Free Essay

Time Driven Activity Based Costing

In: Business and Management

Submitted By ajeprgowe
Words 1955
Pages 8
www.hbr.org
T
OOL K
IT
Time-Driven Activity-
Based Costing by Robert S. Kaplan and Steven R. Anderson

Many companie s abandoned activity-based costing because it did not capt ure the compl exity of their operations, took too long to implem ent, and was too expensive to build and maintai n. Here’s a way ar ou nd th ose problems.
R
eprint
R0411J
T
OOL
K
IT
Time-Driven Activity-
Based Costing by Robert S. Kaplan and Steven R. Anderson harvard business review
• november 2004 pa ge 1
C
OPYRIGHT © 2004 HAR
V
A
R
D BUSINESS SCHO
OL PUBLISHING C
ORP
OR
A
TION. ALL RIGHTS RESER
VED.
Many comp anies abandoned acti vit y-based costing because it did not capture th e complexity of their operations, took too long to implement, and wa s too expensive to build and maintain. Here’s a way around th ose problems.
In the classroom, activity-based costing looks like a great way to manage a company’s lim- ited resources. But many managers who have tried to implement ABC in their organizations on any significant scale have abandoned the at tempt in the face of rising costs and em- ployee irritation. They should try again, be- c ause the new approach we lay out in the fol- lowing pages sidesteps the difficulties traditionally associated with large-scale ABC implementation by relying on informed man- agerial estimates rather than on employee sur- ve ys. It also provides managers with a far more flexible cost model to capture the complexity of their operations.
ABC Made Difficult
The roots of the problem with ABC lie in the way people traditionally construct ABC mod- els. Assume you are analyzing a customer ser- vice department that performs three activi- ties: processing orders, handling inquiries, and performing credit checks. The department’s total expenses (the cost of the personnel, man- agement, IT, telecommunications, and other fixed resources) amount to $560,000. The ac- tual (or estimated) quarterly quantities of work in the three activities are 49,000 orders,
1,400 inquiries, and 2,500 credit checks.
To
build a traditional ABC model for this de- partment, you would survey employees to esti- mate the percentage of time they spend (or ex- pect to spend) on the three activities and then assign the department’s resource expenses ac- cor ding to the average percentages you get from the survey. Let’s say employees report that they spend (or expect to spend) about 70% of their time on customer orders, 10% on in- quiries or complaints, and 20% on credit checks. This implies, under ABC, that each order consumes $8 of resource expense, each inquiry $40, and each credit check $44.80, as shown in the exhibit “Doing ABC the Tradi- tional Way.” Armed with these figures, known as the cost-driver rates, managers can assign the costs of the department’s resources to the customers and products that use its services.
This approach works well in the limited set-
Time-Driven Activity-Based Costing



