Transcript Activity-Based Costing and Other Cost Management Tools

Chapter 18
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Develop activity-based costs (ABC)
Use activity-based management (ABM) to
achieve target costs
Describe a just-in-time (JIT) production
system, and record its transactions
Use the four types of quality costs to make
decisions
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Develop activity-based costs (ABC)
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More accurate method to
attach costs to products
Refines the way indirect costs are allocated to
production
Focuses on costs incurred by each production
activity
Activity costs become the building blocks for
allocating costs to products and services
Each activity has its own cost driver
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Activity-based costing
Divides production process into activities
Assigns costs to products based on how much the
product USES those activities
Cost drivers
Activity that drives the cost to being accumulated
Examples
Quality inspections–number of inspections
Warranty Services–number of service calls
Shipping–number of pounds
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Traditional
system
Uses a plant-wide
manufacturing
overhead
allocation rate
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ABC system
Uses a
separate
allocation
rate for each
activity
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Under traditional system:
The gross profit for specialty DVD is $20 per DVD—five
times as high as the $4 gross profit for the Excel DVD
Management may decide to produce more specialty DVDs
Under ABC:
Costs are more accurate
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Day, Corp. is considering the use of activity-based costing. The
following information is provided for the production of two product
lines:
Day plans to produce 400 units of Product A and 375 units of
Product B.
1. Compute the ABC indirect manufacturing cost per unit for each
product.
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Setup = $106,000 / 200 = $530.00 per set-up
Maintenance = $55,000 / 4000 = $13.75 per machine hour
A
Set-up
Machine
Maintenance
Divide by # units
Cost per unit
530.00 x 20 =
13.75 x 1,600 =
B
$10,600 530.00 x 180 =
22,000
13.75 x 2,400
$95,400
33,000
32,600
128,400
÷ 400
÷ 325
$81.50
342.40
1. The indirect manufacturing cost for Product A is:
$81.50
2. The indirect manufacturing cost for Product B is:
$342.40
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Use activity-based management (ABM) to
achieve target costs
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Uses ABC to make decisions
Increase profits while meeting customer
needs
Types of decisions:
Pricing and product mix
Provides a more accurate cost of products
Determines the profitability of products
Cutting cost
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Reevaluating activities to reduce costs
Requires cross-functional teams
Marketers—identify customer needs
Engineers—design more efficient products
Accountants—estimate costs
Setting sales prices based on target prices
Targeting what customers are willing to pay
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Cost-based:
Full cost
+ Desired profit
Sales Price
Target based:
Target price
- Desired profit
Target Cost
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Consider all production costs:
Direct materials
Direct labor
Allocated manufacturing overhead
Plus all nonmanufacturing costs (operating
expenses):
Administrative
Selling expenses
To determine target costs and target profits.
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Target Cost
Full Cost
Assemble team to:
Cut costs, given current production process
Redesign the production process to further cut costs
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Company decides to redesign setup to reduce the
setup cost per batch
Estimated total cost saving is $160,000
Number of batches stay the same
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Revised Cost
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Accel, Corp., makes two products: C and D. The following data
have been summarized:
Product C
Direct materials cost per unit
Direct labor cost per unit
Product D
$ 700
$ 2,000
300
100
?
?
Indirect manufacturing cost per unit
Indirect manufacturing cost information includes the following:
Activity
Allocation Rate
Product C
Product D
Setup
$1,500/per setup
38 setups
75 setups
Machine maintenance
$ 12/per hour
1,400 hours
4,000 hours
The company plans to manufacture 150 units of each product.
1. Calculate the product cost per unit for Products C and D using
activity-based costing.
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C
D
Set-up
1,500.00 X 38 =
$57,000 1,500.00 X 75 =
$112,500
Machine
Maintenance
12.00 X 1,400 =
16,800 12.00 X 4,000 =
48,000
73,800
160,500
Divide by # units
÷ 150
÷ 150
Cost per unit
$492
1,070.00
Product C
Direct materials cost per unit
Product D
$ 700
$ 2,000
Direct labor cost per unit
300
100
Indirect manufacturing cost per unit
492
1,070
$ 1,492
$ 3,170
Product cost per unit
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In Short Exercise 18-5, Accel Corp. desires a 25% target
profit after covering all costs.
1. Considering the total costs assigned to the Products C
and D in S18-5, what would Accel have to charge the
customer to achieve that profit?
Product C
Direct materials cost per unit
Product D
$ 700
$ 2,000
Direct labor cost per unit
300
100
Indirect manufacturing cost per unit
492
1,070
$ 1,492
$ 3,170
Product cost per unit
Total costs divided by (100% - target profit) =
$1,492 ÷ 0.75 = $ 1,989.33
Total costs divided by (100% - target profit) =
$3,170 ÷ 0.75 = $ 4,226.67
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Describe a just-in-time (JIT) production
system, and record its transactions
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Materials purchased and goods completed “just in time”
for delivery
Deliveries are small and frequent
Suppliers must guarantee a defect rate close to zero
Finished goods inventories are kept to a minimal
amount
Reduces company’s cost to store and insure inventory
Minimizes investment the company has in its
inventories
Lowers risk of the inventory becoming obsolete or
unsalable
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Production completed in work cells
Area where resources are readily available
Employees work in a team without supervision
Goods completed in small batches that are
inspected for quality
As completed products move out, suppliers deliver
more materials
Traditional systems
Production moves to various departments
Work must be moved, between departments
wasting time and money
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Lost sales if materials do not arrive on time or if
the materials are of poor-quality
Strong relations with vendors of quality
materials essential
Some JIT companies have small inventories of
critical materials
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Also called “backflush costing”
Starts with completed products and then assigns
manufacturing costs to units sold and inventory
Traditional
Recording
Build costs as products
production
move through three
activity
inventory accounts
Inventory
Materials inventory
accounts
Work in process
Finished goods
Manufacturing Direct materials
costs
Direct labor
Manufacturing overhead
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Just-in-Time
Record costs when
units are completed
Raw and in-process
inventory
Finished goods
Direct materials
Conversion costs
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JIT does not use a separate Work in process
inventory account
Only two inventory accounts:
Raw and in-process inventory
Finished goods inventory
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Consider the following characteristics of either a JIT production system or
a traditional production system.
a. Products are produced in large batches.
