AcLlvlLy8ased CosLlng (A8C)

M8A ACCCun1lnC
C8Cu 2 8LSLn1A1lCn
ACC 512: Cost Accounting Systems 1
earnlng Cb[ecLlves
W 1he sLraLeglc role of AcLlvlLy8ased CosLlng
W Lxplaln whaL ls meanL A8C
W ldenLlfy Lhe concepLs/assumpLlons of A8C
W ldenLlfy approprlaLe cosL drlvers under
acLlvlLybased cosLlng (A8C)
W CalculaLe cosL per drlver and per unlL uslng
A8C
ACC 512: Cost Accounting Systems 2
earnlng Cb[ecLlves
W Compare A8C and LradlLlonal meLhods of
overheads absorpLlon based on producLlon
unlLs labour hours or machlne hours
W AdvanLages and crlLlclsms of A8C
W Lxplaln Lhe lmpllcaLlons of swlLchlng Lo A8C
on prlclng performance and managemenL and
declslon maklng
ACC 512: Cost Accounting Systems 3
ey 1erms
W CosL drlver
W CosL pool
W CosL ob[ecL
W AcLlvlLy
W 8esource
W 1radlLlonal meLhod of absorpLlon cosLlng
W A8C
ACC 512: Cost Accounting Systems 4
1he sLraLeglc role of AcLlvlLy8ased
CosLlng (A8C)
W A8C ls a meLhod of deLermlnlng accuraLe
cosLs
W A8C ls a recenL lnnovaLlon ln cosL accounLlng
and lLs been rapldly adopLed by companles
across many lndusLrles and wlLhln
governmenL and nCCS
W eLs look aL a qulck scenarlo of how lL works
and how lL ls lmporLanL
ACC 512: Cost Accounting Systems 5
lzza Scenarlo
3 fr|ends d|nner
W Lach order an lndlvldual slze
plzza
W suggesL you all order a
plaLe of appeLlzer for Lhe Lable
W order addlLlonal 2 and
consumed all alone
W 1lme Lo pay for Lhe blll
W suggesLs an equally
shared of Lhe appeLlzer
ordered
nana kk
ACC 512: Cost Accounting Systems 6
M8A C2 lurnlLure Co Ld
W Slmllarly ln manufacLurlng suppose Lhree of you
are producL managers aL a planL LhaL
manufacLures funlLures aL M8A C2 lurnlLures
W nAnA ln charge of Sofa manufacLurlng
W ulnlng room Lables and chalrs
W ?Cu bedroom furnlLures
W Lach of your producL llnes has dlrecL maLerlals
and labour cosLs dlrecLly Lraced Lo each one of
you lL ls your responslblllLy Lo manage Lhese
dlrecL cosLs
ACC 512: Cost Accounting Systems 7
M8A C2 lurnlLure Co Ld
W 1here are also manufacLurlng cosL (overheads)
LhaL cannoL be Lraced Lo each producL
lncludlng Lhe followlng acLlvlLles maLerlal acqulslLlon
maLerlal sLorage and handllng producL lnspecLlon manufacLurlng
supervlslon [ob schedullng equlpmenL malnLenance and fabrlc cuLLlng
W WhaL lf M8A C2 decldes Lo charge Lhe 3
managers a falr share" of Lhe LoLal lndlrecL
cosL uslng Lhe raLlo of unlLs produced ln a
manager's area Lo Lhe LoLal unlLs produced for
all managers?
ACC 512: Cost Accounting Systems 8
M8A C2 lurnlLure Co Ld
W 1hls ls commonly referred Lo as volume8ased
cosLlng or Lhe LradlLlonal meLhod of absorpLlon
cosLlng
W nC1L wheLher Lhe proporLlons used are based
on unlLs produced dlrecL labour hours or
machlne hours each of Lhese ls volumebased
W WhaL happens lf usage of Lhese acLlvlLles ls noL
proporLlonaLe Lo Lhe number of unlLs produced?
