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Activity-based costing for sales and


administrative costs: A case study
By Talbott, John
Publication: The CPA Journal
Date: Saturday, April 1 2000

HEADNOTE
MANAGEMENT COULD NOT UNDERSTAND why the customized line
continually showed a profit while the standard line showed a loss.
In activity-based costing, costs flow from the general ledger to activities and
then to cost objects (products, customers, and services). Early on, a
formidable task for most companies that switch to ABC is collecting
information for specifying and assigning costs to activities. This phase
involves identifying three things:
* What the company actually does (as opposed to its functional identification),
* Appropriate assignment bases (resource drivers) to determine the cost of
the activities, and
* Activity drivers to assign the activity costs to cost objects.
The following case study illustrates the advantages of ABC in the sales and
administrative areas.
Case Study
Robotics (a hypothetical company) is the U.S. distributor for industrial robots
manufactured in Japan by a major Japanese company. The product line
consists of robots designed for applications in the areas of welding, material
handling, dispensing, and cutting. The product is segmented into standard
and nonstandard products. The primary standard product is shipped without
alteration to American customers and constitutes about one-sixth of total
annual sales. The chief customized product is altered in the United States to
fit customer specifications and represents about one-third of total annual sales.
A variety of service endeavors, designated as "Others" in the income
statement, generate approximately $1 million of revenue monthly. Robotics
was relatively satisfied with the accuracy of the gross profit by product line as
initially shown in Exhibit 2.
As with most distributors, Robotics' cost of sales is composed of direct
charges for the product and labor and material related to modification and
installation. However, management didn't like how selling and administrative
costs were allocated. Allocations to product lines were based on booking
dollars, with significant time lag between booking and revenue recognition.
The standard robots usually required little or no additional administrative or
selling effort. The nonstandard, customized robots, however, required
substantial additional administrative effort before customers were satisfied.
Management couldn't understand why the customized line continually showed
a profit while the standard line showed a loss. Management decided to
engage in an activity based costing study to more accurately determine the
selling and administrative effort by product line.
Roboics' Experience
The first step included gathering information from each department.
Questionnaires asked employees two questions:
* What did they feel was the function of the department?
IMAGE TABLE 11
* Given the authority, how would they allocate costs?
The first step was to define activities. The questionnaire results showed that
activities could be approximated by some of the existing cost centers in
Robotics' general ledger system. Exhibit 3 shows a graphical presentation of
this approach.
First, Robotics used a modified step method to allocate some activities to
other activities and allocate other activities directly to cost objects (product
lines). Exhibit 1 shows this assignment of costs to activities and the
intermediate assign menu between activity based on the ques tionnaire
results. For example, 20% of the corporate administrative cost was driven to
the advanced engineering activity.
Once selling and administrative costs were captured by activity, the next step
was to drive activity costs to the various product lines using activity drivers.
The questionnaire results indicated that the number of bookings and
customers had a strong effect on activ ity costs, regardless of the dollar value
of the bookings.
IMAGE ILLUSTRATION 15IMAGE TABLE 16
EXHIBIT 1
IMAGE TABLE 20
EXHIBIT 2
IMAGE TABLE 21
EXHIBIT 3
The last column in Exhibit 1 shows how the drivers are employed, and the
revised section of Exhibit 2 shows the resulting income statement. Using
activity based costing, the monthly operating income of the standard robotic
product line increased by almost $150,000, validating management's
concerns about the old allocation method. Although management realized that
the existing income statement provided erroneous data, the magnitude of the
problem was greater than they anticipated.
This kind of information facilitates strategic decision-making about product line
emphasis. It also shows that activity-based costing is as helpful in the
administrative and marketing areas as in the manufacturing area.
AUTHOR_AFFILIATION
Editor: James L Craig Jr., CPA
The CPA Journal
AUTHOR_AFFILIATION
David Bukovinsky, CPA, Hans Sprohge, CPA, and John Talbot CMA, are
professors at Wright State University, Dayton, Ohio.
© Copyright New York State Society of Certified Public Accountants Apr 2000
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You may not repost, republish, reproduce, package and/or redistribute the
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