T
OOL
K
IT
harvard business review
• november 2004 page 2
Robert S. Kaplan ( rkaplan@hbs.edu ) is the Marvin Bower Professor of Leader- ship Development at Harvard Business
School in Boston.
Steven R. Ander- son ( sanderson@acornsys.com ) is the f ounder and chairman of Acorn Sys- t ems, a software and consulting firm headquartered in Houston. Kaplan serves on the board of Acorn Systems. ting in which it was initially applied, typically a single department, plant, or location. Difficul- ties arise, however, when you try to roll this ap- proach out on a large scale for use on an ongo- ing basis. In one large bank’s brokerage operation, the ABC data-gathering process re- quired 70,000 employees at more than 100 fa- cilities to submit monthly reports of their time allocation. The company employed 14 people full-time just to manage the data collection, processing, and reporting.
The time and cost demands of creating and maintaining an ABC model on this scale is a major barrier to widespread adoption at most c ompanies. Since the systems that are put in place are updated infrequently (because of the c osts of reinterviewing and resurveying), the model’s estimates of process, product, and cus- tomer costs soon become inaccurate. What’s more, people waste their time arguing about the accuracy of cost-driver rates that are de- rived from individuals’ subjective beliefs rather than addressing the deficiencies the model re- v eals: inefficient processes, unprofitable prod- ucts and customers, and excess capacity.
Tr
aditional ABC models also often fail to c apture the complexity of actual operations.
C
onsider the activity “ship order to customer.”
Ra
ther than assume a constant cost per order shipped, a company may wish to recognize the c ost differences when an order is shipped in a full truck, in a less-than-truckload (LTL) ship- ment, using overnight express, or by a com- mercial carrier. In addition, the order may be entered into the system either manually or electronically, and it may be either a standard or an expedited transaction. To allow for the significant variation in resources required by the different shipping arrangements, new ac- tivities must be added to the model, thereby e xpanding its complexity.
As
the activity dictionary expands—either to reflect more detail about activities or to ex- pand the scope of the model to the entire en- terprise—the demands on the computer pro- grams used to store and process the data escalate. Suppose a company has 150 activities in its enterprise ABC model, applies the costs in these activities to some 600,000 cost objects
(products and customers), and runs the model monthly for two years. That would require data estimates, calculations, and storage for more than 2 billion items.
Such expansion has caused ABC systems to exc eed the capacity of generic spreadsheet tools, such as Microsoft Excel, and even many
ABC software packages. The systems could ta ke days to process one month’s worth of data. For example, the automated ABC model f or Hendee Enterprises, a $12 million fabricator of awnings, took three days to calculate costs f or its 40 departments, 150 activities, 10,000 or- ders, and 45,000 line items.
These problems have become obvious to most ABC implementers. But a subtle and more serious problem arises from the inter- view and survey process itself. When people es- timate how much time they spend on a list of activities handed to them, they invariably re- port percentages that add up to 100. Few indi- viduals report that a significant percentage of their time is idle or unused. Therefore, cost- driver rates are calculated assuming that re- sources are working at full capacity. But as we all know, operations often run at considerably less than their capacity. That means that the es- timated cost-driver rates are usually much too high. (Technically, they will be overstated by the reciprocal of the capacity utilization per- c entage: At 80% utilization, the rates are 25% too high; at 67% utilization, the rates are 50% too high.)
The New ABC
The solution to the problems with ABC is not to abandon the concept. ABC after all has helped many companies identify important cost- and profit-enhancement opportunities through the r epricing of unprofitable customer relation- ships, process improvements on the shop floor, lower-cost product designs, and rationalized product variety. Its potential on a larger scale r epresents a huge opportunity for companies.
For
tunately, simplification is now possible through an approach that we call time-driven
ABC, which we have successfully helped more than 100 client companies implement, includ- ing those described in this article. In the revised approach, managers directly estimate the re- source demands imposed by each transaction, product, or customer rather than assign re- source costs first to activities and then to prod- ucts or customers. For each group of resources, estimates of only two parameters are required: the cost per time unit of supplying resource ca- pacity and the unit times of consumption of re- source capacity by products, services, and cus- tomers. At the same time, the new approach
Time-Driven Activity-Based Costing



T
OOL
K
IT
harvard business review
• november 2004 page 3 provides more accurate cost-driver rates by al- lowing unit times to be estimated even for com- plex, specialized transactions.
Estimating the cost per time unit of capac- ity. Instead of surveying employees on how they spend their time, managers first directly estimate the practical capacity of the resources supplied as a percentage of the theoretical ca- pacity. There are various ways to do this. As a rule of thumb, you could simply assume that practical full capacity is 80% to 85% of theoret- ical full capacity. So if an employee or ma- chine is available to work 40 hours per week, its practical full capacity is 32 to 35 hours per week. Typically, managers would allot a lower ra te—say 80%—to people, allowing 20% of their time for breaks, arrival and departure, c ommunication, and training. For machines, managers might allot a 15% differential be- t ween theoretical and practical capacity to allow for downtime due to maintenance, re- pair, and scheduling fluctuations. A more sys- tematic approach, perhaps, is to review past activity levels and identify the month with the largest number of orders handled without ex- c essive delays, poor quality, overtime, or stressed employees. Whichever approach you prefer, it’s important not to be overly sensitive to small errors. The objective is to be approxi- mately right, say within 5% to 10% of the ac- tual number, rather than precise. If the esti- mate of practical capacity is grossly in error, the process of running the time-driven ABC s ystem will reveal the error over time.
R
eturning to our example, let’s assume that the customer service department employs 28 r eps to do the frontline work and that each puts in eight hours per day. In theory, there- fo re
,
each worker supplies about 10,560 min- utes per month or 31,680 minutes per quarter.
The practical capacity at about 80% of theoret- ical is therefore about 25,000 minutes per quarter per employee, or 700,000 minutes in total. Since we already know the cost of sup- plying capacity—the $560,000 in overhead c osts—we can now calculate the cost per minute of supplying capacity ($0.80).
The capacity of most resources is measured in terms of time availability, but the new ABC approach can also recognize resources whose c apacity is measured in other units. For exam- ple, the capacity of a warehouse or vehicle would be measured by space provided, while memory storage would be measured by mega- bytes supplied. In these situations, the man- ager would calculate the resource cost per unit based on the appropriate capacity mea- sure, such as cost per cubic meter or cost per megabyte. Estimating the unit times of activities.
Having calculated the cost per time unit of supplying resources to the business’s activities, managers next determine the time it takes to c arry out one unit of each kind of activity.
These numbers can be obtained through inter- views with employees or by direct observa- tion. There is no need to conduct surveys, al- though in large organizations, surveying employees may help. It is important to stress, though, that the question is not about the per- c entage of time an employee spends doing an activity (say, processing orders) but how long it takes to complete one unit of that activity
(the time required to process one order). Once again, precision is not critical; rough accu…...

