Figure 5-2 shows the direct and indirect costs for the S3 and CL5 lenses using the simple cost system. Plastim's simple costing system may be overestimating the simple S3 lens (assigning it too much cost) and underestimating the complex CL5 lens (assigning it too little cost). These activity descriptions form the basis of the activity-based costing system—sometimes called an activity listing dictionary.
Unlike the single indirect cost pool of Plastim's simple costing system, each of the activity-related cost pools is homogeneous. Plastim's ABC system uses set-up hours - a batch-level cost allocation base - to allocate set-up costs to products.
Learning Objective 4
Plastim's ABC system uses molding machine hours—an output unit-level cost allocation base—to assign machine operating costs to products. Product-sustaining costs (service-sustaining costs) are the costs of activities undertaken to support individual products or services, regardless of the number of units or groups in which the units are produced. Plastim's ABC system uses parts-square-feet - a product-sustaining cost allocation base - to allocate design costs to products.
Learning Objective 5
Exhibit 5-5 shows the direct and indirect costs for the S3 and CL5 lenses using the ABC system. The identification of cost allocation bases determines the number of activity groups into which costs should be grouped in the ABC system. In this step, Plastim assigns the estimated indirect costs for 2011 to the activities (see Exhibit 5-4, column 3) as far as possible based on the causal relationship between the cost allocation basis for the activity and the price.
The strength of the cause-and-effect relationship between the cost allocation base and the cost of an activity naturally varies across cost pools. Exhibit 5-4, column 5, summarizes the calculation of the budgeted indirect cost rates using the budgeted quantity of the cost allocation base from step 3 and the total budgeted indirect costs for each activity from step 4. For each activity, Plastim's operations staff must indicate the total amount of the cost allocation base that will be used by each type of lens (remember Plastim operates at capacity).
Direct costs are calculated in step 2, and indirect costs are calculated in step 6. Homogeneous groups of costs and the choice of cost allocation bases, related to the cost hierarchy, give Plastim managers greater confidence in the activity and product cost numbers. from the ABC system.䊏 Significant amounts of indirect costs are allocated using only one or two cost pools.
䊏 All or most indirect costs are identified as output unit level costs (few indirect costs are described as batch level costs, product maintenance costs, or facility maintenance costs).
Learning Objective 6
Managers choose the level of detail to use in a costing system by evaluating the expected costs of the system against the expected benefits resulting from better decisions. So what are some of the behavioral issues that the management auditor needs to be aware of. It also requires selling the idea to end users and working with members of other departments as business partners for the managers in the various areas affected by the ABC project.
Managers who feel more involved in the process are likely to spend more time and be less skeptical of the ABC effort. However, Plastim's managers must now use this information to make decisions (Step 4 of the 5-step decision process, p. 145) and to implement the decision, evaluate performance, and learn (Step 5, p. 145) . For example, the ABC system indicates that Plastim can match the competitor's S3 lens price of $53 and still make a profit because S3's ABC cost is $49.98 (see Figure 5-5).
Plastim managers are confident they can use the deeper cost understanding the ABC system provides to improve efficiency and further reduce the cost of the S3 lens. Without information from the ABC system, Plastim's managers could have mistakenly concluded that they would incur an operating loss on the S3 lens at a price of $53. The ABC system shows that the cost of making complex lenses is much higher—$132.07 versus $97 shown by the labor-hour-based direct manufacturing costing system that Plastim had been using.
Managers set cost reduction goals in terms of reducing the unit costs of the cost allocation base in different areas of activity.
Learning Objective 7
The Concepts in Action box on page 155 describes some of the behavioral issues that management accountants must be sensitive to when immersing an organization in ABC thinking. Manufacturing and distribution personnel use ABC systems to focus on how and where to reduce costs. For example, the distribution operations area supervisor at Plastim might have a performance goal to reduce distribution costs per cubic foot of products delivered from $5.80 to $5.40 by reducing distribution labor and warehouse rental costs.
