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CHAPTER 5: ACTIVITY-BASED COSTING AND ACTIVITY-BASED MANAGEMENT

Document Type

: Book Summary

Source

: Cost Accounting: A Managerial Emphasis 15th Edition by Charles T
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Datar, and Madhav V
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That’s because simple peanut-butter costing broadly averages or spreads
the cost of resources uniformly to cost objects when, in fact, the individual products or
services use those resources in nonuniform ways
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This
can lead to certain strategic consequences, as follows
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Undercosted products will be
underpriced and may even lead to sales that actually result in losses because the sales
may bring in less revenue than the cost of resources they use
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But what if prices are determined by the market based on
consumer demand and competition among companies? In this case, product
undercosting and overcosting cause managers to focus on the wrong products
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They give less attention to
undercosted products thinking they are highly profitable, when in fact these products
consume large amounts of resources and are far less profitable than they appear
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Learning Objective 3

: Distinguish between Simple and Activity-Based Costing
(ABC) Systems

The ABC system differs from the simple system by its fundamental focus on activities
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Learning Objective 4


: Describe a Four-Part Cost Hierarchy

Output unit–level costs are the costs of activities performed on each individual unit of
a product or service
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Examples include setup
costs, material-handling and quality-inspection costs associated with batches of
products produced and costs of placing purchase orders, receiving materials, and
paying invoices related to the number of purchase orders placed;



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 batches in which the units are produced
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Examples
include the general administration costs
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Identify the products that are the chosen cost objects;

2
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Select the activities and cost-allocation bases to use for allocating indirect costs to the
products;

4
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Compute the rate per unit of each cost-allocation base;
6
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Compute the total cost of the products by adding all direct and indirect costs assigned
to the products
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When managers decide to implement ABC, they must make important choices about the
level of detail to use
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However, ABC system comes with certain costs and limitations
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ABC systems require
managers to estimate costs of activity pools and to identify and measure cost drivers for
these pools to serve as cost-allocation bases
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These measurements are costly
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As ABC systems get very detailed
and more cost pools are created, more allocations are necessary to calculate activity costs
for each cost pool, which increases the chances of misidentifying the costs of different
activity cost pools
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ABM can be defined broadly to include decisions about pricing and product mix, cost
reduction, process improvement, and product and process design
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With this information, managers can make pricing and product-mix
decisions
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They set cost
reduction targets for the cost per unit of the cost-allocation base in different activity
areas
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

Design Decisions
ABC systems help managers to evaluate the effect of current product and process
designs on activities and costs and to identify new designs to reduce costs
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Managers then calculate a
budgeted rate that they use for planning, making decisions, and managing activities
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Management

accountants

make

adjustments

for

underallocated or overallocated indirect costs for each activity using certain methods
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Learning Objective 8

: Compare Activity-Based Costing Systems and Department
Costing Systems

In many situations, department costing systems can be refined using ABC
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