[PPT] - TUTORIAL - TUTORIAL -ABC ABC TOTAL COST for a COST OBJECT TOTAL PowerPoint Presentation

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TUTORIAL TUTORIAL -

ABC

ABC

Ir. Haery
Ir. Haery Sihombing

Sihombing/IP /IP

Pensyarah Pelawat Fakulti Kejuruteraan Pembuatan Universiti Teknologi Malaysia Melaka

TOTAL COST for a COST OBJECT TOTAL COST for a COST OBJECT

Direct Cost Direct Cost (Labor Material) (Labor Material) Overhead Cost Overhead Cost

+ +

Total Object Cost Total Object Cost

EXAMPLE: 1 TRADITIONAL COST ACCOUNTING TRADITIONAL COST ACCOUNTING

Arbitrarily allocates to the cost objects

Arbitrarily allocates to the cost objects

Total Company

Total Company’ ’s overhead is allocated o s overhead is allocated o the products based on volume based the products based on volume based measure ( measure (e.g. labor hours, machine hours e.g. labor hours, machine hours) )

Assumption: relation between overhead

Assumption: relation between overhead and the volume based measure and the volume based measure Product A : Product A :

1 hours of direct labor

1 hours of direct labor

(direct labor cost 1 *RM20/hour (direct labor cost 1 *RM20/hour =RM =RM 20.00/ 20.00/hours) hours)

Demand = 100

Demand = 100

TRADITIONAL COST ACCOUNTING TRADITIONAL COST ACCOUNTING

Product B:

Product B:

2 hours of direct labor

2 hours of direct labor

(direct labor cost 2 *RM20/ hour (direct labor cost 2 *RM20/ hour =RM =RM 40.00 40.00/hours) /hours)

Demand = 950

Demand = 950

Two products: Product A

Product A and Product B Product B

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TOTAL OVERHEAD = RM 100,000.00

TOTAL OVERHEAD = RM 100,000.00

TOTAL DIRECT LABOR = 2,000 Hours

TOTAL DIRECT LABOR = 2,000 Hours

RM 100,000/2000 Hours = RM 50/ Hours RM 100,000/2000 Hours = RM 50/ Hours

Product A :

Product A : 1 hours of direct labor 1 hours of direct labor

Product B :

Product B : 2 hours of direct labor 2 hours of direct labor

TCA Overhead Allocation :

TCA Overhead Allocation : A A = RM = RM 50/unit 50/unit B B = RM = RM 100/unit 100/unit

TRADITIONAL COST ACCOUNTING TRADITIONAL COST ACCOUNTING ACTIVITY BASED COSTING ACTIVITY BASED COSTING

More Accurate Cost Management Methodology

More Accurate Cost Management Methodology

Focuses on indirect costs (overhead)

Focuses on indirect costs (overhead)

Traces rather than allocates each expense

Traces rather than allocates each expense category to the particular cost object category to the particular cost object

Makes

Makes “ “indirect indirect” ” expense expense “ “direct direct” ”

ABC Basic Premise ABC Basic Premise

Cost objects consume activities

Cost objects consume activities

Activities consume resources

Activities consume resources

This consumption of resources is what driver

This consumption of resources is what driver costs costs

Understanding this relationship is critical to

Understanding this relationship is critical to successfully managing overhead successfully managing overhead

When To Use ABC When To Use ABC

Overhead is high

Overhead is high

Products are diverse: complexity,

Products are diverse: complexity, volume, amount of direct labor volume, amount of direct labor

Cost of errors are high

Cost of errors are high

Competition is stiff

Competition is stiff

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ABC Steps ABC Steps

Identifies activities

Identifies activities

Determine cost for each activity

Determine cost for each activity

Determine cost drivers

Determine cost drivers

Collect activity data

Collect activity data

Calculate product cost

Calculate product cost

ABC Illustration ABC Illustration

Set

Set-

up

up

Machining

Machining

Receiving

Receiving

Packing

Packing

Engineering

Engineering

1. INDENTIFY ACTIVITIES
1. INDENTIFY ACTIVITIES
Set

Set-

up

up

Machining

Machining

Receiving

Receiving

Packing

Packing

Engineering

Engineering

ABC Illustration ABC Illustration

2. DETERMINE ACTIVITY COST
2. DETERMINE ACTIVITY COST

= RM 10,000 = RM 10,000 = RM 40,000 = RM 40,000 = RM 10,000 = RM 10,000 = RM 10,000 = RM 10,000 = RM 30,000 = RM 30,000

ABC Illustration ABC Illustration

3. DETERMINE COT DRIVERS
3. DETERMINE COT DRIVERS
Set

Set-

up

up

Machining

Machining

Receiving

Receiving

Packing

Packing

Engineering

Engineering = Number of Setups = Number of Setups = Machining Hours = Machining Hours = Number of Receipt = Number of Receipt = Number of Deliveries = Number of Deliveries = Engineering Hours = Engineering Hours

