- The traditional cost system
- was designed to value inventory in the aggregate and not relate to product cost information.
- uses a common departmental or factory-wide measure of activity, such as direct labor hours or dollars (now a small portion of overall production costs) to distribute manufacturing overhead to products.
- Deemphasize long-term product analysis (when fixed costs become variable costs).
- Causes managers, who are aware of distortions in the traditional system, to make intuitive, imprecise adjustments to the traditional cost information without understanding the complete impact.
- meeting external reporting requirements for aggregate balance sheet valuation and income determination
- providing monthly and quarterly reporting
Management control of operations
- evaluating operations in order to quickly detect problems to allow implementation of corrective action
- comparing costs against budget for monitoring
The purpose and characteristics of ABC
- differentiating costs between value adding and non-value adding activities.
- costing products according to activities involved in the production process.
Benefits of ABC
- Leads to a more competitive position by evaluating cost drivers, e.g., costs associated with the complexity of the transaction rather than the production volume.
- Streamlines production processes by reducing non-value adding activities, e.g., reduced set-up times, optimal plant layout, and improved quality.
- Provides management with a more thorough understanding of product costs and product profitability for strategies and pricing decisions.
The steps to implement activity-based costing
- Evaluation of the existing system to assess how well system supports the objective of an activity-based cost system.
- Identification of the activities for which cost information is needed with differentiation between value adding and non-value adding activities.