Training Presentation: Activity-Based Costing

By David Fukuda

What Will Be Covered

ABC Defined Nuts and Bolts How It Works A Real World Example Summary

ABC Defined
History
Traditional costing Engineering Decisions Pricing Product Mix

ABC Defined-Continued
Activity-based costing focuses on work activities and facilitates decision-making processes by managers.

ABC Defined-Continued
Transition to ABC
Cost Structure Product Diversity

Brainstorming
Develop a list of major costs that exist within your firm. Develop a list of activities that make up these costs.

BrainstormingContinued
Discuss how managers maybe able to improve their decisionmaking abilities by viewing these major costs as activities.

Nuts & Bolts

Goal: Use traditional costing information to provide more focused data for improved decision support. Costs must be assigned to the appropriate categories.

Nuts & Bolts-Continued

Unit-Level Costs
Examples: equipment depreciation, repairs, maintenance, and energy costs.

Batch-Level Costs
Examples: machine set-up costs, placing, orders, receiving materials, and paying suppliers.

Nuts & Bolts-Continued

Product-Level Costs
Examples: design costs, engineering costs.

Facility-Level Costs
Examples: presidents salary, building security.

Nuts & Bolts-Continued

Cost Drivers-activities associated with incurred costs Cost Pools-combined costs affected by the same activities Cost Rates = total costs / # of activity units

How It Works
ABC requirements
Clear Goals Management Support Committed Resources Priority Appropriate Training

How It Works- Continued

Process
Group overhead costs into unit-, batch-, product-, and facility-level items. Identify cost drivers for each item. Items are placed into the appropriate cost pools.

How It Works-Continued
Process (continued)
Within each cost pool, cost rates per activity are determined. Calculated cost rates are multiplied by the number of product or service units consumed.

How It Works-Continued
The ABC process is:
Continuous Flexible Traceable Understandable Logical

How It Works-Continued
ABC data may result in activities being:
Favorably impacted Changed Improved Eliminated

A Real World Example: Farrall Inc.

Explanation
Manufacturer of filter materials Annual sales of $500 million Decides to implement an ABC system

Farrall, Inc.-Continued
Findings of ABC analysis
Activities varied with both unit production volume and work orders (batch production). Low volume custom products were costing the company.

Farrall, Inc.-Continued
Conclusion
Top customers were providing a tremendous share of the profits. Low volume customers were increasing product costs.

Exercise
ABC Cost Pools
Production ($50,000) Inspection ($25,000) Warehousing ($30,000) Purchasing ($95,000) Receiving ($40,000) Order Entry ($40,000)

Exercise-Continued
Match the cost with the appropriate ABC cost driver.
Production Inspection
Warehousing Purchasing Receiving Order Entry

Inspections Customer Orders

Purchase Orders Parts Planned Store Receipts Dock Receipts

Exercise-Continued
Calculate Cost Rates
Production $50,000 Inspection $25,000 $40 per part $5 per inspection $3 per receipt $10 per order $10 per receipt $40 per order Parts Planned 20,000 Inspections 5,000

Warehousing $30,000
Purchasing $95,000 Receiving $40,000 Order Entry $40,000

Store Receipts 10,000

Purchase Orders 9,500 Dock Receipts 4,000 Customer Orders 1,000

What areas should management focus on?

Summary
Focusing on the ABC method:
Considers all costs. Assigns costs to specific products or customers. Helps to identify businesssustaining and low-valued activities.

Summary-Continued
Activity-based costing provides management with an alternate way of viewing costs within an organization.

Readings List
Cokins, G. (2002). Activity-Based Costing: Optional or Required? Transactions of AACE International. Colson, R. and J. Lere. (March 2002). Selling Activity-Based Costing. CPA Journal. Vol. 72, Issue 3. Cortese-Danile, T. and C. Latshaw. (Winter 2002). Activity-Based Costing: Usage and Pitfalls. Review of Business. Vol. 23, Issue 1. Ittner, C., Lanen, W., & D. Larcker. (June 2002). The Association Between Activity-Based Costing and Manufacturing Performance. Journal of Accounting Research. Vol. 40, Issue 3.

Readings List-Continued
Naidoo, S. (May 2002). Voyage of Discovery. Financial Management. Peckenpaugh, J. (April 2002). Teaching the ABCs. Government Executive. Vol. 34, Issue 4. Taylor, J. (May/June 2002). Activity-Based Costing. AFP Exchange. Vol. 22, Issue 3.