Learning Objectives

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# Learning Objectives - PowerPoint PPT Presentation

Learning Objectives. Discuss the importance of unit costs. Describe functional-based costing approaches. Explain why functional-based costing approaches may produce distorted costs. Explain how an activity-based costing system works. Learning Objectives (continued).

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Learning Objectives
• Discuss the importance of unit costs.
• Describe functional-based costing approaches.
• Explain why functional-based costing approaches may produce distorted costs.
• Explain how an activity-based costing system works.
Learning Objectives (continued)
• Provide a detailed description of how activities can be grouped into homogeneous sets to reduce the number of activity rates.
• Describe the role of activity-based costing for organizations with only one product, homogeneous products, or a JIT structure.
Unit Costs

The unit costis the total cost associated with the units produced divided by the number of units produced

Although the concept is simple, the practical reality of the computation can be somewhat more complex because of the following issues:

• What is meant by “total cost”?
• How do we measure the costs to be assigned?
• How do we assign costs to the product?
Unit Costs (continued)

Unit costs are important for:

• inventory valuation
• income determination
• providing input to a variety of decisions such as pricing, make or buy, and accept or reject special orders
Measurement Systems

Two possible measurement systems are actual costing and normal costing.

Actual costingassigns the actual costs of direct materials, direct labour, and overhead to products.

Normal costingassigns the actual costs of direct materials and direct labour to products; however, overhead cots are assigned to products using predetermined rates.

Activity Capacity Measures

Units (of driver)

Theoretical

Practical

Expected actual

Normal

Time

Functional-Based Costing:Plantwide Rate

Assign Costs

Direct Tracing

Plantwide Pool

Stage One: Pool Formation

Assign Costs

Unit-Level Driver

Products

Stage Two: Costs Assigned

Belring, Inc.

Belring, Inc. produces two telephones: a cordless and a regular model. The company has the following actual and budgeted data:

Expected activity (DLH) 100,000

Actual activity (DLH) 100,000

Belring, Inc. (continued)

CordlessRegular

Units produced 10,000 100,000

Prime costs \$78,000 \$738,000

Direct labour hours 10,000 90,000

Belring, Inc. (continued)

= \$360,000  100,000 DLH

= \$3.60 per DLH

Belring, Inc. – Unit Cost Computation:Plantwide Rate

CordlessRegular

Prime costs \$ 78,000 \$ 738,000

\$3.60 x 10,000 36,000 ---

\$3.60 x 90,000 --- 324,000

Total mfg. costs \$114,000 \$1,062,000

Units produced  10,000 100,000

Unit cost \$ 11.40 \$ 10.62

======= ========

Functional-Based Costing:Departmental Rates

Assign Costs

Stage One: Pool

Formation

Department A Pool

Department B Pool

Unit-Level Drivers

Assign Costs

Assign Costs

Products

Stage Two: Costs

Assigned

Products

Belring, Inc. – Departmental Data

FabricationAssembly

Budgeted OH \$252,000 \$108,000

======= =======

Expected and actual usage (DLH):

Cordless 7,000 3,000

Regular 13,000 77,000

20,000 80,000

===== =====

Expected and actual usage (MH):

Cordless 4,000 1,000

Regular 36,000 9,000

40,000 10,000

===== =====

Belring, Inc. – Departmental Rates

Fabrication Rate = Budgeted OH / Expected MH

= \$252,000/40,000

= \$6.30 per MH

Assembly Rate = Budgeted OH / Expected DLH

= \$108,000/80,000

= \$1.35 per DLH

Belring, Inc. – Unit Cost Computation: Departmental Rate

CordlessRegular

Prime costs \$ 78,000 \$738,000

(\$6.30 x 4,000) + (\$1.35 x 3,000) 29,250 ---

(\$6.30 x 36,000) + (\$1.35 x 77,000) --- 330,750

Total mfg. costs \$107,250 \$1,068,750

Units produced  10,000  100,000

Unit cost \$ 10.73 \$ 10.69

======= ========

Symptoms of an OutdatedFunctional Cost System
• The outcome of bids is difficult to explain.
• Competitors’ prices appear unrealistically low.
• Products that are difficult to produce show high profits.
• Operational managers want to drop products that appear profitable.
• Profit margins are difficult to explain.
Symptoms of an Outdated Functional Cost System (continued)
• The company has a highly profitable niche all to itself.
• Customers do not complain about price increases.
• The accounting department spends a lot of time supplying cost data for special projects.
• Some departments are using their own accounting system.
• Product costs change because of changes in financial reporting regulations.
Belring, Inc. – Activity Usage

CordlessRegularTotal

Units produced per year 10,000 100,000 110,000

Prime costs \$78,000 \$738,000 \$816,000

Direct labour hours 10,000 90,000 100,000

Machine hours 5,000 45,000 50,000

Production runs 20 10 30

Number of moves 60 30 90

Belring, Inc. – Additional OH Cost Data

ActivityActivity Cost

Setups \$120,000

Material handling 60,000

Machining 100,000

Testing 80,000

Total \$360,000

=======

ABC: Two-Stage Assignment

Cost Of Resources

Direct Tracing

Assign Costs

Driver tracing

Activities

Assign Costs

Driver Tracing

Products

Belring, Inc. – Activity Rates

Activity rates are computed below:

Setup rate: \$120,000/30 = \$4,000 per run

Material-handling rate: \$60,000/90 = \$666.67 per move

Machining rate: \$100,000/50,000 = \$2 per MH

Testing rate: \$80,000/100,000 = \$0.80 per DLH

CordlessRegular

Prime costs \$ 78,000 \$ 738,000

Setups 80,000 40,000

Material handling 40,000 20,000

Machining 10,000 90,000

Testing 8,000 72,000

Total mfg. costs \$216,000 \$ 960,000

Units produced  10,000 100,000

Unit cost \$ 21.60 \$ 9.60

===== =====

Comparison of Unit Costs

CordlessRegular

Plantwide rate \$11.40 \$10.62

Departmental rate 10.73 10.69

Activity rate 21.60 9.60

Activity Categories

Unit-level Activities are those that are performed each time a unit is produced.

Examples: Power and machine hours are used each time a unit is produced. Direct materials and direct labour activities are also unit-level activities, even though they are not overhead costs.

Activity Categories (continued)

Batch-level Activities are those that are performed each time a batch of products is produced.

Examples: Setups, inspections, production scheduling, and material handling.

Activity Categories (continued)

Product-level (Sustaining) Activities are those that are performed as needed to support the various products produced by a company. These activities consume inputs that develop products or allow products to be produced and sold.

Examples: Engineering changes, and expediting.

Activity Categories (continued)

Facility-level Activities are those that sustain a factory's general manufacturing processes.

Examples: Plant management, landscaping, maintenance, security, property taxes, and plant depreciation.

When To Use An ABC System

Measurement Cost

Cost

Error Costs

Optimal Cost Level

Low

High

Level of Accuracy

1. Pull-through system 1. Push-through system

2. Insignificant inventories 2. Significant inventories

3. Small supplier base 3. Large supplier base

4. Long-term supplier contracts 4. Short-term supplier contracts

5. Cellular structure 5. Departmental structure

6. Multiskilled labour 6. Specialized labour

7. Decentralized services 7. Centralized services

8. High employee involvement 8. Low employee involvement

9. Facilitating management style 9. Supervisory management style

10. Total quality control 10. Acceptable quality level