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 • Cost Drivers • FCO’s

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

4. 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

5. Activity Based Costing (ABC)

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

7. 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

8. Contemporary Advantages • Comprehensive cost information • Emphasis on operations and activities • Costs are attached to activities • Provides driver visibility

9. 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

10. 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

11. 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.

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

13. 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.

14. 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

15. 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

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

17. Activity Based Management (ABM)

18. Ansari: ABM • Strategic Implications • Visibility on the efficiency & effectiveness (the quality) of activities • Visibility of costs for process redesign • Insight into timing consideration of actions

19. ABM, cont. • Attribute Implications • Technical • Greater focus on work • Provides cross-functional cost impact • Highlights operational interdependencies • Behavioral • Heightens importance of process knowledge • Reinforces continuous improvement • Empowers employees--be careful of “non-value” terminology • Cultural • Reorients focus on process not people • Challenges current thinking • May add cultural conflict

20. ABM, cont. • ABM Process • Obtain existing cost information • Determine the major processes • Identify process inputs and outputs • Determine the specific activities • Identify the resources used • Define output measures (what we measure) • Define performance measures (how we measure it) • Assess performance through benchmarking • Brainstorm improvements

21. 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