1. EMBA Session November 15,2012

2. Overview of Lecture  Review of cost behaviors  Rationale for ABC approach  Factors supporting an ABC system  Cost flows  Steps in implementation  Examples  Level of acceptance of ABC costing

3. Types of Costs  Fixed costs  Variable costs  Mixed costs

4. Relating Costs to Objectives  Traceable costs  Direct labor  Direct material  Allocated costs  Fixed overhead  Variable overhead

5. Traditional Allocation Method Purchasing Warehousing Engineering Maintenance Product B Product A Direct Labor Hours

6. Rational for ABC Approach  Single allocation rate not sufficient  Currently many firms must target price their products  ABC assists in target pricing  Advent of high speed computing power made ABC feasible

7. Environmental Factors Supporting ABC Approach  High levels of competition  Very diverse product mix  Low cost of measurement for additional data required

8. ABC Cost Flow Schematic Warehouse Maintenance Purchasing Engineering Product A Product B Purchase Orders Number of Receipts Number of Hours

9. Implementation Steps  Identify the cost objectives  Identify the direct costs of the products  Identify the overhead cost pools  Select the appropriate drivers  Test the assumptions  Install

10. Example of Product Costing Raw Material $150,000 15,000 Receipts Purchased Parts $600,000 1,000 Receipts Material Movements 250,000 250 Setups Product AProduct BProduct C Product D Raw Materials Department $1,000,000

11. Allocation Using Single Driver $1,000,000  16,000 Receipts = $62.50 per receipt No. of ProductReceiptsRate Allocated Cost A4,040$62.50$252,500 B6,200$62.50387,500 C2,000$62.50125,000 D 3,750$62.50 235,000 16,000$1,000,000

12. Calculation of Multiple Rates No. ofPer Cost PoolPool DollarsDriversDriverDriver Raw Material$ 150,00015,000$10Per Receipt Purchased Parts 600,0001,000 $600Per Receipt Material Handling 250,000250$1,000Per Setup $1,000,000

13. Use of Activities by Products

14. Allocation to Products

15. Comparison of Two Methods ProductTraditional ABC Method Variance A$ 252,500$ 114,000$ 138,500 Over B387,500260,000127,500 Over C125,000385,000260,000 Under D 235,000 241,000 6,000 Under Totals $1,000,000$1,000,000 $ 0

16. Retail Example of ABC Costing

17. Traditional Allocation

18. Identify Cost Pools and Drivers No. ofCost per ActivityDriver Cost PoolDriversDriver Ordering# of P.O. $5,20052$100 Delivery# of Del.$8,400105$ 80 Stocking# of L.H. $5,760280$ 20 Cust. Sup.# of Items $10,24051,200.20 Bottle Return$400 Total $30,000

19. New Cost Drivers

20. Results Applying ABC

21. Acceptance of ABC Costing  Approximately 60% of manufacturing firms in the US have tried ABC  10%-20% finally kept it in place  Reasons for rejection:  Cost of gathering information  Complexity outweighs usefulness  Disagreement on proper drivers

22. Copyright by Frank Ilett, 2012