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ABC Illustration ABC Illustration

4. ACTIVITY DATA
4. ACTIVITY DATA

75,500 75,500 24,500 24,500 15,000 15,000 500 500 15,000 15,000 500 500 30,000 30,000 Engineering Engineering 7,500 7,500 3 3 2,500 2,500 1 1 10,000 10,000 Packing Packing 7,500 7,500 3 3 2,500 2,500 1 1 10,000 10,000 Receiving Receiving 38,000 38,000 1900 1900 2,000 2,000 100 100 40,000 40,000 Machining Machining 7,500 7,500 3 3 2,500 2,500 1 1 10,000 10,000 Set Set-

up

up RM RM PRODUCT PRODUCT B B RM RM PRODUCT PRODUCT A A Cost Cost (RM) (RM) ACTIVITY ACTIVITY

Overhead for Product A =

Overhead for Product A = RM 24,500 : 100 = RM RM 24,500 : 100 = RM 245 245

Overhead for Product B =

Overhead for Product B = RM 75,000 : 950 = RM RM 75,000 : 950 = RM 79. 47

79. 47

ABC Illustration ABC Illustration

5. PRODUCT COST CALCULATION
5. PRODUCT COST CALCULATION

PRODUCT COST TCA Vs. ABC PRODUCT COST TCA Vs. ABC

Overhead Overhead TCA TCA RM RM 50,00 50,00 Overhead Overhead ABC ABC RM RM 245,00 245,00 Direct Cost Direct Cost TCA TCA RM RM 20,00 20,00 Direct Cost Direct Cost ABC ABC RM RM 20,00 20,00 TOTAL TOTAL TCA TCA RM RM 70,00 70,00 TOTAL TOTAL ABC ABC RM RM 265,00 265,00 Overhead Overhead TCA TCA RM RM 100,00 100,00 Overhead Overhead ABC ABC RM RM 79.47 79.47 Direct Cost Direct Cost TCA TCA RM RM 40,00 40,00 Direct Cost Direct Cost ABC ABC RM RM 40,00 40,00 TOTAL TOTAL TCA TCA RM RM 140,00 140,00 TOTAL TOTAL ABC ABC RM RM 119,47 119,47

Cost for Product A : Cost for Product A : Cost for Product B : Cost for Product B :

Undercosting & Undercosting & Overcosting Overcosting

Jose, Roberta, and Nancy order separate items for lunch. Jose’s order amounts to $14 Roberta consumed 30 Nancy’s order is 16 Total $60 What is the average cost per lunch?

EXAMPLE: 2

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$60 ÷ 3 = $20 Jose and Nancy are overcosted. Roberta is undercosted.

Undercosting & Undercosting & Overcosting Overcosting

Existing Single Indirect Existing Single Indirect-

Cost Pool System

Cost Pool System

Kole Corporation manufactures a normal lens (NL) and a complex lens (CL). Kole currently uses a single indirect-cost rate job costing system. Cost objects: 80,000 (NL) and 20,000 (CL).

EXAMPLE: 3

Normal Lenses (NL) Direct materials $1,520,000 Direct mfg. labor 800,000 Total direct costs $2,320,000 Direct cost per unit: $2,320,000 ÷ 80,000 = $29

Existing Single Indirect Existing Single Indirect-

Cost Pool System

Cost Pool System

Complex Lenses (CL) Direct materials $ 920,000 Direct mfg. labor 260,000 Total direct costs $1,180,000 Direct cost per unit: $1,180,000 ÷ 20,000 = $59

Existing Single Indirect Existing Single Indirect-

Cost Pool System

Cost Pool System

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All Indirect Costs $2,900,000 50,000 Direct Manufacturing Labor-Hours INDIRECT-COST POLL INDIRECT COST-ALLOCATION BASE $58 per Direct Manufacturing Labor-Hour

Existing Single Indirect Existing Single Indirect-

Cost Pool System

Cost Pool System

Indirect Costs Direct Costs COST OBJECT: NL AND CL LENSES DIRECT COSTS Direct Materials Direct Manufacturing Labor

Existing Single Indirect Existing Single Indirect-

Cost Pool System

Cost Pool System

Kole uses 36,000 direct manufacturing labor-hours to make NL and 14,000 direct manufacturing labor-hours to make CL. How much indirect costs are allocated to each product?