W Some manager would be overcharged oLhers
undercharged under volumebased approach
ACC 512: Cost Accounting Systems 9
A8C versus 1radlLlonal MeLhod of
AbsorpLlon CosLlng
W Assumlng nAnA lnslsL on more frequenL
lnspecLlons of hls producLlon he wlll be falrly
charged a hlgher proporLlon of overhead
(lnspecLlon) Lhan LhaL based on unlLs alone
W Moreover why should you pay for any porLlon of
fabrlc cuLLlng lf your bedroom furnlLure does noL
requlre fabrlc?
W 1he LradlLlonal meLhod of absorpLlon cosLlng
provldes llLLle lncenLlve for managers Lo conLrol
lndlrecL cosLs
ACC 512: Cost Accounting Systems 10
A8C versus 1radlLlonal MeLhod of
AbsorpLlon CosLlng
W 1he only way unforLunaLely Lo reduce your
share of lndlrecL cosL ls Lo reduce your unlLs
produced or hope LhaL nAnA or or boLh
lncrease producLlon
W Cn reflecLlon Lhe approach LhaL charges
lndlrecL cosLs Lo producL based on unlLs
produced does noL provlde very accuraLe
producL cosL Lo Lhe producLs
ACC 512: Cost Accounting Systems 11
A8C versus 1radlLlonal MeLhod of
AbsorpLlon CosLlng
W 1he SCu1lCn ls Lo use AC1lvl1?8ASLu
CCS1lnC Lo charge Lhese lndlrecL cosLs Lo Lhe
producLs uslng deLalled lnformaLlon on Lhe
octlvltles LhaL make up Lhe lndlrecL cosLs le
Lhe maLerlal handllng lnspecLlon fabrlc
cuLLlng
W 1hls presenLaLlon shows how Lo do lL
ACC 512: Cost Accounting Systems 12
8ole of Lhe 1radlLlonal MeLhod of
AbsorpLlon CosLlng
W 1hls meLhod was pracLlce a loL for many years
ago when producLlon sysLems were based on
labourlnLenslve or machlne lnLenslve
W 8uL even Loday lL ls a sLraLeglc cholce of some
flrms
W lL ls generally used when dlrecL cosL are Lhe ma[or
cosL of Lhe producL or servlce
W lL ls used when acLlvlLles supporLlng Lhe
producLlon of Lhe producL or servlce are relaLlvely
small lowcosL and homogeneous producL llnes
ACC 512: Cost Accounting Systems 13
8ole of Lhe 1radlLlonal MeLhod of
AbsorpLlon CosLlng
W 1radlLlonal producL cosLlng measures accuraLely
volumerelaLed resources eg dlrecL cosLs
W 8uL falls Lo measure Lhe way producLs consume
nonvolume relaLed acLlvlLles such as seLup cosLs
maLerlal handllng lnspecLlon
W 8esources are consumed when Lhese acLlvlLles
are Lrlggered by producLlon lL ls Lhe producLs
whlch cause Lhese acLlvlLles Lo arlse and A8C
aLLempLs Lo Lrace Lhe consumpLlon of Lhese
acLlvlLles by Lhe varlous producLs
ACC 512: Cost Accounting Systems 14
WhaL Lhen ls AcLlvlLy8ased CosLlng?
