organization-sustaining activities is another term for

In other words, in the traditional system,87.5%of each manufacturing overhead cost is implicitly assigned to standard stanchions and12.5%is assigned to custom compass housings. Conversely, the traditional cost system assigns only 12.5% of these costs to custom compass housings even though this product caused40%of these costs. Similarly, the traditional cost system assigns 87.5% of the costs of the Product Design activity (a product-level activity) to standard stanchions even though the standard stanchions caused none (0%) of these costs. All (100%) of the costs of the Product Design activity, rather than just 12.5%, should be assigned to custom compass housings. The result is that traditional cost systems overcost high-volume products and undercost low-volume products because they assign batch-level and product-level costs using volume-related allocation bases. The third reason the product margins differ between the two cost systems is that the ABC system assigns the nonmanufacturing overhead costs caused by products to those products on a cause-and-effect basis. The traditional cost system disregards these costs because they are classified as period costs.

Some of the costs may not be avoidable and hence would not be relevant. Having gathered the above data, the design team created the product profitability report shown inExhibit 7–10. The report revealed that standard stanchions are profitable, with a positive product margin of$906,250, whereas the custom compass housings are unprofitable, with a negative product margin of$49,500. Keep in mind that the product profitability report purposely does not include the costs in the Customer Relations and Other activity cost pools. These costs, which total $858,000, were excluded from the report because they are not caused by the products.

How to Determine the Amount of Overhead to Be Allocated to Finished Goods Inventory

For example, direct and indirect labor may be classified as yellow costs because management action would be required to hire or layoff employees. For example, the customer orders activity has six activity rates that sum to the total of three hundred fifteen dollars from the conventional ABC analysis. A conventional ABC analysis does not identify potentially relevant costs. An action analysis report can help in this regard because it shows what costs have been assigned to a cost object and it indicates how difficult it would be to adjust those costs in response to changes in the level of activity. ABC systems produce numbers, such as product margins, that are at odds with the numbers produced by traditional cost systems. Managers are not accustomed to managing their operations using these numbers; hence, ABC inevitably faces resistance. This underscores the importance of having top management support for and cross-functional involvement with the ABC implementation.

For example, the$320,000total annual cost for the Customer Orders cost pool (which was computed inExhibit 7–5) is divided by the total of1,000customer orders per year to arrive at the activity rate of$320per customer order. Similarly, the$252,000totalcost for the Product Design cost pool is divided by thetotalnumber of designs (i.e., 400 product designs) to determine the activity rate of$630per design. Note that an activity rate is not computed for the Other category of costs.

Activity Based Costing MCQs

This is because theOthercost pool consists of organization-sustaining costs and costs of idle capacity that are not allocated to products and customers. Second, Classic Brass’s traditional cost system allocates all of the manufacturing overhead costs using a volume-related allocation base—machine-hours—that may or may not reflect what actually causes the costs.

The team should include representatives from each area that will use ABC data, such as the marketing, production, engineering, and accounting departments. These cross-functional employees possess intimate knowledge of many parts of an organization’s operations that is necessary for designing an effective ABC system. Furthermore, tapping the knowledge of cross-functional managers lessens their resistance to ABC because they feel included in the implementation process. Time after time, when accountants have attempted to implement an ABC system on their own without top-management support and cross-functional involvement, the results have been ignored.

Activity-Based Costing Compliance With GAAP

There are several service industries where ABC has started to emerge, and will continue to prove useful. Activity-based management focuses on business processes and managerial activities driving organizational business goals. Activity driver analysis identifies and assesses the factors involved in the costing of goods and services and is part of activity-based costing. Investopedia requires writers to use primary sources to support their work. These include white papers, government data, original reporting, and interviews with industry experts. We also reference original research from other reputable publishers where appropriate. You can learn more about the standards we follow in producing accurate, unbiased content in oureditorial policy.

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Companies began creating new products and services at an ever-accelerating rate that differed in volume, batch size, and complexity. Managing and sustaining this product diversity required investing in many more overhead resources, such as production schedulers and product design engineers, that had no obvious connection to direct labor-hours or machine-hours. Throughout the 19th century and most of the 20th century, cost system designs were simple and satisfactory. Typically, either one plantwide overhead cost pool or a number of departmental overhead cost pools were used to assign overhead costs to products. The plantwide and departmental approaches always had one thing in common—they relied on allocation bases such as direct labor-hours and machine-hours for allocating overhead costs to products.

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The shipping costs have no corresponding allocation percentages. This is because the shipping costs will be directly traced to customer orders.  ABC uses more allocation bases than traditional cost systems which rely solely on volume as the base for allocating overhead costs. Must be used organization-sustaining activities is another term for for external financial reporting since an activity-based costing system cannot be designed to generate full product costs for external reporting purposes. The expected costs for direct materials and direct labor for one-pound bags of two of the company’s coffee products appear below.

organization-sustaining activities is another term for

For example, the Avon branch may purposely spend more time with new customers to win their loyalty. The higher cost of opening new accounts at the Avon branch may be justified by future benefits of having more satisfied customers. Nevertheless, comparative studies of the costs of activities may provide a useful starting point for identifying best practices within a company and where improvements can be made. Similarly, the second-stage allocation process requires assigning product costs by each type of overhead cost. In the Classic Brass illustration, there are, for example, six activity cost assignments from the customer orders activity to the standard stanchions. These six assignments total six hundred thirty dollars as in the conventional ABC analysis.

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Customer Relations costs are caused by customers, not products. The Other costs are organization-sustaining costs and unused capacity costs that are not caused by any particular product. This chapter has emphasized using activity-based costing information in internal decisions. However, a modified form of activity-based costing can also be used to develop product costs for external financial reports.

organization-sustaining activities is another term for

Activity-based costing is a method of assigning overhead and indirect costs—such as salaries and utilities—to products and services. Product‐line activities are those activities that support an entire product line but not necessarily each individual unit.