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From the course by University of Illinois at Urbana-Champaign

Managerial Accounting: Cost Behaviors, Systems, and Analysis

297 ratings

University of Illinois at Urbana-Champaign

Managerial Accounting: Cost Behaviors, Systems, and Analysis

297 ratings

Course 1 of 7 in the Specialization Value Chain Management

In this course, you will learn how to use accounting to facilitate and align decisions made by owners, managers, and employees. You will learn how accountants create, organize, interpret, and communicate information that improves internal processes, and allows organizations to identify and leverage opportunities to create value within the supply chain and with customers. Upon successful completion of this course, you will be able to: • Understand what managerial accounting is and why it is important. • Describe fundamental concepts of managerial accounting. • Apply the financial perspective of accounting for costs. • Identify problems associated with relying on financial accounting information for internal decision making. • Organize cost information according to the decision-making needs of the organization. • Apply activity-based costing (ABC) and recognize the influence of setting and decision characteristics on the relevance of ABC systems. • Address common "what-if" questions using cost-volume-profit (CVP) analysis. • Apply CVP analysis in a variety of scenarios. This course is part of the iMBA offered by the University of Illinois, a flexible, fully-accredited online MBA at an incredibly competitive price. For more information, please see the Resource page in this course and onlinemba.illinois.edu.

From the lesson

Costing Systems II - Activity-Based Costing

Activity-based costing systems adopt a more refined view of the organization, and can increase the accuracy of cost information. In this module, we introduce the fundamentals of activity-based costing systems, identify related advantages and disadvantages, and demonstrate how such systems are implemented using an in-depth example.

Learning Objectives and Steps Through an Example19:20

Other Considerations4:26

What We've Learned in Lesson 3.20:55

Module 3 Review0:48

Meet the Instructors

Gary Hecht, Ph.D.
Associate Professor of Accountancy
Department of Accountancy, College of Business

[ Silence ]

>> So now that we've seen what ABC can do,

let's talk about the types of firms or situations

where ABC is extremely beneficial.

Two perspectives that we can adopt.

One is operational and two is more decision making oriented.

When a firm's cost structure is comprised mostly

of direct materials and direct labor

and overhead is a very small portion,

well then we don't really have an issue

with the traditional costing system.

Making cost estimates based on a small amount

of overhead won't hurt the firm too much; however,

when overhead is a substantial portion

of cost structure then the information accuracy that's

brought to the table by activity based costing systems really

harnesses benefits of that information.

More accurate information, better decisions.

Turning to those decisions there's often times a situation

where an accounting department produces standard reports

and when they have to spend significant resources

customizing information for people then what

that is a signal of is

that those standardized reports are not cutting it.

Information that they normally produce is not being used

by decision makers in the firm

and they would rather see information provided

in a different way.

The flexibility offered

by an activity based costing system meets this need.

Two other interrelated items are

that product line profitability information is difficult

to rationalize, and line managers do not believe product

cost reports.

In other words, the information that's being provided via the

existing costing system isn't believable.

When people have this feeling they know

that there's something missing

that the information could potentially be misleading

and activity based costing systems can bring

that information advantage to the table.

And finally, a signal can come

from outside of the firm as well.

A firm might identify high margin

or high profitability products and other products

that are perhaps lower profitability.

And when they see their competitors ignore what we think

as the higher profitability products

and the competitors are competing

on the lower profitability products, then it could be

that we have our cost information wrong.

It could be that our traditional

or over simplified system is allocating too much cost

to one product and not enough to another,

which makes us view the products differently in terms

of profitability than other parties

that have better information.

Activity based costing will help us to identify these situations,

especially when we see competitors shy away

from our higher profitability products.

So a related question is when do ABC systems not carry benefits

or perhaps even fail?

Well there's an old adage, garbage in, garbage out.

This has to do with the information that we use as part

of the development and implementation process.

When managers can't make reasonable cost estimates

or identify activity pools or measure drivers or identify them

to begin with, then we have poor information that serves

as the inputs to our system

and the outputs will be poor as well.

Another way in which ABC systems fail is

that it unnecessarily increases complexity.

In other words it makes things worse before it makes

things better.

If activity rates, if activity cost rates need

to be updated regularly this can lead to confusion.

People never know if they have the most updated information.

Also, if the system is costly to operate and difficult

to understand because of the high level

of detail well then the benefits aren't warranting the costs.

So in all, activity based costing systems are not a cookie

cutter approach, it depends on the type of firm,

and while there's a lot of situations

where activity based costing systems help there's a lot

of situations where it can actually hurt

and increase the cost that the firm faces.

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