Cost accounting

1. Copyright © 2003 Pearson Education Canada Inc. Slide 5-54
Chapter 5
Activity-Based Costing and
Activity-Based Management

2. Copyright © 2003 Pearson Education Canada Inc. Slide 5-55
Traditional (Peanut Butter) Costing
Peanut Butter Costing Approaches
• a traditional costing approach which uses broad
averages to spread costs among products and
services even though the resources are are
consumed in a non-uniform way
• leads to overcosting and undercosting of
products and services
Pages 148 - 149
Product cost cross-subsidization
• if some products are overcosted, other products
are undercosted
• the overcosted products are subsidizing the
undercosted products

3. Copyright © 2003 Pearson Education Canada Inc. Slide 5-56
Refining a Costing System
• Three things to consider to improve an existing
costing system
1. Direct-cost tracing
• reduce the amount of indirect costs by
classifying more costs as direct
2. Indirect-cost pools
• expand the number of indirect-cost pools until
the costs in each pool are homogeneous
3. Cost-allocation bases
• consider using a different cost-allocation base
for each indirect-cost pool
• based on what causes the cost pool to change
Page 152

4. Copyright © 2003 Pearson Education Canada Inc. Slide 5-57
Activity-Based Costing (ABC)
• refinement of an existing cost system which focuses
on individual activities as the basic cost objects
• an activity is an event, task, or unit of work with a
specified purpose
• examples of activities include designing the product
or service, set up of machinery, operating machinery,
distribution of finished product, administration
Fundamental
Cost Object
Allocations to
Other Cost Objects
Cost of
• Product
• Service
• Customer
Pages 152 - 153
Costs of
Activities
Activities

5. Copyright © 2003 Pearson Education Canada Inc. Slide 5-58
Cost Hierarchies
• when thinking about splitting indirect costs into
homogeneous cost pools considering four cost
hierarchies or cost categories
1. Output unit-level costs: costs relating to individual
units of output such as materials
2. Batch-level costs: costs relating to batches of output
such as set-up charges
3. Product-sustaining costs: costs relating to the support
of a particular product such as product design costs
4. Facility-sustaining costs: costs relating to the
organization as a whole
Pages 155 - 156

6. Copyright © 2003 Pearson Education Canada Inc. Slide 5-59
Traditional versus ABC Costing
Traditional Costing
System
Pages 156 - 160
Indirect Costs / DLHs
= $2,000,000 / 40,000
= $50 per DLH
Total Indirect Costs
Simple
Lens
Complex
Lens
Direct Costs
ABC Costing System
Indirect Cost
Pool A
Simple
Lens
Complex
Lens
Direct Costs
Pool A
Indirect Costs / DLHs
= $500,000 / 40,000
= $12.50 per DLH
Pool B
Indirect Costs / MHs
= $1,500,000 / 10,000
= $150 per MH
Indirect Cost
Pool B

7. Copyright © 2003 Pearson Education Canada Inc. Slide 5-60
Benefits of ABC Systems
• Promotes the use of activity-based management
(ABM) within the organization
• ABM focuses management’s attention on the activities
that cause costs to be incurred
• results in
• better product and pricing decisions
• reduced costs
• performing activities more efficiently
• eliminating activities that do not add value
• improving product design
• eventually leads to improved operations and
processes, satisfied customers, and increased profits
Pages 151 -152

8. Copyright © 2003 Pearson Education Canada Inc. Slide 5-61
“Tell-Tale” Signs of Need to Consider ABC
1. Significant amounts of costs are allocated using
one or two cost pools
2. All or most of the costs are identified as output
unit-level costs
3. Products make diverse demands on resources
4. Main products show little profit while secondary
products show large profits
5. Complex products appear to be profitable while
simple products appear to be losing money
6. Operations and accounting staff disagree about the
costs of manufacturing and marketing products
Pages 154 -155

9. Copyright © 2003 Pearson Education Canada Inc. Slide 5-62
Growing Interest in Activity-Based Costing
Factor %
More accurate cost information for product pricing 61
More accurate profit analysis 61
By product 22
By customer 20
By process 24
By department 43
Improved performance measures 43
Improved insight into cost causation 37
Source: Armitage, H., and R. Nicholson, “Activity-Based Costing: A
Survey of Canadian Practices”, supplement to CMA Magazine (1993)
Page 163