Chapter 1 Activity-based costing and activity-based management

P2 ¨C Advanced Management Accounting

CH1 ¨C ABC and ABM

Chapter 1

Activity-based costing and

activity-based management

Chapter learning objectives:

Lead

Component

A.1 Evaluate

techniques for

analysing and

managing costs for

competitive

advantage.

(a) Evaluate activitybased management.

Indicative syllabus content

?

Activity-based costing to derive ¡®long-run¡¯

costs appropriate for use in decision

making.

?

Activity-based management and its use in

improving the efficiency of repetitive

overhead activities.

?

Direct and activity-based cost methods for

tracing costs to ¡®cost objects¡¯, such as

customers or distribution channels, and the

comparison of such costs with appropriate

revenues to establish ¡®tiered¡¯ contribution

levels, as in the activity-based cost

hierarchy.

?

Direct customer profitability and

distribution channel profitability.

Page 1

P2 ¨C Advanced Management Accounting

1.

CH1 ¨C ABC and ABM

Activity-based costing

?

In the late 1980s, Cooper and Kaplan developed a new approach (activity-based

costing) that assigns overheads to products to determine the product cost.

?

They claimed that ABC provides product-cost information that is useful for decisionmaking purposes.

Activity-based costing is an approach to the costing and monitoring of activities which

involves tracing resource consumption and costing final outputs. Resources are assigned

to activities and activities to cost objects based on consumption estimates. The latter

utilise cost drivers to attach activity costs to outputs.

(CIMA Terminology)

A look at traditional systems

?

Traditional systems accurately measure volume-related resources that are consumed

in proportion to the number of units produced of the individual product.

?

Such resources include material, direct labour, energy and machine-related resources.

?

But many organisational resources exist for activities that are not related to physical

volume. Non-volume-related activities include supporting activities:

Page 2

P2 ¨C Advanced Management Accounting

CH1 ¨C ABC and ABM

o Material handling

o Material procurement

o Set-ups

o Production scheduling

o First-time inspection activities

Traditional product cost systems that assume that the products consume all activities in

proportion to their production volumes thus reported distorted product costs.

?

In contrast to traditional cost-accounting systems, ABC systems first accumulate

overhead costs for each organisational activity and then assign the costs of the

activities to the products, services or customers (cost objects) causing that activity.

?

The most critical aspect of ABC is activity analysis. This is the process of identifying

appropriate output measures for activities and resources (cost drivers) and their

effects on the costs of making a product or providing a service.

?

Activity analysis provides a foundation for remedying the distortions inherent in

traditional cost-accounting systems.

2. The ABC process

Cooper and Kaplan developed a simple three-step process on the basis that it is the

supporting activities that cause many overheads.

?

Support activities cause costs.

?

Products consume cost activities.

?

Costs should be charged to products on the basis of consumption of activities.

ABC method

?

Identify the organisation¡¯s major activities.

?

Estimate the cost associated with performing each activity. These costs are collected

in the cost pool.

?

Identify the cost drivers that affect the cost pool ¨C the number of set-ups will affect the

cost of setting up the machinery.

?

Calculate the cost driver rate, for example:

- A rate per set-up

- Rate per material requisition

- Rate per inspection

???? ????

Formula = ????? ?? ???? ???????

Page 3

P2 ¨C Advanced Management Accounting

?

CH1 ¨C ABC and ABM

Charge the overheads to the products by applying the rates of the cost drivers to the

activity usage of the product.

3. Activity-based cost hierarchy

?

In 1991, Cooper and Kaplan proposed a cost hierarchy framework that maintains that

costs are driven by and variable with respect to activities that occur at four levels.

Unit-level activities

?

Performed each time a unit is produced.

?

Consumed in direct proportion to the number of units produced.

?

These include:

o Direct material

o Direct labour

o Energy costs

o Machine maintenance

Batch-level activities

?

Performed each time a batch is produced.

?

Cost of batch-related activities varies with the number of batches made.

?

But cost is common or fixed for all of the units in the batch.

Product-sustaining activities

?

Performed to support different products in the product line.

?

Performed to enable different products to be produced and sold.

Page 4

P2 ¨C Advanced Management Accounting

CH1 ¨C ABC and ABM

Resources consumed are independent of how many units and batches are being

produced.

?

Facility-sustaining activities

?

Costs that cannot be associated with a particular product line.

?

Related to maintaining the building and the facilities, including:

o Maintenance of the building

o Plant security

o Business rates

ABC has predominantly been used to support strategic decisions such as pricing,

outsourcing, and identification and measurement of process improvement initiatives

because:

?

It helps to identify inefficient products, departments and activities.

?

It helps to allocate more resources to profitable products, departments and activities.

?

It helps to control the costs at an individual level and on a departmental level.

?

It helps to find unnecessary costs.

?

It helps to fix the price of a product or service scientifically.

4. Benefits and limitations of ABC

Benefits

Limitations

?

Provides more accurate product line costing in the

instance of significant non-volume-related overheads

and a diverse product line

?

A lack of evidence to date

that ABC improves

corporate profitability

?

Flexible enough to analyse costs by cost objects other

than products

?

?

Provides a reliable indication of long-run variable

product cost that is particularly relevant to managerial

decision-making at the strategic level

Deals with historic

information that is internally

oriented, and hence lacks

direct relevance to future

strategic decisions

?

Provides meaningful financial and non-financial

measures relevant to cost management and

performance assessment at the operational level

?

Lacks practicality and gives

rise to problems such as

cost driver selection

?

Aids identification and understanding of cost behaviour

and thus has the potential to improve cost estimation

?

Provides a logical, acceptable and comprehensible

basis for costing work

Could be viewed as simply

a rigorous application of

conventional costing

procedures

Page 5

 ................
................

In order to avoid copyright disputes, this page is only a partial summary.

Google Online Preview   Download