Existing Single Indirect Existing Single Indirect-

Cost Pool System

Cost Pool System

NL: 36,000 × $58 = $2,088,000 CL: 14,000 × $58 = $812,000 What is the total cost of normal lenses? Direct costs $2,320,000 + Allocated costs $2,088,000 = $4,408,000 What is the cost per unit? $4,408,000 ÷ 80,000 = $55.10

Existing Single Indirect Existing Single Indirect-

Cost Pool System

Cost Pool System

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What is the total cost of complex lenses? Direct costs $1,180,000 + Allocated costs $812,000 = $1,992,000 What is the cost per unit? $1,992,000 ÷ 20,000 = $99.60

Existing Single Indirect Existing Single Indirect-

Cost Pool System

Cost Pool System

Normal lenses sell for $60 each and complex lenses for $142 each. Normal Complex Revenue $60.00 $142.00 Cost 55.10 99.60 Income $ 4.90 $ 42.40 Margin 8.2% 29.9%

Existing Single Indirect Existing Single Indirect-

Cost Pool System

Cost Pool System

Refining a Costing System Refining a Costing System

Direct-cost tracing Indirect-cost pools Cost-allocation basis

Refining a Costing System Refining a Costing System

1. Design of Products and Process

The Design Department designs the molds and defines processes needed (details of the manufacturing operations).

2. Manufacturing Operations

Lenses are molded, finished, cleaned, and inspected.

3. Shipping and Distribution

Finished lenses are packed and sent to the various customers.

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Activity Activity-

Based Costing System

Based Costing System

Fundamental Cost Objects Activities Costs of Activities Assignment to Other Cost Objects Cost of:

Product
Service
Customer

Activity Activity-

Based Costing System

Based Costing System

A cross-functional team at Kole Corporation identified key activities: Design products and processes. Set up molding machine. Operate machines to manufacture lenses. Maintain and clean the molds.

Activity Activity-

Based Costing System

Based Costing System

Set up batches of finished lenses for shipment. Distribute lenses to customers. Administer and manage all processes.

Activity Activity-

Based Costing System

Based Costing System

No. of

Setup Hours Lenses NL Lenses CL Lenses Other Cost Allocation Base Product Cost Objects

No. of

Shipments Parts- Square feet Setup Design Shipping Activity Indirect Cost Pool

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Activity Activity-

Based Costing System

Based Costing System

NL CL Quantity produced 80,000 20,000

No. produced/batch

250 50 Number of batches 320 400 Setup time per batch 2 hours 5 hours Total setup-hours 640 2,000 Total setup costs are $409,200.

Activity Activity-

Based Costing System

Based Costing System

What is the setup cost per setup-hour? $409,200 ÷ 2,640 hours = $155 What is the setup cost per direct manufacturing labor-hour? $409,200 ÷ 50,000 = $8.184

Activity Activity-

Based Costing System

Based Costing System

Allocation using direct labor-hours: NL: $8.184 × 36,000 = $294,624 CL: $8.184 × 14,000 = $114,576 Total $409,200 Allocation using setup-hours: NL: $155 × 640 = $ 99,200 CL: $155 × 2,000 = $310,000 Total $409,200

Cost Hierarchies Cost Hierarchies

A cost hierarchy is a categorization

f costs into different cost pools.

Cost drivers bases (cost-allocation bases) Degrees of difficulty in determining cause-and-effect relationships

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Cost Hierarchies Cost Hierarchies

ABC systems commonly use a four-part cost hierarchy to identify cost-allocation bases: 1. Output unit-level costs 2. Batch-level costs 3. Product-sustaining costs 4. Facility-sustaining costs

Output Unit Output Unit-

Level Costs

Level Costs

These are resources sacrificed

n activities performed on each

individual unit of product or service. Energy Machine depreciation Repairs

Batch Batch-

Level Costs

Level Costs

These are resources sacrificed on activities that are related to a group

f units of product(s) or service(s)

rather than to each individual unit

f product or service.

