CHAPTER 5: ACTIVITY-BASED COSTING AND CUSTOMER PROFITABILITY ANALYSIS QUESTIONS
5-1Undercosting a product may appear to have increased the reported profit the product earned (assuming the firm did not lower its selling price because of the reported lower product cost). However, the increased profit is, at best, a twist in truth. Costs of the product not charged to the product itself are borne by other products of the firm. Worse, undercosting a product may result in managers erroneously believing the product to be more profitable than other products and shifting the limited resource the firm has into manufacturing, promotion, and sales of the product when, in fact, other products are more profitable to the firm. Severe cost distortions may lead firms not to drop unprofitable products because the cost data show these products are profitable. 5-2Overcosting does not increase revenues. A firm can increase the selling price of a product, thereby increasing the total revenue from the product only if the market allows. Increases in the selling price of a product without experiencing noticeable decrease in the sales quantity of the product is likely an indication that the product was not priced properly, which might be a result of undercosting of the product. Furthermore, overcosting a product is likely accompanied by undercosting of the firm’s other products and, as a result, underpricing of one or more of the firm’s other products. When a firm sets a high selling price that is a result of overcosting, competitors also are likely to enter the market and take away the firm’s market share. A firm also may drop or de-emphasize an erroneously overcosted product when it erroneously believes the product is either unprofitable or having a low-margin. 5-3Product costs are likely distorted when a firm uses a volume-based rate if the plant has more than one activity in its operations and not all activities consume overhead in the same proportion. The more diverse the product mixes of the plant are in volume, sizes, manufacturing processes, or product complexities, the greater the cost distortions are likely to be in using a volume-based rate. 5-4Activity-based costing recognizes that resources are spent on activities and the cost of a product or service is the sum of the costs of activities performed in manufacturing the product or providing the service. An activity-based costing system traces costs to the activity that consumes resources. Costs are determined based on the activities performed for cost objects and their underlying cost drivers that consume resources. Product or service costs determined using activity-based costing reflect costs of resources consumed for activities performed in manufacturing products or providing services. In contrast, a volume-based costing system uses cost allocations to channel indirect costs to products or services. As a result, the cost of a product or service often bears little or no relationship to activities performed in the manufacturing of the product or service. 5-5 Based on the activities of most manufacturing firms, the general levels of cost hierarchy of an activity-based costing system are: Unit-level cost;
Product-level cost; and
5-6 In an activity-based costing system, the second-stage procedure in tracing costs to products or services is a process by which the costs of activities or activity pools are assigned to cost objects using one or more appropriate activity consumption cost drivers. 5-7All firms should use an ABC system when the benefits of such a system exceed the costs of implementing it. It is especially beneficial to firms with product diversity and/or process complexity. 5-8Unit-level activities are activities performed on individual units of product or service. The frequency of a unit-level activity varies in proportion with the units of product manufactured or service provided. Examples of unit-level activities are using...
...ActivityBasedCostingAnalysis for Band-aid
Band-aid (BA) is a worldwide renowned wound care brand which has been produced in two manufacturing plants—Brazil and China. This analysis is for the factory in Shanghai, China, which mainly supports the sales in Japan, North America, Australia and China. On July, 2009, the operation team was asked to do the business plan for 2010, including the annual volume, the total production hours and the overall operation cost.
Based on the unique production process of Band-aid, there are seven work centers to go through from raw material and packaging material to the finish goods, including film coating, film slitting, strips making, cutting, sterilization, auto pack and manual pack. For each work center, the cost will be split into four types: Labor cost, Indirect overhead, direct overhead and machine depreciation. Here is the detail explanation.
Labor cost is the wages or salaries for the operator of each work center.
Direct overhead refers to the expense directly consumed by each work center, including the electricity, the gas, the petrol and the maintenance expense for each work center.
Indirect overhead stands for the cost which is not directly allocated to each production work center, including administration, personnel, training and other supporting expense.
Machine depreciation is the annual depreciation cost allocated for...
...Chapter 3 - Activity-BasedCosting
-Rather than use a plantwide overhead rate (POHR), many companies use departmental overhead rates with a different predetermined overhead rate in each production department. The nature of the work performed in a department will determine the department's allocation base
-Ex. Overhead costs in a machining department may be allocated on the basis of machine-hours. In contrast, the overhead costs in an assembly department may be allocated on the basis of direct labor-hours
-Like POHR can often overapply or underapply overhead, departmental overhead rates will not correctly assign overhead costs ins situations where a company has a range of products and complex overhead costs. The reason is that the departmental approach usually relies on a single measure of activity as the base for allocating overhead cost to products.
-Activitybasedcosting seeks to account for the departmental overhead rate's shortcomings. Activity-BasedCosting (ABC) is a technique that attempts to assign overhead costs more accurately to products than the simpler methods discussed thus far.
