Transcript Cost–Volume–Profit Analysis - Zakiya Abdul Samad

CHAPTER 5:
COST MANAGEMENT IN
AUTOMATED BUSINESS: ABC, ABM
AND TQM
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Learning Objectives
1.
2.
3.
4.
5.
Explain how broad averaging undercosts and
overcosts products or services
Present three guidelines for refining a costing
system
Distinguish between simple and activity-based
costing systems
Describe a four-part cost hierarchy
Cost products or services using activity-based
costing
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Learning Objectives
6.
7.
Evaluate the costs and benefits of implementing
activity-based costing systems
Explain how managers use activity-based costing
systems in activity-based management
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Explain How Broad Averaging
Undercosts and Overcosts Products
or Services
Learning Objective 1
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Broad Averaging

Simple costing broadly averages or spreads the cost of
resources uniformly to cost objects
However, the individual products or services use those
resources in nonuniform ways
 Therefore, simple costing is less realistic



There are a variety of methods to accomplish this goal
These methods often involve trade-offs between
simplicity and realism
Simple Methods
Unrealistic
Complex Methods
Realistic
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Overcosting and Undercosting

Broad averaging often leads to:
 Product
undercosting—a product consumes a high level
of resources per unit but is reported to have a low cost
per unit
 Product overcosting—a product consumes a low level of
resources per unit but is reported to have a high cost
per unit
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Product-Cost Cross-Subsidization


If a company undercosts one of its products, it will
overcost at least one of its other products
If a company overcosts one of its products, it will
undercost at least one of its other products
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Simple Costing System Using a Single
Indirect-Cost Pool
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The Five-Step Decision-Making Process
Identify the problem and uncertainties
Obtain information
Make predictions about the future
Make decisions by choosing among alternatives
Implement the decision, evaluate performance, and learn
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Present Three Guidelines for
Refining a Costing System
Learning Objective 2
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Refined Costing System


Reduces the use of broad averages for assigning
the cost of resources to cost objects
Reasons for increase in demand of refinements:
 Increase
in product diversity
 Increase in indirect costs
 Competition in product markets
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Guidelines for Refining a Costing
System



Direct-cost tracing
Indirect-cost pools
Cost-allocation bases
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Distinguish Between Simple and
Activity-Based Costing Systems
Learning Objective 3
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ABC Systems Identifying Activities
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The Logic of ABC


When managers structure activity cost pools more
finely with cost drivers for each activity cost pool as
the cost-allocation base, it leads to more accurate
costing of activities
Allocating these costs to products by measuring the
cost-allocation bases of different activities used by
different products leads to more accurate product
costs
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Describe a Four-Part Cost Hierarchy
Learning Objective 4
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Four-Part Cost Hierarchy




Output unit-level costs
Batch-level costs
Product-sustaining costs
Facility-sustaining costs
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Cost Products or Services Using
Activity-Based Costing
Learning Objective 5
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Traditional Two-Stage Cost Allocation
Overhead Costs
Department 1
Department 2
Product 1
Product 2
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5-19
Activity-Based Cost Allocation
Overhead Costs
Activity
Center 1
Activity
Center 2
Product 1
Activity
Center 3
Product 2
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5-20
Seven-Step Approach to Costing
Identify the products that are the chosen cost objects
Identify the direct costs of the products
Select the activities and cost-allocation bases to use for
allocating indirect costs to the products
Identify the indirect costs associated with each cost-allocation
base
Compute the rate per unit of each cost-allocation base
Compute the indirect costs allocated to the products
Compute the total cost of the products by adding all direct
and indirect costs assigned to the products
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Two Features of ABC Systems


These systems identify all costs used by products,
whether the costs are variable or fixed in the short
run
Recognizing the hierarchy of costs is critical when
allocating costs to products
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Comparing Simple Costing and ABC
System


Single indirect-cost pool system tends to overcosts or
undercosts the product-mix in an organization
The homogeneous cost pools and the choice of costallocation bases, tied to the cost hierarchy, give
managers greater confidence in the activity and
product cost numbers from the ABC system
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Evaluate the Costs and Benefits of
Implementing Activity-Based Costing
Systems
Learning Objective 6
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ABC System Likely to be Used When:





Significant amounts of indirect costs are allocated
using only one or two cost pools
All or most indirect costs are identified as output
unit-level costs
Products make diverse demands on resources
Products that a company is well suited to make and
sell show small profits
Operations staff has substantial disagreement with
the reported costs
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Costs and Limitations of an ABC System



Its measurements are costly and the rates need to
be updated regularly
It increases the chances of misidentifying the costs
of different activity cost pools
It can be misleading
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Behavioral Issues in Implementing ABC
Systems





Gaining support of top management and creating
a sense of urgency for the ABC effort
Creating a guiding coalition of managers
throughout the value chain for the ABC effort
Educating and training employees in ABC as a basis
for employee empowerment
Seeking small short-run successes as proof that the
ABC implementation is yielding results
Recognizing that ABC information is not perfect
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Explain How Managers Use
Activity-Based Costing Systems in
Activity-Based Management
Learning Objective 7
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Activity-Based Management (ABM)

Is a method of management decision making that
uses activity-based costing information to improve
customer satisfaction and profitability
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Activity-Based Management (ABM)
Defined
1.
2.
3.
4.
Pricing and product-mix decisions
Cost reduction and process improvement decisions
Design decisions
Planning and managing activities
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ABC in Service and Merchandising
Companies

Service companies, in particular, find great value
from ABC because a vast majority of their cost
structure comprises indirect costs
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Exercise 5 -1A
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Exercise 5 -2A
Provide at least one example of an appropriate cost driver
(allocation base) for each of the following activities:
a. Maintenance is performed on manufacturing equipment.
b. Sales commissions are paid.
c. Direct labor is used to change machine configurations.
d. Production equipment is set up for new production runs.
e. Engineering drawings are produced for design changes.
f. Purchase orders are issued.
g. Products are labeled, packaged, and shipped.
h. Machinists are trained on new computer-controlled
machinery.
i. Lighting is used for production facilities.
j. Materials are unloaded and stored for production
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Exercise 5 -3A
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Exercise 5 -4A
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