L03-New Costing Methods_1

L03-New Costing Methods_1 - Topic 3: Topic 3: New Costing...

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Unformatted text preview: Topic 3: Topic 3: New Costing Methods Introduction Introduction • This topic describes how ABC systems help companies make better pricing and product mix decisions. • It illustrates how ABC assists in cost management decisions by improving processes and product designs. • This topic also show how ABC provides managers with cost information for strategic and other decisions Structure of lecture Structure of lecture Under­ and over­costing – why it happens? Activity Based Costing (ABC) Indicators of need for ABC Implementing ABC Difference between ABC and Traditional Product Costs • Activity Based Management (ABM • Value and non­value added costs • Target costing • • • • • Undercosting and Overcosting Undercosting and Overcosting • Product undercosting: – A product consumes a relatively high level of resources but is reported to have a relatively low total cost. • Product overcosting: – A product consumes a relatively low level of resources but is reported to have a relatively high total cost. Undercosting and Overcosting • Why does it happen? • Traditional costing uses a single cost pool and averages the allocation of overheads. • Traditional costing uses labour as the main cost driver. • Common­type products tend to require less overhead inputs then more complex products. Activity Based Costing (ABC) Activity Based Costing (ABC) ABC is designed to provide managers with cost information for strategic and other decisions that potentially affect capacity and therefore “fixed” costs. ABC is a good supplement to our traditional cost system I agree! Activity­Based Costing System Activity­Based Costing System • ABC systems refine costing systems by focusing on individual activities as the fundamental cost object. • ABC calculates the costs of individual activities and assigns costs to cost objects such as products and services on the basis of the activities undertaken to produce each product or service. Activity Based Costing (ABC) Both manufacturing and nonmanufacturing costs may be costs assigned to assigned products. A number of cost pools each of allocated to a product allocated or cost object. Some manufacturing costs may be excluded from product costs. Allocation bases often differ from traditional costing systems. Overhead rates may Overhead be based on activity at capacity. ABC: Some Key Issues ABC: Some Key Issues The Past – Small number of products which did not differ much in required manufacturing support. – Labor was the dominant element in the cost structure. The Present – Numerous products with more and complicated production requirements. – Labor is becoming an ever smaller part component of total production costs. Indicators of Need for ABC Indicators of Need for ABC Direct labor is a small percentage of total costs Product-line profit margins are hard to explain Sales are increasing, but profits are declining. Line managers do not believe the product costs reports Marketing does not use costs reports for pricing decisions Some products that have reported high profit margins are not sold by competitors Traditional, Volume­Based Product­ Traditional, Volume­Based Product­ Costing System • Terrabyte produces three complex printed circuit boards referred to as Basic, Intermediate, and Advanced. • The following information is obtained from company records: Prod uction: U nits Runs Basic Intermediate Ad anced v 10,000 20,000 4,000 1 of 10,000 4 of 5,000 10 of 400 Traditional, Volume­Based Product­ Traditional, Volume­Based Product­ Costing System Additional information includes: Direct materials Direct labor (hr/board) Setup time (hr/run) Machine time (hr/board) Basic $ 50.00 3 10 1 Intermediate $ 90.00 4 10 1.25 Adv anced $ 20.00 2 10 2 Manufacturing overhead is determined as follows Traditional, Volume­Based Product­ Traditional, Volume­Based Product­ Costing System Budgeted manufacturing overhead Budgeted Budgeted direct-labor hours Budgeted $3,894,000 118,000 = $33 per hour Traditional, Volume­Based Product­ Traditional, Volume­Based Product­ Costing System With these product costs, Terrabyte established target selling prices (Cost × 125%). 209.00 x 1.25 Traditional, Volume­Based Product­ Costing System Terrabyte wishes to see what target Terrabyte wishes to see what target selling prices would be suggested when using activity­based costing. Implementing Activity­Based Implementing Activity­Based Costing • Step 1: Identify the chosen cost objects. • Step 2: Identify the direct costs of the product. • Step 3: Select the cost­allocation bases to use in allocating indirect costs to the products. • Step 4: Identify the indirect costs associated with each cost­allocation base. Implementing Activity­Based Costing • Step 5: Compute the rate per unit of each cost allocation base used to allocate indirect costs to the products. • Step 6: Compute the indirect costs allocated to the products. • Step 7: Compute the costs of the products by adding all direct and indirect costs assigned to them. Cost Hierarchies Cost Hierarchies • ABC systems commonly use a four­part cost hierarchy to identify cost­allocation bases: 1 Output unit­level cost 2 Batch level costs 3 Product­sustaining costs 4 Facility­sustaining costs Output