Cost Actg. Review

1. Cost Actg. Review • Cost…an economic sacrifice

2. Critical Cost Terms • Fixed vs. Variable • Product vs. Period • Manufacturing vs. Non-manufacturing • Direct vs. Indirect • Controllable vs. Uncontrollable • Opportunity and Sunk Costs • Differential Cost and Revenue • Critical Success Factors (CSF’s)

3. Cost Drivers and Final Cost Objectives • Cost Drivers • Activity • Volume • Other • Structural • Executional • Final Cost Objective (FCO)

4. Risk and Cost Mgt. • Risk plays a role • Risk-prone vs. risk adverse • Systems are designed to mitigate the negative aspects of risk preference

5. RAW MATERIAL WORK-IN-PROCESS FINISHED GOODS BOH I O EOH B O/H R/M B O/H WIP B O/H F/G R/M TRANSFERS DIR. LABOR MFG OVERHEAD MANUFACTURING COSTS COST OF GOODS MANUFACTURED (COGM) E O/H WIP COGM COST OF GOODS SOLD (COGS) E O/H F/G R/M PURCHASES TRANSFERS TO WIP E O/H R/M P&L Manufacturing Cost Flows

6. Learning Curve Analysis • Aircraft industry based • Practice make perfect--or at least more efficient • Experience curve • Cumulative unit-time learning model • x% unit reduction as volume doubles • Used in pricing, financial plans & stds. • Softech example

7. Learning Curve Applications • Make vs. buy • Construction contracts • C-V-P • Standard cost development • Management control

8. Learning Curve Limitations • Requires repetitive tasks • Assumes constant rate of learning • Productivity not effected only by learning

9. Regression Analysis • Basic equation y = a + bx • Consider statistical relevance • Use common sense

10. Activity Based Costing (ABC)

11. Contemp. Mfg. Environment • JIT • Kanban • Work cells • CAD/CAM • FMS • CIM

12. Trad. Costing Limits • Overall purpose: accounting values • Volume • Size • Complexity

13. Activity Based Costing • Benefits • More accurate costs • More accurate operating information • Better access to relevant costs • Limits • Allocations are still used • Cost omission • Time and expense

14. Ansari: MOA • Strategic Implications • Info @ the cost of value-added features • Info @ the overall cost of the product • Reflects time considerations in the attribution process

15. MOA, cont. • Attribute Implications • Technical • Provides decision relevant information • Enhances process understanding • Behavioral • Cost structure visibility • Facilitates communication • Empowers employees • Risk of “failed expectations” re: “true” cost • Cultural • Supports process focus • Encourages cross-functional participation

16. Ansari: IDC • Strategic Implications • Quality: IDC draw together activities that ensure quality (ie. supervision for medication administration) • Cost: IDC are a major part of the total cost package and s/b managed • Time: IDC reflect the impact of time based decisions (ie. hours of operation)

17. Indirect Cost Definition • IDC are costs that are common to more than one cost objective.

18. IDC Sources • Corporate overhead • Group overhead • Factory overhead • Marketing • Development • Other joint costs • See Ansari: IDC pg. IC-5

19. Basis of Allocation is Key • Controllable costs: users choice • Attributable costs: users situation • All indirect costs • REGARDLESS--all IDC’s must be recovered

20. Ansari: IDC • Attribute Implications • Technical: Improves decision relevance and work process knowledge • Behavioral: Must determine how the IDC system will impact people’s behavior • Cultural: Allocation methods used will reflect the imbedded cultural values

21. ABC Implementation • Select an area • Identify primary activities (5-10) • Cost each activity • Determine one driver for each activity • Apply the costs to the final cost objectives on the basis of the drivers.

22. Remember... • ABC does NOT yield “true” costs!

23. ABC/ABM Case-Gulfstream Recreation Gulf Stream Recreation, a major sporting goods firm in California has two major products--the Bobcat Racer and the Snidley Whiplash Cruiser. For the current year, overhead was planned at $850K. Overhead is applied on the basis of machine hours. Each racer uses 2 machine hours and each cruiser uses 1 machine hour. GSR planned to build 10K racers and 50K cruisers. The cost structure for each product is as follows: Racer Cruiser Direct Material $35 $50 Direct Labor 25 13 Machine Hours 2 1 GSR is considering some type of activity based costing system. Sandra Jones, the cost accounting manager, suggested the following drivers: Driver Relationship to FCO DriverTotal Activity CostTotalRacerCruiserActivity P.O.'s (#) $300K 2000 1250 750 Purchasing Rework Hrs. (Hrs) $200 450 200 250 Quality Control Invoices (#) $200 600 150 450 Billing Change Orders (#) $150 300 150 150 Mfg. Eng. 1. Calculate the unit costs of each product under the traditional method. 2. Calculate the unit costs of each product under activity based costing. 3. What pricing implications are inherent in this example.

24. Gulfstream Recreation Solution Standard Overhead Rate: $850K/70K Mhrs. = $12.14 per machine hour Traditional Cost Structure: Racer Cruiser Direct materials $35 $50 Direct labor $25 $13 Overhead $24 $12 Total $84 $75

25. Gulfstream Solution, continued ABC Overhead Rate: Racer Cruiser Purchasing $187.5 $112.5 Quality control $ 88.9 $111.1 Billing $ 50.0 $150.0 Mfg. Engineering $ 75.0 $ 75.0 Total $401.4 $448.6 Per unit $40.10 $ 8.97 ABC Cost Structure: Racer Cruiser Direct materials $35 $50 Direct labor $25 $13 Overhead $40 $ 9 Total $100 $72

26. ABC, ABM & Strategic Cost Applications • Comparison of cost structure to competition • Pricing, design and other operational impact • Mass customization impact • Behavioral impact of common components • Changes in the production process • Changes in the distribution system • Changes in source and types of supplies/suppliers • Profitability impact • Identification and elimination of non-value added activities • Quality and time implications

27. Implementation Strategy • Involve management and employees • Parallel system approach • Find a winner • KISS • Incentivize • Education users