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# of purchase orders Material handling# of parts Production scheduling# of batches Quality inspections# of inspections Photocopying# of pages copied Warranty service# of service calls 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 Estimated total indirect cost Estimated total quantity of the allocation base Copyright (c) 2009 Prentice Hall. All rights reserved.

7 Allocated activity cost Cost allocation rate Actual quantity of allocation base 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$2 per part Machine setup 3,300Number of setups 20$165 per setup Insertion of parts 54,000Number of parts 3,000$18 per part Finishing80,000Finishing direct labor hours 2,000$40 per direct labor hour 8Copyright (c) 2009 Prentice Hall. All rights reserved.

9 ActivityCost allocation rate Activity per 1,000 bumpers Indirect cost allocated Materials handling $2 per part3,000 parts$6,000 Machine setup$165 per setup20 setups$3,300 Insertion of parts $18 per part3,000 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  Types of decisions: ◦ Pricing and product mix  ABC provides a more accurate cost of products  Helps companies determine how profitable products are ◦ Cost cutting 11Copyright (c) 2009 Prentice Hall. All rights reserved.

 Reevaluating activities to reduce costs  Requires cross-functional teams ◦ Marketers ◦ Engineers ◦ Accountants  Setting sales prices based on target prices ◦ What customers are willing to pay 12Copyright (c) 2009 Prentice Hall. All rights reserved.

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

 Questions? Copyright (c) 2009 Prentice Hall. All rights reserved.14

1. Activity-based costing: A. determines a cost driver for each production activity. B. is less accurate than using a predetermined overhead application rate. C. is less common in a competitive business environment. D. is all of the above. Copyright ©2009 Prentice Hall. All rights reserved.15

1.Activity-based costing: A.determines a cost driver for each production activity. B.is less accurate than using a predetermined overhead application rate. C.is less common in a competitive business environment. D.is all of the above. Copyright ©2009 Prentice Hall. All rights reserved.16

2. Under ABC, which of the following would be a reasonable cost driver for materials handling? A. Direct labor hours B. Machine hours C. Number of parts D. Square feet of warehouse Copyright ©2009 Prentice Hall. All rights reserved.17

2.Under ABC, which of the following would be a reasonable cost driver for materials handling? A.Direct labor hours B.Machine hours C.Number of parts D.Square feet of warehouse Copyright ©2009 Prentice Hall. All rights reserved.18

3. What types of decisions are made with activity-based management? A. Pricing B. Product mix C. Cost cutting D. All of the above Copyright ©2009 Prentice Hall. All rights reserved.19

3.What types of decisions are made with activity-based management? A.Pricing B.Product mix C.Cost cutting D.All of the above Copyright ©2009 Prentice Hall. All rights reserved.20

4. This method of pricing begins with the amount customers are willing to pay and subtracts desired profit to determine the desired cost. A. Traditional costing B. Target pricing C. Market-based costing D. Price profit analysis Copyright ©2009 Prentice Hall. All rights reserved.21

4.This method of pricing begins with the amount customers are willing to pay and subtracts desired profit to determine the desired cost. A.Traditional costing B.Target pricing C.Market-based costing D.Price profit analysis Copyright ©2009 Prentice Hall. All rights reserved.22

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

 Materials purchased & goods completed “just in time” for delivery  Production completed in work cells  Employees work in a team without supervision  Goods completed in small batches that are inspected for quality 24Copyright (c) 2009 Prentice Hall. All rights reserved.

25 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.

26 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 27Copyright (c) 2009 Prentice Hall. All rights reserved.

 Also called “Backflush costing” ◦ Starts with completed products and then assigns manufacturing costs to units sold and inventory 28 TraditionalJust-in-time Recording production activity Build costs as products move through three inventory accounts Record costs when units are complete Inventory accountsMaterials inventory Work in process Finished goods Raw and in-process inventory Finished goods Manufacturing costsDirect materials Direct labor Manufacturing overhead Direct materials Conversion 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 29Copyright (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 ◦ Improve quality ◦ Eliminate defects and waste ◦ Invest in research & development 31Copyright (c) 2009 Prentice Hall. All rights reserved.

Prevention Avoid poor-quality goods Appraisal Detect poor- quality goods Internal failure Avoid poor-quality before delivery External failure Poor-quality goods delivered 32Copyright (c) 2009 Prentice Hall. All rights reserved.

33 Examples of Quality Costs PreventionAppraisal costs Training personnel Inspection during production Improved materials Inspection of final product Preventative maintenance Product testing Internal failureExternal failure Production loss caused by downtime Lost profits from unhappy customers Rework Warranty costs Rejected units Service costs at customer sites Sales returns Copyright (c) 2009 Prentice Hall. All rights reserved.

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5. Which of the following is NOT a characteristic of just-in-time (JIT) production? A. Small quantity of materials on hand B. Machines and workers grouped in “cells” C. Strong relationship with suppliers D. Minimization of lost sales Copyright ©2009 Prentice Hall. All rights reserved.35

5.Which of the following is NOT a characteristic of just-in-time (JIT) production? A.Small quantity of materials on hand B.Machines and workers grouped in “cells” C.Strong relationship with suppliers D.Minimization of lost sales Copyright ©2009 Prentice Hall. All rights reserved.36

6. What is unique about accounting for product costs in a JIT system? A. Costs aren’t recorded until the goods are complete. B. Manufacturing overhead is not allocated to goods. C. Cost of goods sold is an estimate. D. All of the above are true. Copyright ©2009 Prentice Hall. All rights reserved.37

6.What is unique about accounting for product costs in a JIT system? A.Costs aren’t recorded until the goods are complete. B.Manufacturing overhead is not allocated to goods. C.Cost of goods sold is an estimate. D.All of the above are true. Copyright ©2009 Prentice Hall. All rights reserved.38

7. Continuous improvement is an essential piece of which management approach? A. Profit maximization B. Total quality management C. Autocratic approach D. Efficiency model Copyright ©2009 Prentice Hall. All rights reserved.39

7.Continuous improvement is an essential piece of which management approach? A.Profit maximization B.Total quality management C.Autocratic approach D.Efficiency model Copyright ©2009 Prentice Hall. All rights reserved.40

8. Which of the following of the four quality costs is likely to be the most expensive? A. Prevention B. Appraisal C. Internal failure D. External failure Copyright ©2009 Prentice Hall. All rights reserved.41

8.Which of the following of the four quality costs is likely to be the most expensive? A.Prevention B.Appraisal C.Internal failure D.External failure Copyright ©2009 Prentice Hall. All rights reserved.42

9. Product testing is an example of which quality cost? A. Prevention B. Appraisal C. Internal failure D. External failure Copyright ©2009 Prentice Hall. All rights reserved.43

9.Product testing is an example of which quality cost? A.Prevention B.Appraisal C.Internal failure D.External failure Copyright ©2009 Prentice Hall. All rights reserved.44

10. Training personnel is an example of which quality cost? A. Prevention B. Appraisal C.Internal failure D. External failure Copyright ©2009 Prentice Hall. All rights reserved.45

10.Training personnel is an example of which quality cost? A.Prevention B.Appraisal C.Internal failure D.External failure Copyright ©2009 Prentice Hall. All rights reserved.46