ACTIVITY BASED COSTING

1. ACTIVITY BASED COSTING SEMINAR HELD AT LACPA NOVEMBER 29TH 2007 PRESENTED BY AHMAD HAMZEH

2. ABCACTIVITY BASED COSTING COST CONCEPT 1- COST DEFINITION AND PHILOSOPHY. 2-COST AND THE DIFFERENT FORMS OF BUSINESS ENTERPRISES. 3- THE DIFFERENT TYPES OF ACCOUNTING AREAS. 4- THE IMPORTANCE OF COST IN THE FINANCIAL STATEMENTS. 5- THE MANUFACTURING COST BASIC COMPONENTS. 6- THE IMPORTANCE OF PROPER DETERMINATION OF COST IN STRATEGIC DECISIONS. 5- THE COST FLOW AND COST ACCOUNTS.

3. COST DEFINITION AND PHILOSOPHY • OPTIONAL. • SACRIFICE. • MONETARY. • AIM IS ANTICIPATED FUTURE RETURN. • DIFFERENT FROM EXPENSES. • DIFFERENT FROM INTEREST. • DIFFERENT FROM DONATIONS. • DIFFERENT FROM TAXES.

4. COST IN DIFFERENT BUSINESS ENTERPRISES • MERCHANDISE COST PURCHASE PRICE + • MANUFACTURING COST RAW MATERIALS+LABOR+OVERHEADS • SERVICE ENTERPRISE NO COST

5. IMPORTANCE OF COST IN THE FINANCIAL STATEMENTS • IN THE PROFIT AND LOSS STATEMENT THE COST OF GOODS SOLD THE COST OF GOODS MANUFACTURED AND SOLD • IN THE BALANCE SHEET THE INVENTORY OF RAW MATERIALS THE INVENTORY OF WORK IN PROCESS THE INVENTORY OF FINISHED GOODS

6. MANUFACTURING COST BASIC COMPONENTS • RAW MATERIALS • LABOR • FACTORY EXPENSES • DIRECT COST = TRACEABLE • INDIRECT COST = DIFFICULT TO TRACE • DIRECT MATERIALS, DIRECT LABOR, OVERHEADS (INDIRECT MATERIALS, INDIRECT LABOR, FACTORY EXPENSES) • MANUFACTURING COST EQUATION COST = DM + DL + MOV

7. DIFFERENT ACCOUNTING AREAS • FINANCIAL ACCOUNTING = THE FINANCIAL STATEMENTS • LEGAL ACCOUNTING = TAXES, SOCIAL SECURITY… • MANAGERIAL ACCOUNTING = COST, BUDGETS… USING ACCOUNTING SHARED INFORMATION AND DATA TO PREPARE AND ISSUE INFORMAL REPORTS HELPING MANAGEMENT IN STRATEGIC DECISIONS.

8. THE COST FLOW • RAW MATERIALS LEDGER BEGINNING + PURCHASES – USED FOR PRODUCTION = ENDING • WORK IN PROCESS BEGINNING + RAW MATERIALS USED FOR PRODUCTION + LABOR + FACTORY EXPENSES – COST OF FINISHED GOODS MANUFACTURED = ENDING • FINISHED GOODS BEGINNING + COST OF FINISHED GOODS MANUFACTURED – COST OF GOODS SOLD = ENDING

9. MOV COST DRIVERS • THE DISTRIBUTION OF MOV IN PARALLELL AND MULTI MANUFACTURING ENVIROMENTS. • THE FACTOR THAT MOSTLY AFFECTS THE PRODUCTION COMPLEXITY. • THE IMPLICATION OF “COMPLEXITY” ON COST CALCULATION. • MOV COST DRIVER IN A MORE MANUAL MANUFACTURING ENVIRONMENT. • MOV COST DRIVER IN A MORE AUTOMATED MANUFACTURING ENVIRONMENT. • THE LIMITATIONS OF USING ONE MOV COST DRIVER TO ALL MOV ACTIVITIES. • THE EMERGENCE OF ACTIVITY BASED COSTING.

10. HOW DOES ABC WORK? • ACTIVITY: SEPARATE IDENTIFICATION OF EACH AND EVERY MOV ACTIVITY. • ACTIVITY COST DRIVER: FOCUS ON THE SEPARATE FACTOR THAT MOSTLY AFFECTS THE COMPLEXITY OF EACH MOV ACTIVITY. • ACTIVITY TOTAL UNITS: COUNT THE UNITS MEASURED FOR EACH ACTIVITY IN SEPARATE AND RELATED UNITS OF MEASUREMENT. • SEPARATE PRODUCTS ACTIVITY UNITS: COUNT THE UNITS OF EACH ACTIVITY SEPARATELY SPENT ON EACH PRODUCT. • TOTAL ACTIVITY COST/TOTAL ACTIVITY UNITS * SEPARATE PRODUCTS ACTIVITY UNITS = ALLOCATED ACTIVITY COST ON SEPARATE PRODUCTS.

