Activity-based Costing Ppt 2ht1h
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Activity-Based Costing Phuong Nguyen – Kim Tran – Amal Alqadi – Justine Laporte
Table of content Purposes of Cost Allocation Traditional Costing System
Product cost and period cost Usage Criticisms
Activity-Based Costing System
Definition Comparison Steps Benefits and Limitations
Application in GM
Purposes of Cost Allocation
Traditional Costing Systems
Product Costs Direct labor Direct materials Factory Overhead
Easy to trace to products The problem comes with factory overhead
Period Costs istrative expense Sales expense
Appear on the income statement when goods are sold, prior to that time they are stored on the balance sheet as inventory. Appear on the income statement in the period incurred.
Traditional Costing Systems
Typically used one rate to allocate overhead to products.
This rate was often based on direct labor dollars or direct labor hours.
This made sense, as direct labor was a major cost driver in early manufacturing plants.
Criticisms of Traditional Allocation
Assumes all overhead is volume-related
Factory-wide or departmental rates
All related to single activity measure
Departmental focus, not process focus
Focus on costs incurred, not cause of costs
Over-costing or under-costing
Complex products are not allocated an adequate amount of overhead costs. Simple products get too much.
Today’s Manufacturing Plants
More complex; Often make more than one product
Often automated
Use proportionately smaller amount of direct labor making direct labor a poor allocation base for factory overhead
Multiple allocation bases should be used to allocate overhead expense In such situations, managers need to consider using activity based costing (ABC)
ABC Definitions
Activity based costing is an approach for allocating overhead costs.
An activity is an event that incurs costs.
A cost driver is any factor or activity that has a direct cause and effect relationship with the resources consumed.
Comparison with Traditional allocation Traditional allocation method
Costs
Products
Activity-based allocation method
Costs
Activities
First stage 9
Products
Second stage
Example
ABC Steps
Examples of Activities 1. Processing purchase orders. 2. Handling materials and parts. 3. Inspecting incoming material and parts. 4. Setting up equipment.
5. Producing goods using manufacturing equipment 6. Supervising assembly workers. 7. Inspecting finished goods.
8. Packing customer orders.
Examples of Associated Costs 1. Various labor costs. 2. Depreciation.
Examples of Cost Drivers 1. Number of purchase orders processed. 2. Number of material requisitions. 3. Number of receipts. 4. Number of setups.
5. Number of machine hours. 6. Number of assembly labor hours. 7. Number of inspections.
8. Number of boxes shipped.
Level of costs
Activity Based Management Activity-based management (ABM) is a method of activities analysis, which is the process of studying activities to classify them and to devise way of minimizing or eliminating non-value added activities Activity-based management focuses on managing activities to reduce costs and improve customer value.
Activity based Management
Application When do we use ABC? •
The manufacturing process or number of products has changed significantly—for example, from labor intensive to capital intensive automation.
•
Production or marketing managers are ignoring data provided by the existing system and are instead using ―bootleg‖ costing data or other alternative data when pricing or making other product decisions.
ABC Was Generally Worth It…But Not Always
ABC as a GM policy (1986-1993)
Started developing ABC in 1986, GM has fully implemented ABC as a statistical analysis system for product costing since 1993.
Successfully developed & implemented in Pontiac plant in 1987
In 1989, ABC system was applied in additional 11 sites and search for the ability to implement ABC system in other 22 plans
In 1990, GM decided to implement ABC system in every plants, COF of GM was named « corporate ABC champion »
6 stages of ABC system at GM
Initiation – feasibility analysis is done (1986)
Adoption (1987)– decision to invest some level of resources is made
Adaptation (1990) – analysis is made of firm’s activities and cost drivers, ABC information is available but not yet used by noning staff for decision-making ? Acceptance(1991) – occasionally used by upper management AS AN INPUT for decision-making, but still considered a project or model Routinization – commonly used by upper management for decisionmaking and considered a normal part of the information system, astablishing a net-work ABC in GM. Infusion/integration – used extensively and fully integrated within the primary financial system
How ABC helps GM in making profits
Helps GM to find the most profitable assets in company, including customers, investments and products. Drives GM efficient decision making in manufacturing more profitable products and stopping unprofitable ones. It will enable GM to be more cost effective and run the business more efficiently. Reduce expenditures by eliminating un-value-added process ABC system creates a competitive advantage for GM
Advantages of ABC system Identifying and eliminating waste and non-value added activities
Easy to identify where high (and low) costs are being incurred and the cause. Helps companies figure out ways to raise profits without raising prices More accurate costing of products/services, customers, distribution channels. A valuable tool for both business and process improvement. Helps with future product planning by allocating resources effectively
Integrates well with continuous improvement programs (Six Sigma, Kaizen, Just-in time, Total Quality Management...), A valuable tool for both business and process improvement
Limitations of ABC system ABC reports do not conform to generally accepted ing principles (GAAP)
Complex, time consuming, and costly to collect data Cost of buying, implementing and maintaining activity based system
May provide too much detail – obscuring the bigger picture
Conclusion ABC was developed in 1988 as a solution to the inadequacy of traditional system, however, there are many limitations in ABC system that lead to further research and result in the development of lean ing methods such as Balanced Scorecards and Economic Value Added (EVA) which is less complex and costly than ABC system
Reference l
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l
l
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http://maaw.info/ArticleSummaries/ArtSumAnderson 95.htm http://www.questia.com/googleScholar.qst?docId=50 01658502 http://en.wikipedia.org/wiki/List_of_GM_transmission s http://www.questia.com/googleScholar.qst?docId=50 00488038 http://deepblue.lib.umich.edu/bitstream/2027.42/353 57/2/b1784201.0001.001.pdf
Table of content Purposes of Cost Allocation Traditional Costing System
Product cost and period cost Usage Criticisms
Activity-Based Costing System
Definition Comparison Steps Benefits and Limitations
Application in GM
Purposes of Cost Allocation
Traditional Costing Systems
Product Costs Direct labor Direct materials Factory Overhead
Easy to trace to products The problem comes with factory overhead
Period Costs istrative expense Sales expense
Appear on the income statement when goods are sold, prior to that time they are stored on the balance sheet as inventory. Appear on the income statement in the period incurred.
