Activity Based Costing Study Guide

Hours of design time| Facility-level| General manufacturing unit administration Plant building and grounds| Direct labor-hours* Direct labor-hours*| *Facility-level costs cannot be traced on a cause-and-effect foundation to particular person products. Nevertheless, these prices are often allocated to products for exterior reviews using some arbitrary allocation foundation such as direct labor-hours -Unit-level activities- are performed every time a unit is produced. The prices of unit-level actions should be proportional to the variety of items produced.

-Ex.

Providing power to run processing gear is a unit-level activity as a result of power tends to be consumed in proportion to the number of models produced. -Batch-level activities- encompass tasks which might be carried out each time a batch is processed, similar to processing purchase orders, organising gear, packing shipments to prospects, and dealing with materials. Costs at the batch level depend upon the number of batches processed rather than on the variety of models produced. -Ex. The value of processing a purchase order is similar irrespective of how many units of an merchandise are ordered.

Product-level activities- relate to specific merchandise and typically must be carried out no matter what number of batches or units of the product are manufactured. Product-level activities embody maintaining inventories of components for a product, issuing engineering change notices to modify a product to fulfill a customer’s specifications, and growing special check routines when a product is first positioned into manufacturing. -Facility-level activities- are actions which may be carried out regardless of which merchandise are produced, how many batches are run, or how many units are made.

Include gadgets similar to manufacturing facility administration salaries, insurance coverage, property taxes, and building depreciation. An Example of an ABC System Design -Under ABC, the manufacturing overhead costs on the prime are allotted to products via a two-stage course of. -In the first stage, overhead prices are assigned to the activity price swimming pools. In the second stage, the costs in the activity value pools are allotted products utilizing activity charges and exercise measures. -Ex. In the first stage price task, varied manufacturing overhead costs are assigned to the production order exercise value pool.

These costs may embody the salaries of engineers who modify products for individual orders, the value of scheduling and monitoring orders, and different prices which may be incurred as a consequence of the variety of totally different orders obtained and processed by the corporate. -Once the quantity of price in production-order exercise is known, procedures from Job-Order Costing are adopted. Example of Activity Based Costing Comtek Sound, Inc. , makes two merchandise, a radio with a built-in CD player (called a CD unit) and a radio with a built-in DVD participant (called a DVD unit).

Both of these merchandise are sold to car manufacturers for installation in new vehicles. Recently, the corporate has been shedding bids to provide CD players as a result of competitors have been bidding less than Comtek Sound has been willing to bid. At the same time, Comtek has been profitable every bid it has submitted for its DVD player, which management regards as a secondary product. The advertising manager has been complaining that on the prices Comtek is willing to bid, competitors are taking the company’s high-volume CD business and leaving Comtek with simply the low-volume DVD enterprise.

However, the prices rivals quote on the CD gamers are below Comtek’s manufacturing costs for these units–at least according to Comtek’s typical accounting system that applies manufacturing overhead to merchandise based on direct-labor hours. Production managers suspected that the standard costing system may be distorting the relative prices of the CD player and the DVD player–the DVD participant takes extra overhead sources to make than the CD player and but their manufacturing overhead prices are similar under the standard costing system.

The firm might have even been suffering a loss on the DVD items with out knowing it as a outcome of the cost of these units has been so vastly understated. Conversely, it appears Comtek has been overcharging for the CD units all along since their prices have been overstated. -When a company implements activity-based costing, overhead cost often shifts from high-volume merchandise to low-volume merchandise, with a higher unit product price ensuing for the low-volume merchandise. -This occurred in the Comtek example, the place the value of the low-volume DVD models elevated from $150 to $207. 0 per unit. This increase in value resulted from batch-level and product-level costs, which shifted from the high-volume product to the low-volume product. Fewer DVD items are processed per manufacturing order than CD items. Evaluation of Activity Based Costing Benefits -improves the accuracy of product costs in 3 ways: -it often increases the variety of cost pools used to accumulate overhead prices, which in turn accumulates prices for each main activity -the activity price pools are more homogenous than departmental value pools.

In precept, the entire prices in an exercise cost pool pertain to a single activity. In contrast, departmental price swimming pools include the prices of many alternative actions carried out within the division. -Activity-based costing uses a variety of exercise measures to assign overhead prices to products, a few of that are correlated with volume and some which are not. -makes it clear that batch setups, engineering change orders, and different actions cause overhead prices somewhat than just direct labor.

Managers thus have a greater understanding of the causes of overhead costs, which should lead to higher decisions and higher cost management. -can be used as part of packages to enhance operations Limitations -The Cost of implementing ABC -the price system should be designed, which entails a cross-functional team. It requires taking valued workers away from different tasks for a major project. -The data utilized in ABC must be collected and verified. In some cases, this requires amassing information that has by no means been collected earlier than. Because of these prices, some managers may resolve that the prices outweigh the expected benefits ABC costing would result in. *When is ABC most likely definitely worth the effort? When companies have: -products that differ substantially in volume, batch size, and within the activities they require -conditions have considerably modified for the explanation that existing value system was established -overhead prices are high and rising and no one appears to grasp why -management doesn’t belief the prevailing price system and ignores data from the system when making selections -Limitations of ABC Model relies on numerous crucial assumptions: -the price in every exercise pool is strictly proportional to its activity measure. We have little evidence on this, suggesting that overhead costs are less than proportional to exercise. Also known as rising returns to scale–as exercise will increase, the typical value drops. -This signifies that product prices computed by traditional or activity-based costing shall be overstated for the purposes of making decisions