Setup-hours Procurement costs

Product Product-

Sustaining Costs

Sustaining Costs

These are often called service-sustaining costs and are resources sacrificed on activities undertaken to support individual products or services. Design costs Engineering costs

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Facility Facility-

Sustaining Costs

Sustaining Costs

These are resources sacrificed on activities that cannot be traced to individual products or services but support the organization as a whole. General administration – rent – building security

Implementing Implementing Activity Activity-

Based Costing

Based Costing

Identify cost objects. NL CL Identify the direct costs

f the products.

Direct material Direct labor Mold cleaning and maintenance Step 1 Step 1 Step 2 Step 2

Implementing Implementing Activity Activity-

Based Costing

Based Costing

Cleaning and maintenance costs of $360,000 are direct batch-level costs. Why? Because these costs consist of workers’ wages for cleaning molds after each batch of lenses is run.

Implementing Implementing Activity Activity-

Based Costing

Based Costing

Normal Lenses (NL) Cost Hierarchy Description Category Direct materials Unit-level $1,520,000 Direct mfg. labor Unit-level 800,000 Cleaning and maint.Batch-level 160,000 Total direct costs $2,480,000

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Implementing Implementing Activity Activity-

Based Costing

Based Costing

Complex Lenses (CL) Cost Hierarchy Description Category Direct materials Unit-level $ 920,000 Direct mfg. labor Unit-level 260,000 Cleaning and maint.Batch-level 200,000 Total direct costs $1,380,000

Implementing Implementing Activity Activity-

Based Costing

Based Costing

Select the cost-allocation bases to use for allocating indirect costs to the products. (1) (2) (3) Activity Cost Hierarchy Total Costs Design Product-sustaining $450,000 Setups Batch-level $409,200 Operations Unit-level $637,500 Step 3

Implementing Implementing Activity Activity-

Based Costing

Based Costing

Identify the indirect costs associated with each cost-allocation base. Overhead costs incurred are assigned to activities, to the extent possible, on the basis of a cause-and-effect relationship. Step 4 Step 4

Implementing Implementing Activity Activity-

Based Costing

Based Costing

Compute the rate per unit. (1) (5) NL CL Total Setup-hours: 640 2,000 2,640 Step 5 $409,200 ÷ 2,640 = $155

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Implementing Implementing Activity Activity-

Based Costing

Based Costing

Compute the indirect costs allocated to the products. NL: $155 × 640 = $ 99,200 CL: $155 × 2,000 = 310,000 Total $409,200 Step 6

Implementing Implementing Activity Activity-

Based Costing

Based Costing

Compute the costs of the products. NL and CL would show three direct cost categories. Step 7 1. Direct materials 2. Direct manufacturing labor 3. Cleaning and maintenance

Implementing Implementing Activity Activity-

Based Costing

Based Costing

NL and CL would show six indirect cost pools. 1. Design 2. Molding machine setups 3. Manufacturing operations 4. Shipment setup 5. Distribution 6. Administration

ABC and Department ABC and Department Indirect Indirect-

Cost Rates

Cost Rates

Many companies have evolved their costing system from using a single cost pool to using separate indirect-cost rates for each department: Design Manufacturing Distribution

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ABC and Department ABC and Department Indirect Indirect-

Cost Rates

Cost Rates

Why? Because the cost drivers of resources in each department or subdepartment differ from the single, company-wide, cost-allocation base. ABC systems are a further refinement of department costing systems.

SUMMARY of ABC APPOACH SUMMARY of ABC APPOACH

ABC is more accurate cost management system

ABC is more accurate cost management system than Traditional Cost Accounting (TCA) than Traditional Cost Accounting (TCA)

Traditional Cost Accounting (TCA) is unable to

Traditional Cost Accounting (TCA) is unable to calculate the calculate the “ “true true” ” of a product

f a product

Benefits of ABC Systems Benefits of ABC Systems

Significant amounts of indirect costs are allocated using only one or two cost pools. All or most costs are identified as output unit-level costs. Products make diverse demands on resources because of differences in volume, process steps, batch size,

r complexity.

Benefits of ABC Systems Benefits of ABC Systems

Products that a company is well-suited to make and sell show small profits while products for which a company is less suited show large profits. Complex products appear to be very profitable and simple products appear to be losing money.

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Benefits of ABC Systems Benefits of ABC Systems

Operations staff have significant disagreements with the accounting staff about the costs of manufacturing and marketing products and services.

Limitations of ABC Systems Limitations of ABC Systems

The main limitations of ABC are the measurements necessary to implement the system. ABC systems require management to estimate costs of activity pools and to identify and measure cost drivers for these pools.