1. Advanced Cost Management-Spring 2004 3-1 Cost Actg. Review Cost…an economic sacrifice

2. Advanced Cost Management-Spring 2004 3-2 Critical Cost Terms Fixed vs. Variable Product vs. Period Manufacturing vs. Non-manufacturing Direct vs. Indirect Controllable vs. Uncontrollable Opportunity and Sunk Costs Differential Cost and Revenue Cost Drivers FCO’s

3. Advanced Cost Management-Spring 2004 3-3 Cost Drivers and Final Cost Objectives Cost Drivers Activity Volume Other Structural Executional Final Cost Objective (FCO)

4. Advanced Cost Management-Spring 2004 3-4 Manufacturing Cost Flows BOH I O EOH RAW MATERIAL WORK-IN-PROCESS FINISHED GOODS B O/H R/M B O/H WIP B O/H F/G R/M PURCHASES TRANSFERS TO WIP E O/H R/M R/M TRANSFERS DIR. LABOR MFG OVERHEAD MANUFACTURING COSTS COST OF GOODS MANUFACTURED (COGM) E O/H WIP COGM COST OF GOODS SOLD (COGS) E O/H F/G P&L

5. Advanced Cost Management-Spring 2004 3-5 Activity Based Costing (ABC)

6. Advanced Cost Management-Spring 2004 3-6 Trad. Costing Limits Overall purpose: accounting values Volume Size Complexity

7. Advanced Cost Management-Spring 2004 3-7 Activity Based Costing Benefits More accurate costs More accurate operating information Better access to relevant costs Limits Allocations are still used Cost omission Time and expense

8. Advanced Cost Management-Spring 2004 3-8 Contemporary Advantages Comprehensive cost information Emphasis on operations and activities Costs are attached to activities Provides driver visibility

9. Advanced Cost Management-Spring 2004 3-9 Ansari: MOA Strategic Implications Info @ the cost of value-added features Info @ the overall cost of the product Reflects time considerations in the attribution process

10. Advanced Cost Management-Spring 2004 3-10 MOA, cont. Attribute Implications Technical Provides decision relevant information Enhances process understanding Behavioral Cost structure visibility Facilitates communication Empowers employees Risk of “failed expectations” re: “true” cost Cultural Supports process focus Encourages cross-functional participation

11. Advanced Cost Management-Spring 2004 3-11 ABC Implementation Select an area Identify primary activities (5-10) Cost each activity Determine one driver for each activity Apply the costs to the final cost objectives on the basis of the drivers.

12. Advanced Cost Management-Spring 2004 3-12 Remember... ABC does NOT yield “true” costs!

13. Advanced Cost Management-Spring 2004 3-13 ABC/ABM Case- Gulfstream Recreation Gulf Stream Recreation, a major sporting goods firm in California has two major products--the Bobcat Racer and the Snidley Whiplash Cruiser. For the current year, overhead was planned at $850K. Overhead is applied on the basis of machine hours. Each racer uses 2 machine hours and each cruiser uses 1 machine hour. GSR planned to build 10K racers and 50K cruisers. The cost structure for each product is as follows: RacerCruiser Direct Material$35$50 Direct Labor 25 13 Machine Hours 2 1 GSR is considering some type of activity based costing system. Sandra Jones, the cost accounting manager, suggested the following drivers: Driver Relationship to FCO Driver Total Activity Cost Total Racer Cruiser Activity P.O.'s(#)$300K 2000 1250 750Purchasing Rework Hrs. (Hrs)$200 450 200 250 Quality Control Invoices (#)$200 600 150 450 Billing Change Orders (#)$150 300 150 150 Mfg. Eng. 1.Calculate the unit costs of each product under the traditional method. 2.Calculate the unit costs of each product under activity based costing. 3.What pricing implications are inherent in this example.

14. Advanced Cost Management-Spring 2004 3-14 Gulfstream Recreation Solution Standard Overhead Rate: $850K/70K Mhrs. = $12.14 per machine hour Traditional Cost Structure: RacerCruiser Direct materials$35$50 Direct labor$25$13 Overhead$24$12 Total$84$75

15. Advanced Cost Management-Spring 2004 3-15 Gulfstream Solution, continued ABC Overhead Rate: RacerCruiser Purchasing$187.5$112.5 Quality control$ 88.9$111.1 Billing$ 50.0$150.0 Mfg. Engineering$ 75.0$ 75.0 Total$401.4$448.6 Per unit$40.10$ 8.97 ABC Cost Structure: RacerCruiser Direct materials$35$50 Direct labor$25$13 Overhead$40$ 9 Total $100$72

16. Advanced Cost Management-Spring 2004 3-16 Implementation Strategy Involve management and employees Parallel system approach Find a winner KISS Incentivize Education users

17. Advanced Cost Management-Spring 2004 3-17 Activity Based Management (ABM)

18. Advanced Cost Management-Spring 2004 3-18 Ansari: ABM Strategic Implications Visibility on the efficiency & effectiveness (the quality) of activities Visibility of costs for process redesign Insight into timing consideration of actions

19. Advanced Cost Management-Spring 2004 3-19 ABM, cont. Attribute Implications Technical Greater focus on work Provides cross-functional cost impact Highlights operational interdependencies Behavioral Heightens importance of process knowledge Reinforces continuous improvement Empowers employees--be careful of “non-value” terminology Cultural Reorients focus on process not people Challenges current thinking May add cultural conflict

20. Advanced Cost Management-Spring 2004 3-20 ABM, cont. ABM Process Obtain existing cost information Determine the major processes Identify process inputs and outputs Determine the specific activities Identify the resources used Define output measures (what we measure) Define performance measures (how we measure it) Assess performance through benchmarking Brainstorm improvements

21. Advanced Cost Management-Spring 2004 3-21 ABC, ABM & Strategic Cost Applications Comparison of cost structure to competition Pricing, design and other operational impact Mass customization impact Behavioral impact of common components Changes in the production process Changes in the distribution system Changes in source and types of supplies/suppliers Profitability impact Identification and elimination of non-value added activities Quality and time implications