Assign Costs to Activities
Next, the costs are multiplied by the percentages to make allocations to each cost pool. For example, 20% of indirect material is allocated to robotics ($1,000,000 total indirect material X 20% = $200,000), etc. This process is revealed in the spreadsheet on the next page.
Determine Per-Activity Allocation Rates
Once the total cost for each activity pool is determined, it is divided by the activity quantity metric. For example, robotics cost $22,605,000 and 2,000,000 units were produced. Thus, this activity cost $11.3025 per unit. This calculation is repeated for each activity cost pool, and is summarized in the lower portion of the schedule on the next page.
Apply Costs to Cost Objects
Based upon this new information, the final step is to analyze the results. The consultant developed the following information. The top portion of this profitability analysis applies the per-activity cost information to show how the total cost of CAPlayer is actually much less than the total cost of GLASSESong. The lower portion compares costs and revenues to determine product profitability. Finally, note that the unallocated cost is included in the total column only; it is important, but not tied to either product.
What Just Happened?
By now your head is probably spinning with all the numbers. How is it possible that ABC's results were so different than the traditional costing method? In this case, traditional costing applied overhead based on direct labor costs. But, direct labor was just a small piece of the whole puzzle, and it did not fall evenly on both products. Further, the glasses required a lot more production set ups and tech support. In addition, glasses were very expensive to market in Asia because the advertising cost only benefited the one product in that market. These facts were not taken into account with the traditional costing method.
A Great Tool, But not a Panacea
The lesson for you as a manager or future manager is to move carefully in using cost information. It is important to fully consider many variables, some of which are not always apparent. Managerial accounting provides many tools to support your decision making task. ABC is one tool which has gained many fans, for the reasons illustrated in this chapter. It is about applying logic and reason. It provides a basis for costing and more. It enables systematic review of activities that will help you pinpoint opportunities for cost control and reallocation of capacity to higher yielding products. But, ABC is not perfect. In fact, ABC is no better than the process used to identify activities and allocation percentages. These elements are ultimately based on human judgment. Office politics can play a heavy hand in setting the components of any allocation model - after all it is human nature for employees to want their products to appear to be performing well! Therefore, a good manager must provide strong leadership to be sure that the ABC model is constructed with financial integrity.