Unit­Level Costs ... Output Unit­Level Costs ... – are resources sacrificed on activities performed on each individual unit of product or service. • Energy • Machine depreciation • Repairs Batch­Level Costs ... Batch­Level Costs ... – are resources sacrificed on activities that are related to a group of units of product(s) or service(s) rather than to each individual unit of product or service. • Set­up hours • Procurement costs Product­Sustaining ... Product­Sustaining ... – or service­sustaining, costs are resources sacrificed on activities undertaken to support individual products or services. • Design costs • Engineering costs Facility­Sustaining Costs ... Facility­Sustaining Costs ... – are resources sacrificed on activities that cannot be traced to individual products or services but support the organisation as a whole. • General administration – Rent – Building security Activity Cost Pools Activity Cost Pools Activity Cost Pool is a “bucket” in which costs are accumulated that relate to a single activity measure in the ABC system. $$ $ $$ $ Homogeneous Activity Cost Pools Homogeneous A homogeneous cost pool is a grouping of overhead costs in which each cost component is consumed in roughly the same proportion by each product line. A homogeneous cost pool uses a single cost driver. Cost Drivers Cost Drivers A characteristic of an event or activity that results in the incurrence of costs. In selecting a cost driver, we must consider . . . Degree of Correlation Cost of Measurement Behavioral Effects Overhead Costs Overhead Activity must be done on each unit produced. Total budgeted cost = $3,894,000 Activity Cost Pools Unit Level Batch Level ProductSustaining Level Machinery cost pool $1,212,600 Setup cost pool $3,000 Engineering cost pool $700,000 Activity performed on each batch produced. Activities needed to support an entire product line Identification of Activity Cost Pools Facility Level Facility cost pool $507,400 Activity required in order for the production process to occur. Overhead Costs Overhead Total budgeted cost = $3,894,000 Activity Cost Pools Unit Level Batch Level ProductSustaining Level Machinery cost pool $1,212,600 Setup cost pool $3,000 Engineering cost pool $700,000 More Cost Pools Identification of Activity Cost Pools Facility Level Facility cost pool $507,400 Unit Level Batch Level ProductSustaining Level Machinery cost pool $1,212,600 Setup cost pool $3,000 Engineering cost pool $700,000 Receiving/Inspection Receiving/Inspection cost pool $200,000 cost $200,000 Material-Handling cost pool $600,000 cost $600,000 Quality-Assurance cost pool $421,000 cost $421,000 Packaging/Shipping cost pool $250,000 cost $250,000 Facility Level Facility cost pool $507,400 Various overhead Various costs related to machinery to machinery Activity cost pool Maintenance Lubrication Depreciation Electricity Computer Support Calibration Machinery Cost Pool Total budgeted cost = $1,212,600 Calculate Calculate the pool rate Cost Assignment Budgeted Machinery Costs = $1,212,600 Budgeted Machine Hours 43,000 = $28.20/hour $28.20/hour Calculation of Calculation total setup cost total setup Activity cost pool Setup Cost Pool Total budgeted cost = $3,000 Calculate Calculate the pool rate Cost Assignment Budgeted Setup Costs = $3,000 Planned Production Runs 15 runs = $200 per run $200 Various overhead Various costs related to engineering to engineering Activity cost pool Engineering salaries Engineering software Engineering supplies Depreciation Engineering Cost Pool Total budgeted cost = $700,000 Allocate based Allocate on engineering on engineering transactions Cost Assignment Engineering Cost Pool Total budgeted cost = $700,000 Various overhead Various costs related to general to general operations Activity cost pool Plant depr. Property taxes Plant mgmt. Insurance Plant maint. Security Facility Cost Pool Total budgeted cost = $507,400 Calculate Calculate the pool rate Cost Assignment Budgeted Facilities Cost = $507,400 Budgeted Direct-Labor Hours 118,000 = $4.30/hour $4.30/hour Product Cost from ABC Product Cost from ABC Here are the new product costs so far . . . Other Overhead Costs Other Overhead Costs Board Basic Intermediate Adv anced Receiving and Inspection Cost Pool Ov erhead $ 200,000 200,000 200,000 × × × × % 6% 24% 70% ÷ ÷ ÷ ÷ U nits 10,000 20,000 4,000 Board Basic Intermed iate Adv anced Board Basic Intermed iate Adv anced Quality­Assurance Cost Pool Ov erhead $ 421,000 421,000 421,000 × × × × % 20% 40% 40% ÷ ÷ ÷ ÷ U nits 10,000 20,000 4,000 Board Basic Intermediate Adv anced = = = = Cost/U nit $ 1.20 2.40 35.00 Material­Handling Cost Pool Ov erhead $ 600,000 600,000 600,000 = = = = × × × × % 7% 30% 63% ÷ ÷ ÷ ÷ U nits 10,000 20,000 4,000 = = = = Cost/U nit $ 4.20 9.00 94.50 = = = = Cost/U nit $ 1.00 3.75 41.25 Cost/U nit $ 8.42 8.42 42.10 Packaging and Shipping Cost Pool Ov erhead $ 250,000 250,000 250,000 × × × × % 4% 30% 66% ÷ ÷ ÷ ÷ U nits 10,000 20,000 4,000 Other Overhead Costs Board Basic Interm iate ed Ad anced v Receivin g and In spection Cost P ool Ov erhead $ 200,000 200,000 200,000 % 6% 24% 70% ÷ ÷ ÷ ÷ Board Basic Intermed iate Ad anced v $14.82 Board Basic Intermed iate Ad anced v × × × × Quality­Assurance Cost Pool Ov erhead $ 421,000 421,000 421,000 × × × × % 20% 40% 40% ÷ ÷ ÷ ÷ = = = = Cost/U nit $ 1.20 2.40 35.00 Material­Handling Cost Pool Ov erhead $ 