What are the advantages of using activity based costing versus absorption costing
- Able to give more accurate costing and therefore able to set better selling prices. Also able to make better decision making in terms of profitability.
- Focuses attention on what causes overheads which can lead to savings. For example in chapter 1 example one part B for delivery receiving the price was 30,000÷22 = 1364 so for product A the total cost was 13640 however this was for 20000 units so cost £0.68 a unit but for product C it was £1.36 ( 2,728/2,000) so can easily identify the high spend, so rather than having 2 deliveries for product C why not 1 if it’s so costly ??
What is the problem of activity based costing
- Not always possible to determine the cost driver (what causes the cost e.g rent ? What causes the rent to be the rate it is, is it the size ?)
Solution: Use ABC where possible and where it’s not possible use traditional absorption on the remaining overheads
The difference between activity based costing and absorption costing
If we use absorption costing then we decide on a suitable basis for absorption for example labour hours and absorb overheads on that basis however with activity based costing attempts to absorb overheads in a more accurate and therefore more useful way
The steps to follow for activity based costing
- Identify the major activities they give rise overheads for example machining dispatching of orders receiving of orders
- Determine what causes the cost of each activity which is called the COST DRIVER EG machine hours number of dispatched orders
- Calculate the total cost for each activity called the COST POOL E.g. total machine in costs or total cost of dispatch Department
- Calculate an absorption rate for each cost
- Calculate the total overhead cost for each product manufactured
6. Calculate the overhead costs per unit for each product
What is target costing
From research of the market determine a selling price at which the company expects to achieve the desired market share (the TARGET SELLING PRICE)
Determine the prophet acquired e.g. have acquired profit margin or required return on investment
Calculate the maximum cost per unit in order to achieve the required profit (the TARGET COST)
Compare the estimated actual costs with the target costs. If the actual cost is higher than the target cost then look for ways of reducing costs and if no way can be found of meeting the target cost then this product should not be produced
What is a cost gap
A cost gap is the difference between the target cost and the estimated actual costs (e.g using ABC). And the company should look for ways to remove this otherwise they should not proceed with the product
How to calculate gross profit of X of selling price
This is the easy one
Selling price X %
£20 selling price is a 20% GP on selling price would be -
£20 x 20% = £4
How to calculate profit of X of cost
This is a tricky one
Let’s say we want the profit to be 25% of cost. If cost is £100 the profit would have to be 25% which is £25 and therefore the selling price would be £125. Therefore for every £125 selling price the profit is £25.
So if the selling price is £50
Profit is 25/125 x £50 = £10
Possible ways of attempting to close the target gap
 Examine costs and look for cheaper alternatives (can we buy cheaper materials or hire cheaper labour or ask labour to work faster so we don’t need as many)
Re-examine design of product (Can we reduce cost without needing to reduce price) e.g we are making a desk, rather than it being 2m across could we make it 1.9m (tiny difference) the customer wouldn’t notice and we would save money
Can Target costing be used in service industries
Much more difficult to use target costing as it tends to be on a product however it can be used and the reasons are (below example is all based on the service of a dentist)
- Intangibility - can’t touch it
- Inseparability / Simultaneity - if we make a product we first make it and then it goes to the customer, two separate things so we can examine how we make it then sell etc. with a dentist he is doing the work the same time as you are receiving it so we can’t stop and ask how much is this costing as it is happening at the same time
- Variability/ heterogeneity - things are different. With a product it is identical for each unit but for dentist the work is different for each patient (customer)
- Perishability - once the service there is nothing there to check, you can’t check it like with a product
- No transfer of ownership - work is being done for you but there is no product to own
What is life-cycle costing
The costs involved in making a product and the sales revenue generated are likely to be different at different stages in the life of a product. For example during the initial development of the product the costs are likely to be high and the revenue minimum i.e. the product is likely to be loss-making.
If costing and decisions based on the costing only to be ever done on the short-term it could easily lead to bad decisions. Life cycle cost thing identifies the phases in the life-cycle and attempt to accumulate the costs over the entire life of the product
What are the five phases of the product life-cycle
Development
Introduction
Growth
Maturity
Decline
Ways to maximise the return over the product life-cycle
Within a development and introduction phase there would be costs for potentially new profits being made and is currently at a loss making position and it isn’t until the growth phase that profits would normally occur. Therefore to maximise the return over the whole cycle it would be-
Design costs out of products - Meaning in the development phase try to minimise costs where ever possible
Minimise the time to markets-ensure that the development phase are as short as it can be. Faster to market the faster you can start making profits
Minimise break even time – when we stop making loss and start making profit, sooner we can achieve break even the better
Maximise the length of life - it may be out of control (e.g new technologies come in) but longer the maturity phase the better
What is environmental management accounting EMA
Environmental management accounting focuses on the efficient use of resources and the disposal of waste and effluent
What are the importance to consider of environmental management accounting EMA
If a company is wasteful in its use of resources or alternatively causes pollution and this impacts in three ways
- There is the direct cost to the company of spending more than is needed on resources or having to spend money cleaning up the pollution
- Where is the damage to the reputation of the company as consumers are becoming more and more environmentally aware