Traditional Costing Systems
Typically used one rate to allocate overhead to products.
This rate was often based on direct labor dollars or direct labor hours.
This made sense, as direct labor was a major cost driver in early manufacturing plants.
Criticisms of Traditional Allocation
Assumes all overhead is volume-related
Factory-wide or departmental rates
All related to single activity measure
Departmental focus, not process focus
Focus on costs incurred, not cause of costs
Over-costing or under-costing
Complex products are not allocated an adequate amount of overhead costs. Simple products get too much.
Today’s Manufacturing Plants
More complex; Often make more than one product
Often automated
Use proportionately smaller amount of direct labor making direct labor a poor allocation base for factory overhead
Multiple allocation bases should be used to allocate overhead expense In such situations, managers need to consider using activity based costing (ABC)
ABC Definitions
Activity based costing is an approach for allocating overhead costs.
An activity is an event that incurs costs.
A cost driver is any factor or activity that has a direct cause and effect relationship with the resources consumed.
Comparison with Traditional allocation Traditional allocation method
Costs
Products
Activity-based allocation method
Costs
Activities
First stage 9
Products
Second stage
Example
ABC Steps
Examples of Activities 1. Processing purchase orders. 2. Handling materials and parts. 3. Inspecting incoming material and parts. 4. Setting up equipment.
5. Producing goods using manufacturing equipment 6. Supervising assembly workers. 7. Inspecting finished goods.
8. Packing customer orders.
Examples of Associated Costs 1. Various labor costs. 2. Depreciation.
Examples of Cost Drivers 1. Number of purchase orders processed. 2. Number of material requisitions. 3. Number of receipts. 4. Number of setups.
5. Number of machine hours. 6. Number of assembly labor hours. 7. Number of inspections.
8. Number of boxes shipped.
Level of costs
Activity Based Management Activity-based management (ABM) is a method of activities analysis, which is the process of studying activities to classify them and to devise way of minimizing or eliminating non-value added activities Activity-based management focuses on managing activities to reduce costs and improve customer value.
Activity based Management
Application When do we use ABC? •
The manufacturing process or number of products has changed significantly—for example, from labor intensive to capital intensive automation.
•
Production or marketing managers are ignoring data provided by the existing system and are instead using ―bootleg‖ costing data or other alternative data when pricing or making other product decisions.
ABC Was Generally Worth It…But Not Always
ABC as a GM policy (1986-1993)
Started developing ABC in 1986, GM has fully implemented ABC as a statistical analysis system for product costing since 1993.
Successfully developed & implemented in Pontiac plant in 1987
In 1989, ABC system was applied in additional 11 sites and search for the ability to implement ABC system in other 22 plans
In 1990, GM decided to implement ABC system in every plants, COF of GM was named « corporate ABC champion »
6 stages of ABC system at GM
Initiation – feasibility analysis is done (1986)
Adoption (1987)– decision to invest some level of resources is made
Adaptation (1990) – analysis is made of firm’s activities and cost drivers, ABC information is available but not yet used by noning staff for decision-making ? Acceptance(1991) – occasionally used by upper management AS AN INPUT for decision-making, but still considered a project or model Routinization – commonly used by upper management for decisionmaking and considered a normal part of the information system, astablishing a net-work ABC in GM. Infusion/integration – used extensively and fully integrated within the primary financial system
How ABC helps GM in making profits
Helps GM to find the most profitable assets in company, including customers, investments and products. Drives GM efficient decision making in manufacturing more profitable products and stopping unprofitable ones. It will enable GM to be more cost effective and run the business more efficiently. Reduce expenditures by eliminating un-value-added process ABC system creates a competitive advantage for GM
Advantages of ABC system Identifying and eliminating waste and non-value added activities
Easy to identify where high (and low) costs are being incurred and the cause. Helps companies figure out ways to raise profits without raising prices More accurate costing of products/services, customers, distribution channels. A valuable tool for both business and process improvement. Helps with future product planning by allocating resources effectively
Integrates well with continuous improvement programs (Six Sigma, Kaizen, Just-in time, Total Quality Management...), A valuable tool for both business and process improvement
Limitations of ABC system ABC reports do not conform to generally accepted ing principles (GAAP)
Complex, time consuming, and costly to collect data Cost of buying, implementing and maintaining activity based system
May provide too much detail – obscuring the bigger picture
Conclusion ABC was developed in 1988 as a solution to the inadequacy of traditional system, however, there are many limitations in ABC system that lead to further research and result in the development of lean ing methods such as Balanced Scorecards and Economic Value Added (EVA) which is less complex and costly than ABC system
Reference l
l
l
l
l
http://maaw.info/ArticleSummaries/ArtSumAnderson 95.htm http://www.questia.com/googleScholar.qst?docId=50 01658502 http://en.wikipedia.org/wiki/List_of_GM_transmission s http://www.questia.com/googleScholar.qst?docId=50 00488038 http://deepblue.lib.umich.edu/bitstream/2027.42/353 57/2/b1784201.0001.001.pdf
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