Similar Documents

Premium Essay

Activity Based Costing

...Activity Based Costing 2.1 Traditional costing system Before going into detail on the activity based costing method, here is a brief presentation of the traditional costing system and say how it differs from ABC. The traditional costing system traces indirect costs to products/services through a single, or a few rates. Firstly, indirect expenses are assigned to production and service departments. After that, the costs from the service departments are moved to production departments. Separate rates are made per department and indirect costs are assigned to products/services through direct labor or machine hours. What we will see with ABC is that this method differs so that activities are used instead of departments and indirect costs are assigned to main activities in a company. One looks at what drives costs and does not only use labor or machine hours. 2.2 What is ABC? Activity based costing is like a bag of tools from which anyone can take what they need at the time. On the other hand, ABC might be closed in the everyday accounting practices as it tends to promise more accurate product costs. This method is mostly about experimentations. Nowadays the name ABC is full of competing and contradictory ideas and practices with so many authors that there appears to be no clear guidance. What is clear is that this method simply cannot be separated from the activities and events to which it is connected. According to Langfield-Smith, Thorne and Hilton, an activity based...

Words: 4626 - Pages: 19

Premium Essay

Activity-Based Costing System

...Journal of Business and Management Vol. 6, No. 11; November 2011 Activity-Based Costing System in the Service Sector: A Strategic Approach for Enhancing Managerial Decision Making and Competitiveness Ashford C. Chea School of Business, Kentucky Wesleyan College 4721 Covert Avenue, Evansville, IN 47714, USA Tel: 1-812-471-9341 E-mail: achea@ix.netcom.com Received: June 21, 2011 doi:10.5539/ijbm.v6n11p3 Accepted: July 4, 2011 Published: November 1, 2011 URL: http://dx.doi.org/10.5539/ijbm.v6n11p3 Abstract The author begins the article by outlining a brief historical evolution of activity-based costing (ABC) in the USA preceded by an operating definition of terminologies. Next, he presents the literature review and the methodology employed during the study. He reviews the application of ABC in the service sector, followed by an analysis of the unique attribute of the service sector. Moreover, the researcher briefly profiles several service-oriented firms that have successfully adopted and implemented ABC, and presents his findings from the study. He then addresses the limitations of ABC in the service sectors and offers strategies for dealing with these drawbacks. Finally, the researcher outlines the managerial implications of implementing ABC in the service sector. Keywords: Activity-based costing, Service sector, Managerial decision making, Cost measurement 1. Introduction The concept of activity-based costing (ABC) was introduced in the US, initially in the......

Words: 7039 - Pages: 29

Free Essay

Activity Based Costing

.... | Activity Based Costing | | | | | . | Executive Summary The success of any business that offers a product or service is greatly dependent on the ability of the products it offers to compete in a market. If a firm can determine its costs and the demand at each possible price offering it is likely to find the market price that maximizes profit. (Bakken, 2012). Hence, it is important that companies employ strategies that will ensure that cost allocation is accurate and gives management an accurate view of production cost. Having a full picture of every production step and their respective cost can help management make better pricing and sells decisions. This paper is aimed at exploring the process of cost allocation, specifically, the Activity Based Costing System (ABC). It examines how the ABC system diverges from the previous traditional accounting system. It highlights the advantages and disadvantages of the ABC model, and presents an alternate approach that tries to fix the loop holes that exist in the ABC system. This paper shows that the analysis of costs and resources used in the production of goods and services is the most important tool needed in determining business performance (Veres, 2011). Cost Allocation: Purpose and Process When a firm produces more than one product or provides more than one type of service, a resource may be shared. This shared resource places a financial burden on the firm. Cost allocation is the......

