Cost Chapter 9

direct costs are traced in both

trasitional and activity based costing

indirect cost allocation provides challenges in determinign

costs of prodcuts and services

activty based costing is a method of

refining a cost system

what is ABC costing

focuss on individual activities as fundamental cost objects and uses these activities as a basis for assigning costs to cost objects (products and services)

focuses on cause and effect relationships

reflects the underlyign structure of operations

what does a refined costing system do

reduces use of broad averages and provides better measurement of costs

what are the reasons for a refined costing system

increase in product diversity: customized products (coffee, whole bean, ground, k-cups)

increase in indirect costs: technology and process advances_ less reliance on DL. DL may not be the best cost driver

competition in product markets: increased: generates need for more accurate cost information; help improve strategic decisions, pricing, and product mixes

the guidelines for refining a cost system

direct cost tracing

indirect cost pools (homogenous cost pools)

cost allocation bases (cost drivers)

what is direct cost tracing

classify as many direct costs as economically feasible

blurs line between product and period costs

what is indirect cost pools

expand the number of indirect costs pools so that each pool is somewhat homogeneous

what is cost allocation bases

identify cost drivers for individual cost pools using cause/effect criterion

cause of indirect costs

allocation base to allocate to indirect costs

what is the purpose of trasitional costing

systematically allocate MOH to each job

simpler, cheaper

what is the purpose of ABC costing

derive more accurate costs

more complex

costly

what is the assignment of DM and DL for traditional costing

traced to each product/unit

what is the assignment of DM and DL for ABC costing

traced to each product/ unit

what is the method of MOH allocation for traditional costing

broad averages

plant-wide rate

single cost pool

single cost driver

costs allocated uniformly

smoothing of costs

what is the method of MOH allocation for ABC costing

refined te cost system

multiple activity cost pools

multiple related cost drivers

what is the reporting for traditional costing

financial reporting

GAP approved

record JE

what is the reporting for ABC costing

ABC only for MOH: product and period costs separate — GAAP

ABC for product and period costs (full costing) for management decision making — Not GAAP

what is the usefullness for decision making with traditional costing

no rule requiring use in decision making

]useful for product line gross margin determination

decision making for one product situations or external users

what is the usefullness for decision making for ABC costing

full cost more inclusive than just product costs

“all-in” cost based for pricing products and making businss decisions

provides expanded unit cost for decision making

ABC for MOH only purposes provided more accurate gross margin determination

what does traditional costing not match

does not match resource consumption. It assumes overhead is incurred proportionally with the volume of output

“peanut butter” costing

what is the reality of costing compared to traditional costing

products use different amounts of resources “nonuniform ways”

using one cost driver obscures the resources each product uses. masks the truth of how each product used MOH resources differently

results in product cross subsidation

skewed product costs, imprecise prices, lost profitability and market share

what is the result of using broad averages (smoothing of costs)

product over-costing: consumes low level of resources then reports high cost per unit

product under costing: consumed high level of resources then reports to have low cost per unit

what is the challenge of traditional costing

determining the cost of the product

product may seem profitable when it is not and vice versa

impacts prcing, sales mix, bids on contrast and performance emtrics

departmental costing

departmental cost pools rather than plant-wide cost pools

MOH computed for each department that the product or service passes through

cost driver for each department determined

more detailed MOH allocations and better costing than plant wide cost pools

ABC costing

decision making is not for financial statements (not GAAP)

supplements firms product costing system

assigns costs based on activities in the production process

how does ABC costing assign costs based on activities in the production process

cost object: (product/service/customers) require activities

activities consume resources - cause overhead costs

acivity cost pools - distinct types of activities or actions performed

activity measures (cost drivers)

• transaction drivers or allocation base

• durration drivers

what is the basic idea of ABC costing

managers want to know all costs that are casually related to a firms product

• will not keep product costs separate from period costs

• some S&A costs are causally related

• some MOH costs are not causally related

• indirect costs = overhead not MOH

what is the advantages of ABC costing

divides a large cost pool into a variety of smaller cost pools, which represent activities undertaken in the value chain

uses relevant cost drivers for each activity to allocate costs to products or services

how to identify activities as cost pools

flowchart processess

observe and document tasks undertaken

• identify non-value added activities (do not increase value of the deliverable product/service)

value chain

• review each step, identify cost pools, and understand how the activities attract costs. also how employees divide their time among activities

cost pools

discrete activities that attract costs

cost drivers

task, effort, or other usage of a resource that causes a particular cost

• transaction driver: duration driver

identify the most relevant cost driver for each of the activities

consider: trade-off between more accurate information and too many subgroups

what is the cost hierarchy

ranking of four layers of costs incurred in a business

helps identify best cause and effect relationships between activities and cost drivers

