Click to edit Master title style,Click to edit Master text styles,Second level,Third level,Fourth level,Fifth level,2011 by The McGraw-Hill Companies,Inc,.,*,Click to edit Master title style,Click to edit Master text styles,Second level,Third level,Fourth level,Fifth level,2011 by The McGraw-Hill Companies,Inc,.,*,Criticisms of Absorption Cost Systems:Inaccurate Product Costs,Chapter Eleven,Copyright 2021 by The McGraw-Hill Companies,Inc.All rights reserved.,McGraw-Hill/Irwin,Outline of Chapter 11Criticisms of Absorption Cost Systems:Inaccurate Product Costs,Inaccurate Product Costs,Activity-Based Costing,Analyzing Activity-Based Costing,Acceptance of Activity-Based Costing,11-,2,Connection to Other Chapters,Chapter 11 compares activity-based costing(ABC)to traditional absorption costing.,Chapters 9 and 10 began the discussion of absorption costing.,Chapter 4 discussed how changes in performance measurement require changes in other parts of organizational architecture(performance measurement and decision rights partitioning).,11-,3,Inaccurate Product Costs,When firms produce multiple products,absorption costing often does not accurately represent the opportunity costs of different products.,The cost drivers in absorption costing use a few input factors,such as direct labor hours or machine hours,to allocate overhead costs,Absorption costing does not clearly show how costs are influenced by the diversity and complexity of production processes.,Absorption cost systems assign too few costs to small batches and complex special orders.,11-,4,ABCs Major Features,Better identifies activities that drive costs,Especially set-up costs associated with each batch and product line,Analyzes activities rather than input resources,Each department could use different cost drivers.,Cost analysts attempt to identify cause-and-effect cost drivers for allocating overhead costs.,Reduces overhead cost pools that are allocated with an arbitrary allocation base,11-,5,Classifying ABC Cost Drivers,Classify cost drivers into one of four categories:,1.Unit-level,2.Batch-level,3.Product-level,4.Production-sustaining,See Figure 11-1.,11-,6,Unit-level Costs,Defined:,activities performed at least once for each unit of product,Total amount of unit-level costs is a linear function of the quantity produced.,Examples:,Direct labor and direct material,Machine servicing related to number of units produced,11-,7,Batch-level Costs,Defined,:activities performed once for each batch of products,Batch-level costs are independent of the number of units in the batch.,Examples:,Indirect labor,such as production supervisors,Machine set-ups,Moving batches,11-,8,Product-level Costs,Defined:,activities that support production of a product type or model,Product-level costs do not vary with the number of batches produced.,Examples:,Engineering support,Equipment usable for only one product line,11-,9,Production-sustaining Costs,Defined:,all remaining activities required for overall operation of production facility,Production-sustaining costs do not depend on number of units,batches,or product lines.,Examples:,Plant security,insurance,general maintenance,Plant accounting and administration,11-,10,Example:ABC vs.Absorption,Similarities:Direct and unit-level costs are allocated the same.,Differences:ABC allocates more indirect costs to products with smaller production volume and more complex set-up(models 801 and 901).,Model number,105 205 305 801 901,Batches per year 800 1,000 600 400 200,(100 units/batch),Absorption cost per unit$162$169$173$206$217,ABC cost per unit$134$169$151$265$273,Difference 17%0%-12%29%26%,Also review Self-Study problem.,11-,11,ABC and Decision Making,ABC improves pricing decisions because product costs are presumably more accurate estimates of opportunity cost.,Low-volume high-complexity products should get higher prices or be dropped.,ABC focuses attention on reducing use of activities that are most associated with costs.,Review the Insteel Industries example.,11-,12,ABC and Decision Control,ABC requires more monitoring.,Time to identify and measure activities,Meetings to resolve disputes over activity drivers,ABC shifts decision rights over activity drivers to lower-level managers with specialized knowledge of the relation between costs and activities.,Departmental managers could pick cost drivers that maximize their performance rewards.,11-,13,What is the Optimal Number of Cost Drivers?,Consider Figure 11-4,The optimal number of drivers is less for decision management and control than it is for decision management only.,Explain this.,11-,14,ABC Measures Costs,Not Benefits,ABC does not measure the benefits of producing/selling multiple products.,Firms offer multiple products because of economies of scale and scope.,ABC allocates common costs,not the common or joint benefits of multiple products.,11-,15,History of ABC,Pre-cursors of ABC were efforts to improve cost allocations in 19th century businesses.,(See side-bar examples).,Activit