MANAGEMENT ACCOUNTING abc.docx

MANAGEMENT ACCOUNTING abc.docx - MANAGEMENT ACCOUNTING...

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MANAGEMENT ACCOUNTING: CONCEPTS AND TECHNIQUES By Dennis Caplan PART 3: PRODUCT COSTING AND COST ALLOCATIONS CHAPTER 11: ACTIVITY-BASED COSTING Chapter Contents: - Background - Apparel Factory Example of Two-Stage ABC Allocations - Cost Hierarchy - Milwood Mills - ABC in the Service Sector - ABC Implementation Issues Background: Activity-based costing ( ABC ) is a better, more accurate way of allocating overhead. Recall the steps to product costing:
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1. Identify the cost object ; 2. Identify the direct costs associated with the cost object; 3. Identify overhead costs ; 4. Select the cost allocation base for assigning overhead costs to the cost object; 5. Develop the overhead rate per unit for allocating overhead to the cost object. Activity-based costing refines steps #3 and #4 by dividing large heterogeneous cost pools into multiple smaller, homogeneous cost pools. ABC then attempts to select, as the cost allocation base for each overhead cost pool, a cost driver that best captures the cause and effect relationship between the cost object and the incurrence of overhead costs. Often, the best cost driver is a nonfinancial variable. ABC can become quite elaborate. For example, it is often beneficial to employ a two-stage allocation process whereby overhead costs are allocated to intermediate cost pools in the first stage, and then allocated from these intermediate cost pools to products in the second stage. Why is this intermediate step useful? Because it allows the introduction of multiple cost drivers for a single overhead cost item. This two-stage allocation process is illustrated in the example of the apparel factory below. ABC focuses on activities. A key assumption in activity-based costing is that overhead costs are caused by a variety of activities, and that different products utilize these activities in a non- homogeneous fashion. Usually, costing the activity is an intermediate step in the allocation of overhead costs to products, in order to obtain more accurate product cost information. Sometimes, however, the activity itself is the cost object of interest. For example, managers at Levi Strauss & Co. might want to know how much the company spends to acquire denim fabric, as input in a sourcing decision. The “activity” of acquiring fabric incurs costs associated with negotiating prices with suppliers, issuing purchase orders, receiving fabric, inspecting fabric, and processing payments and returns. Apparel Factory Example of Two-Stage ABC Allocations:
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Assume that an apparel factory uses forklifts in only two departments: The first department is Receiving, where large rolls of fabric are unloaded from semi- trailers and moved into storage, and later moved from storage to the cutting room. The second department is Shipping, where cartons of finished pants are staged and then loaded onto semi-trailers for shipment to the warehouse.
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