3. There are possible fines or penalties as a result of breaking environmental regulations.
For all of the above reasons it is important for the company to attempt to identify and to manage the various costs involved
What are some typical environmental costs
The costs that come to mind of most people immediately are those relating to dealing with waste however there are many other costs that are likely to be just as important
For example amount of raw material used in production a publisher should consider ways of using less paper or recycle paper as a way of saving costs for themselves as well as helping the environment
Transport costs. Consideration of alternative ways of delivering goods, haps reduce costs and reduce the impact of the environment
Water and energy consumption. Environmental management accounting may help to identify inefficiencies and Waze for practices and therefore opportunities for cost saving
Different methods of accounting for environmental costs EMA
Although you cannot be required to perform any calculation for the section you should be able to explain briefly for methods that have been suggested as ways of accounting for environmental costs
- INFLOW / OUTFLOW ANALYSIS - This approach balances the quantity of resources that is input with the quantity that is output either as production or as waste. Measuring in physical quantities and in monetary terms focus is the business to focus on environmental costs. Note that resources are not just for materials but also things like energy and water
2. FLOW COST ACCOUNTING - This is really inflow/outflow analysis was instead of applying simply to businesses as a whole it takes into account the organisational structure. Resources imports into the business are divided into three separate categories
Material-the resources used in storing raw materials and in production
System-the resources used in for example storing production and quality control
Delivery and disposal – resources used in delivering to the customer and then disposing of any waste
As with inflow/outflow analysis for aim is to reduce the quantities of resources used which saves costs for the company and leads to increased ecological efficiency
- LIFECYCLE COSTING - this has been discussed previously in previous chapters. The relevance of environmental management accounting EMA is that it is important to include environmentally driven costs such as the cost of disposal of waste. It may be possible to design out these costs before the product is launched
- ENVIRONMENTAL ACTIVITY BASED COSTING - Activity based costing has been discussed in early chapters its application to environmental costs is that those costs that are environmental related e.g. costs related to a sewage plants are attributed to joint environmental cost centres. As with activity based costing in general this focuses more attention on these costs and potentially leads to greater efficiency and cost reduction
What is key factor analysis
Key factor analysis is where we manufacture several products all of which use the same limited resource then we need to decide how best to use the limited resource in production. The standard key factor approach is to rank the products on the basis of the contribution earned per unit of the limited resource
For example if we have two products. Product a and product b, the both provide profit of £2 but product a takes 2 hours to produce and product b takes 1 hour. If the maximum output is 20,000 for product a and 10,000 for product b (50,000 in total) but we only have 48,000 hours available which do we produce more of ??
Key factor analysis calculation
Contribution per unit / Machine hours per unit = contribution per machine hour
For example is the contribution per hour for product a is £5 and for product b is £4 then it seems as though product a is superior however if product a takes two hours to produce and product b takes one hour then product b is superior (£4 vs £2.50)
What is contribution per unit
Contribution per unit is either-
- Sales - variable costs
- Profit before fixed costs
They both come to the same number the reason we remove fixed costs is they will stay the same regardless of the units produced whereas variable costs are, well variable
What is throughput accounting
Throughput accounting is similar to key factor analysis in that it focuses on where best to use limited resources in production however there are two main concepts of throughput accounting which will result in us amending the approach
- In the short run all costs in the factory are likely to be fixed with the exception of material costs ( for example labour, labour is a fixed cost in that in most companies people are paid a fixed annual salary regardless of house much or little they produce in a week)
- In a JIT environment Then we should be attempting to eliminate inventories. Use of a limited resource in production of inventory is should be avoided and therefore any work in progress should be valued at only the material costs
What is the difference between throughput accounting and key factor analysis
They are both the same apart from one key difference and that is within key factor analysis only the fixed costs are classed as fixed costs Whereas in through put accounting only material costs are seen as variable and unlike with key factor analysis labour costs are also seen as fixed
What is the throughput accounting ratio
Return per factory hour / Cost per factory hour
Return per factory hour = The contribution (for throughout its called the throughout and not contribution) which is the selling price less variable costs (which for throughout is only materials and not labour) divided by hours to produce = return per factory hour
Cost per factory hour = total factory costs (excluding materials) so in essence fixed costs for the expected hours and not actual hours / hours available
What are the relevance for calculating the throughput accounting ratio
- When ranking products about which product to do first the higher the ratio the better
- More importantly, The cost per factory hour which is the bottom line on the equation is how much it costs per hour to run the factory so therefore the higher above this the more profitable it would be. Therefore we want the through pot ratio to be more than 1
