Chapter 7Activity-Based Costing: A Tool to Aid Decision MakingDiscussion Case (20 minutes)Potential benefits of adopting an ABC system that arise from having more accurate product (or service) costs include:• Improved product (or service) pricing decisions• Improved product (or service) mix dec...
Chapter 7
Activity-Based Costing: A Tool to Aid Decision
Making
Discussion Case (20 minutes)
Potential benefits of adopting an ABC system that arise from having more
accurate product (or service) costs include:
• Improved product (or service) pricing decisions
• Improved product (or service) mix decisions
• Ability to target process improvements in key activities that can
result in cost savings
The income effect of each alternative would be calculated as: (price per
unit x estimated volume) – (variable cost per unit × estimated volume) –
fixed expenses. This operating income level would then be multiplied by
the subjective probability of achieving the predicted volume level given the
new price. These steps would be repeated for other possible sales volume
levels and the results summed to come up with the expected profit margin
given the change in sales price. The expected profit margin could then be
compared to the current profit margin to determine if the benefits exceed
the costs of adopting the ABC system.
7-9 Benchmarking is a systematic approach 7-11 The second stage allocation in activity-
used to compare the performance of some aspect based costing is the process by which activity
of an organization’s operations to that of rates are used to apply costs to products and
outstanding external companies or other divisions customers.
within the same organization. For example,
manufacturing companies could benchmark 7-12 The two chief limitations are: First, the
defect rates against other top companies in the portion of overhead costs that relate to facility-
industry. Benchmarking is often used in level activities are still usually allocated to
conjunction with activity-based management as a products on some arbitrary basis, such as
means of improving key processes or operations machine-hours or direct labour-hours. Critics of
identified as performing below acceptable levels. activity-based costing argue that facility-level
activities account for the bulk of all overhead
7-10 In traditional cost systems, product-level costs in some companies. Second, high
costs are spread across all products measurement costs are involved in operating an
indiscriminately using direct labour-hours or some activity-based costing system. That is, the system
other basis that is tied to volume. As a requires the tracking of large amounts of detail
consequence, high-volume products are assigned and the completion of many separate
the bulk of such costs. If a product is responsible computations in order to determine the cost of a
for 40 percent of the direct labour in a factory, it unit or product.
will be assigned 40 percent of the manufacturing
overhead cost in the factory—including 40 percent 7-13 The activity-based costing approach
of the product-level costs of low-volume products. described in the chapter is probably unacceptable
In an activity-based costing system, batch-level for external financial reports for two reasons.
and product-level costs are assigned more First, activity-based product costs, as described in
appropriately. This results in shifting product-level this chapter, exclude some manufacturing costs
costs back to the products that cause them and and include some nonmanufacturing costs which
away from the high-volume products. (There will is not allowed under GAAP. Second, the first-stage
be a similar effect with batch-level costs if high- allocations are usually based on interviews rather
volume products are produced in larger batches than verifiable, objective data.
than low-volume products.)
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