AcLlvlLybased cosLlng (A8C) ls a costloq opptoocb
tbot osslqos tesootce costs to cost objects socb os
ptoJocts setvlces ot costomets boseJ oo
octlvltles petfotmeJ fot tbe cost objects
ln oLher words lL ls concerned wlLh cost otttlbotloo
to cost oolts oo tbe bosls of beoeflt tecelveJ ftom
Jltect octlvltles eq OtJetloq setop ossotloq
poollty (aplan Cooper)
ACC 512: Cost Accounting Systems 15
A8C Anu CosL urlvers
W 1he A8C approach ls Lo llnk overheads cosLs Lo
producLs or servlces LhaL causes Lhem by
absorblng overheads cosL on Lhe basls of
octivities LhaL 'drive' cosL (cost drivers) raLher
Lhan on Lhe basls of producLlon volume
ACC 512: Cost Accounting Systems 16
W Cver head expenses lncurred
W Step 1 overheads allocaLed Lo
cosL pools uslng sulLable bases
W CosL pools (usually
acLlvlLles)
W Step 2 Cverheads
absorbed lnLo unlLs of
producLlon uslng cosL
drlvers
Cverheads
x ? Z
roducLlon ouLpuL
ACC 512: Cost Accounting Systems 17
W A cost poo/ ls an acLlvlLy LhaL consumes resources
for whlch overhead cosLs are ldenLlfled and
allocaLed lor each cosL pool Lhere should be a
drlver
W A cost driver ls a unlL of acLlvlLy LhaL consumes
resources An alLernaLlve deflnlLlon of a cosL
drlver ls a facLor lnfluenclng Lhe level of cosL
W An octivity ls a speclflc Lask or acLlon of work
done
W A resource |s an ecn|c e|eent needed r
cnsed |n perfr|ng act|v|t|es
ACC 512: Cost Accounting Systems 18
ConcepLs or AssumpLlons underlylng
A8C
1) ln Lhe long run all overheads cosL are varlable
Some overheads are varlable ln Lhe shorL run
Powever overhead cosL do noL necessarlly vary
wlLh producLlon volume or servlce level
2) AcLlvlLles consumes resources
3) 1he consumpLlon of resources drlves cosL
4) roducLs lncur overhead cosLs because of Lhe
acLlvlLles LhaL go lnLo provldlng Lhe producLs or
servlce Lhese acLlvlLles are noL necessarlly
relaLed Lo Lhe volumes of Lhe producL LhaL are
manufacLured
ACC 512: Cost Accounting Systems 19
ConcepLs or AssumpLlons underlylng
A8C
3) ulrecL labour hours and machlne hours are noL
Lhe drlvers of cosL ln many modern buslness
envlronmenLs
AbsorpLlon of overheads lnLo unlL cosL on a
volume basls may be mlsleadlng parLlcularly ln a
modern manufacLurlng envlronmenL where
overhead cosLs are lnfluenced by dlverslLy and
complexlLy of ouLpuL raLher Lhan Lhan volume
ACC 512: Cost Accounting Systems 20
lllusLraLlon A8C
M8A C2 company manufacLures Lwo producLs x and ? M8A C2 uses
absorpLlon cosLlng and flxeJ ptoJoctloo costs ote obsotbeJ loto
ptoJoctloo cost oo o Jltect loboot boots bosls1he budgeLed lnformaLlon
for Lhe nexL flnanclal year ls as follows
dL x dL ? 1oLal
roducLlon Sales 2000unlLs 3000unlLs
u hrs/unlL 3hrs 2hrs
8udgeL u hrs 6000hrs 10000hrs 16000hrs
llxed producLlon cosL 48000
ACC 512: Cost Accounting Systems 21
DS1kA1- ConL
uslng A8C a revlew of Lhe lncldence cosLs has esLabllshed LhaL Lhe
number of
seLups ls Lhe drlver of Lhe flxed producLlon cosL uslng A8C Lhe flxed
producLlon cosLs would be allocaLed as follows
dL x dL ? 1oLal
no of seLups per 1000unlLs 8 16
8udgeLed seLups 16 8 24
llxed producLlon cosL 48000
ACC 512: Cost Accounting Systems 22
