Chapter 5 Activity-Based Costing

1. Chapter 5Activity-Based Costing

3. Over- and Undercosting • Overcosting – a product consumes a low level of resources (costs) but is allocated high costs per unit • Undercosting – a product consumes a high level of resources (costs) but is allocated low costs per unit

4. Plastim Corporation • Manufactures lenses for rear taillights of automobiles • Makes two types of lenses for Giovanni Motors • A complex lens, CL5 • A simple lens, S3 • Processes at Plastim include: • Design products • Manufacture lenses • Distribute lenses

5. Some Basic Data at Plastim • Simple S3 lenses – 60,000 units (sales) budgeted for 2010 • Uses 30,000 DLH’s • Sells for $63 each • Competitor has offered this product for $53 to Giovanni • Complex CL5 lenses – 15,000 units (sales) budgeted for 2010 • Uses 9,750 DLH’s • Sells for $137 each • No price pressure exists

6. Product Costing at Plastim • To guide pricing and cost-management decisions, Plastim assigns all costs (both mfg. and non-mfg.) to its products • Plastim’s simple costing system traces direct materials and direct labor costs to products (CL5 and S3 lenses) • All other costs in the value chain are allocated to products using a single overhead rate using DLH as the allocation base

7. Overview of Plastim’s Simple Costing System

10. Plastim’s Product Costs Using Simple Costing

12. Guidelines for Refining a Cost System • Direct-cost tracing - categorize as many of the overall costs as direct costs (as economically feasible) • Divide indirect-cost pool into several homogeneous groups (pools) with cause-and-effect relationships between the cost driver and indirect cost • Define cost-allocation bases (cost drivers) for each cost pool using cause-and-effect criterion

13. Activity-Based Costing Systems

18. Cost Hierarchies • A cost hierarchy defines each activity cost pool as falling into one of four categories • The four categories in ABC systems are as follows: • Unit-level (output-level) costs • Batch-level costs • Product-sustaining-level costs • Facility-sustaining-level costs

19. Definitions • Unit-level – activities undertaken for every part made (machining operations) • Batch-level – activity is related to a group of units produced (setup, move material) • Product-sustaining – activity supports individual products regardless of the number of units or batches produced • Facility-sustaining – activities that support the organization as a whole. Assigned costs cannot be traced to any particular product (administrative costs, building rent, landscaping services)

20. Overview of Plastim’s ABC System

22. Activity-Cost Rates for Plastim’s Indirect Costs Pools

23. Plastim’s Product Costs Using ABC

24. Plastim: Simple & ABC Compared

25. Activity-Based Management • A method of management that used ABC as an integral part in critical decision-making situations, including: • Pricing and product-mix decisions • Cost reduction and process improvement decisions • Design decisions • Planning and managing activities