In the problem above, the traditional method a. That is why most companies have moved to for inventory and other operating activities. The graphic illustration in Figure 7-4 shows this in a somewhat more dramatic way. A s a general rule, if non-volume related activities and their related costs are not isolated, high-volume customers and high-volume products will subsidize low-volume customers and low-volume products. Company C is assumed to have the same cost structure as Companies A and B.
This distorts the product costs per unit because V2 consumes only two thirds of the non-production volume related activities , i. Production volume based allocations based on direct labor hour proportions are illustrated in Figure 7-3 below for each activity cost pool. Data collected for a longer period e. Although some activity costs tend to be fixed, i. Activities merely represent secondary cost drivers, although the distinction between primary and secondary is likely to be forgotten or ignored after the system is designed.
Company D is assumed to have the same cost structure as Companies A, B and C. Do the terms production volume and activity volume mean the same thing? Just-in-time processes reduce batch sizes, in some cases to lot sizes of one , to minimize waste. The unit overhead cost for X1 using the traditional method rounded to 2 decimal places is a. The generalizations in the previous paragraphs are summarized in Exhibit 7-1. You believe that the benefits of activity-based costing system exceeds its costs, so you sat down with Aaron Mason, the chief engineer, to identify the activities which the firm undertakes in its sofa division. This chapter contains two relatively long sections and three fairly short sections. Volume-driven setups normally do not change any machine settings.
Managing costs: An outmoded philosophy. Problem 7-2 provides a fourth company in this sequence. However, the value of manufacturing overheads assigned is more accurately estimated. Solution In activity-based costing, direct materials cost, cost of purchased components and labor cost remains the same as in traditional product costing. Setup work is required to recognize and process the file regardless of how many deposits are in the file. Allocating overhead costs to the job involves multiplying the budgeted allocation rate by the number of actual direct labor hours. To avoid the rounding error, we can compare the total costs in Exhibits 7-7 and 7-8, i.
Staubus activity accounting culminates in a comparison of outputs, at standard cost or net realizable value, and inputs Staubus, 1971. Traditional costing equally distributes overheads by unit across all products, which clearly subsidizes lower-volume products. Costs that are caused by, or driven by, the same activity are pooled together and then allocated, or traced, to products using an appropriate measure of the activity volume. Conceptually, the idea is that each type of product requires engineering, purchasing, inspection and other support, regardless of the number of units produced, thus these support costs do not vary in proportion to the number of units, but instead vary with other factors that are unrelated to production volume. In Company B, it is the small product, but production volume is not an issue.
Activity-based costing researcher Robin Cooper, whose work was manufacturing based, documented four types of activities that have different drivers. The unit-level activities are most easily traceable to products while facility-level activities are least traceable. The same two aggregated cost pools used for Company A can also be used for Company B because the consumption proportions are the same for each of the three non-production volume related activities. All of these processes are more efficient to process in batches. This is because each product requires the same number of direct labor hours per unit i. Journal of Management Accounting Research 5 : 1-14. This saves hundreds of hours in machine setup time and keeps products more consistent throughout the process.
Now, just consider cost pool 1, i. Therefore, purchasing is technically a secondary driver of purchasing costs. More numbers of cost drivers are practically important and provide more accurate cost estimation Babad and Balachandran, 1993. Long list of activities can lead to complex design, implementation and use of the system but on the other hand greater number of activities will assign cost more accurately, so there is tradeoff between number of activities and the complexity of system Garrison, Noreen, Brewer, 2008:316. Higher-volume products, which are likely to be more frequently interrupted by lower-volume products, have setup costs assigned to them that are not a necessary cost to producing the product.
Although the non-production volume related costs could be combined as above, each activity cost pool is kept separate in Figure 7-2 to provide a somewhat different view of the solution. The relevant information appears in the tables below. This means that too much overhead cost is allocated to some products, while too little overhead cost is allocated to other products. Definition: Batch-level costs are expenses related to a group of products that cannot readily be traced back to an individual item. However, V3 is a larger size, high volume product that requires more direct material and direct labor because of it's size, but no additional support from purchasing, engineering or setups.