Chapter 7

Costing method designed to provide managers w/ cost info for decisions that potentially affect capacity - Fixed and variable costs.

Supplement for company's usual costing system.

Internal users. Managers, etc.

1. Both manufacturing and nonmanufacturing costs may be assigned to products - only on cause and effect basis.

2. Some manufacturing costs may be excluded from product costs.

3. Many cost pools used, allocating costs to products w/ its own activity measure.

Manufacturing and nonmanufacturing.

Direct costs are traced.

Indirect costs are allocated when products have presumably caused costs to be incurred.

Organization-sustaining costs (ex: factory guard, secretary's supplies, etc).

Capacity not used - Only used capacity costs are assigned.

Simple. Plant-wide overhead cost pool.

Usually DLH and Machine Hours

Event that causes consumption of overhead resources.

Bucket in which costs are accumulated that relate to an activy measure.

Allocation base in an ABC system.

Cost driver.

Counts of the number of times an activity occurs (Ex: # bills sent to customers)

Measures amount of time required to perform an activity.

More accurate measures, but more effort to record.

1. Unit-level

2. Batch-level

3. Product-level

4. Customer-level

5. Organization-sustaining

Performed each time a unit is produced.

Performed each time a batch is handled or processed, regardless of how many units are in batch.

Relate to specific products and typically must be carried out regardless of how many batches are run or units of product are produced or sold.

Relate to specific customers and include activities such as sales calls, catalog mailings, and general technical support not tied to any specific product.

Carried out regardless of which customers are served, which products are produced, how man batches are run, or how many units are made.

1. Top managers must support it.

2. Should be tied to how people are evaluated and awarded.

3. Cross-functional team should be created to design and implement ABC system.

1. Define activities, activity cost pools, and activity measures.

2. Assign overhead costs to activity cost pools.

3. Calculate activity rates.

4. Assign overhead costs to cost objects using activity rates and activity measures.

5. Prepare management reports.

Interview people who work in OH depts and ask for list of major activities.

Shorten it to handful of activities by combining similar ones.

First stage allocation.

Process of assigning functionally organized overhead costs derived from a company's general ledger to the activity cost pools.

Activity rates computed by dividing the total cost for each activity by its total activity.

Second-stage allocation

Activity rates are used to apply overhead costs to products and customers.

Product and customer profitability reports.

Help companies channel resources to their most profitable growth opportunities while highlighting products and customers that drain profits.

1. Traditional allocates all MOH to products. Does not assign OH costs included in org. sustaining and used capacity costs not caused by any particular product.

2. Traditional allocates all of MOH costs using volume-related allocation base that may not reflect what actually causes costs.

3. ABC system assigns nonmanufacturing overhead costs caused by products to those products on a cause-and-effect basis.

Provides more detail about costs and how they might adjust to changes in activity.

Involves focusing on activities to eliminate waste, decrease processing time, and reduce defects.

Systematic approach to identifying activities w/ greatest room for improvements.

1. External reports are less detailed.

2. Often difficult to make changes in company's accounting system.

3. ABC does not conform w/ GAAP

4. Auditors would be uncomfortable w/ allocations that are based on interviews w/ co's personnel.

1. Requires substantial resources.

2. More costly to maintain.

3. Benefits may not outweigh costs.