1rad|t|na| Methd
Ca|c|at|n f Absrpt|n rate
48000/16000hrs 3/uP
llxed C/P absorbed
roducL x 6000hrs x 3/uP 18000
roducL ? 10000hrs x 3/uP 30000
A8C Methd
llxed C/P allocaLed
48000/24seLups 2000/seLup
roducL x 16 x 2000 32000
roducL ? 8 x 2000 16000
1he dlfference ln cosLlng could have slgnlflcanL lmpllcaLlons for
prlclng especlally lf a cosLbased approach ls used for proflL
calculaLlon
ACC 512: Cost Accounting Systems 23
AcLlvlLybased cosLlng could provlde much
meanlngful lnformaLlon abouL producL cosLs and
proflLs when
W lndlrecL cosL are hlgh relaLlve Lo dlrecL cosL
W roducLs or servlces are complex
W roducLs and servlces are Lallored Lo cusLomer
speclflcaLlons
W Some producLs are sold ln large numbers and
oLhers ln small numbers
ACC 512: Cost Accounting Systems 24
ldenLlfylng approprlaLe cosL drlver
under A8C
W under A8C cosL are drlven by acLlvlLles and noL
producLlon volume
Lxamples of overheads whlch are nC1 drlven by
producLlon lnclude Lhe followlng
SeLup cosLdrlven by no of manufacLurlng seLups
Crderlng processlng cosL drlven by no of orders
acklng depL cosLs no of packlng orders
Lnglneerlng depL cosL no of producLlon orders
Alr condlLlonlng malnLenance no of AC unlLs
ACC 512: Cost Accounting Systems 25
1esL our undersLandlng
Act|v|ty Cst | Act|v|ty Cst dr|ver
AdverLlslng
CuallLy conLrol
urchaslng
SeLup cosLs
SLores
uespaLch
LqulpmenL preparaLlon
aLlenL preparaLlon
aLlenL afLercare
lllm processlng
lllm reporLlng
ACC 512: Cost Accounting Systems 26
1esL our undersLandlng
Act|v|ty Cst | Act|v|ty Cst dr|ver
AdverLlslng 1he value of sales ln each sales area
CuallLy conLrol 1he number of quallLy LesLs
urchaslng 1he number of purchase orders
SeLup cosLs 1he number of seLups/prdLn runs
SLores 1he number of maLerlal requlslLlons
uespaLch 1he number of despaLch orders
LqulpmenL preparaLlon 1lme Laken or number of seLups
aLlenL preparaLlon 1lme Laken or number of paLlenLs
aLlenL afLercare 1lme Laken or number of paLlenLs
lllm processlng 1he number of lmages
lllm reporLlng 1he number of lmages
ACC 512: Cost Accounting Systems 27
CalculaLlon of cosLs per drlver and per
unlL uslng A8C
llve (3) 8aslc sLeps
1 ldenLlfy acLlvlLles LhaL consume resources and
lncur overhead cosLs
2 AllocaLed overhead cosLs Lo Lhe acLlvlLles LhaL
lncur overhead cosLs
3 ueLermlne Lhe cosL drlver for each acLlvlLy or
cosL pool
ln Lhls way each acLlvlLy becomes a cosL pool for overhead cosLs lL ls
lmporLanL LhaL overhead cosLs should be dlrecLly allocaLed Lo a cosL
pool 1here should noL be any arblLrary apporLlonmenL of overhead
cosLs
ACC 512: Cost Accounting Systems 28
CalculaLlon of cosLs per drlver and per
unlL uslng A8C
4 CollecL daLa abouL acLual acLlvlLy for Lhe cosL
drlver ln each pool
3 CalculaLe Lhe overhead cosL of producLs or
servlces 1hls ls done by calculaLlng an
overhead cosL per unlL of Lhe cosL drlver
Cverhead cosLs are Lhen charged Lo
producLs or servlces on Lhe basls of acLlvlLles
used for each producL or servlce
ACC 512: Cost Accounting Systems 29
lllusLraLlon A8C
M8A C2 manufacLures Lwo parLs A and 8 MonLhly relaLlng Lo
producLlon and sales are as follows
roducL A roducL 8
