Chapter 17

Develop activity-based costs (ABC)

 Refines the way indirect costs are allocated to production  Focuses on costs incurred by each production activity  Each activity has its own cost driver 3Copyright (c) 2009 Prentice Hall. All rights reserved.

Activities:Cost Drivers: Material purchasing? Material handling? Production scheduling? Quality inspections? Photocopying? Warranty service? 4Copyright (c) 2009 Prentice Hall. All rights reserved.

Identify each activity and estimate its total indirect cost Identify the cost driver for each activity and estimate the quantity of each driver Compute the cost allocation rate for each activity Allocate indirect costs to the cost object 5Copyright (c) 2009 Prentice Hall. All rights reserved.

6 Cost allocation rate ? ? ? ? Copyright (c) 2009 Prentice Hall. All rights reserved.

7 Allocated activity cost ? ? ? ? Copyright (c) 2009 Prentice Hall. All rights reserved.

ActivityBudgeted Cost Allocation base Estimated base activity Cost allocation rate Materials handling $6,000Number of parts 3,000? Machine setup 3,300Number of setups 20? Insertion of parts 54,000Number of parts 3,000? Finishing80,000Finishing direct labor hours 2,000? 8Copyright (c) 2009 Prentice Hall. All rights reserved.

9 ActivityCost allocation rate Activity per 1,000 bumpers Indirect cost allocated Materials handling $2 per part3000 parts$6,000 Machine setup$165 per setup20 setups$3,300 Insertion of parts $18 per part3000 parts$54,000 Finishing$40 per hour2,000 hours$80,000 Total indirect costs allocated to 1,000 bumpers$143,300 Indirect cost for one bumper$ ? Copyright (c) 2009 Prentice Hall. All rights reserved.

Use activity-based management (ABM) to achieve target costs

 Uses ABC to make decisions that increase profits while meeting customer needs 11Copyright (c) 2009 Prentice Hall. All rights reserved.

 Reevaluating activities to reduce costs  Requires cross-functional teams  Setting sales prices based on target prices 12Copyright (c) 2009 Prentice Hall. All rights reserved.

13 Target Sales Price minus Desired profit ? equals Target Pricing Traditional Cost-based Pricing Full product cost plus Desired profit equals ? Copyright (c) 2009 Prentice Hall. All rights reserved.

Describe a just-in-time (JIT) production system, and record its transactions

 Materials purchased and goods completed “just in time” for delivery 15Copyright (c) 2009 Prentice Hall. All rights reserved.

16 Receive order from customer Schedule production Defect-free materials are delivered by suppliers just in time for production Defect-free materials are delivered by suppliers just in time for production Finished product is delivered to customer Demand- pull system Copyright (c) 2009 Prentice Hall. All rights reserved.

17 cutting shaping smoothing grinding Finished Goods Copyright (c) 2009 Prentice Hall. All rights reserved.

 Lost sales can occur if materials do not arrive on time or if the materials are of poor-quality  Strong relations with quality materials’ vendors are essential  Some JIT companies have small inventories of critical materials 18Copyright (c) 2009 Prentice Hall. All rights reserved.

19 TraditionalJust-in-time Recording production activity ?? Inventory accounts?? Manufacturing costs?? Copyright (c) 2009 Prentice Hall. All rights reserved.

(a) Products produced in large batchesTraditional (b) Large stocks of finished goods protect against lost salesTraditional (c) Suppliers make frequent deliveries of small quantities of materials JIT (d) Long setup timesTraditional (e) Employees do a variety of jobsJIT (f) Machines are grouped into self-contained in production cellsJIT (g) Machines are grouped according to functionTraditional (h) Suppliers can access the company’s intranetJIT (i) The final operation in the production sequence “pulls” parts from the preceding operation Traditional (k) Management works with suppliers to ensure defect-free materials JIT 20Copyright (c) 2009 Prentice Hall. All rights reserved.

Use the four types of quality costs to make decisions

Goals  To provide customers with superior products and services  Continuous improvement 22Copyright (c) 2009 Prentice Hall. All rights reserved.

PreventionAppraisal Internal failure External failure 23Copyright (c) 2009 Prentice Hall. All rights reserved.

24 Examples of Quality Costs PreventionAppraisal costs ? ? ? ? ? ? Internal failureExternal failure ? ? ? ? ? ? ? Copyright (c) 2009 Prentice Hall. All rights reserved.