Chapter 8 Activity-based costing Copyright ª 2006 McGraw­Hill Australia Pty Ltd 8­ 1 Problems with conventional product costing systems • General features of conventional product costing systems – Direct material and direct labour costs are traced to products – Manufacturing overhead costs are allocated to products using a predetermined overhead rate – Manufacturing overhead rate is calculated using some measure of production volume – Non-manufacturing costs are not assigned to products continued Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 8-2 Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 8-3 Problems with conventional product costing systems • Failure to adapt to the changing business environment – Increasing levels of non-volume-driven manufacturing overhead costs – Increasing proportion of non-manufacturing costs – Causes of changes in costs – Changing product structures and increased product diversity Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 8-4 Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 8-5 Indicators of problems with a product costing system • Product costing systems are likely to result in inaccurate product costs when … – Proportion of direct labour costs decreases – Proportion of manufacturing overhead costs increases – Proportion of manufacturing overhead costs, not related directly to production volume, increases – Non-manufacturing costs that are product-related become substantial – Product diversity increases Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 8-6 Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 8-7 Problems with costing in service businesses • Service firms tend to use firm-wide, volume-based overhead rates – Overhead costs are increasing in importance, and are increasingly non-volume driven • Customers are demanding more diverse and higher quality services – Increases in product diversity and quality increase the level of non-volume-driven overhead costs – Cast doubt on the accuracy of service costs derived from a conventional product costing system Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 8-8 Activity-based costing • A methodology that can be used to measure both the cost of cost objects and the performance of activities • Can help solve problems such as – Distorted product costs – Poor cost control • The form of ABC method adopted depends on the problems that need to be addressed Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 8-9 Copyright 2006 McGraw-Hill Australia Pty Ltd