600,000 600,000 600,000 U nits 10,000 20,000 4,000 Board Basic Intermed iate Ad anced v U nits 10,000 20,000 4,000 = = = = × × × × % 7% 30% 63% ÷ ÷ ÷ ÷ U nits 10,000 20,000 4,000 = = = = Cost/U nit $ 4.20 9.00 94.50 = = = = Cost/U nit $ 1.00 3.75 41.25 Cost/U nit $ 8.42 8.42 42.10 Packaging and Shipping Cost Pool Ov erhead $ 250,000 250,000 250,000 × × × × % 4% 30% 66% ÷ ÷ ÷ ÷ U nits 10,000 20,000 4,000 Product Cost from ABC Product Cost from ABC These are the new product costs when Terrabyte uses ABC. Product Diversity Product Diversity Both original and ABC target selling prices are based on (Cost × 125%). The selling price of Basic and Intermediate are reduced and the selling price for Advanced is increased. [$209.00 × 1.25] [$183.44 × 1.25] Product Diversity Product Diversity Can you identify any problems Terrabyte is likely to face as a result of this distortion? Traditional costing understates the cost of complex, low volume products. Difference Between ABC and Difference Between ABC and Traditional Product Costs Batch­level or product­ level costs will ordinarily shift overhead costs from high­volume products produced in large batches to low­ volume products produced in small batches. Under ABC both manufacturing and nonmanufacturing costs may be assigned to products. Organization­ sustaining costs and the costs of idle capacity are not assigned to products. Activity­Based Costing and External Activity­Based Costing and External Reporting Most companies do not use ABC for external reporting because . . . 1. External reports are less detailed than internal External reports. reports. 2. It may be difficult to make changes to the company’s It accounting system. accounting 3. ABC does not conform to GAAP. 4. Auditors may be suspect of the subjective allocation Auditors process based on interviews with employees. process Activity­Based Management Activity­Based Management Activity-based costing establishes relationships between overhead costs and activities so that we can better allocate overhead costs. Activity-based management focuses on managing activities to reduce costs. Activity­Based Management Activity­Based Management • ABM describes management decisions that use activity­based costing information to satisfy customers and improve profits. – Product pricing and mix decisions – Cost reduction and process improvement decisions – Design decisions Product Pricing and Mix Product Pricing and Mix Decisions • ABC gives management insight into the cost structures for making and selling diverse products. • It provides more accurate product cost information and more detailed information on costs of activities and the drivers of those costs. Cost Reduction and Process Cost Reduction and Process Improvement Decisions • Manufacturing and distribution personnel use ABC systems to focus on cost reduction efforts. • Managers set cost­reduction targets in terms of reducing the cost per unit of the cost­allocation base. Design Decisions Design Decisions • Management can identify and evaluate new designs to improve performance by evaluating how product and process designs affect activities and costs. • Companies can work with their customers to evaluate the costs and prices of alternative design choices. What ABM does… What ABM does… Activities Analysis and Classification Valueadded costs Continually Evaluate Continually and Improve and Value­Added Costs Value­Added Costs • A value­added cost is a cost that customers perceive as adding value, or utility, to a product or service: – Adequate memory – Pre­loaded software – Reliability – Easy­to­use keyboards What ABM does… What ABM does… Activities Analysis and Classification Non valueadded Activities Valueadded Activities Reduce or Eliminate Continually Evaluate Continually and Improve and Non value­Added Costs Non value­Added Costs • A non value­added cost is a cost that customers do not perceive as adding value, or utility, to a product or service. – Cost of expediting – Rework – Repair Using ABM to Eliminate Non­ Using ABM to Eliminate Non­ Value­Added Activities and – Identify Activities. Costs — Identify Non­Value­Added Activities. ˜ Understand Activity Linkages, Root Causes, and Triggers. Specify parts Select vendor Receive parts Produce goods ™ Establish Performance Measures. š Report Non­Value­Added Costs. Inspect finished goods Rework defective products Achieving Cost Reduction Achieving Cost Reduction Activity Reduction Activity Selection Reduce Non-Value-Added Costs Activity Sharing Activity Elimination Non­value Added Activities Why do organizations have incentives to eliminate non-value added activities? Competitors are constantly striving to create more value for customers at lower cost Competition can appear quickly The organization can apply the freed- up resources to valueadded activities or distribute them to the employees of the organization. Keys to Successfully Implementing Keys to Successfully Implementing ABC and ABM 1. Organizational Culture. 2. Top-Management Commitment. 3. Change Champion. 4. Change Process. 5. Continuing Education. End of Topic 3 Now, this is an activity I can manage! ...
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This note was uploaded on 09/19/2011 for the course ACCOUNTING 211 taught by Professor Min during the Three '11 term at Curtin.

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