Chapter 3 Activity-Based Management. 2 Activity-based Costing & Management (ABCM) (Slide 1 of 4) ABCM rests on this premise: –Products and services require/consume

Chapter 3

Activity-Based Management

2

Activity-based Costing & Management (ABCM)(Slide 1 of 4)

• ABCM rests on this premise:

– Products and services require/consume activities and activities consume resources

• To understand the cost of a product or service, one must:

– Identify activities required to make the product or provide the service

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Activity-based Costing & Management(ABCM)(Slide 2 of 4)

– Identify resources used to provide for those activities

– Determine the cost of those resources

• To be competitive, managers must know both:

– Activities involved in making the goods or providing the services, and

– The cost of those activities

4

Activity-based Costing & Management (ABCM) (Slide 3 of 4)

• ABCM has 2 parts: What are they?

– The costing part known as Activity-based Costing (ABC)

– The management part known as Activity-Based Management (ABM)

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Activity-based Costing & Management (ABCM) (Slide 4 of 4)

• ABC treats mostly indirect costs including:

– Overhead costs related to the manufacture of a product or providing a service

– Indirect costs of marketing a product

– Indirect costs of managing a company

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Discuss Strategic Uses of ABCM

• Managers use activity-based information in what 5 ways?

1. To add surcharges for particular customers

2. To “fire” some customers

3. To seek to serve more profitable customers

4. To raise or lower product prices

5. To drop products

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What are the 4 steps of activity analysis?

1. Chart the activities used to complete the product or service

2. Classify activities as value-added or non-value-added

3. Eliminate or reduce non-value-added activities

4. Continuously improve & reevaluate efficiency of activities or replace them with more efficient activities

8

Define Cost Pools

• Cost pools are groups of costs

• List three major types of cost pools:

– Plant (traditional)

– Department (traditional)

– Activity center (activity-based costing)

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Product Costing Allocation MethodsProduct Costing Allocation Methods

PPRROODDUUCCTTSS

Plantwide Overhead RatePlantwide Overhead Rate

Multiple Department RatesMultiple Department Rates

Activity-Based CostingActivity-Based Costing

Activity

Department

Activity

Department

Single Rate

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Discuss Traditional Allocation Methods

• Plantwide allocation

– Uses the entire plant as a cost pool

– This approach is best for simple organizations with only a few departments and little variety in activities

• Department allocation

– Uses separate cost pools with different overhead allocation rates for each department

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Discuss Activity-Based Costing

• Activity-based costing (ABC)

– Assigns costs first to activities

– Then to products or services based on the activities used to produce the product or provide the service

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Single Plantwide Factory Overhead RateSingle Plantwide Factory Overhead Rate

Total budgeted factory overhead costs

Total budgeted plantwide allocation base

= $80 per hour$1,600,000

20,000 direct labor hours

Snowmobile:$80 x 10 direct labor hours = $800

Lawnmower:$80 x 10 direct labor hours = $800

What are the advantages of the single plantwide overhead rate method?

What are the advantages of the single plantwide overhead rate method?

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Multiple Department Factory Overhead RateMultiple Department Factory Overhead Rate

Fabrication Department Overhead Rate:

= $103 per hour$1,030,000


Snowmobile:Fabrication: $103 x 8 dlh $824Assembly: $57 x 2 dlh 114 $938

Lawnmower:Fabrication: $103 x 2 dlh $206Assembly: $57 x 8 dlh 456 $662

Assembly Department Overhead Rate:

= $57 per hour$570,000


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Conditions for Product Cost DistortionConditions for Product Cost Distortion

Fabrication Fabrication DepartmentDepartment

$103 per directlabor hour


Assembly Assembly DepartmentDepartment

Condition 1:Different department overhead rates



Condition 2:Different ratios of allocation-base usage

Snowmobile8 direct 2 direct

labor hours labor hours

Snowmobile8 direct 2 direct


Lawnmower2 direct 8 direct


Lawnmower2 direct 8 direct


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What are the required steps of activity-based costing?

1. Identify activities that consume resources and assign costs to those activities

2. Identify cost drivers associated with each activity

– A cost driver is a factor that causes or “drives” an activity’s costs

3. Compute a cost rate for each cost driver4. Assign costs to products

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Cost Rates per Cost Driver Unit

• Calculate predetermined cost rate for each cost driver as follows:

Predetermined = Estimated indirect cost cost rate Est. volume of allocation base

Multiply predetermined cost driver rate times volume of cost drivers consumed

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Activity Amount Activity Rate

Fabrication $ 530,000 / 10,000 dlh = $53Assembly 70,000 / 10,000 dlh = $7Setup 480,000 / 120 setups = $4,000Quality control 312,000 / 104 insps. = $3,000Engineering 208,000 / 16 changes = $13,000 Total $1,600,000

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Snowmobile 8,000 $53 $424,000Lawnmower 2,000 53 106,000 Total 10,000 $530,000

Fabrication: DL Hours Rate Total


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Snowmobile 2,000 $7 $14,000Lawnmower 8,000 7 56,000 Total 10,000 $70,000

Assembly: DL Hours Rate Total



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Snowmobile 100 $4,000 $400,000Lawnmower 20 4,000 80,000 Total 120 $480,000

Setup: Setups Rate Total



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Quality Control: Insps. Rate Total



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Engineering: Changes Rate Total



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Activity Snowmobile Mower Total

Cost Allocation Summary:

Fabrication $ 424,000 $106,000 $ 530,000Assembly 14,000 56,000 70,000Setup 400,000 80,000 480,000Quality control 300,000 12,000 312,000Engineering 156,000 52,000 208,000 Total $1,294,000 $306,000 $1,600,000

Budgeted units 1,000 1,000 Cost per unit $1,294 $306

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Distortion in Product CostsDistortion in Product Costs

Single plantwide rate $ 800 $ 800Multiple department rates 938 662Activity-based costing 1,294 306

Snowmobile Lawnmower

Factory Overhead Cost per Unit:

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1. Post-sale technical support

2. Order writing

3. Promotional support

4. Order entry

5. Customer return processing

6. Shipping document preparation

7. Shipping and handling

8. Field service

Selling and administrative activities may include:

Selling and Administrative ActivitiesSelling and Administrative Activities

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Activity-Based Costing in Service BusinessesActivity-Based Costing in Service Businesses

PPAATTIIEENNTTSS

$200 per hour

Hopewell Hospital—Activity-Based Costing

$120 per specimen

$150 per day

$320 per image

$180 per admissionAdmittingAdmitting

RadiologicalRadiologicalTestingTesting

Operating Operating RoomRoom

PathologicalPathologicalTestingTesting

Dietary andDietary andLaundryLaundry

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Activity Costs Allocated to a PatientActivity Costs Allocated to a Patient

Activity-Base Activity ActivityActivity Usage Rate Cost

Admitting 1 admission $180 $ 180Radiology testing 2 images 320 640Operating room 4 hours 200 800Pathological testing 1 specimen 120 120Dietary and laundry 7 days 150 1,050 Total $2,790

Patient Name: Mary Wilson

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Cost Hierarchies

Activity Category• Capacity

• Customer

• Product

• Batch

• Unit

Examples• Plant Mgmt & Depr

• Mkt Research

• Product Specs & Testing

• Machine Setups

• Direct Materials

Documents

Chapter 3 Activity-Based Management. 2 Activity-based Costing & Management (ABCM) (Slide 1 of 4) ABCM rests on this premise: –Products and services require/consume