Cost Accounting Traditions and Innovations Barfield, Raiborn, Kinney

1. Chapter 4
Activity-Based Cost Systems
for Management
Cost Accounting
Traditions and Innovations
Barfield, Raiborn, Kinney

2. Learning Objectives (1 of 2)
• Identify the focus of activity-based
management
• Explain why non-value-added activities
cause costs to increase unnecessarily
• Explain why cost drivers are designated in
activity-based costing
• Contrast activity-based costing to the
traditional cost accounting system

3. Learning Objectives (2 of 2)
• Describe how activity-based costing
systems affect behavior
• Describe attribute-based costing and explain
how it extends activity-based costing

4. Activity-Based Management
• Focuses on activities during production and
performance process
• Improves the value received by customers
• Improves profitability

5. Activity-Based Management
Activity analysis
Cost driver analysis
Activity-based costing
Continuous improvement
Operational control
Performance evaluation
Business process
reengineering

6. Activity Analysis
Value-added activity
• Increases worth of
product or service to a
customer
• Customer is willing to
pay for
Non-value-added activity
• Increases time spent on
product or service but
does not increase worth
• Unnecessary from
customer perspective
• Some can be eliminated
without affecting market
value or quality
• Business-value-added
activities are essential
ABM

7. Activity Analysis
• Create a Process Map for each process
– Identify each step
• Create Value Chart
– Identify stages and time spent in stages
Value-Added
Processing Time
Service Time
Non-Value-Added
Inspection Time
Transfer Time
Idle Time

8. Cycle Time
Cycle Value- Non-
Time = Added + Value-Added
Activities Activities

9. Manufacturing Cycle Efficiency
• 100% efficiency unrealistic
• Reducing non-value-added activities will
increase Manufacturing Cycle Efficiency
• Value-added activity usually represents
about 10% of total cycle time
Value-Added
Processing Time
Total Cycle Time
Manufacturing
Cycle
Efficiency
=

10. Non-Value-Added Activities
• Attributed to following factors
– Systemic
– Physical
– Human
• Eliminate non-value-added activities that
create the most costs

11. Cost Driver Analysis
• Cost drivers are factors that have a direct
cause-effect relationship to a cost
– Limit number of cost drivers
– Cost of measurement should not exceed benefit
of using the cost driver
– Easy to understand
– Directly related to activity being performed
– Appropriate for measurement
ABM

12. Cost Driver Analysis
• Unit-level costs
– direct material, direct labor
• Batch-level costs
– setup, inspection
• Product/process-level costs
– engineering changes, product development
• Organizational or facility costs
– building depreciation, plant manager’s salary

13. Product Cost
Batch-Level
Costs
Cost per unit
in batch
Allocate over number
of units in batch
Product/Process-
Level Costs
Allocate over number
of units produced in
related product line
Cost per unit
in product line
Cost per unit
Unit-Level
Costs
Allocate over number
of units produced

14. Product and Company
Profitability
Total product revenue
<Total product cost>
Net product margin
<Organizational/facility-level costs>
Company profit or loss
For each
product line
Not
GAAP

15. Activity-Based Costing
• Recognizes several levels of costs
• Accumulates costs into related cost pools
• Uses multiple cost drivers to assign costs to
products and services
ABM

16. Use ABC When ….
• Wide variety of products or services
• High overhead costs not proportional to the
unit volume of individual products
• Automation makes it difficult to assign
overhead to products using direct labor or
machine hours
• Profit margins are difficult to explain
• Hard-to-make products show big profits and
easy-to-make products show losses

17. Two-Step Allocation
• Collect costs in general ledger and
subsidiary accounts
• Identify activity centers
• Accumulate costs into activity center cost
pools
– cost driver
• Allocate costs to products and services
– activity driver

18. Choosing an Activity Center
• Geographical proximity of equipment
• Centers of managerial responsibility
• Magnitude of product costs
• Manageable number of activity centers

19. Activity-Based Costing
• Important assumptions about activity center
cost pools
• Costs in each cost pool are
– Driven by homogenous activities, and
– Strictly proportional to the activity

20. Activity-Based Costing
Record
Costs in GL
Accumulate in
Activity Center
Cost Pool
Cost
Driver
Activity
Driver
Cost
Objects

21. Traditional vs. ABC Costing
• When ABC implemented
– Cost reduced for high volume, standard
products
– Cost increased for low-volume, complex
specialty products

22. Long-Term Variable Costs
• Cost drivers
– Product variety
– Product complexity

23. Attribute-Based Costing (ABC II)
• Identify customer needs
– reliability
– durability
– responsiveness
• Calculate cost of incremental improvements
to obtain these attributes
• Uses planned costs
• Focuses on development stage of product
life cycle

24. When to Use ABC
• Product Variety and Process Complexity
– Caused by mass customization
• too many choices, opportunity for errors
• Pareto principle
– Reduced by
• Simultaneous engineering

25. When to Use ABC
• Lack of Commonality in Overhead Costs
– Some products/services use substantially more
overhead than others
• Problems with Current Cost Allocations
– Significant changes in process with no change
in cost allocations
• Changes in Business Environment
– Increase in competition

26. Criticisms of ABC
• Significant amount of time and cost to
implement
• Must overcome barriers to change
• Does not conform to GAAP
• Does not promote total quality management

27. Questions
• What are the differences between activity-
based costing and traditional cost
accounting?
• What are cost drivers?
• How does attribute-based costing extend
activity-based costing?