Cost Acc. Chapter 5 Notes PDF

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Chapter notes from the textbook for cost and managerial accounting...

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Chapter 5 - Activity Based Costing ➔ Background ◆ Historically, firms produced a limited variety of goods while their indirect costs were relatively small. ◆ Allocating overhead costs was simple: use broad averages to allocate costs uniformly regardless of how they are actually incurred ◆ The end-result: over-costing & under-costing

Using machines to replace labor Find out the costs in overhead and what drives them Some driven by labor hours, some by number of products. Many different factors. Want to find out and use that to allocate the cost. ➔ Refining a Costing System ◆ Activity-based costing (ABC) refines a costing system by identifying individual activities as the fundamental cost objects ● An activity is an event, task, or unit of work with a specified purpose ◆ Reasons: ● Increase in product diversity ● Increase in indirect costs ● Advances in information technology ➔ Example ◆ Haribo makes two types of candy at a plant: Gummi Bears and Strawberry Wheels. They use DLH to allocate overhead. ◆ 450 DLH were used to make Gummi Bears, and 500 DLH for Strawberry Wheels. ◆ Direct laborers are paid $15 per hour ◆ $5,000 of materials were used to make Gummi Bears, $8,000 to make Wheels ◆ Total O/H Costs were $140,000, most of which was machine depreciation. What is the total cost for each product if DLH is used to allocate all overhead?

◆ The two main production costs for Haribo are mixing and molding. Gummi Bears used a total of 500 mixing machine hours last month and Strawberry Wheels used 200. Gummi Bears took up 1,400 molding racks during the month, and Strawberry Wheels used 800. ◆ Of the $140,000 overhead, $100,000 comes from mixing equipment, the remainder from molding department costs. ◆ If Haribo adopts ABC and uses mixing machine hours and molding racks to allocate department costs, what do product costs become?

➔ Takeaway ◆ Each method is mathematically correct ● ABC is more accurate ◆ Each method yields a different cost figure, which will lead to different Gross Margin calculations ◆ Only MOH is involved. Total Costs for the entire firm remain the same – they are just allocated to different cost objects within the firm ◆ Selection of the appropriate method and drivers should be based on experience, industry practices, as well as a cost-benefit analysis of each option under consideration ➔ Refining a Costing System ◆ Activity-based costing (ABC) refines a costing system by identifying individual activities as the fundamental cost objects ● An activity is an event, task, or unit of work with a specified purpose ◆ Reasons: ● Increase in product diversity ● Increase in indirect costs ● Advances in information technology ➔ ABC vs. Simple Costing ◆ In ABC, production volume is not the only important driver of indirect costs ● Allocation bases like direct labor costs and hours and machine hours are closely related to production volume ◆ ABC is generally perceived to produce superior costing figures due to the use of multiple drivers across multiple levels ◆ ABC is only as good as the drivers selected, and their actual relationship to costs. Poorly chosen drivers will produce inaccurate costs, even with ABC ◆ Volume-based model: total cost = a + d × o ● a = fixed cost ● d = variable cost (direct and indirect) per unit of output ● o = output volume (number of units of output) ◆ ABC model: total cost = f + c1 ◊ p + c2 ◊ b + c3 ◊ o ● f = facility-sustaining cost ● c1 = product-sustaining cost per product; p = # of products ● c2 = batch-level cost per batch; b = # of batches ● c3 = output unit-level cost per unit; o = # of units of output ◆ p and b are non-volume allocation bases ◆ 4 levels of cost (f, p, b, o) = ABC hierarchy ➔ What do we do with ‘better’ productand activity cost information?

◆ Product pricing ● But what if price is set by competitive market? ◆ Reconsider the portfolio of products and customers ● 80% of profits are from 20% of customers or products ◆ Choose which activities to outsource ◆ Choose which activities to restructure or reengineer ◆ Reward managers whose products generate high profit Chapter 5 suggested problems 5-20, 28, 29, 35, 36, 37...