Traditional
b. Large stocks of finished goods protect against lost sales if customer
demand is higher than expected.
Traditional
c. Suppliers make frequent deliveries of small quantities of raw
materials.
JIT
d. Employees do a variety of jobs, including maintenance and setups as
well as operating machines.
JIT
1. Indicate whether each is characteristic of a JIT production system or a
traditional production system.
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Consider the following characteristics of either a JIT production system or
a traditional production system.
e. Machines are grouped into self-contained production cells or
production lines.
JIT
f.
Machines are grouped according to function. For example, all cutting
machines are located in one area.
Traditional
g. The final operation in the production sequence “pulls” parts from the
preceding operation.
JIT
h. Each employee is responsible for inspecting his or her own work.
JIT
i.
Management works with suppliers to ensure defect-free raw materials.
JIT
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Use the four types of quality costs to make
decisions
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JIT more vulnerable to production shutdowns
Critical element–defect free direct materials
Solution
Monitor activities to improve quality and eliminate defects
and waste
Total Quality Management (TQM)
Goal of continuous improvement
Well-designed products reduce inspections, rework, and
warranty claims
Design and build quality into the product
Research & development investments can generate
savings in marketing and customer service
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1. Prevention costs—spent to avoid poor-quality
goods or services
2. Appraisal costs—spent to detect poor-quality
goods or services
3. Internal failure costs—incurred when the
company detects and corrects poor-quality
goods or services before delivery to customers
4. External failure costs—spent after the company
delivers poor-quality goods or services
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Prevention costs occur in the R&D stage of the
value chain
Appraisal and internal failure costs occur in
production
External failure occurs in customer service or
results from lost sales due to an unhappy
customer
Prevention much cheaper than external failure
Deciding whether to adopt a new quality program
involves comparing costs versus benefits
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How to decide:
Classify each cost into one of the four categories
Total the estimated cost per category
Total estimated cost reductions
Decide whether to undertake or not
Costs versus benefits
Quality costs can be hard to measure:
Measure in nonfinancial terms
Number of customer complaints
Volume of incoming customer-service phone calls
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Sammy, Inc. manufactures motor scooters. Consider each of the
following examples of quality costs.
1. Preventive maintenance on machinery.
P
2. Direct materials, direct labor, and manufacturing overhead costs
incurred to rework a defective scooter that is detected in-house
through inspection.
IF
3. Lost profits from lost sales if company’s reputation was hurt
because customers previously purchased a poor-quality scooter. EF
4. Costs of inspecting raw materials, such as chassis and wheels. A
1. Indicate which of the following quality cost categories each
example represents.
● P Prevention costs
● A Appraisal costs
● IF Internal failure costs ● EF External failure costs
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Sammy, Inc., manufactures motor scooters. Consider each of the
following examples of quality costs.
5. Working with suppliers to achieve on-time delivery of defect-free
raw materials.
P
6. Cost of warranty repairs on a scooter that malfunctions at
customer’s location.
EF
7. Costs of testing durability of vinyl.
8. Cost to re-inspect reworked scooters.
A
IF
1. Indicate which of the following quality cost categories each
example represents.
● P Prevention costs
● A Appraisal costs
● IF Internal failure costs ● EF External failure costs
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Activity-based costing (ABC) focuses on
activities. The costs of those activities become
the building blocks for measuring (allocating)
the costs of products and services. The total
production process and the related costs are
divided among the various production
activities.
A cost driver for the activity is identified, and a
rate per activity is calculated. The costs are
then allocated to individual products based on
the amount of products’ USE of each activity.
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Activity-based management (ABM) uses
activity-based costs to make decisions that
increase profits while meeting customer needs.
Most companies adopt ABC to get better product
costs for pricing and product-mix decisions.
However, they often benefit more by cutting
costs. Target pricing takes the sales price and
subtracts desired profit to determine the target
cost of manufacturing.
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ABC and value engineering work together to
re-evaluate activities with the goal of reducing
manufacturing overhead costs to meet the
target cost. By reducing costs, companies can
maintain desired profit levels.
Just-in-time (JIT) systems streamline
manufacturing and accounting by developing
relationships with suppliers, resulting in no
need for the company to maintain large
supplies of raw materials on hand. Defect-free
raw materials arrive JIT to the work cell for
production.
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Because of the more efficient production process,
the accounting is streamlined to match it. Only two
inventory accounts need to be kept—Raw and inprocess inventory and Finished goods inventory.
Labor and overhead are tracked in a temporary
account—Conversion costs—where they are
allocated to products as they are completed.
The four types of quality related costs are
prevention, appraisal, internal failure, and external
failure costs. Quality improvement programs that
reduce internal and external failure costs by more
than the increased cost to prevent or appraise the
product are smart total quality management
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decisions.
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