ulrecL MaLerlal CosL/unlL() 13 20
ulrecL abour Pour/unlL 1hr 2hrs
ulrecL abour CosL/unlL() 20 40
Sales demand 100unlLs 930unlLs
roducLlon overheads are 200000 each monLh and are
absorbed on a dlrecL labour hours basls CA8 ls 100/uP
1he managemenL accounLanL of M8A C2 company Ld has
produced a reporL of poLenLlal value of A8C as a preferred alLernaLlve
Lo Lhe LradlLlonal absorpLlon cosLlng sysLem and has found LhaL Lhere
are flve maln areas of acLlvlLy LhaL can be sald Lo consume overhead
cosLs 1he managemenL accounLanL has gaLhered Lhe followlng
monLhly lnformaLlon
ACC 512: Cost Accounting Systems 30
CalculaLe Lhe cosLs ln LoLal and per unlL for roducL A
and 8 uslng A8C
Act|v|ty 1C Cst dr|ver 1ta| - dt rdt
A 8

SeLLlng up 20000 no of seLups 4 1 3

Machlnlng 80000 Machlne hours 2000 100 1900
Crder handllng 20000 no of orders 4 1 3
CuallLy conLrol 20000 no of lnspecLlons 3 1 4
Lnglneerlng 60000 Lnglneerlng hours 1000 300 300
200000
ACC 512: Cost Accounting Systems 31
Worklngs
Cst per dr|ver
W SeL up/unlL 20000/4seLups 3000/seLup
W Machlnlng 80000/2000hrs 40/hr
W Crder 20000/4orders 3000/order
W CC 20000/3lnspecLlons 4000/lnspecLlon
W Lnglneerlng 60000/1000hrs 60/hr
Ds|ng A8C
W SeLLlng up allocaLlon
roducL A 1 seLup x 3000/seLup3000
roducL 8 3seLup x 3000/seLup 13000
W Machlnlng
roducL A 100hrs x 40/hr 4000
roducL 8 1900 hrs x 40 /hr 76000
ACC 512: Cost Accounting Systems 32
Worklngs
Cst per dr|ver
W SeL up/unlL 20000/4seLups 3000/seLup
W Machlnlng 80000/2000hrs 40/hr
W Crder 20000/4orders 3000/order
W CC 20000/3lnspecLlons 4000/lnspecLlon
W Lnglneerlng 60000/1000hrs 60/hr
Ds|ng A8C
W Crder handllng
dL A 1 order x 3000/order 3000
dL 8 3 order x 3000/order 13000
W CuallLy ConLrol
dL A 1 lnspecLlon x 4000/lnspecLlon 4000
dL 8 4 lnspecLlon x 4000/lnspecLlon 16000
W Lnglneerlng
dL A 300 hours x 60/hr 30000
dL 8 300 hours x 60/hr 30000
ACC 512: Cost Accounting Systems 33
soluLlon
Act|v|ty 1C Cst dr|ver 1ta| - dt rdt
A 8

SeLLlng up 20000 CosL per seLup 3000 3000 13000
Machlnlng 80000 CosL per Machlne hour 40 4000 76000
Crder handllng 20000 CosL per order 3000 3000 13000
CuallLy conLrol 20000 CosL per of lnspecLlon 4000 4000 16000
Lnglneerlng 60000 CosL per Lng hour 60 30000 30000
200000 48000 132000
ACC 512: Cost Accounting Systems 34
dt A () rdt 8 ()
ulrecL MaLerlals 1300 19000
ulrecL abour 2000 38000
Cverheads 48000 132000
1oLal CosL 31300 209000
number unlLs (31300/100) 100 930
CosL per unlL (209000/930) 313 220
Advantages f A8C
W 8etter prf|tab|||ty easres
A8C provldes more accuraLe and lnformaLlve producL cosLs leadlng Lo
more producL and accuraLe producL and cusLomer proflLablllLy
measuremenLs and Lo beLLerlnformed sLraLeglc declslons abouL
prlclng producL llnes and markeL segmenLs
W 8etter dec|s|n ak|ng
A8C provldes more accuraLe measuremenLs of acLlvlLydrlvlng cosLs
helplng managers Lo lmprove producL and process value by maklng
beLLer producL declslons beLLer cusLomer supporL declslons and
fosLerlng value enhancemenL pro[ecLs
W rcess |prveent
1he A8C sysLem provldes Lhe lnformaLlon Lo ldenLlfy areas where
process lmprovemenL ls needed
W Cst est|at|n
