ACT 5733 Advanced

Managerial Accounting

Chapter 5 ABC/ABM

ACT 5733 - Chapter 5 - Felo

Session Outline
Review Exam 2
Activity-based costing
Activity-based management

ACT 5733 - Chapter 5 - Felo

Traditional Allocation
Typically designed to satisfy GAAP
Volume-based
Single cost pool
Results:
1. Inaccurate cost allocations
2. Cross subsidization

ACT 5733 - Chapter 5 - Felo

Red Flags Concerning Costing
Systems
Indirect costs are significant
Many products & services that differ in
consumption of activities
Many different types of customers served
Prices seem out of touch with competition

ACT 5733 - Chapter 5 - Felo

Activity-Based Costing/
Activity-Based Management
Activities are the unit of analysis

Cost allocation technique

Cost management tool

ACT 5733 - Chapter 5 - Felo

Activity-Based Costing
Two step allocation
Deal with costs across entire value chain
Does not allocate all manufacturing costs
Typically more cost pools than in a
traditional system
Use of non-volume related cost drivers
Recognizes that products/services
consume activities differently

ACT 5733 - Chapter 5 - Felo

Cost Hierarchy
What type of activity causes cost to be
incurred (cost driver)
Unit-related
Batch-related
Product-sustaining
Customer-sustaining
Channel-sustaining
Organization-sustaining

ACT 5733 - Chapter 5 - Felo

Selecting Activity Cost Drivers
Trade-off between accuracy & cost

Transaction drivers

Duration drivers

Intensity or Direct charging

ACT 5733 - Chapter 5 - Felo

Transaction Drivers
These deal with how often an activity is
performed
Example: All service calls take approx 1
hour

ACT 5733 - Chapter 5 - Felo

Duration Drivers
These deal with the amount of time
necessary to perform an activity
Example: Each call requires a different
amount of time
Assumption: All operators earn the same
amount (time is equally expensive)

ACT 5733 - Chapter 5 - Felo

Intensity or Direct Charging
These directly charge for resources used

each time an activity is performed

This is appropriate if resources for an

activity are expensive and varied in use

Not really allocation

Example: Law firm

ACT 5733 - Chapter 5 - Felo

Implementation & Use of an
ABC System
Lack of clear business purpose
Lack of senior management commitment
Delegating the project to consultants
Poor ABC model design
Resistance to change
Difficult to maintain

ACT 5733 - Chapter 5 - Felo

Activity-Based Management
Use of ABC information for decision-making
Identification of non-value adding activities
Cost control through efficient use of cost drivers
Product design
Type of customer to target
Benchmarking
Make-or-Buy Decisions
Pricing
Customer profitability

ACT 5733 - Chapter 5 - Felo

Customer Profitability
ABC can help identify characteristics that
cause customers to be more or less
expensive to serve
Can be especially important for service
companies
80/20 rule of thumb

ACT 5733 - Chapter 5 - Felo

Customer Profitability
High Cost to Serve
Order custom products
Small order quantities
Unpredictable order arrivals
Customized delivery
Change delivery requirements
Manual processing
Large amount of pre-sale support
Large amount of post-sale support
Require company to hold inventory No requirement
Pay slowly (high A/R)
Low Cost to Serve
Order standard products
High order quantities
Predictable order arrivals
Standard delivery
No changes in requirements
Electronic processing (EDI)
Little to no pre-sale support
No post-sales support
Pay on time

ACT 5733 - Chapter 5 - Felo