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TRANSCRIPT
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ACCA - F5 Performance Management 1
ACCA F5Performance Management
8th and 14th July
2011
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ACCA - F5 Performance Management 2
Activity Based
Costing(ABC)
Chapter 2
ACCA F5Performance Management
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Products consume activities,Activities consume resources
Manufacturing costs generally consist of:
Direct costs & Indirect costsTraditional: higher portion direct costs than indirect costs
Traditional absorption costing system acceptable sinceindirect cost portion is small accuracy
Recent year changes (advanced manufacturing technology ATM) indirect cost is getting higher accuracy?
ABC introduced for accuracy in costing and tool for PM
Performance ManagementABC: Introduction
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The emergence of ABC systems
Traditional systems were appropriate when:
1.Direct costs were the dominant costs2.Indirect costs were relatively small
3.Information costs were high
4.There was a lack of intense globalcompetition
5.A limited range of products was produced.
Performance ManagementABC: Introduction
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Performance ManagementABC Concept
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Performance ManagementABC: Introduction
Activity-Based CostingActivity-Based Costing
Involves the identification ofcost
drivers which cause the costs of acompanys activities, and
The allocation of indirect costs toindividual product or service onthe basis of the usage of costdrivers
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Activities
Aggregation oftasks that consume resources Resources are assigned to activities
Activities are assigned to cost objects Assignment to cost objects by cost drivers Support activities: production scheduling, set-
up machine, move materials, inspect items,process purchase orders, process customer
orders Production activities: machine products,
assemble products
Performance ManagementABC
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Cost drivers:
ABC systems seek to use only cause-and-effect cost drivers
Traditional systems often rely on arbitraryallocation bases (volume based). A cost driveris a factorwhich causes the cost
of an activity (a factor which causes a changein the cost of an activity)
Example: no of orders handled for despatchcosts, no of store requisitions for materials
Performance ManagementABC
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Examples of cost drivers:Activity Cost driver Material purchases no of POsMaterial handling no of movements
quality control no of inspectionsmaintenance no of break-downsline set-up no of set-upsPatient movement no of in-patientsbooking appointment no of patients
patient reception no of patientsx-ray equipment preparation time taken
Performance ManagementABC
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Types of costing systems
Costing system varies in terms of :Which cost are assigned to cost units
Accuracy depends on level ofsophistication
Classification:
Marginal costing systemTraditional absorption costing systemActivity-based costing system (ABC)
Performance ManagementABC v Traditional Systems
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Performance ManagementABC v Traditional Systems
Types of costing systems(cntd)
Traditional absorption costing systems:1. Assign indirect cost to cost unit
2. Use unsophisticated methods to assignindirect costs.
ABC systems:
1. Assign indirect cost to cost unit2. Use sophisticated methods to assign indirect
costs
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Both systems use the two-stage allocationprocess
Traditional systems:
Stage 1: allocates OHs to production & servicedepartments, then reallocates service department coststo production departments (cost pools)
Stage 2: allocates costs from cost centres/pools toproducts/costunits using small number of 2nd
stage cost drivers (volume based OAR)
C
Performance ManagementABC v Traditional Systems
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Both systems use the two-stage allocationprocess
Traditional systems: cntd
Cost drivers usually known as allocation basis;OH allocation rates
Normally use direct labour hours or machine hours Normally allocate service /production costs to
production centresMerged with production centre costs cost poolsThen allocate to cost objects based on OAR
C
Performance ManagementABC v Traditional Systems
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Outli
1. Identify an organisations major activities that takeplace in an organization
2. Identify the factors which determine the size of the
costs of an activity. These are known as cost drivers
3. Collect the costs of each activity into what is knownas cost pools, equivalent tocost centres undertraditional costing methods
4. Charge costs to products on the basis of their usageof the activity. A products usage of an activity ismeasured by the number of the activitys cost driver
it generates
Performance ManagementABC: Steps
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Both systems use the two-stage allocationprocess
Major difference:ABC relies on greater numberof cost centres & 2nd stage
drivers that cause activity resource consumptionABC assigns activity costs to cost units on basis ofcost
driver usage ABC measures resources consumed by cost units more
accuratelyTraditional system reports less accurate cost as cost drivers
used do not have cause-and-effect relationships existbetween support cost and cost objects
C
Performance ManagementABC v Traditional Systems
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Assigning the cost of activities to products:
Example 1:
Cost pool for sales order handling
Cost driver = no of orders processedTotal in cost pool = $300,000Total orders in the year = 1,000 orders
Cost per Driver = $300 per order
Product A with 200 orders for the yearOrder processing cost to charge to Product A = $60,000
($300 x 200)
Performance ManagementABC
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Assigning the cost of activities to products:
Example 2:
4 departments use purchasing function
Total purchasing dept costs = $10,000,000 per yearUsage of purchasing function:
Department No of orders Cost allocationA (10M/300x200K) 200,000 6,666,667B (10M/300x50K) 50,000 1,666,667C (10M/300x40K) 40,000 1,333,333D (10M.300x10K) 10,000 333,333
300,000 10,000,000
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Assigning the cost of activities to products:Example 3: Std cost of Product XFunction rate x usage$ allocated cost $Quality control 200 x 50 10,000Process set-up 300 x 50 15,000Purchasing 105 x 50 5,250
Customer orders 60 x 10 600Occupancy cost 2 x 50,000 100,000
(1M x 3min / 60 = 50,000) 130,850
Allocated cost per unit = 130,850 / 1,000,000 units = $0.14
Std unit cost for Product B:Material $0.50Labour 0.40Ohead 0.14
$1.04
Performance ManagementABC
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A
B
Product costs are more accurate
Allows company to assess product profitability realistically competitive market
Cost behaviour is better understoodFacilitates cost control enable ultimate cost reduction
Enhances better decisions
Recognises the current complexity in manufacturing withmultiple cost drivers (wider product range, shorterlife cycles, complex processes)
Performance ManagementABC: Advantages
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A
B
Cost of implementation may exceed itsbenefits
Not significant where indirect costs are low,small product range
Performance ManagementABC: Advantages
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A
BC
May cause distortion to pricing strategy over-priced orunder-priced profitability v competitive market
Product strategy encourages focus on products with
higher profit margin
Helps in identifying value added and non-value addeditems/activities with a view to elimination
Forces managers to evaluate drivers that effect costs andwhat these drivers contribute to the final product
Performance ManagementABC
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A
B
Decision making Accurate costenhances management
decisions such as make-or- buy,expansion or discontinuingbusiness line
Modern Business ApplicationsABC
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Performance ManagementABC