Chapter 1 Flashcards
(25 cards)
How do you calculate the Overhead absorption rate?
Budgeted overhead/budgeted (normal) activity level (eg labour hours )
What is activity based costing?
Where overheads of a cost centre are split into cost pools then absorbed using a difference number of cost drivers
What is an example of a cost driver?
Factors that cause overheads to rise or fall - management costs will depend upon number of quality inspections
What are three situations where activity based costing should give more accurate results?
1) Overheads are a large proportion of production costs
2) Overheads are caused by a wide range of diverse and complex processes
3) Products are tailor made to individual customer needs
What are the 4 steps involved in ABC analysis?
1) Analyse overheads costs into cost pools
2) Establish cost driver basis for each cost pool
3) Work out OAR for each cost driver
4) Use OAR calculated to absorb costs from each pool into cost units to work out the overhead cost per unit
What is the order of the hierarchy of activities?
1) Product (unit) Level - production volume - eg machine power, labour and materials
2) Batch level - No of batches - eg set up costs, quality control
3) Product sustaining - No and diversity of products - eg product management ( marketing, design)
4) Facility sustaining - The fact that the business exists - eg rent and rates, building maintenance
What decisions might a business make based upon the results of changing from absorption costing to Activity Based Costing?
1) Charge more for some products and less for others
2) Stop producing some products as no longer profitable
3) Change its marketing strategy to push product that is now more profitable
What are three problems with absorption costing?
1) lack of understanding - ABC is not fully understood by many managers and therefore is not fully accepted as means of cost control
2) Difficulty in identifying appropriate cost drivers
3) Lack of appropriate accounting records - ABC needs new set of accounting records which is not immediately available
What is target costing?
A market driven approach to pricing that seeks to derive an acceptable level of costs based on a selling price that has been researched in the external market
What are the four steps used to derive a target cost?
1) Specification of product (only features valued by customers should be included in product design
2) Price - take into account competitor products and market conditions at time of launch
3) Margin - From the price determination, a margin an be created which creates the cost target
4) Cost gap - If cost target can’t be achieved, then then shortfall is called the cost gap.
What are 5 things a company can do to close a target cost gap?
1) Redesign product or service
2) Redesign production process
3) Renegotiate with suppliers
4) Improve staff efficiency through training
5) Use cheaper staff
What are 5 benefits of using target costing?
1) Business will have an external focus to its product development, reducing time to market
2) Useful where business does not dominate market and competition means it is forced to accept the selling price
3) Product design will include features that customers value
4) May force the business to examine its internal processes carefully if a cost gap exists
5) Cost control will begin earlier in the products life cycle
What are 6 characteristics of a service industry ?
1) Spontaneity - A service is consumed at the exact time it is made available. No service exists until experienced by the customer
2) Heterogeneity - service is different depending on who performs it
3) Intangibility - Unlike goods, services cannot be stored for future use
4) Perishability - Unused capacity cannot be stored for future use
5) No transfer of ownership takes place
6) Rely heavily on staff
What are four difficulties with target costing in service industries?
1) May be difficult to define service being provided
2) May be difficult to determine likely sales volume and price potential customers will be prepared to pay at concept stage
3) It costs need to be reduced, the business must reduce time spent or use lower grade staff, impact value of service
4) Target costing will need to re-addressed for each customer
What is life cycle costing?
Looks at tracing all costs and revenues to a product of service over its complete life cycle
What are the 5 stages of a products life cycle, in order:
1) Research and development
2) Introduction
3) Growth
4) Maturity
5) Decline
What are four benefits to life cycle costing?
1) Better idea of profitability
2) Better pricing strategy over the different stages of the life cycle
3) Assists long-term planning
4) Avoids focus on production costs only - visibility of all costs particularly development is increased
When is throughput accounting used?
When there are resource limitations (bottlenecks) and efficient use of these scarce resources is considered important
What is the theory of constraints?
Works on the principle that there will always be a function or resource in a business that is stopping the business from increasing returns
What are the 5 steps of Goldratts ‘five focusing steps’ theory?
1) Identify systems bottlenecks
2) Decide how to exploit systems bottlenecks
3) Subordinate everything else to decision made in step 2
4) Elevate systems bottlenecks - eg expand machine capacity by capital expenditure
5) If new constraint is broken, go back to step 1. Do not let inertia be bottleneck. Ultimate constraint should be market demand
What is contribution?
Revenue less variable costs
What is throughput contribution?
Revenue less material purchases only
How do you calculate throughput accounting ratio?
Throughout contribution per time period / conversation cost (labour plus overhead costs per unit of bottleneck resource) per time period
What are four things a business can do to improve throughput accounting ratio?
1) Reduce bottleneck
2) Increase selling price
3) Reduce material cost
4) Reduce conversation costs
