Professional Documents
Culture Documents
Background
Recall that Factory Overhead is applied to
production in a rational systematic manner, using some type of averaging. There are a variety of methods to accomplish this goal. These methods often involve tradeoffs between simplicity and realism Simple Methods Unrealistic Complex Methods Realistic
Broad Averaging
Historically, firms produced a limited variety of goods
while their indirect costs were relatively small. Allocating overhead costs was simple: use broad averages to allocate costs uniformly regardless of how they are actually incurred
Peanut-butter Costing
resources but is allocated high costs per unit Undercosting a product consumes a high level of resources but is allocated low costs per unit
Cross-subsidization
The results of overcosting one product and
undercosting another. The overcosted product absorbs too much cost, 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
Case facts
Plastim corp manufactures lenses for rear tail lights of
automobiles. Under its contract with Tata motors Produces 2 types, a complex lens CL5 and a simple lensS3. Compex lens has special features in contrast to the simple lens Operates at capacity and has low marketing costs and mini. customer servicing cost. Business environment very competitive with respect to simple lens New supplier, Jain Motors who offers to supply S3 Lens at Rs.53 well below Plastims price of Rs.63. Fortunately ,Same comp pressures do not exist for the complex lens priced at Rs.132 per lens.
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Simple costing system using a single Indirect cost Pool used by Plastim
1.Identify the products that are chosen Cost objects-
60,000 simple S3lenses & 15,000 complex CL5 2.Identify the Direct cost of the products 3.Select the cost allocation bases to use for allocating Indirect costs to the products Plastim uses direct Manufacturing labor hours as the only allocation bases to allocate all the manufacturing & non manufacturing indirect costs to S3 & CL5. 4.Identify the indirect costs associated with each cost allocation base 5.Compute the indirect costs allocated to the products. 6.Compute total cost of the products by adding all 2009 Pearson Prentice Hall. All rights reserved. direct and indirect costs.
4.Identify the indirect costs associated with each cost allocation base
Compute the rate per unit of each cost-Allocation Base: Budgeted Indirect-Cost Rate = Budgeted TCs in Indirect Pool/Budgeted total quantity of cost allocation base =23,85,000/39,750 =Rs 60 per direct manufacturing labour hours
An Example: Plastim
The mgt team identifies the foll 7 activities by developing a flowchart of all the steps & processes needed to design ,manufacture, distribute S3 & CL5
properly held in place and parts are properly aligned before manufacturing starts. Operate molding machines to manufacture lenses Clean & maintain the molds after lenses are manufactured- Identified as direct cost Prepare batches of finished lenses for shipment Distribute lenses to customers Administer and manage all processes at Plastim
2009 Pearson Prentice Hall. All rights reserved.
for allocating indirect costs to the products Identify the indirect costs associated with each cost allocation base Compute the rate per unit of each cost allocation base Compute the indirect costs allocated to the products Compute total costs of the products by adding all direct and indirect costs assigned to the products.
2009 Pearson Prentice Hall. All rights reserved.
performed on each individual unit of a product or service. Eg:Machine operations cost Batch Level costs are the cost of activities related to a group of units of products or services rather than to individual unit of product or service. Eg: Setup costs Product Sustaining Costs are the costs of activities undertaken to support individual products or services regardless of the number of units or batches in which the units are produced.
2009 Pearson Prentice Hall. All rights reserved.
costs, marketing costs to launch new products. Facility Sustaining costs are the costs of activities that cannot be traced to individual products or services but that support the organization as a whole.Eg:General Administration costs(including top mgt compensation, rent and building security)
Conclusions
Each method is mathematically correct Each method is acceptable Each method yields a different cost figure, which will lead
to different Gross Margin calculations Only Overhead is involved. Total Costs for the entire firm remain the same they are just allocated to different cost objects within the firm Selection of the appropriate method and drivers should be based on experience, industry practices, as well as a costbenefit analysis of each option under consideration
A Cautionary Tale
A number of critical decisions can be made using this
information;
Should one product be pushed over another? Should one product be dropped?
Accordingly, best efforts should be put forward to arrive at a cost that is fair and reasonable.
Cost Hierarchies
ABC uses a four-level cost structure to determine how
figures due to the use of multiple drivers across multiple levels ABC is only as good as the drivers selected, and their actual relationship to costs. Poorly chosen drivers will produce inaccurate costs, even with ABC
Activity-Based Management
A method of management that used ABC as an
cost pools Most or all overhead is considered unit-level Products that consume different amounts of resources Products that a firm should successfully make and sell consistently show small profits Operations staff disagreeing with accounting over manufacturing and marketing costs
2009 Pearson Prentice Hall. All rights reserved.