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Session Three Topics

3. Session Three Topics. Fundaments of ABC costing Applications of ABC costing. Cost allocation – Rising share of overheads. Cost allocation – A(ctivity) B(ased) C(osting). Fundamental questions underlying ABC What activities are being performed?

geoffrey-lancaster
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Session Three Topics

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  2. Session Three Topics • Fundaments of ABC costing • Applications of ABC costing

  3. Cost allocation – Rising share of overheads

  4. Cost allocation – A(ctivity) B(ased) C(osting) • Fundamental questions underlying ABC • What activities are being performed? • What resources are used in these activities? • How much do these resources cost? • What really drives these costs (activity drivers)?

  5. ABC vs. conventional costing – cost drivers

  6. ABC vs. conventional costing – Example (1) An inbound warehouse employs 12 people with the total cost (not limited to labour cost) of 20 000 USD: first stage cost driver = number of employees receiving parts – requires 6 employees so cost is 10 000 USD;second stage allocation basis is number of shipments of purchased parts (250 per month)receiving raw material – requires 3 employees so cost is 5 000 USD;second stage allocation basis is number of shipments of raw materials (50 per month)distributing material – requires 3 employees so cost is 5 000 USD;second stage allocation basis is number of production runs (200 per month)

  7. ABC vs. conventional costing – Example (2) Stage 2    Remove costs from activity cost pools and assign to products using second stage cost drivers:receiving purchased parts        10 000 USD/250 = 40 USD per shipmentreceiving raw material               5 000 USD/50 = 100 USD per shipmentdistributing materialrun 5 000 USD/200=25 USD per run For product A, the 100 produced require 200 purchased part shipments, 40 raw material shipments and 100 production runs. The direct labour requirement is 2 000 hrs. For product B, the 2 000 produced require 50 purchased part shipments, 10 raw material shipments and 100 production runs. The direct labour requirement is 3 000 hrs.

  8. ABC vs. conventional costing – Example (3) If we use this information to compute conventional cost allocation, we see the following results:  Warehouse (indirect) cost is 20 000 USD allocated to 5 000 hrs gives 4 USD/hr, what translates into: for product A: 2000hr/100*4 USD = 80 USD/unit; for product B: 3000 hrs/2000*4USD =6 USD/unit If we use this information to compute the ABC cost based, we see the following results:   A Parts receipt200 * 40 USD =  8 000 USD Raw material receipt40 * 100 USD = 4 000 USDDistributing material   100 * 25 USD =  2 500 USD 14 500/100 = 145 USD per unit B Parts receipt50 * 40 USD =    2 000 USD Raw material receipt10 * 100 USD = 1 000 USDDistributing material   100 * 25 USD =  2 500 USD 5 500 USD/2000 = 2,75 USD per unit

  9. ABC – sources of differences to conventional costing • Complexity (more operations – more costs) – an example of newspapers attachments • Volume (large vs. small batches) • Size of products – an example of packaging line • Value of fixed assets used

  10. ABC – advantages for services • Minimal level of variable and small of direct costs • Focus on customers rather than on products • Products definition very complex, flexible and customized • High operational gearing

  11. ABC – advantages for services This enabled managers to examine indirect cost in more detail. For example, consider this example from an order processing department: Using the traditional costing system, the question that managers would ask was: Why was £74,000 spent on travel?Using ABC, the new question is: Why was £35,000 spent on resolving problems?

  12. Cost allocation – Homework Exercise 11-1 in Excell

  13. Cost allocation – exercises Buccaneers

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