11. NUMERICAL EXAMPLE MANUAL ENVIRONMENT • THREE PRODUCTS X, Y AND Z MANUFACTURED SAME PRODUCTION TIME, SAME FACTORY, SAME MACHINES, SAME STAFF…. • 100,000 UNITS OF X, 50,000 UNITS OF Y AND 25,000 UNITS OF Z. • DM USED FOR X $150,000, Y $200,000, AND Z $300,000. • DL FOR X $150,000, Y $250,000, AND Z $600,000. • TOTAL MOV SPENT FOR THREE PRODUCTS $2,000,000. • KEY FOR SOLUTION: DIRECT LABOR HOURS ARE CONSIDERED AS MOV COST DRIVER PRODUCTDMDLMOVTOTALUNIT X $150,000 $150,000 = 15% $300,000 $600,000 $6 Y $200,000 $250,000 = 25% $500,000 $950,000 $19 Z $300,000 $600,000 = 60% $600,000 $1,500,000 $60

12. NUMERICAL EXAMPLE AUTOMATED ENVIRONMENT • MACHINE HOURS SPENT FOR COMPLETION OF X MH7,000, FOR Y MH2,000 AND Z MH1,000 PRODUCT% MHMOVTOTALUNIT X 70% $1,400,000 $1,700,000 $17 Y 20% $ 400,000 $ 850,000 $17 Z 10% $ 200,000 $1,100,000 $44

13. NUMERICAL CASE ABC (P1) • MOV = $2,000,000 ACTIVITY$COST DRIVERTOTAL UNITS INSPECTION $300,000 BATCHES 10,000 BATCHES MACHINING $1,000,000 MACHINE HOURS 10,000 MH MACHINE SET UP $700,000 SET UPS 1,000 SET UPS INSPECTION PER BATCH $30 MACHINING PER MH $100 PER SET UP $700 PRODUCTINSPECTIONMACHININGSET UP X 2,500 BATCH 7,000 MH 200 SET UP Y 2,500 BATCH 2,000 MH 100 SET UP Z 5,000 BATCH 1,000 MH 700 SET UP

14. NUMERICAL CASE ABC (P.2) • X INSPECTION $75,000 $915,000 MACHINING $700,000 SET UP $140,000 TOTAL COST (X) = $1,215,000 UNIT COST (X) = $12.15 _________________________________________________ • Y INSPECTION $75,000 $345,000 MACHINING $200,000 SET UP $70,000 TOTAL COST (Y) = $795,000 UNIT COST (Y) = $15.90 _________________________________________________ • Z INSPECTION $150,000 $740,000 MACHINING $100,000 SET UP $490,000 TOTAL COST (Z) = $1,640,000 UNIT COST (Z) = $65.6

15. DIFFICULTIES OF IMPLEMENTING ABC • REQUIRES CONTINUOUS OBSERVATION OF DETAILS THEREFORE TIME CONSUMING. • REQUIRES ACCOUNTANTS APPLYING IT TO BE FAMILIAR WITH ALL OPERATIONS OF COMPANY. • REQUIRES VARIOUS COMPLICATED CALCULATION TECHNIQUES. • REQUIRES PATIENCE DURING DEVELOPMENT PHASE. • REQUIRES SOPHISTICATED INTEGRATED SOFTWARE. • USUALLY FACED WITH STAFF RESISTENCE • REQUIRES REGULAR UPDATING OF ACTIVITIES DETAILS AND RELATIONSHIPS.

16. ADVANTAGES OF USING ABC • INCREASES THE % OF COST TRACED TO INDIVIDUAL PRODUCTS. • OBSERVES ALL PRODUCTION ACTIVITY CENTERS. • INCREASES COST ACCURACY. • INCREASES FLEXIBILITY OF PRODUCTION CHANGES DUE TO COST REDUCTION PURPOSES. • INCREASES THE CHANCES OF DECREASING NON-VALUE ADDED COST ELEMENTS. • INCREASES THE UPDATED AVAILABILITY OF COST DATA. • INCREASES COMPARABILITY BETWEEN VARIOUS ACTIVITIES. • INCREASES THE UNDERSTANDING OF COST CAUSE EFFECT RELATIONSHIP. • INCREASES THE IDENTIFICATION OF INTERRELATIONSHIPS AMONG ACTIVITIES AND DEPARTMENTS.