Words: 2484 - Pages: 10

Free Essay

Summary of Time-Based Activity-Based Costing

...Mark Hamrick & Dakata Brodie 17 Nov 2013 Assignment 2.1 Summary of Time-Based Activity-Based Costing This article’s purpose is to explain the new version of Activity-Based Costing that uses approximations to determine time-driven Activity-Based Costing. Base on rate of technological growth and dealing with companies on larger scales, the traditional method of ABC is very cumbersome. The new time-driven activity-based costing is a much more effective technique. The article further went on to contrast the two methods of costing by showcasing traditional inefficiencies, demonstrating the ease of use for the new method, and applying real-time data to increase situational awareness. The inefficiencies of the traditional activity-based costing were the primary reasons for the new time-driven method. The article explains how the process was so cumbersome that Excel programs were not powerful enough to crunch all the numbers. Tracking information was overbearing and required dedicated teams more than a day to interpret the data. Ease of use was a primary concern for anyone to venture back to the new activity-based costing. By simply averaging the amounts and getting ballpark figures, teams could use formulas to effectively average the costs based on the average time to complete a job, not each individual task. This method didn’t require thousands of surveys to determine the cost-only estimates. This reduced the number of items tracked and provided......

Words: 424 - Pages: 2

Premium Essay

Activity Based Costing

...Activity-based Costing Activity-based costing, is a system that follows a two-stage procedure to assign overhead costs to products. It identifies activities in a company and assigns the cost of each activity resource to all products and services according to the actual consumption by each. As revealed in the article, this costing method had both pros and cons. The article favored the advantages of the ABC method although the satisfaction scores were below the average for all tools used. For those companies that disfavored ABC method, the most common complain was that it took too much money and time using this method, and the method might not capture the complexity of their operations. In fact, ABC method is not production-specified. For production costs, standard costing was still “kill of the hill” with a usage rate of 42% according to the article. However, it is inaccurate to say that ABC method is increasingly being abandoned, only four out of 141 organizations previously used ABC but no longer use it according to the survey. In addition, the survey revealed that around sixteen percent companies considered ABC but chose not to implement it. The main concerns of managers of those companies regarding which cost-measurement system to choose were that they were not sure if it was a better way to allocate cost, if it accurately reflected how resources were used, if the information was timely, and if updating the system was difficult. Having said about the disadvantages......

Words: 596 - Pages: 3

Premium Essay

Activity Based Costing Analysis

...Critically discuss: a) Why Cambridge Hospital Community Health Network embarked on the ABC study? There are two main reasons why the Cambridge Hospital Community Health Network (the Network) embarked on the Activity Based Costing (ABC) study. Firstly, the Network needed to gain a better understanding of its unit-of-service costs, which had been rising at a rate of 10% per year. In fact it had recently been rated the third-highest cost hospital in the state of Massachusetts. Being a high cost provider could make the Network uncompetitive for Medicaid and other public contracts. Secondly, the Network’s new operating budget required a $14 million reduction, which represented 15% of the total hospital network’s operating budget, in expenditures during the next two fiscal years. This was largely due to the downward pressure on hospital revenues by the government reform and managed care forced providers to cope with conditions that were constantly changing, while continuing to provide quality health care services in a time of intense competition. The Network's traditional method of analysing costs is the Medicare step-down costing system. It gave little information about the cost at the unit of service level. It gave only aggregate costing information (i.e. information about the departmental or global costs) but it does not provide the costs at the patient or procedure level that is needed in order to push cost reduction and also price their services......

Words: 1132 - Pages: 5

Premium Essay

Activity Based Costing

...Activity Based Costing Presentation by: Viraj Vaidya (12F353) & Nikhil Vanage (12F360) SCM Introduction Activity-based costing (ABC) is a costing methodology that identifies activities in an organization and assigns the cost of each activity with resources to all products and services according to the actual consumption by each. This model assigns more indirect costs (overhead) into direct costs compared to conventional costing. CIMA (Chartered Institute of Management Accountants) defines ABC as an approach to the costing and monitoring of activities which involves tracing resource consumption and costing final outputs. Resources are assigned to activities, and activities to cost objects based on consumption estimates. The latter utilize cost drivers to attach activity costs to outputs. Aims of model With ABC, a company can soundly estimate the cost elements of entire products ACTIVITIES and services. That may help inform a company's decision to either: * Identify and eliminate those products and services that are unprofitable and lower the prices of those that are overpriced (product and service portfolio aim) * Or identify and eliminate production or service processes that are ineffective and allocate processing concepts that lead to the very same product at a better yield (process re-engineering aim). In a business organization, the ABC methodology assigns an organization's resource costs through activities to the products and......

