Distinguish between activities and cost objects in activity-based costing.
7. (Appendix 8A) Prepare an action analysis report using activity-based costing data and interpret the report. Show Chapter Overview A. Background. A few general comments will help set the stage for the chapter.
B. Differences Between ABC and Traditional Costing. The product costs computed in this chapter differ in major ways from the product costs in Chapters 2, 3, and 4 that describe traditional costing systems.
C. Cost Hierarchy in Activity-Based Costing. Thousands of activities are carried out in most organizations. It would not be practical to track all of them in an activity-based costing system. A great deal of simplification is necessary. Activities and their costs must be combined to reduce complexity and record-keeping requirements. One way to simplify is to group activities into a hierarchy. Activities, and their costs, can be combined within each level of the hierarchy into activity cost pools—hopefully with minimal loss in accuracy. The cost hierarchy used in the text is not the only scheme that could be used, but it is reasonably comprehensive. The levels in the hierarchy are as follows:
D. Mechanics of Activity-Based Costing. Exhibit 8-6 is a useful Exhibit for summarizing the mechanics of activity-based costing. You may want to refer to it frequently as you walk students through the steps of assigning costs using ABC.
E. Activity Rates and Activity-Based Management. Activity rates (i.e., the cost per unit of activity) can be useful to managers in targeting business process improvements. If activity rates are available from other organizations, an unusually high cost for carrying out a particular activity can signal room for improvement. Also, if similar activities are carried out at different locations within the same organization, activity rates can help identify which locations are most efficient. The methods used at the most efficient locations can then be applied to other locations. F. The Impact on Product Costs of Adopting an ABC System. Unit product costs are different under activity-based costing and traditional cost systems for a number of reasons. First, some manufacturing costs (i.e., the costs of idle capacity and organization-sustaining costs) are excluded from product costs under the activity-based costing approach described in the text. Second, some non-manufacturing costs are included in product costs under activity-based costing. These two differences affect the total amount of cost allocated to products. However, even if these differences are ignored or suppressed, the unit product costs will still differ between activity-based costing and traditional costing systems. For example, if a company switches to activity-based costing for external financial reports, the total costs allocated to products will remain the same, but the pattern of allocation will differ. The biggest changes in product costs from switching to an ABC system occur when the ABC system includes batch or product-level costs. In this case, costs ordinarily shift from high-volume products to low-volume products. Consequently, the total and per unit costs of the high-volume products decrease and the total and per unit costs of the low-volume products increase. When overhead costs are shifted from one product to another, a given dollar amount is implicitly subtracted from the total cost of one product and added to the total cost of the other product. Since the total cost of all products remains the same, what is taken away from one product must be added to another product. However, the effects on unit costs are not symmetrical. The per-unit costs of the low-volume products must go up more than the per-unit costs of the high-volume products go down. G. Appendix 8A: ABC Action Analysis. The conventional ABC analysis discussed in the chapter has some important drawbacks for decision-making. Most importantly, with a product margin analysis such as the one shown in Exhibit 8-9, it is unclear who is actually responsible for a cost. For example, if a product is dropped because of a negative margin, it is unclear who would be responsible for actually carrying out reductions in costs. An activity cost pool may contain costs from many departments. If a product is dropped, the activities associated with the product will presumably disappear, but will the costs? If it is unclear who would be responsible for reducing the costs, no one may actually take any action. This is particularly true for personnel costs. What manager will voluntarily give up personnel if there is no accountability? Be sure to reinforce the idea that the costs assigned to a product, customer, or whatever in an activity-based costing system are relevant in a decision only if the costs would actually change if the decision were taken. For example, in a product drop decision, the costs of resources are relevant only if spending would decrease as a result of the decision or the resources would be redeployed to more profitable uses. In the latter case, this means that the resources would have to be redeployed to the constraint. An action analysis report makes it much clearer what costs are likely to be relevant in a decision and who in the organization would be responsible for the cost if an action is taken. Unfortunately, preparing an action analysis report requires considerably more work than the more conventional analysis.
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