For example, Plastim can reduce distribution costs by packaging the lenses in such a way that the delivered packages are less bulky. For example, design decisions that reduce mold complexity reduce the costs of design, materials, labor, machine setups, machine operation, and mold cleaning and maintenance. Plastim's customers may be willing to give up some features of the lens in exchange for a lower price.
Many companies implementing ABC systems for the first time analyze actual costs to identify activity cost pools and activity cost rates. Companies often use cost accounting systems that have features of ABC systems, such as multiple cost pools and multiple cost allocation bases, but do not emphasize individual activities. Plastim calculates design activity by dividing the total design department cost by the total square footage of parts, a measure of mold complexity and the driver of design department costs.
Based on what we just explained, using departmental indirect cost rates to allocate costs to products results in similar information to activity cost rates if (1) a single activity accounts for a significant portion of the department's costs takes; or (2) significant costs are incurred for different activities within a department, but each activity has the same cost driver and therefore the same cost allocation basis (as was the case in Plastim's design department).
Learning Objective 8
Managerial decisions that use activity-based cost information are described in Chapter 6, where we discuss activity-based budgeting; Chapter 11, which discusses outsourcing and adding or dropping business segments; in Chapter 12, in which we evaluate alternative design choices to improve efficiency and reduce non-value-added costs; in Chapter 13, in which we discuss renovation and downsizing; in Chapter 14, in which we explore customer profitability management; in Chapter 19, where we explain quality improvements; and in Chapter 20, in which we describe how to evaluate suppliers. Plastim does not find it reasonable to calculate separate activity rates within the design department for different design activities such as product design, temporary mold making, and design processes. Companies such as Cooperative Bank, Braintree Hospital, BCTel in the telecommunications industry, and Union Pacific in the railroad industry have implemented some form of ABC to identify profitable product mixes, improve efficiency, and improve customer satisfaction.
It calculated the costs of various activities, such as carrying out PIN transactions, opening and closing accounts, administering mortgages and processing Visa transactions. It then used activity cost rates to calculate the costs of different products, such as checking accounts, mortgages and Visa cards, and the costs of supporting different customers. Activity-based costing raises some interesting issues when applied to a public service like the US.
In this case, activity-based costing is valuable for understanding, managing, and reducing costs, but not for pricing decisions. Time-based activity-based costing (“TDABC”) helps Charles Schwab, a leading brokerage, strategically analyze, measure and manage stock trading activities across multiple channels such as branches, call centers and the Internet. Because costs vary for each channel, TDABC helps answer questions such as: What are the total costs of branch transactions versus online transactions?
TDABC then uses the capacity cost rate to drive resource costs to cost objects, such as stock transactions executed through branch brokers, by estimating the resource capacity demand (time) required by the cost object.
Solution
What is the difference between designing a simple costing system and an activity-based costing (ABC) system? 5-18 Alternative Allocation Basis for a Professional Services Firm. Walliston Group (WG) provides tax advice to multinational firms. Calculate the budgeted cost of trophies and plaques if Tarquin allocates overhead costs to each department using activity-based costing.
Calculate the cost of standard work and special work using the activity costing system. Why do simple and activity-based costing systems differ in costing standard work and special work. Calculate the cost of interior and exterior doors using the activity costing system.
Why do the simple and activity-based cost systems differ in the cost of an interior and exterior door?䊏 Cutting Activity Area – The production line produces (a) 250 pounds of retail potato wedges per cutting hour and (b) 400 pounds of institutional potato wedges per cutting hour .䊏 Area of Packaging Activity: The packaging line packs (a) 25 pounds of retail potato wedges per packing hour and (b) 100 pounds of institutional potato wedges per packing hour.
5-39 Activity-Based Labor Costing, Unit Cost Comparisons. Tracy Corporation has a machining facility specializing in jobs for the aerospace component market. Calculate unit manufacturing costs for each job in an activity-based costing system. Using activity-based costing, calculate the gross margin per unit of the Regal and Monarch models.
