accounting project and need support to help me learn.
Q1. Discuss with suitable examples why activity-based costing (ABC) is better than the traditional costing system. Provide a suitable numerical example of ABC in the manufacturing sector and show all the necessary calculations required under the ABC system. (3 Marks)
Note: Your answer must include suitable numerical examples showing all the calculations of the ABC system. You are required to assume values of numerical examples of your own and they should not be copied from any sources.
Requirements: Answer the good question
© John Wiley & Sons, 2011Chapter 7: Activity-Based Costing and ManagementEldenburg & Wolcott’s Cost Management, 2eSlide # 1Cost ManagementMeasuring, Monitoring, and Motivating PerformanceChapter 7Activity-Based Costing and Management
© John Wiley & Sons, 2011Chapter 7: Activity-Based Costing and ManagementEldenburg & Wolcott’s Cost Management, 2eSlide # 2Chapter 7: Activity-Based Costing and ManagementLearning objectives•Q1: What is activity-based costing (ABC)?•Q2: What are activities and how are they identified?•Q3: What process is used to assign costs in an ABC system?•Q5: What are GPK and RCA?•Q4: What is activity-based management?•Q6: How does information from ABC, GPK, and RCA affect managers’ incentives and decisions?
© John Wiley & Sons, 2011Chapter 7: Activity-Based Costing and ManagementEldenburg & Wolcott’s Cost Management, 2eSlide # 3Q1: Activity-Based Costing (ABC)•ABC is a method of cost system refinement.•Indirect costs are divided into “sub-pools” of costs of activities.•Activity costs are then allocated to the final cost objects using a cost allocation base (more commonly called cost drivers in ABC).•Activities are measurable, making it more likely that cost drivers can be found so that a final cost object will absorb indirect costs in proportion to its use of the activity.
© John Wiley & Sons, 2011Chapter 7: Activity-Based Costing and ManagementEldenburg & Wolcott’s Cost Management, 2eSlide # 4Q1: Traditional Costing vs. ABCProduct AProduct BProduct CTraditional costing systems:IndirectCostsDirect CostsDirect CostsDirect CostsDirect costs are traced to the individual products.The individual products are the final cost objects.Indirect costs are grouped into one (or a small number) of cost pools; a cost allocation base assigns costs to the individual products
Q1: Traditional Costing Systems© John Wiley & Sons, 2011Chapter 7: Activity-Based Costing and ManagementEldenburg & Wolcott’s Cost Management, 2eSlide # 5
© John Wiley & Sons, 2011Chapter 7: Activity-Based Costing and ManagementEldenburg & Wolcott’s Cost Management, 2eSlide # 6Q1: Traditional Costing vs. ABCActivity-based costing systems:IndirectCostsProduct AProduct BProduct CDirect CostsDirect CostsDirect CostsThe individual products are the final cost objects & direct costs are traced to the individual products.Indirect costs are assigned (traced & allocated) to various pools of activity costs.Activity 1Activity 2Activity 3Activity costs are allocated to products
Q1: ABC Costing Systems© John Wiley & Sons, 2011Chapter 7: Activity-Based Costing and ManagementEldenburg & Wolcott’s Cost Management, 2eSlide # 7
© John Wiley & Sons, 2011Chapter 7: Activity-Based Costing and ManagementEldenburg & Wolcott’s Cost Management, 2eSlide # 8Q2: What are Activities and How are They Identified?The ABC cost hierarchy includes the following activities:•organization-sustaining – associated with overall organization•facility-sustaining – associated with single manufacturing plant or service facility•customer-sustaining – associated with a single customer•product-sustaining – associated with product lien or single product•batch-level – associated with each batch of product•unit-level – associated with each unit produced
© John Wiley & Sons, 2011Chapter 7: Activity-Based Costing and ManagementEldenburg & Wolcott’s Cost Management, 2eSlide # 9Q2: ABC Cost Hierarchy ExampleSome of the costs incurred by the Dewey Chargem law firm are listed below. This firm specializes in immigration issues and family law. For each cost, identify whether the cost most likely relates to a(n) (1) organiz-ation-sustaining, (2) facility-sustaining, (3) customer-sustaining, (4) product-sustaining, (5) batch-level, or (6) unit-level activity and explain your choice.CostCost Hierarchy LevelBookkeeping softwareSalary for partner in charge of family lawOffice suppliesSubscription to family law update journalTelephone charges for local callsLong distance telephone chargesWindow washing serviceSalary of receptionist
© John Wiley & Sons, 2011Chapter 7: Activity-Based Costing and ManagementEldenburg & Wolcott’s Cost Management, 2eSlide # 10Q3: What Process is Used to Assign Costs in an ABC system?1.Identify the relevant cost object. 2.Identify activities and group homogeneous activities. 3.Assign costs to the activity cost pools. 4.Choose a cost driver for each activity cost pool. 5.Calculate an allocation rate for each activity cost pool. 6.Allocate activity costs to the final cost object.