Words: 2056 - Pages: 9

Free Essay

Activity Based Costing

...|The ratio of adopting ABC | | |system |use of data of different |How do firms consider ABC system | |Activity based costing in |Earlier experience of ABC system |survey |CIMA research on ABC system | |manufacturing: |ABC implementation case studies |Journals |Detail case study of two | |two case studies |comparison & conventional costing |articles |companies | | |system |Different case studies | | |Year 1998 | | | | |Page 137-147 | | | | |2. "Activity-Based Costing." |The structure of ABC and its pit |Study of research magazine & |Potential pitfalls of activity | |Encyclopedia of Small Business. Ed. |falls |article |based costing. | |Kevin Hillstrom and Laurie Collier | | | | |Hillstrom.......

Words: 438 - Pages: 2

Premium Essay

Activity Based Costing

...Nowadays, global competition is driving the business towards restoration in order to strengthen their position in the global economy. The attention focuses on product quality, processes for the production, and improving workforce. However, many companies are still using the same traditional costing systems, Cooper and Kaplan (1991).The absorption costing paved way due to the lack of visibility for indirect costs so the ABC has been adopted by many organizations rapidly. According to Krajnc et al. (2011), the main difference of ABC to absorption costing lies on how they treat indirect production costs (overheads) and sales. The fundamental goal of ABC is to identify as much as possible direct relationships between products and resources consumed through activities conducted from production to disposal. The ABC system is based on the assumption that the support activities such as activities and sales, the cost of which traditional systems characterized as overheads, offer opportunities for the implementation of activities, and thus are not just for sharing costs. In an absorption costing when the volume of overheads is larger, the likelihood of distortions in reported costs is also greater. In general, overheads that exceed 15 percent of the total cost can cause inaccuracies, Turney (1996). Many companies had major problems by these inaccuracies and so they started using ABC. The traditional approach to cost allocation consists of three steps: Concentration of costs in the......

Words: 1869 - Pages: 8

Premium Essay

Activity-Based Costing

...The Pros and Cons of Activity-Based Costing (ABC) Activity-based costing, rooted from the 1970ies, were a novel way of assigning costs more accurately to cost objects. As R. Cooper and R. S. Kaplan brought notice to these concepts, they stressed its main innovation: assigning the direct and indirect costs of each activity to products based on the resources they consume. In contrast, the traditional costing system assigned overheads in proportion to an activity’s direct costs1, which would oftentimes distort the real costs incurred by a product. The reason is that if product B needs a lot more engineer’s time to be developed, it should have higher costs than product A needing less time. This example is taken from the article1 “Idea: Activity-based costing” by the Economist, which sheds light on the ABC method’s merits, but also mentions that a lot of firms were reluctant to implement this system. The article goes on to explain that the ABC system had a strong start, but soon fell into a period of disrepute, as Mr. Kaplan has admitted. Since the ABC system is generally accepted and its advantages are taught in business schools worldwide, this article inspired me to briefly discuss reasons as to why or why not a firm should implement such a system. First and foremost, as mentioned, activity-based costing is the basis for a more accurate cost allocation, especially when the rate of overhead costs is high or when products consume different proportions of overhead rates. A more......

Words: 506 - Pages: 3

Premium Essay

Activity Based Costing

...Activity Based Costing By: Azalea McSwain ACC310: Cost Accounting 1 Instructor: Susan Paris Date: April 18, 2011 Outline I: Introduction a. What is Activity Based Costing b. How Does it Work II. Body a. What does ABC do for Firms b. How to develop the ABC system in a firm c. What are the Steps d. Examples III. Conclusion IV. References Abstract Activity Based Costing was developed in the manufacturing sector of the United States during the 1970’s and 1980’s. This system is used as a method for developing cost estimates in which projects were discrete or subdivided activities. ABC systems calculates the costs of individual activities and assigns costs to their related cost object such as products and services on the basis of the activities performed to produce each product. The Chartered Institute of Management Accountants (CIMA) technology defines ABC as “an approach to the costing and monitoring of activities which involves tracing resource consumption and costing final outputs. (Edwards, 2006)” This paper will address what the ABC system does for firms which use it, how to develop such a system in a firm, the steps of the ABC system and some common examples. Activity Based Costing Introduction Activity Based Costing (ABC) addresses internal operating concerns of a firm and is an augmentation to the traditional ledger based cost management system. It doesn’t replace traditional accounting, but it makes use of the source documents provided......

