Chapter 2 - Traditional And Advanced Costing Methods

Question 0

ABC costing

Answer 0

Calculating the full production cost per unit using ABC:

Step 1: Group production overheads to how they are driven.

Step 2: Identify cost drivers for each activity.

Step 3: Calculate an OAR for each activity.

Step 4: Absorb the activity costs into the product.

Step 5: Calculate the full production cost and/ or the profit or loss.

Question 1

Absorption costing

Answer 1

The aim is to determine the full production cost per unit.

Total cost -> Production costs + Non-production costs
Production costs -> Direct (prime) costs + Indirect costs (production overheads)
$
Direct materials per unit x
Direct labour per unit x
Production overhead per unit x
Full production cost per unit X

OAR = Production overhead/ Activity level

Production overhead ($) = (Units of production or machine hours or labour hours per unit) x OAR

Question 2

Throughout accounting

Answer 2

Throughput = Sales revenue - Direct material cost

Throughout (return) per factory hour = Throughput per unit/ Products time on the bottleneck resource

Cost per factory hour = Total factory cost/ total bottleneck resource time available

Throughout accounting ratio (TPAR) = Return per factory hour/ Cost per factory hour

Question 3

Interpretation of TPAR

Answer 3

TPAR > 1 suggests throughput exceeds operating costs so the product should make a profit.

TPAR < 1 suggests throughput insufficient to cover operating costs resulting in a loss

Question 4

Improving the TPAR

Answer 4

1. Increase the sales price for each unit sold to increase the throughput per unit.
2. Reduce material costs per unit to increase the throughput per unit.
3. Reduce total operating expenses to reduce the cost per factory hour.
4. Improve the productivity of the bottleneck.

Question 5

Multi product decision making TPAR

Answer 5

Step 1: Identify the bottleneck constraint

Step 2: Calculate the throughput per unit for each product.

Step 3: Calculate the throughput put unit of the bottleneck resource for each product.

Step 4: Rank the products in order of the throughput per unit of the bottleneck resource.

Step 5: Allocate resources using this ranking.

Question 6

Target costing steps (manufacturing industries)

Answer 6

Step 1: Product developed which is perceived to be needed by customers and will attract adequate sales volume.

Step 2: Target price is set based on customers perceived value of the product. This will be a market based price.

Step 3: The target operating profit per unit is then calculated either by return on sales or return on investment.

Step 4: Target cost is derived by subtracting target profit from target price. Target cost gap = Estimated product cost - Target cost.

Step 5: If there is a cost gap, attempts made to close the gap.

Step 6: Negotiations with customers may take place before deciding whether to go ahead with the project.

Question 7

Cost plus pricing system

Answer 7

1. The cost is established first.
2. A profit is then added.
3. This results in a current selling price.

Question 8

Life cycle costing

Answer 8

Specific costs associated with each stage.

1. Pre-production/ Production development stage.
   High level of setup costs including R&D, product design.
2. Launch/ Market development stage.
   Depending on success and trial of product, this stage is likely to have extensive marketing and promotion costs.
3. Growth stage.
   Marketing and promotion will continue through this stage.
   Sales volume increases and unit costs fall as fixed costs are recovered.
4. Maturity stage.
   Profits continue to increase as initial and fixed costs are recovered.
   However price competition and product differentiation will decrease profitability as firms compete for limited new customers remaining.
5. Decline stage.
   Marketing costs are usually cut as the product is phased out.
   Production economies may be lost as volumes fall.
   A replacement product will need to have been developed.
   Alternatively, additional development costs may be incurred to the model to extend life cycle.

Question 9

Benefits of life cycle costing

Answer 9

1. The visibility of all costs is increased rather than just costs relating to one period. This facilitates better decision making.
2. Individual profitability for products is more accurate because of this. This facilitates performances and decision making and prices can be determined with better knowledge of the true costs.
3. More accurate feedback can take place when assessing whether new products are a success or a failure since the costs of researching, developing and designing those products are also taken into account.

Question 10

Environmental management accounting techniques.

Answer 10

1. Input/ Outflow analysis.
   What comes in must come out.
2. Flow cost accounting.
   Uses material flows and organisational structure.
3. Activity- based costing.
   Allocates internal costs to cost centres and cost drivers.
4. Lifecycle costing.
   Requires full environmental consequences ‘from cradle to the grave’.