© John Wiley & Sons, 2011Chapter 7: Activity-Based Costing and ManagementEldenburg & Wolcott’s Cost Management, 2eSlide # 11Q3: How Are Cost Drivers Selected for Activities?•For each activity, determine its place in the ABC cost hierarchy. •Look for drivers that have a good cause-and-effect relationship with the activities’ costs.•Use a reasonable driver when there is no cause-and-effect relationship.
© John Wiley & Sons, 2011Chapter 7: Activity-Based Costing and ManagementEldenburg & Wolcott’s Cost Management, 2eSlide # 12Q3: ABC in Manufacturing ExampleAlphabet Co. makes products A & B. Product A is a low-volume specialty item and B is a high-volume item. Estimated factory- wide overhead is $800,000, and the number of DL hours for the year is estimated to be 50,000 hours. DL costs are $10/hour. Each product uses 2 DL hours. Compute the traditional cost of each product if Products A & B use $25 and $10 in direct materials, respectively.First, compute the estimated overhead rate:Estimated overhead rate = $800,000/50,000 hours = $16/hour.Product AProduct BDirect materials$25$10Direct labor (2hrs @ $10)2020Overhead (2 hrs @ $16)3232$77$62
© John Wiley & Sons, 2011Chapter 7: Activity-Based Costing and ManagementEldenburg & Wolcott’s Cost Management, 2eSlide # 13Q3: ABC in Manufacturing ExampleAlphabet Co. is implementing an ABC system. It estimated the costs and activity levels for the upcoming year shown below.First, compute the estimated overhead rate for each activity:Prod. AProd. BTotalCost DriverMachine set-ups$200,0003,0002,0005,000# set-upsInspections140,000500300800# inspectionsMaterials handling80,000400400800# mat’l requistionsMachining dep’t320,00012,00028,00040,000# machine hoursQuality control dep’t60,000600150750# tests$800,000Estimated Activity LevelsEstimated Costs
© John Wiley & Sons, 2011Chapter 7: Activity-Based Costing and ManagementEldenburg & Wolcott’s Cost Management, 2eSlide # 14Q3: ABC in Manufacturing ExampleMachine set-ups$200,0005,000set-ups$40/setupInspections140,000800inspections$175/inspectionMaterials handling80,000800mat’l requistions$100/requisitionMachining dep’t320,00040,000machine hours$8/mach hrQuality control dep’t60,000750tests$80/test$800,000Estimated CostsOverhead RateEstimated Activity$40/setup$175/inspection$100/requisition$8/mach hr$80/test
© John Wiley & Sons, 2011Chapter 7: Activity-Based Costing and ManagementEldenburg & Wolcott’s Cost Management, 2eSlide # 15Q3: ABC in Manufacturing ExampleAlphabet recently completed a batch of 100 As and a batch of 100 Bs. Direct material and labor costs were as budgeted. Information about each batch’s use of the cost drivers is given below. Compute the overhead allocated to each unit of A and B.100 BsMachine set-ups6010Inspections102Materials handling42Machining dep’t240120Quality control dep’t31100 AsOverhead allocated:100 As100 BsMachine set-ups$2,400$400Inspections1,750350Materials handling400200Machining dep’t1,920960Quality control dep’t24080Overhead for batch$6,710$1,990Overhead per unit$67.10$19.90
© John Wiley & Sons, 2011Chapter 7: Activity-Based Costing and ManagementEldenburg & Wolcott’s Cost Management, 2eSlide # 16Q3: ABC in Manufacturing ExampleCompute the total cost of each product and compare it to the costs computed under traditional costing.Traditional costing assigned $77 to a unit of Product A and $62 to a unit of Product B.Prod AProd BDirect material$25.00$10.00Direct labor20.0020.00Overhead67.1019.90Total$112.10$49.90•The only difference between the two costing systems is that Product A is assigned more overhead costs under ABC. •The additional overhead assigned to Product A reflects Product A’s consumption of resources.
