Activity Based Costing – Glaser Health Products Case

Topics: Management accounting, Costs, Cost accounting Pages: 8 (1998 words) Published: May 25, 2014
Introduction
Glaser Health Products manufactures medical items for the health care industry. Production involves machining, assembly and painting. Finished units are then packed and shipped. The financial controller is interested to introduce an activity-based costing (ABC) system to allocate (or distribute) indirect costs to products. Indirect costs, as distinct from direct costs, cannot be unambiguously linked to specific products. The controller would like to calculate product costs based on ABC for planning and control, not inventory valuation. Under an ABC system, the allocation of costs to products is achieved through at least four analytical steps. Firstly, costs are grouped into activity levels. Secondly, cost drivers are selected for each activity level to link activities with costs. Thirdly, for each activity level, a cost function is defined to arithmetically describe the relationship between cost drivers and costs. Finally, a unit allocated cost is calculated for each product (Schneider, 2012). This paper outlines a process for introducing an ABC system at Glaser. The paper is divided into six sections. The first section groups cost categories identified at Glaser by division. The second section groups cost categories by division and activity level. The third section identifies specific cost drivers for each activity level. The fourth section explains preliminary stage allocation. The fifth section explains primary stage allocation. The final section summarizes the main conclusions. Cost Categories by Division

Glaser is organized into three functional divisions - Operations, Sales, and Administration. Operations is the only cost or activity center. Glaser recognizes 22 cost categories. These cost categories are grouped by division in Table 1, shown in the appendix. Cost Categories by Division by Activity Level

The second step in an ABC system involves grouping costs based on the level of activity at which they are generated. An activity involves the movement or handling of any part, component, or finished product within the relevant organizational unit. The rationale for this grouping is that costs at each activity level are determined by different cost drivers. Four levels of activity are commonly recognized – unit, batch, product and facility level. Unit-level activities are the most granular level of activity. They are performed each time a sub-unit is produced. Unit-level activities are on-going and reflect basic production tasks. Direct labor or direct materials are examples. Costs of these activities mainly vary according to the number of units produced. Batch-level activities are relevant to batch (rather than continuous) production processes. They are performed each time a batch of product sub-units is produced. Typical examples of these costs relate to machine setups, order processing, and materials han¬dling. Costs of these activities vary mainly according to the number of batches produced, not the number of units in each the batch. Product-level activities support production of each product. The costs of these activities vary mainly according to the number of separate product models. Examples include maintaining bills of materials, processing engineering changes, and product testing routines. Facility-level activities are common to a variety of different products and are the most difficult to link to individual product-specific activities. These activities sustain the production process at an overall production plant or facil¬ity. Examples include plant supervision, rental expense and other building occupancy costs. Some firms, including Glaser, choose not to allocate facility-level costs to product costs.

Based on these activity level distinctions, the 22 Glaser cost categories may be grouped by division and activity level as shown in Table 2. By way of digression, it is worth mentioning that as a broad generalization, unit-level activities tend to generate mainly variable costs while and...

References: Edmonds, T.; Olds, P. & McNair, F. (2012). Fundamental financial accounting concepts.
Kindle Edition.
Hansen, D. R. & Mowen, M. M. (2006). Cost management accounting and control. Ohio:
Thomas South-Western.
Kimmel, P.D., Weygandt, J.J. & Kelso, D.E. (2010). Financial accounting: Tools for business
decision-making (5th ed.). John Wiley Sons: Hoboken, NJ.
Leslie, C. (ed.)(2009). Management accounting: information for creating and managing
value. McGraw-Hill Australia.
Schneider, A. (2012). Managerial accounting: Decision making for the service and
manufacturing sectors. San Diego, CA: Bridgepoint Education.
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