Overheads Flashcards
Overhead Treatment - Volume based absorption, Time based absorption, Activity based costing - process, Benefits and Problems.
Original method of absorbing overheads was to absorb on a product basis
volume based absorption = cost/units
It is not a fair way to absorb costs as hours may not be used evenly
Hours based absorption - more time spent on making a product then the more overhead it absorbed.
Cost per unit = Cost/hour (OAR) * hrs/unit
first calculate total hours
divide by total O/H to get cost per hour
cost per unit is then hrs taken to make product by CPH
This is a widely accepted method and easy to understand, labour dominated business use labour hour whilst machine dominated business uses machine hours.
Activity based costing - The modern environment made ABC more appropriate -
less emphasis on pure manufacturing costs, more on R&D, service and support
cost base is more complicated and less dominated by manufacturing cost or time - labour or machine.
Other activities are driving costs, different overheads will need different activity drivers
ABC process
1. cost allocated to cost pools
2. drivers identified per cost pool
3. cost per driver calculated = cost/driver
4. product driver / total volume = driver per unit
5. cost per unit = cost per driver * drivers per unit
Benefits
1. Better understanding of costs
2. more realistic costing method
3. better decision making
4. prices could reflect true cost of product, there are other drivers of cot e.g. competition and customer affordability
5. could lead to ABB
6.Could lead to ABM and so better control
Problems
1. Entirely new info required to gather activity data
2. complicated and hard to understand and apply
3. can be costly to set up e.g. require new data system
4. difficult to identify sensible drivers in some cases e.g. R&D
5. may not change total cost by much if O/H is dominated by property costs or costs where time is driver.
6. customers may not accept a change to the pricing system
Activity Based budgeting
If activity drives cost then
budgeted activity * budgeted cost per activity = Budget cost
Benefits
1. if activity does indeed drive cost then this may produce an accurate budget
2. if more accurate budget is produced, then this is a better basis for assessment of subsequent performance.
Problems
1. Many O/H are fixed by nature
2. Identifying drivers and driver info can be difficult or costly
3.may not be trusted or understood
4. can be difficult to assign direct responsibility for a driver
Activity Based management
ABM involves taking output from ABC and considering how performance could be improved.
Areas of potential improvement
1. It helps identify and remove non value added activities - Does customer value the activity? Other stakeholders might value some activities that customer is not aware of. Get it right first time e.g. excessive control, waste reduction
2. if cost per activity is too high, can we achieve our aims in a different way e.g. outsourcing or re design process
3. Activity costs can be passed to the customers who caused them, this may cause resistance
Exam Slide
1.ABC, ABB and ABM are suitable where dealing with a complex
product and more money is pent on pre and post production rather
than production itself.
2. Activities drive costs and cut across conventional boundaries
3. Cost per unit = cost per driver * drivers per unit
4. ABC results in better cost understanding, decision making and pricing.
5. ABC is complicated , costly and may not always produce significant change in cost.
6. ABB can produce more accurate budgets but may not be understood or trusted.
7. ABM can result in better performance
8. Non value added activity should be removed
9. Expensive activity could be carried out in a different way
10. ABM can reveal inefficiency if cost per driver appears too high.
