Chapter 8Activity-based costing

Activity-based costingA methodology that can be used to measure both the cost of cost objects and the performance of activitiesCan help solve problems such as

distorted product costspoor cost controlThe ABC method adopted, depends on the problems that need to be addressed

Activity-based costing terminologyActivity - a unit of work performedCost driver - a factor that causes costResource driver - cost driver used to estimate the cost of resources consumed by an activityActivity driver - a cost driver used to estimate the cost of an activity consumed by the cost object

Cont.

Activity-based costing terminologyRoot-cause cost driver - the basic factors that cause activities to be performed and their costs to be incurred Bill of activities - identifies the activities, the activity cost per unit of activity driver, the quantity of activity drivers consumed, and, therefore, the cost of the activities consumed by the product

Different forms of ABCSimple approach - includes manufacturing overheadABC system for indirect costs - includes manufacturing and non-manufacturing costsComprehensive system - includes all product-related costs, except direct material

An activity-based costing modelThe costing view

measuring the cost of activitiesassigning activity costs to productsActivity management view

used to determine the causes of costs

The costing view of ABCMeasuring the cost of activities

assigning costs to activity centresidentify and cost the activities performed in each activity centreAssigning activity costs to products

calculating the activity cost per unit of activity driverpreparing a bill of activities for each product

Activity-based hierarchy of costs and activitiesUnit-level activitiesBatch-level activities Product-level (or product-sustaining) activitiesFacility-level (or facility-sustaining) activities

not usually included in product costs

Activity-based versus conventional product costsConventional costing assumes product costs are driven by volume-based cost driversConventional costing ignores batch size - units produced in large batches consume a relatively low consumption per unit of batch costs ABC includes non-manufacturing costs

ABC benefits will be greatest where...Overhead costs are a significant proportion of total cost, and a large part of overhead is not directly related to production volumeThe business has a diverse product range, and individual products use of support resources differs from their use of volume-based cost drivers

Cont.

ABC benefits will be greatest where...Production activity involves diverse batch sizes and product complexityThere are likely to be high costs associated with making inappropriate decisions, based on inaccurate product costsThe cost of designing, implementing and maintaining the ABC system is relatively low due to sophisticated IT support

Impediments to introducing ABCLack of awareness of ABCUncertainty about the potential benefits from ABCFirms understand the need for change but are concerned about the extensive resource requirements to implement ABCResistance to change among managers and employees

Other activity-based costing issuesSources of variations in types of ABC include whether

actual (past) or budgeted costs are analysedthe implementation is a one-off project or an on-going systemcost objects, other than products, are includedCont.

Other activity-based costing issuesImplications of excess capacity

ABC estimates the cost of resources used to perform activities to produce and sell products, which may not always equal the cost of resources suppliedneed to account for the costs of unused capacity when budgeted costs have been used to generate activity-based product costsCont.

Other activity-based costing issuesBehavioural issues

change can be perceived as threateningABC may require changes in data collected and collection and analysis proceduresbottom-up change management may give some degree of ownership of any changes caused by ABCmanagement must be seen as committed to the change process

Limitations of activity-based costingIf a high level of facility-level costs are allocated to products, this can lead to an arbitrary element of product costUnitised batch, product and facility-level costs can lead to product costs that are of limited use for decision makingThe cost of updating an ABC system can be very high, but is needed to avoid producing outdated, irrelevant information

Activity-based costing in service organisationsABC can be difficult to implement in service firms, because

high levels of facility costs cause problems with costing servicesindividual activities are difficult to identify because they are non-repetitivea non-repetitive production environment makes it difficult to identify service outputs

Exhibit 8.2

Exhibit 8.3

Exhibit 8.4