What are the reasons for the development of Activity Based Costing?
- Size/Proportion of Overheads.
- Traditional manufacturing had small overheads in relation to other costs.
- Labour intensive production usually results in lower production overheads (Dep’n) as production becomes automated this shifts.
- Modern Manufacturing
- More machine intensive manufacturing = more related production overheads & lower direct costs.
- Complexity/Diversity
- Nature of manufacturing and consumer demand has changed to create more highly competitive environments.
- Companies need to offer greater product diversity in order to remain competitive.
- Not all production overheads are driven by level of activity.
What are the 5 steps in activity based costing?
- Group production overheads in to activities, according to how they are driven.
- This is a cost pool = an activity that consumes resources and for which overhead costs are identifiable and allocated.
- Identify cost drivers for each activity.
- The cost driver is the factor which influences the cost.
- Calculate an OAR for each Cost pool
- OAR = Budgeted cost/budgeted activity.
- Absorb activity costs in to products.
- Calculate full production cost per unit.
What are the advantages and disadvantages of Activity Based Costing?
Advantages
- Through clear understanding of the drivers of costs cost control can be improved.
- The Cost per unit can be more accurate meaning that:
- Pricing can be fine tuned to ensure profitability while remaining competitive.
- Decisions such as discontinuation of products can be made.
- Better motivator for staff as costs are allocated on a fair basis relating to their cause.
Disadvantages
- The process is longer, more time consuming and as a result more costly.
- Is of limited benefit if there is a low level of production overheads.
- It can be difficult to identify cost pools and drivers.
What are Total Quality Management and Just in Time production?
Total Quality management - TQM
Continuous improvement in quality , productivity and effectiveness through focussing on both product and consumer. Requires buy in to the process by employees and commitment of senior management to process.
Just in Time - JIT
Pull based system of production, work is pulled through the system in response to customer demand. This eliminates the need to hold stocks of inventory and finished goods.
What is the aim/purpose of through put accounting?
This approach aims to make best use of a scarce resource in a JIT environment. Maximising profitability while simultaneously reducing operating expenses and inventory.
Throughput = Sales revenue less direct material cost.
The process will determine the bottleneck (limiting factors) and best use of the bottleneck resources should be made.
Long term the business will look to eliminate the bottleneck.
What are the Five steps in the “Theory of Constriants”
This is the process of identifying and removing constraints that restrict output.
- Identify the systems bottle necks
- Identify how to exploit the bottle necks
- Subordinate everything else to the decision in step 2
- Elevate the systems bottle necks
- If in previous steps a bottle neck has been broken go back to step 1.
What are the different Through put accounting ratio’s?
Throughput(Return) per factory hour = Throughput per unit (Contribution)/ product time on bottle neck resource.
Cost per Factory Hour - Total Factory Cost/total bottleneck resource time available
nb Total factory cost is everything except direct materials.
Throughput Accounting ratio (TPAR) = Return per factory hour/Cost per factory hour
If TPAR > 1 - throughput exceeds operating costs so the product should be profitable.
TPAR<1 would indicate a loss making product.
In production priority should be given to products generating highest TPAR.
How can the TPAR be improved and what are the shortcoming of using TPAR?
To improve TPAR:
- Increase price per unit for each unit sold.
- Reduce material costs per unit.
- Reduce total operating expenses.
- Improve productivity of the bottle neck, reducing time required for each unit.
Disadvantages of TPAR
Better for short term due to the assumption that all costs except materials are fixed, as time horizon increases variability of costs will also increase.
How might throughput accounting be applied to multi product decision making?
The objective is to maximise profit which in the short term equates to maximising throughput (Contribution) earned.
- Identify the bottle neck constraint.
- Calculate the throughput per unit for each product.
- Calculate the throughput per unit of the bottle neck resource for each product.
- Rank the products in order of throughput per unit of bottle neck resource.
- Allocate resources using this ranking.
What are the steps for deriving a target cost?
- Set the target price - this will be based on customer perceived value of the product so will be market based.
- Calculate target operating profit per unit - may be based on return on sales or return on investment.
- Target cost is identified from the above.
- Cost gap is calculated - difference between target cost and current production cost.
- Cost gap is closed/reduced through value engineering and value analysis ect.
What can make target costing more difficult in service based businesses?
Intangibility - it can be difficult to define what service has been provided and a value for that service.
Inseparability - A service only exists while it is in progress/being carried out so cannot be taken away.
Heterogeneity - Quality and consistency of services will vary from day to day
Perishability - unused services cannot be stored for later use.
No transfer of ownership - services do not result in the transfer of property.
What are the different stages in a products lifecycle?
Product Dev - High level of set up costs incurred.
Launch/Market dev - extensive marketing & promotion costs, low production volumes will result in high production costs.
Growth Stage - Marketing and promotion continuing, sales volume increasing and unit costs decreasing. Due to economies of scale.
Maturity Stage - Economies of scale achieved, initial setup and fixed costs are recovered. Marketing costs may still increase to maintain market position.
What is environmental Management accounting?
- Is concerned with the accounting information needs of managers to support:
- Identifying costs of the environment related activities
- Estimating costs of the activities
- Controlling the costs.
2. Assesses the likelihood and impact of environmental risks.
3. Considers the non financial environmental cost or benefit.
4. Includes environmental KPI’s as part of routine performance monitoring.
5. It bench marks activities against environmental best practice.
What types of environmental costs are considered?
- Conventional Costs - covers energy & raw materials which would usually be reported as overheads or part of COS.
- Contingent costs - Future compliance or decommissioning. Recognise, build in to project appraisal and seek to reduce.
- Relationship Costs - PR, the impact of public image as a result of environmental information.
- Reputation costs - Impact of failure to address environmental issues on the business image.
What techniques might be used for Environmental Management accounting?
- ABC - Cost drivers are identified, product costs are more realistic, environmental costs are not hidden within overheads.
- Lifecycle Costing - Considers control/reduction of environmental costs at start of project, and that all costs are taken in to account.
- Flow cost accounting - Looks at material flows and losses with the aim to reduce usage and wastage.
- Input/Outflow analysis - Balancing inflows with outflows, assumes what goes in must come out.