© John Wiley & Sons, 2011Chapter 7: Activity-Based Costing and ManagementEldenburg & Wolcott’s Cost Management, 2eSlide # 17•ABM is the process of using ABC information to evaluate opportunities for improvements in an organization.Q4: Activity-Based Management (ABM)•Examples include managing & monitoring•customer profitability•product and process design •environmental costs•quality•constrained resources
© John Wiley & Sons, 2011Chapter 7: Activity-Based Costing and ManagementEldenburg & Wolcott’s Cost Management, 2eSlide # 18•Activities can be defined so that different costs of servicing customers are accumulated.Q4: ABM & Customer Profitability•Examples include•analyzing the types of bank transactions used by various categories of customers•comparing the costs of servicing insurance contracts sold to married versus single individuals•comparing the costs of different distribution channels
© John Wiley & Sons, 2011Chapter 7: Activity-Based Costing and ManagementEldenburg & Wolcott’s Cost Management, 2eSlide # 19•Activities can be defined so that the costs of stages of production or of a business process are accumulated.Q4: ABM & Product/Process Improvements•Examples include•determining the costs of non-value-added activities so the most costly can be reduced or eliminated•changing the steps in the accounts payable function to reduce the number of personnel•determining the most costly stages of product development so that the time to market is reduced
© John Wiley & Sons, 2011Chapter 7: Activity-Based Costing and ManagementEldenburg & Wolcott’s Cost Management, 2eSlide # 20•Activities can be defined so that types of environmental costs are accumulated.Q4: ABM & Environmental Costs•Examples include•capturing the costs of contingent liabilities for waste disposal site remediation•comparing the cost of recycling packaging to the cost of disposal•computing the costs of treating different kinds of emissions
© John Wiley & Sons, 2011Chapter 7: Activity-Based Costing and ManagementEldenburg & Wolcott’s Cost Management, 2eSlide # 21•Activities can be defined so that categories of costs of managing quality are accumulated.Q4: ABM & Quality Costs•Common categories of quality costs are•costs of prevention activities•costs of appraisal activities•costs of production activities•costs of postsales activities
Q5: What are GPK and RCA?•Costing approaches similar to ABC because they involve multiple pools and multiple drivers•GPK can be described as marginal planning and cost accounting–Each cost is traced to a cost center (smaller than a department) which performs a single repetitive activity, and is the responsibility of one manager)–Output measures tracks the volume of resource use–Costs are segregated into proportional (change with volume in resource use) and fixed–Practical capacity is used for estimated allocation rate volumes© John Wiley & Sons, 2011Chapter 7: Activity-Based Costing and ManagementEldenburg & Wolcott’s Cost Management, 2eSlide # 22
Q5: Capacity Definitions•Theoretical capacity – maximum assuming continuous, uninterrupted operations 365 days/year•Practical capacity – typical operating conditions•Budgeted capacity – expected volume for the upcoming time period•Idle/excess capacity – difference between activity capacity used and one of the above measures of capacity© John Wiley & Sons, 2011Chapter 7: Activity-Based Costing and ManagementEldenburg & Wolcott’s Cost Management, 2eSlide # 23
•Resource Consumption Accounting (RCA)•Builds on GPK and ABC principles•Each cost is assigned to a resource cost pool–Labor and machinery are often placed in different cost pools since they are different types of resources–RCA involves a significantly larger number of cost pools than traditional accounting–Like GPK, segregates proportional and fixed costs–Utilizes theoretical rather than practical capacity for allocating fixed costs•More likely to focus manager attention on reducing idle and non-productive resource time© John Wiley & Sons, 2011Chapter 7: Activity-Based Costing and ManagementEldenburg & Wolcott’s Cost Management, 2eSlide # 24Q5: What are GPK and RCA?
Q5: Benefits/Drawbacks to GPK/RCA•Benefits–Generates multi-level internal income statements useful for short terms decisions because it focuses on marginal cost–Increases cause & effect awareness among managers–Categorizes costs (and generates profit margin) at the product, product group, division, and company level–Avoids arbitrary allocations of fixed costs •Drawbacks–Can be costly to implement–Can result in a large number of variances to analyze© John Wiley & Sons, 2011Chapter 7: Activity-Based Costing and ManagementEldenburg & Wolcott’s Cost Management, 2eSlide # 25
Q5: Comparison of ABC, GPK, and RCAABCGPKRCACharacter of cost accounting systemFull costingMarginal costingFull and marginal costingLocation of dataDatabase separate from general ledgerComprehensive accounting systemComprehensive accounting systemPrimary decision relevanceMid- to long-termShort-termShort-, Mid-, and Long termAllocation of overhead based onActivitiesCost CentersResources and/or activitiesCost DriversActivity –BasedResource Output relatedResource output or activity relatedFixed cost allocation rate denominatorActual, budgeted, or practical capacityBudgeted or practical capacityTheoretical capacity© John Wiley & Sons, 2011Chapter 7: Activity-Based Costing and ManagementEldenburg & Wolcott’s Cost Management, 2eSlide # 26
© John Wiley & Sons, 2011Chapter 7: Activity-Based Costing and ManagementEldenburg & Wolcott’s Cost Management, 2eSlide # 27•Benefits•more accurate and relevant product cost information•employees focus attention on activities•measurement of the costs of activities and business processes•identify non-value-added activities and reduce costsQ6: Decision Making with ABC, GPK, and RCA•Costs•systems can be difficult to design and maintain•more information must be captured •decision makers may not use the information appropriately
© John Wiley & Sons, 2011Chapter 7: Activity-Based Costing and ManagementEldenburg & Wolcott’s Cost Management, 2eSlide # 28•Judgment is required when determining activities.Q6: Uncertainties in ABC and ABM Implementation•Judgment is required when selecting cost drivers.•Denominator levels for cost drivers are estimates.•ABC information includes unitized fixed costs, so decision makers must use ABC information correctly.
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