What are three reasons for development of ABC?
- Overheads used to be small in relation to other costs in traditional manufacturing
- Overheads are now a larger proportion of total costs in modern manufacturing
- The diversity and complexity of products has increased.
What does ABC establish?
Separate cost pools for support activities such as material handling. As the costs of these activities are assigned directly to products through cost driver rates, reapportionment of service departments is avoided
How does ABC charge overheads to products?
Cost drivers as absorption bases (I.e. Number of orders, or the number of despatches)
How does absorption costing charge overheads to products?
Labour or machine hours
What does ABC costing highlight?
What causes costs to increase
What is a cost pool?
A cost pool is an activity which consumes resources and for which overhead costs are identified and allocated
For each cost pool, there should be a ?
What is a cost driver?
A cost driver is a factor that influences (or drives) the level of cost.
What are the five steps for calculating the full production cost?
- Group production overheads into activities, according to how they are driven.
- Identify cost drivers for each activity, i.e. what causes these costs to be driven.
- Calculate OAR for each activity
- Absorb the activity costs into the product.
- Calculate the full production cost/and or the profit or loss.
What are the advantages of ABC? (7)
- More accurate cost per unit. As a result, pricing, sale, strategy, performance management and decision making should be improved.
- Much better insight into what drives overhead costs
- ABC recognises that overhead costs are not all related to production and sales volume.
- It can be applied to derive realistic costs in a complex business environment.
- ABC can be applied to all overhead costs, not just production overheads.
- ABC can be used just as easily in service costing as in product costing
- Overhead costs can be controlled by managing cost drivers.
What are the disadvantages of ABC? (5)
- ABC will be of limited benefit if the overhead costs are primary volume related or if the overhead is a small proportion of the overall cost.
- It is impossible to allocate all overhead costs to specific activities
- The choice of activities and cost drivers may be inappropriate
- ABC can be more complex to explain to the stakeholders of the costing exercise.
- The benefits obtained from ABC might not justify the costs
What are the four main drivers for introducing ABC?
Public responsibility, public accountability, resource allocation within organisations and helping managers to manage.
What is public responsibility?
Responsible public organisations must have tight control of running costs at a time when resources provided by central government are strictly limited
What is public accountability?
Many organisations are being challenged as to whether or not they spend tax payers money wisely and feel a need to demonstrate when the questions are asked
What is resource allocation within organisations?
There have been concerns in many organisations as to whether the services provided had an equitable distribution of scarce resource - or whether those who shouted the loudest got the resource
What is total quality management?
continuous improvement in quality, productivity and effectiveness through a management approach focusing on both the process and the product
What are six fundamental features of total quality management?
- Prevention of errors before they occur
- Importance of total quality in the design of systems and products
- Real participation of all employees
- Commitment of senior management to be cause
- Recognition of the vital role of customers and suppliers
- Recognition of the need for continual improvement
What is just in time?
Just in time is a pull-based system of production, pulling work through the system in response to customer demand. This means that goods are only produced when they are needed; eliminating large stocks of materials and finished goods
What is throughput accounting?
Throughput accounting aims to make the best use of a scare resource (bottleneck) in a JIT environment.
How do you measure throughput?
Throughput = sales revenue – direct material cost
What is bottleneck?
There may be a limited number of machine hours or labour hours.
What is the steps to the theory of constraints? (5)
- Identify the systems bottlenecks
- Decide how to exploit the bottlenecks
- Subordinate everything else to the decision in step 2
- Elevate the system’s bottlenecks
- If, in the previous steps a bottleneck has been broken, go to step 1
What is the formula for throughput (return) per factory hour?
Throughput per unit/product’s time on the bottleneck resource
What is the formula for cost per factory hour?
Total factory cost/total bottleneck resource time available.
What is the formula for throughput accounting ratio? (TPAR)
Return per factory hour/cost per factory hour
What is the total factory cost?
Fixed production cost, including labour.
What may the total factory cost be referred as?
What would a TPAR which is more than 1 indicate?
Would suggest that throughput exceeds operating costs so the product should make a profit. Priority should be given to the products generating the best ratios.
What would a TPAR that is less than 1 indicate?
Would suggest that throughput is insufficient to cover operating costs, resulting in a loss.
What is target costing?
Target costing involves setting a target cost by subtracting a desired profit from a competitive market price.
How do you calculate the cost gap?
Estimated product cost – Target cost
What is value analysis also known as?
Cost engineering and value engineering
What is value engineering?
A technique in which a firm’s products, and maybe those of its competitors, are subjected to a critical and systematic examination by a small group of specialists. They can be representing various functions such as design, production, sales and finance.
What is cost value?
This is the cost incurred by the firm incurring the product.
What is exchange value?
The amount of money that consumers are willing to exchange to obtain ownership of the product, i.e. its price.
What is the use value?
This is related entirely to function, i.e. the ability of a product to perform its specific intended purpose. For example, a basic small car provides personal transport at a competitive price and is reasonably economic to run.
What is the esteem value?
This relates to the status or regard associated with ownership. Products with high esteem value will often be associated with premium or even price-skimming prices.
What is lifecycle costing?
Lifecycle costing, however, tracks and accumulates costs and revenues attributable to each product over its entire product lifecycle.
How do you work out a products lifecycle cost?
Total costs of product A over its entire lifecycle/Total number of units
What are internal environmental costs?
These are costs that directly impact on the income statement of a company.
What are some examples of internal environmental costs? (5)
- Improved systems and checks in order to avoid fines
- Waste disposal costs
- Product take back costs (i.e. recycling)
What are external environmental costs?
These are costs that are imposed on society at large, but not borne by the company that generates the cost in the first instance.
What are some examples of external environmental costs? (5)
- Carbon emissions
- Usage of energy and water
- Forest degradation
- Health care costs
- Social welfare costs.
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What is input/outflow analysis?
This technique records material inflows and balances this with outflows on the basis that what comes in, must go out.
What is flow cost accounting?
This technique uses not only material flows, but also the organisational structure. It makes material flows transparent by looking at the physical quantities involved, their costs and their value. It divides the material flows into three categories : material, system and delivery and disposal. The values and costs of each of these three flows are then calculated.
What is the aim of flow cost accounting?
The aim of flow cost accounting is to reduce the quantity of materials which, as well as having a positive effect on the environment, should have a positive effect on a business’ total costs in the long run.
What is Activity-based costing?
ABC allocates internal costs to cost centres and cost drivers on the basis of the activities that give rise to the costs.
What is Activity-based costing in an environmental accounting concext?
It distinguishes between environment-related costs, which can be attributed to joint cost centres, and environment-driven costs, which tend to be hidden on general overheads.
What is lifecycle costing in an environmental accounting concext?
Lifecycle costing is a technique which requires the full environmental consequences, and, therefore, costs, arising from the production of a product to be taken account across its whole lifecycle, literally ‘from cradle to grave’.
What are advantages of environmental costing? (6)
- Better/fairer products
- Improved pacing
- Better environmental cost control
- Facilitates the quantification of cost savings from “environmentally-friendly” measures.
- Should integrate environmental costing into the strategic management process
- Reduces the potential for cross-subsidisation of environmentally damaging products
What are disadvantages of environmental costing? (5)
- Time consuming
- Expensive to implement
- Determining accurate costs and appropriate costs drivers is difficult
- External costs not experienced by the company (e.g. carbon footprint) may still be ignored/unmeasured
- Some internal environmental costs are intangible (e.g. impact on employee health) and these are still ignored