• cost allocation bases that are cost drivers for cost pools

caegorize indirect costs into different cost pools based on

• type of cost driver or

• degree of difficulty in determinig cause and effect relationships

what are the hierarchies

output unit level

batch level

product-sustaining level

facility sustaining level

output unit level

activities performed on each unit of product or service

costs vary with each unit of product or service provided

• cost increase as number of units produce increase

DM, DL, most MOH costs not unit level

ex. enery; airline: meal costs vary per number of passengers

batch level

group of items processed together

costs vary with each batch

fixed with respect to numebr of units in a batch (up to capacity limits)

ex. setup for production run, procurrent costs, machine cleaning or maintenance

product sustaining level

support individual products/services. common to all units

unaffected by nmber of units or batches produced

benefitis products as a whole rather than individual units or batched

ex. design costs, complexity of design not # of units or batches

faility sustaing level

support organization as a whole, entire process

cannot be traced to individual units, batches, and products/services

usually lack a cause and effect relationship between cost and cost driver

ex. rent, security, general and administrative expenses, maintaining and operating airline reservation system

require good judgement in allocation costs

what are the steps to using ABC costing for product costing

1. identify direct costs

• DL and DM easily traced

• use source documents

2. identify activities and cost drivers

• clearly differentiate activities that incur MOH and direct costs

• causes or sources of costs for MOH using concepts of cost behavior and cost estimation - truest cause of the activities costs

3. calculate cost driver rates and assign MOH (activity driver rates

• number of units made, pounds, moved or sorted, machine hours, DL hours, etc

• availability of each aactivities capacity is grounded by the firms total production capacity expressed as

  • theoretical capacity, practical capacity, normal capacity

4. record MOH costs

• JE same as chapter 8

• have separate MOH control accounts for each cost pool

what are theoretical capacity

assumes production using a facilities highest and best use, which assumes no downtime. its a level that can only be achieved if the plant can produce at full efficiency, all the time. this is unrealistic

practical capacity

reduces theoretical capacity by considering unavoidable interuptions for things like maintenance, holiday shutdowns, and employee training. it is cahllenging, but plausible, production level

normal capacity

the quantity needed to satisfy average customer demand over a period of time, assuming that avaible production capacity is greater than or equal to expected customer demand

what are the impact of ABC costing on product and service costs

expensive to implement - must weight costs and benefits of better cost information

why should you use ABC costing

manufacturing firms - MOH costs and allocating SG&A

merchandising firms - facilitiy level costs and SG&A

service businesses and nonprofit entities - cost of services and SG&A

ABC can be used to allocate SG&A to arrive at full cost

broader outcomes of using ABD costing

must undergo an intensive, detailed revew of functions in value chain

better identify and understand mission-critical activities

help identify most profitable customers/products and most expensive vendors

could lead to right sicing facilities to support product or service delivery or adjustments to company strategy

time driven ABD costing

a time saving alternative

estimate how much item one transaction with an activity takes

• then assign costs according to how many transactions are completed

determines how much capacity is available for each activity, measured in time, with a cost applied

implementing this is a great way to measure and cost excess capacity

• idle time - available capacity that goes unused

what does time driven ABC costing rely on

• the cost of productive time supplied by an organization for all facilities, machines, and people and

• the usage of that time by transaction type as the basis for allocating costs

managers choose level of detail based on

cost/benefit

signs that may indicate an ABC system will provide benefit

• Significant amounts of IC are allocated using only 1 or 2 cost pools

• Indirect Costs are primarily unit-level costs

• Products make diverse demands on resources due to differences in volume, process steps, batch size or complexity.

• Products company most suited to make/sell show small profits; Products company less suited to make/sell show large profits.

• Operations staff and accounting staff have disagreements about cost of manufacturing and marketing products and services.

what must you do before implementing

weight the cost/benefit

benefits:

• More accurate cost information can lead to better decisions.

• Focuses on cause and effect.

• Reflects underlying structure of operations.

• Enhanced controls

limitations

• cost of implementation may exceed benefits

• still some arbitrtary allocation