5 Activity-Based Costing

and Management

FOCUS COMPANY >>>

THIS CHAPTER’S FOCUS COMPANY is the Patio Grill Company,

which manufactures high-end gas barbeque grills in its Denver

plant. The company has recently experienced intense competition in its two

high-volume product lines, forcing management to drop these products’

prices below their target levels. A careful study of this situation revealed that

Patio Grill Company’s traditional product-costing system distorted product costs by assigning

too much cost to the high-volume gas-grill lines and not enough cost to the low-volume,

complex line of grills. Management then implemented a new costing system, called activity-

based costing, or ABC, which assigns product costs more accurately than traditional product-

costing systems. Armed with the cost insights from the ABC system, management was able to

change its pricing structure to compete more effectively in the gas-grill market.
 <<< IN CONTRAST
In contrast to the manufacturing setting of the Patio Grill Company, we
D
Delaware
explore the use of activity-based costing by the Delaware Medical Center’s Medical
M
Center
C
Primary Care Unit. ABC is used in this health care services setting to assign treatment costs

to categories of patient visits, such as routine, extended, and complex visits, as well as new

and continuing patients. With a good understanding of how much it costs the Primary Care

Unit to provide various types of patient appointments, the clinic’s administration is in a much

better position to make decisions.

 After completing this chapter, you should be able to:

5-1 Compute product costs under a traditional, volume-based product-costing

system.

5-2 Explain how an activity-based costing system operates, including the use of a
two-stage procedure for cost assignment, the identification of activity cost pools,
and the selection of cost drivers.

5-3 Explain the concept of cost levels, including unit-level, batch-level,

product-sustaining-level, and facility-level costs.

5-4 Compute product costs under an activity-based costing system.

5-5 Explain why traditional, volume-based costing systems tend to

distort product costs.

5-6 Explain three criteria for selecting cost drivers.

5-7 Discuss several key issues in activity-based costing, including

data collection and storyboarding.

5-8 Explain the concepts of activity-based management and two-dimensional ABC.

5-9 Explain and execute a customer-profitability analysis.

5-10 Understand and discuss how activity-based costing is used in

service-industry organizations.

A revolution is transforming the world of business. Not since the mid-19th century have
we seen changes as sweeping and dramatic. The growth of international competition,
the breakneck pace of technological innovation, and startling advances in computer-
ized systems have created a new playing field for manufacturers around the globe. Some
manufacturers have emerged as world-class producers, while others have fallen by the
wayside. World-class companies such as Caterpillar, Coca-Cola, Johnson & Johnson, and
Pfizer are among the many manufacturers that have changed key business processes to
compete effectively in the 21st century.
The service industry also is undergoing dramatic transformation. The growth of the
Internet, the trend toward a service economy, and the willingness of businesses to out-
source many critical service functions have caused many service organizations to rein-
vent the way they do business. Among the many service-industry firms that have adapted
most successfully to the changing business environment are American Express, Bank of
America, FedEx, Google, and Southwest Airlines.
What is the role of managerial accounting in this rapidly changing environment?
To explore this issue, we will review recent events in the life of Patio Grill Company, a
manufacturer of barbeque grills and accessories. The company’s Denver plant manufac-
tures three product lines, all high-end gas barbeque grills. The plant’s three gas grill lines
are the Patio Standard (STD), the Deluxe (DEL), and the Ultimate (ULT).
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