-Ex. If Nordstrom orders a line of women's skirts from Calvin Klein, a production order is generated, patterns are created, materials are ordered, textiles are cut to pattern and then sewn, and the finished products...
A Discussion on Activity-BasedCosting
ACC-532 Graduate Paper
A Discussion on Activity-BasedCosting
When we think of cost of accounting it is easy to come up with numerous different cost accounting methods which is because over the year’s cost accounting has developed in numerous ways to accommodate different types of situations. While every type of cost accounting is important and has its own benefit and disadvantages this paper will focus on what I believe is one of the most important cost accounting methods. The method that this research paper will focus on is the activity-basedcosting method, more commonly known as the ABC method. “A costing method that first assigns costs to activities and then to goods and services based on how much each good or service uses the activities” (Hilton, 2014), this is the definition of the ABC method according to the textbook Advanced Cost Accounting. While I believe that this definition gives us a good idea of the general idea of what the ABC method is it does not even begin to crack the surface of how important this costing method is and how essential it is to the companies that utilize it. In order to get a broad understanding of the ABC method this research paper will focus on three focus points. The first focus point...
The management of costs remains pertinent to the successful operation of any company. To achieve a competitive edge a company must consistently improve their service or product quality, lower their service or product costs, and eliminate services or products that incur profit losses. Using a traditional costing system the portion of overhead costs allocated to the production of a service or product is determined by the total of direct labor hours used in production of the service or product. Companies implement refined cost allocation systems such as the activitybasedcosting method with the intention of helping management strategically plan because these systems provide quality information to help management make informed decisions. In this essay, I will examine the use of cost allocations, the activitybasedcosting method, and how companies can implement and benefit from activitybasedcosting.
The allocation of costs serves four primary purposes throughout a company. The first is to present the information management needs to make an informed decision. The second is the reduction of non-essential uses of common company resources. The third is to encourage management to assess the efficiency of services provided internally. Finally, the fourth reason is the calculation of the “full...
...ActivityBasedCostingActivity-BasedCosting (ABC) was developed as a practical solution for problems
Associated with traditional cost management systems. In the early 1980’s many
Companies began to realize that their traditional accounting systems were
generating inaccurate costing information. Traditional cost accounting systems
that were designed to address the issues of inventory valuation for external
audiences have two deficiencies. The inability to accurately determine actual
total product and service costs and the inability to provide useful information to
management for purposes of making operating decisions.
Users of ABC
Businesses want to know which of their products and services make or lose
money so they can remain competitive. To get a handle on this information, some companies have embraced activity-basedcosting/management (abc/m) to help them tract product and customerprofitability and reduce operating costs. armed with the facts from, the abc/m data, managers can make better decisions about how they can use resources and can improve business processes.
Activity-basedcosting is an accounting methodology that links the following
elements; costs, which are the expenditures are classified as product costs. That...
...ActivityBasedCosting can be defined as an accounting methodology that assigns costs to activitiesbased on their use of resources, rather than products or services. This enables resources and other associated costs to be more accurately attributed to the products and the services which they use. It doesn’t change or eliminate any costs; it provides detailed information about how costs are consumed. (Online manager-net.com).
Traditional cost accounting looks at what is spent, while ABC methods look at what is done in terms of activities. In ABC it is much easier to identify opportunities to reduce costs and improve performance, while maintaining the quality of care provided.
Traditional Cost Systems use cost allocation methods, do not focus on where or why costs occur, Report information that is accounting oriented and inaccurate. These systems are also not easily understood by operational managers, since the focus is fiscal.
Whereas ActivityBasedCosting assigns costs to activitiesbased on the resources they consume. ABC provides insights into the sources of costs and the possible impact of different decisions. It also provides the information required to take action and realize performance breakthroughs.
Implementation of ActivityBasedCosting
In Most cases,...
... * Activity-BasedCosting (Encyclopedia of Management)
* Activity-BasedCosting (Encyclopedia of Small Business)
Activity-basedcosting (ABC) is an accounting method that allows businesses to gather data about their operating costs. Costs are assigned to specific activitiesuch as planning, engineering, or manufacturingnd then the activities are associated with different products or services. In this way, the ABC method enables a business to decide which products, services, and resources are increasing their profitability, and which are contributing to losses. Managers are then able to generate data to create a better budget and gain a greater overall understanding of the expenses that are required to keep the company running smoothly. Generally, activity-basedcosting is most effective when used over a long period of time, as opposed to shorter-term solutions such as the theory of constraints (TOC).
Activity-basedcosting first gained notoriety in the early 1980s. It emerged as a logical alternative to traditional cost management systems that tended to produce insufficient results when it came to allocating costs. Harvard...