a firm produces more than one product or provides more than one type of service, a resource may be shared. This shared resource places a financial burden on the firm. Cost allocation is the process...
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...Managerial & Cost Accounting ACCT610 Activity-Based Management Made Possible By Activity-Based Costing Supervised by Professor Majboor Alnamri Prepared by: EMBA Student 1 KAAU - EMBA Overview • • • • • • Over/Under Costing Methods of Allocating Indirect Cost Refining a cost system Costs/Benefits of ABC ABC in service & retail Example from an Organization 2 KAAU - EMBA Over Costing & Under Costing Over Costing—a product consumes a low level of resources but is allocated high costs per unit. Under Costing—a product consumes a high level of resources but is allocated low costs per unit. KAAU - EMBA 3 KAAU - EMBA Activity-Based Costing Identifies activities required to produce the product or service Determines the cost of the activities Allocates costs to the cost object based on the object’s consumption of activities 4 KAAU - EMBA Methods of Allocating Indirect Cost Cause-and-effect Using this criterion, managers identify the variable or variables that cause resources to be consumed Benefits-received Using this criterion, managers identify the beneficiaries of the outputs of the cost object 5 KAAU - EMBA Methods of Allocating Indirect Cost Fairness or equity This criterion is often cited on government contracts when cost allocations are the basis for establishing a price satisfactory to the government and its suppliers. Ability to bear This criterion advocates allocating costs in proportion...
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...Activity-based costing, or ABC, is a method of assigning costs to products or services based on the resources that they consume. this is a more logical manner than the traditional approach of simply allocating costs on the basis of machine hours. Activity based costing first assigns costs to the activities that are the real cause of the overhead. It then assigns the cost of those activities only to the products that are actually demanding the activities. Activity-based costing became popular in the early 1980s largely because of growing dissatisfaction with traditional ways of allocating costs. After a strong start, however, it fell into a period of discredit. Even Robert Kaplan, a Harvard Business School professor sometimes credited with being its founding father, has admitted that it stagnated in the 1990s. The difficulty lay in translating the theory into action. Many companies were not prepared to give up their traditional cost-control mechanisms in favour of ABC. ABC is linked to Lean Practices because you are able to trace each cost of production or service to its root, which enables management to make improvements by being able to see how much is going to each and every part of the process or service. This allows you to see if you are spending too much in one area, or possibly too little. activity based costing can give management a larger view of the costs of process or service. activity analysis can highlight waste and have been used for straightforward cost reduction...
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