PUTRI ROUDINA M

041411331084 / Accounting English Class

Chapter 7: Activity-Based Costing and Management

Two major factors impair the ability of unit-based plant-wide and departmental rates to assign
overhead costs accurately:
o The proportion of nonunit-related overhead costs to total overhead costs is large.
o The degree of product diversity is great.
Categorizing Costs under ABC

Nonunitlevel
activity
drivers are
factors that
measure
the

consumption of nonunit-level activities by products and other cost objects, whereas unit-level
activity drivers measure the consumption of unit-level activities.
Activity drivers are factors that measure the consumption of activities by products and
other cost objects and can be classified as either unit-level or nonunit-level.
Product diversity means that products consume overhead activities in systematically
different proportions.
The proportion of each activity consumed by a product is defined as the consumption ratio.
Amount of Activity Driver per Product
Consumption Ratio=
Total Driver Quantity
A plantwide rate based on direct labor hours is calculated as

Overhead r ate=

Total Ov er head Cost

Total Di r ect Labo r Hour s

Activity-Based Product Costing

Functional-based overhead costing involves two major stages:
o Overhead costs are assigned to an organizational unit (plant or department).
o Overhead costs are then assigned to cost objects.

PUTRI ROUDINA M

041411331084 / Accounting English Class

Activity dictionary, lists the activities in an organization along with some critical activity attributes
(financial and nonfinancial information items that describe individual activities)
resource drivers are factors that measure the consumption of resources by activities
Activity costs are assigned to products by multiplying a predetermined activity rate by the usage of the
activity, as measured by activity drivers
Activity-based management is a system-wide, integrated approach that focuses managements attention
on activities with the objective of improving customer value and profit achieved by providing this value.
Process value analysis focuses on cost reduction instead of cost assignment and emphasizes the
maximization of system-wide performance. Process-Value Analysis is concerned with:

Activity inputs are the

resources consumed by the activity in producing its output. Activity output is the result or product of an
activity.
An activity output measure is the number of times the activity is performed. It is the quantifiable
measure of the output. For example, the number of moves or distance moved are possible output
measures for the material moving activity.
Driver analysis is the effort expended to identify those factors that are the root causes of activity
Activity analysis is the process of identifying, describing, and evaluating the activities that an
organization performs. Activity analysis produces four outcomes:
1. what activities are done
2. how many people perform the activities
3. the time and resources required to perform the activities
4. An assessment of the value of the activities to the organization, including a recommendation to
select and keep only those that add value.
Those activities necessary to remain in business are called value-added activities
All activities other than those that are absolutely essential to remain in business, and therefore considered
unnecessary, are referred to as nonvalue-added activities.
Activity Management Reduces Costs in Four Ways

PUTRI ROUDINA M

041411331084 / Accounting English Class

* Activity elimination
focuses on nonvalueadded activities.

* Activity selection
involves choosing
among different sets of
activities that are caused
by competing strategies.

* Activity reduction
decreases the time and
resources required by an
activity.

* Activity sharing
increases the efficiency
of necessary activities
by using economies of
scale.

Activity Performance Measurement

Measures of activity performance center on three major dimensions:
o Efficiency - the relationship of activity inputs to activity outputs.
o Time - time required to perform an activity.
o Quality - doing the activity right the first time it is performed.

Cycle time measures it measures how long it takes to produce an output from start to finish.
o Time/Units produced
o In a manufacturing process, cycle time is the length of time that it takes to produce a unit of output
from the time raw materials are received (starting point of the cycle) until the good is delivered to
finished goods inventory (finishing point of the cycle).
Velocity is the number of units of output that can be produced in a given period of time
o Units produced/Time
o Velocity is the reciprocal of cycle time.
Quality improvement can increase profitability in two ways:
o by increasing customer demand and thus sales revenues
o by decreasing costs
The costs of performing these activities are referred to as costs of quality.
The definitions of quality-related activities imply four categories of quality costs:
o prevention costs
o appraisal costs
o internal failure costs
o external failure costs
Control costs are the costs of performing control activities.
o Prevention costs are incurred to prevent poor quality in the products or services being produced.
o Appraisal costs are incurred to determine whether products and services are conforming to their
requirements or customer needs.
Failure activities are performed by an organization or its customers in response to poor quality (poor
quality does exist).
Failure costs are the costs incurred by an organization because failure activities are performed.
o Internal failure costs are incurred when products and services do not conform to specifications or
customer needs before being shipped.
o External failure costs are incurred when products and services fail to conform to requirements or
satisfy customer needs after being delivered to customers
Environmental costs are associated with the creation, detection, remediation, and prevention of
environmental degradation

PUTRI ROUDINA M

041411331084 / Accounting English Class