Words: 612 - Pages: 3

Premium Essay

Activity-Based Costing

...INTRODUCTION TO COST MANAGEMENT Activity-Based Costing and Management After studying this chapter, you should be able to . . . 1. Explain the strategic role of activity-based costing 2. Describe activity-based costing (ABC), the steps in developing an ABC system, and the benefits and limitations of an ABC system 3. Determine product costs under both the volume-based method and the activity-based method and contrast the two 4. Explain activity-based management (ABM) PART I 5. Describe how ABC/M is used in manufacturing companies, service companies, and governmental organizations 6. Use an activity-based approach to analyze customer profitability 7. Identify key factors for successful ABC/M implementation Beware of little expenses. A small leak will sink a great ship. Benjamin Franklin This chapter has a lot to do with implementing the spirit of Benjamin Franklin’s observation—in cost management terms—that it really does matter how accurately you calculate a cost. Why? Having accurate costs is important for a variety of reasons: a company might find that it has a difficult time determining which of its products is most profitable. Alternatively, it finds its sales increasing but profits declining and cannot understand why. Perhaps the company keeps losing competitive bids for products and services and does not understand why. In many cases, accurate cost information is the answer to these questions. Accurate cost information provides a competitive......

Words: 26360 - Pages: 106

Free Essay

Activity Based Costing Case

...Managerial & Cost Accounting ACCT610 Activity-Based Management Made Possible By Activity-Based Costing Supervised by Professor Majboor Alnamri Prepared by: EMBA Student 1 KAAU - EMBA Overview • • • • • • Over/Under Costing Methods of Allocating Indirect Cost Refining a cost system Costs/Benefits of ABC ABC in service & retail Example from an Organization 2 KAAU - EMBA Over Costing & Under Costing Over Costing—a product consumes a low level of resources but is allocated high costs per unit. Under Costing—a product consumes a high level of resources but is allocated low costs per unit. KAAU - EMBA 3 KAAU - EMBA Activity-Based Costing Identifies activities required to produce the product or service Determines the cost of the activities Allocates costs to the cost object based on the object’s consumption of activities 4 KAAU - EMBA Methods of Allocating Indirect Cost Cause-and-effect Using this criterion, managers identify the variable or variables that cause resources to be consumed Benefits-received Using this criterion, managers identify the beneficiaries of the outputs of the cost object 5 KAAU - EMBA Methods of Allocating Indirect Cost Fairness or equity This criterion is often cited on government contracts when cost allocations are the basis for establishing a price satisfactory to the government and its suppliers. Ability to bear This criterion advocates allocating costs in......

Words: 1207 - Pages: 5

Premium Essay

Activity Based Costing

...Chapter 8 Activity-based costing 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 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 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 Problems with costing in service businesses Service......

Words: 1246 - Pages: 5

Premium Essay

Activity Based Costing

...Cost Allocation Definition¶ All of us have used cost allocation, the process of assigning common costs to ending inventory and cost of goods sold (COGS), as part of our Financial Services offerings since it is required by GAAP. Our goal has been to either reduce taxes or increase reported earnings, depending on our client's needs and circumstances. But what about cost allocation's other uses? Are we shortchanging our clients by not offering services in this area (usually referred to as cost or management accounting services)? Managers’ use cost allocation for a number of reasons. First and foremost, cost allocation provides a methodology for assigning overhead costs of various activities, usually support departments, to products or services being produced and/or sold allowing upper management to assess and analyze their profitability. By knowing what the true "cause-and-effect" relationship is, managers are able to more accurately assess the true cost of a product or service and determine if carrying certain products and/or services contributes to overall profitability given the demand for and price these products/services sell for. This is especially important as it pertains to both operational decisions (such as calculating the maximum price a firm can charge, especially for a "commodity" product, determining the maximum cost a firm is willing to pay to provide this product or service, and in making special order and transfer pricing decisions) and capital/long-term......

Words: 1432 - Pages: 6