What is the formula for Activity Based Costing (ABC)?
OAR = Cost Pool/Cost Driver
What are the four benefits of ABC?
- Cost Control
- Production Decisions
- Pricing Decisions
- Profitability Analysis
What are the four criticisms of ABC?
- Time Consuming
- Costly
- Some Arbitrary Apportionment May Still Exist
- Limited Benefit if Products Have Similar Cost Structures
Explain why ABC differs from traditional absorption costing.
Costs are more closely linked with the causes of the overhead which makes a more reliable allocation of cost thus better decision making.
This is appropriate where:
- Overheads are high vs. Prime costs
- Product ranges are diverse (customisation)
- Resources are not merely driven by volume
What are the main steps for ABC?
- Identify cost pools
- Identify cost driver
- Calculate cost per unit for each cost driver
- Absorb costs into production based on actual usage of cost drivers.
How do we derive a target cost?
Target Cost = Selling Price - Desired Profit Margin
How do we derive the cost gap?
Cost Gap = Target Cost - Estimated Cost
How do we generally close a cost gap?
Through product design and processing improvements
Give 5 specific examples of how we can close a cost gap?
- Reduce material costs
- Redesign product (smaller)
- Reduce quality of parts
- Remove non value adding elements
- Manufacturing process savings.
What is the Target Costing Process?
- Design Product
- Find appropriate sell price (competitive/market)
- Work out target cost
- Calculate expected cost
- Calculate cost gap
- Close cost gap
- Decide if product is viable
Is Target Costing an internally or externally focused approach?
Externally focused - looks at market and margins
Why is target costing good for performance management?
It focuses on:
- Sales targets and selling price
- Improves processes to drive down cost
- Cost control considered upfront during product development stage.
True of False: Target costing is easier to implement in service industries?
False - Cost measurement is more difficult and price is set based on qualitative information.
SHIP is the pneumonic for characteristics of the service industry. Name these.
Simultaneity
Hetrogenity
Intangibility
Perishability
How do we calculate the lifecycle cost of a product?
Lifecycle Cost = All Costs Over Lifetime of Product / Total Number of Units
What are the 5 stages of the product life cycle?
DIGMD
- Development
- Introduction
- Growth
- Maturity
- Decline
How do costs differ at different stages of the life cycle?
- Development = R&D costs
- Introduction = High Fixed Costs
- Growth = Increasing Variable Costs
- Maturity = Mainly Variable Costs
- Decline = Mainly Variable Costs
What are the benefits of lifecycle costing?
1 - Promotes maximisation of return over the product lifecycle
2 - Considers ALL costs leading to cost reduction
3 - Suitable for modern environment with short lifecycles
4 - Considers external factors throughout product’s life
What is the theory of constraints?
Theory of Constraints focuses on the bottlenecks in production that stop throughput maximisation.
In the short term all production should be at the pace of the bottleneck.
What are Goldratt’s 5 Steps of Bottlenecks
- Identify
- Exploit
- Subordinate (Slow Pace)
- Evaluate (i.e train more staff)
- Return to step 1
What are the 4 key elements of Throughput Accounting?
- Material cost is the ONLY variable cost
- Operates in a JIT environment
- Only inventory is a small buffer before the bottleneck
- WIP valued at material cost only
What is the benefit of Just in Time (JIT)?
JIT stops us predicting what isn’t going to sell - thus only a small inventory buffer as to not lose profit.
What is the aim of the Throughput Accounting Ratio (TPAR)?
To identify the bottleneck within a production line.
How do we calculate the TPAR?
TPAR = Return per hour / Cost per hour
