Study Unit 2

1. Study Unit 2 ABC – Activity-Based Costing LCC – Life-Cycle Costing

2. Activity-based costing • Traditional costing system: OH is simply dumped into a single cost pool • Under ABC, indirect costs are attached to activities and then rationally allocated • ABC may be used by manufacturing service or retailing

3. Traditional Costing System • Peanut-butter costing = product-cost cross-subsidization  inaccurate allocation of indirect costs over products or service units • DL + DM are traced to products/services • A single pool of indirect costs is allocated based on a single rate (overhead) How much resources did I use to product X?

4. Steps in ABC process • Activity Analysis: understand the different steps and process from DM to Finished Goods • Assign Resource Costs to Activities: first-stage allocation. Identify resource costs: a separate Accounting System may be necessary to track resource costs separately from the GL. Then we need to define resource drivers to allocate it. • Allocate Activity Cost Pools to Cost Objects: allocating the activity cost pools to final cost objects = second-stage allocation  What are my activity drivers?

5. Cost Drivers • Cause-&-effect relationship • Cost object may be a job, product, process, activity, service or anything else for which a cost measure is desired • Process value analysis: Organization flow • Value-adding Vs. Non Value-adding • Product costing / continuous improvement ABC used to obtain full-absorption cost (US GAAP)

6. ABC Advantages/Disadvantages • Product costing is improved, better decision making • Process value analysis (non-value adding activities can be removed) • More cost assignment of OH • Better cost control and more efficient operations • Maintain a separate Accounting System to capture resource costs • Design and implement drivers and cost pools • ABC-derived costs of products or services may not conform with GAAP • Cost of implementing an ABC system

7. Organizational Benefits • Significant variance in volume, diversity of activities, complexity of operations, relatively high OH costs… • ABC difficult for service organizations: high facility-level costs hard to assign to service • DL as a base for allocating OH • No benefit for a single product and average regular volume of activity • Real benefits for high level of FC + wide variety of products and level of production

8. Life-cycle costing • Estimate revenues & expenses • Over the entire sales life cycle • Upstream costs (R&D, Design) • Manufacturing • Downstream costs (Mktg & Distribution, Customer Service)  Great value for Pricing Decision

9. Potential Benefits • Relationships among costs incurred at different value-chain stages • Incurring costs vs. locking in costs (SUNK) • Focus on cost control Vs. cost reduction • After-purchase costs (operating, support, repair, disposal…) • Life-cycle and whole-life cycle  target costing • Value engineering: minimize cost without reducing customer satisfaction

10. Internal & External Reporting • For external financial statement purposes, costs during the upstream phase must be expensed in the period incurred • IFRS allows development costs to be capitalized • For internal purposes, the costs (R&D) must be capitalized in a life-cycle costing • Organizations must develop an accounting system consistent with GAAP

11. Advantage • Better measure for evaluating the performance of Product Managers • Life-cycle costing combines all costs and revenues for all periods to provide a better view of a product’s overall performance