Chapter 5 - Pearson Canada

Chapter 5
Activity-Based Costing and
Activity-Based Management
Copyright © 2003 Pearson Education Canada Inc.
Slide 5-54
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
Product cost cross-subsidization
• if some products are overcosted, other products
are undercosted
• the overcosted products are subsidizing the
undercosted products
Copyright © 2003 Pearson Education Canada Inc.
Pages 148 - 149
Slide 5-55
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
Copyright © 2003 Pearson Education Canada Inc.
Page 152
Slide 5-56
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
Cost Object
Copyright © 2003 Pearson Education Canada Inc.
Allocations to
Other Cost Objects
Costs of
Cost of
• Product
• Service
• Customer
Pages 152 - 153
Slide 5-57
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
Copyright © 2003 Pearson Education Canada Inc.
Pages 155 - 156
Slide 5-58
Traditional versus ABC Costing
Traditional Costing
Indirect Costs / DLHs
= $2,000,000 / 40,000
= $50 per DLH
Total Indirect Costs
Direct Costs
Copyright © 2003 Pearson Education Canada Inc.
ABC Costing System
Pool A
Indirect Costs / DLHs
= $500,000 / 40,000
= $12.50 per DLH
Indirect Cost
Pool A
Pool B
Indirect Costs / MHs
= $1,500,000 / 10,000
= $150 per MH
Indirect Cost
Pool B
Direct Costs
Pages 156 - 160
Slide 5-59
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
Copyright © 2003 Pearson Education Canada Inc.
Pages 151 -152
Slide 5-60
“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
Copyright © 2003 Pearson Education Canada Inc.
Pages 154 -155
Slide 5-61
Growing Interest in Activity-Based Costing
More accurate cost information for product pricing
More accurate profit analysis
By product
By customer
By process
By department
Improved performance measures
Improved insight into cost causation
Source: Armitage, H., and R. Nicholson, “Activity-Based Costing: A
Survey of Canadian Practices”, supplement to CMA Magazine (1993)
Copyright © 2003 Pearson Education Canada Inc.
Page 163
Slide 5-62