lmproved producL cosLs lead Lo beLLer esLlmaLes of [ob cosLs for prlclng
declslons budgeLlng and plannlng
ACC 512: Cost Accounting Systems 35
AdvanLages of A8C
W lL provlde much beLLer lnslghL lnLo whaL drlves
overhead cosLs
W A8C recognlses LhaL overhead cosLs are noL
relaLed Lo producLlon and sales volume
W ln many buslnesses overhead cosL are slgnlflcanL
proporLlon of LoLal cosLs and managemenL needs
Lo undersLand Lhe drlvers of overhead cosLs ln
order Lo manage Lhe buslness properly Cverhead
cosLs can be conLrolled by cosL drlvers
ACC 512: Cost Accounting Systems 36
CrlLlclsms of A8C
W A||cat|n
noL all cosL have approprlaLe acLlvlLy cosL drlvers Some cosLs requlre
allocaLlons Lo deparLmenLs and producLs based on arblLrary volumes
measures because flndlng Lhe
acLlvlLy LhaL causes Lhe cosL ls lmpracLlcal Lxamples are faclllLy susLalnlng
cosLs such as Lhe cosLs of lnformaLlon sysLem facLory manger's salary facLory
lnsurance and properLy Laxes for Lhe facLory 1hus lL ls lmposslble Lo allocaLe
all overhead cosLs Lo speclflc acLlvlLles
W pense and 1|e
An A8C sysLem ls noL free and ls Llmeconsumlng Lo develop and lmplemenL
lor flrms uslng volumebased cosLlng meLhod sysLem lnsLalllng a new A8C
sysLem ls llkely Lo be very expenses lurLhermore llke mosL lnnovaLlve
managemenL or accounLlng sysLems A8C usually requlres a year or longer
for successful developmenL and lmplemenLaLlon
ACC 512: Cost Accounting Systems 37
CrlLlclsms of A8C
W A8C cosL are based on assumpLlons and slmpllflcaLlon 1he
cholce of boLh acLlvlLles and cosL drlvers mlghL be
lnapproprlaLe
W A8C can be more complex Lo explaln Lo sLakeholders of
cosLlng exerclse
W 1he beneflLs obLalned from A8C mlghL noL [usLlfy Lhe cosL
ACC 512: Cost Accounting Systems 38
1he lmpllcaLlon of swlLchlng Lo A8C
1he use of A8C has poLenLlally slgnlflcanL
commerclal lmpllcaLlons
W rlclng can be based on more reallsLlc cosL
daLa
W Sales sLraLegy can be more soundly based
W erformance managemenL and declslon
maklng can be lmproved
ACC 512: Cost Accounting Systems 39
8ecap
W 1radlLlonal producL cosLlng measures accuraLely
volumerelaLed resources eg dlrecL cosLs buL fall
Lo measure Lhe way producLs consume non
volume relaLed acLlvlLles such as seLup cosLs
maLerlal handllng lnspecLlon
W A8C ls a meLhod of deLermlnlng accuraLe cosLs
W A8C ls a recenL lnnovaLlon ln cosL accounLlng and
lLs been rapldly adopLed by companles across
many lndusLrles and wlLhln governmenL and
nCCS
ACC 512: Cost Accounting Systems 40
AcLlvlLles consumes resources and Lhe
consumpLlon of resources drlves cosL
1herefore overhead cosL ls falrly or equally
allocaLed among producLs or servlces when
lL ls based on Lhe acLlvlLles LhaL consumes
resource whlch subsequenLly drlves cosL
ACC 512: Cost Accounting Systems 41
CuoLe
8eware of llLLle expenses A small leak wlll slnk
a greaL shlp" 8en[amln lranklln
ACC 512: Cost Accounting Systems 42
Croup 1wo Members
W AugusLlne Cwusu Applah
W uorcas uanladl
W lrederlck lorkuo ?eboah
W nehemlah 1eLLeh
W lrank wadwo 8onsu
W 8ev lr lsaac Cpoku1wumasl
ACC 512: Cost Accounting Systems 43
1PAn ?Cu
Lnu
ACC 512: Cost Accounting Systems 44