Two-Step Allocation

5 Two-Step Allocation

How does the installation of an activity-based costing system

After being recorded in the general ledger and subledger accounts, costs are ac-

affect behavior?

cumulated in activity center cost pools. An activity center is a segment of the production or service process for which management wants a separate report of

Chapter 4 Activity-Based Cost Systems for Management

the costs of activities performed. In defining these centers, management should consider the following issues: geographical proximity of equipment, defined cen- ters of managerial responsibility, magnitude of product costs, and a need to keep the number of activity centers manageable. Costs having the same driver are ac- cumulated in pools reflecting the appropriate level of cost incurrence (unit, batch, or product/process). The fact that a relationship exists between a cost pool and a cost driver indicates that, if the cost driver can be reduced or eliminated, the re- lated cost should also be reduced or eliminated.

Gathering costs in pools reflecting the same cost drivers allows managers to recognize cross-functional activities in an organization. In the past, some compa- nies may have accumulated overhead in smaller-than-plantwide pools, but this ac- cumulation was typically performed on a department-by-department basis. Thus, the process reflected a vertical-function approach to cost accumulation. But pro- duction and service activities are horizontal by nature. A product or service flows through an organization, affecting numerous departments as it goes. Using a cost driver approach to develop cost pools allows managers to more clearly focus on the various cost impacts created in making a product or performing a service than was possible traditionally.

After accumulation, costs are allocated out of the activity center cost pools and assigned to products and services by use of a second driver. These drivers are often referred to as activity drivers. An activity driver measures the demands placed on

activity driver

activities and, thus, the resources consumed by products and services. An activity driver selected often indicates an activity’s output. The process of cost assignment is the same as the overhead application process illustrated in Chapter 3. Exhibit 4–7 illustrates this two-step process of tracing costs to products and services in an

EXHIBIT 4–7 ABC system.

Tracing Costs in an Activity- Based Costing System

COSTS INITIALLY

(By department and

(Used to assign

CENTER

(Used to assign

COST

general ledger accounts) costs to cost pools)

COST POOL

costs to cost objects )

OBJECTS

$ Setup Cost

Number of setups

Number of setup

hours

Overhead

Dollars Processing time Machine Consumed

Number of

machine hours

Power Cost

per unit

Square footage of

Warehouse

Storage time per

occupied space

Cost

square foot occupied

resulting Individual products from

Value- Non-Value- Added

Added Activities

Activities

Work to eliminate

Part 2 Systems and Methods of Product Costing

As noted in Exhibit 4–7, the cost drivers for the collection stage may differ from the activity drivers used for the allocation stage because some activity center costs are not traceable to lower levels of activity. Costs at the lowest (unit) level of activity should be allocated to products by use of volume- or unit-based dri- vers. Costs incurred at higher (batch and product/process) levels may also be al- located to products by use of volume-related drivers, but the volume measure should include only those units associated with the batch or the product/process— not total production or service volume. Exhibit 4–8 provides some common drivers for various activity centers.