Lecture 5 Flashcards
Unit costs
Truly variable costs. Additional cost incurred for each additional unit produced
Batch cost
Cost incurred anytime we start a new batch, but fixed for any additional units within the batch
Product-level costs
Costs associated with maintaining a product line. Adding new product lines adds more costs, but fixed for any additional units within the product line
Facility costs
CCcosts associated with having any operations running at all. Will occur regardless of how many products/batches/units we produced
Problems with the old approach (overcosting)
A product consumes a low level of resources but is allocated high cost per unit
Problems with the old approach (undercosting)
A product consumes a high level of resources but is allocated low costs per unit
Problems with the old approach (cross subsidization)
One product subsidizes another
The overcosted product absorbs too much costs
Making it seem less profitable than it really is
The undercosted product is left with too little cost
Making it seem more profitable than it really is
ABC allows fledxibility
With activity based costing we can account for costs the way they really occur
E.g.
Unit costs: direct labor, direct materials, unit level overhead
Batch costs: setup, cleanup, test runs, ordering
Product line costs: designing patent licenses
How do I find the cost/unit
We dont erally thing cost/unit anymore
We are thinking cost to produce the entire product line
People order in different quantities. The price per unit may change depending on the quantity they order
Then sometimes we might try to figure out the average cost per unit, recognizing that its not the marginal cost per unit
Average cost
total cost/units produced
Marginal cost
Cost of making one more unit. Usually equal to the variable cost, as long as its withing an existing batch
ABC vs simple costing
ABC is more complicated
ABC is usually more accurate
ABC is only as good as the drivers selected
Are changes in the driver closely related to changes in costs in that pool
Poorly chosen drivers will produce inaccurate costs even with ABC
When to implement ABC
Losts of overhead
Products of different complexity
Different volume levels
Production does not happen “one unit at a time”
E.g. production in batches
Low reported profits on main products, high reported profits on low-volume products
Drivers
For the unit, batch, and product levels we generally try to choose a driver that is causally related to the cost:
Unit - DLH, MH, etc.
Batch - Number of batches, setup time, etc.
Notes about ABC
We no longer think of “cost per unit”
Instead we think of “cost per activity”
-Cost per design
-Cost per batch
-Cost per unit
We can make everyone happier if we reduce unnecessary activities
Using ABC to improve operations
Activities cause costs
ABC helps us correctly attribute costs to activities
Knowing what causes costs can help us reduce costs
Activity based management
The use of ABC information to reduce the cost of activities and the frequency of non-value-added activities
Non-valule-added activities
An activity that generates cost but no value to the customer, and therefore reduces the supply chain surplus. We should eliminate/reduce these if possible!
Supply chain surplus
The value of the product provided to the customer inus the sum of all supplier costs. The total societal benefit of the sale
Insufficient-value-added activities
Add some value, but not enough to justify their existence
Activity based pricing
The use of ABC information to generate prices that more accurately reflect the cost of activities taht customers desire
Distributive bargaining
Arguing about who get the larger piece of a pie
– ABC lets us change the game! now we try to come up with solutions that benefit both parties
Integrative bargtaining
WQorking together to make the pie bigger so everyone gets a bigger piece
Overhead as incentive to use allocation rates
Allocation rates charge people/products/divisions for activities
Those costs change behavior
Changing operations
When you tax specific activiteis, managers will cut back on those activities and replace them with other activities
Reduced use of machines (doing things by hand)
But sometimes those original costs were fixed! E.g. maybe we bou7gh some nice machines to automate tasks, but managers dont want to be charged to use them so they do the tasks by hand instead
Machines continue to depreciate (and incur expenses) but we also incur more labor costs
Which cost system is right
Different managers may argue about which cost system is right
What should we use as our cost drivers
Which costs should go to which pool
A poor costing system can lead to poor decisions
With a bad costing system, sam may take all of those student orders, while a smarter competitor may take the larger orders that are more profitable
Supporting departments
In the real world, departments support each other.
IT supports HR, Maintenance, and the end product (academic departments)
HR supports IT, maintenance and the end product
Maintenance supports IT, HR, and the end product
How do we allocate these costs?
Three allocation methods
Direct
Step down
Reciprocal
Direct method of allocating costs
Simple and widely used
Ignores the fact that departments support each other, which can affect allocation of costs
Step down method of allocating costs
Cascading costs. Top department supports everything below it, but costs dont flow back up
Still pretty fast and simple
Not quite the truth
E.g Hr is supporting IT too
Reciprocal method of allocating costs
Recognizes that every department supports every other department
Can only be solved using simultaneous equations (Algebra)
Fair method
Reflects the real world
Difficult to explain. Requires complex(ish) math to solve
Often doesn’t make a big difference in total costs
-Will make a big difference if the support departments spend a lot of their time supporting each other rather than the finished product
What do we do with fixed costs
There are a lot of fixed costs running a business
The first client is the most expensive because of all the fixed costs
Later clients are less expensive, but should they get some of the initial fixed costs
