Advanced Cost Management-Fall 2002 1 Cost Actg. Review Cost…an economic sacrifice.

Advanced Cost Management-Fall 2002 1

Cost Actg. Review

• Cost…an economic sacrifice

Advanced Cost Management-Fall 2002 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• Critical Success Factors (CSF’s)

Advanced Cost Management-Fall 2002 3

Cost Drivers and Final Cost Objectives

• Cost Drivers•Activity•Volume•Other

•Structural•Executional

• Final Cost Objective (FCO)

Advanced Cost Management-Fall 2002 4

Risk and Cost Mgt.

• Risk plays a role• Risk-prone vs. risk adverse• Systems are designed to

mitigate the negative aspects of risk preference

Advanced Cost Management-Fall 2002 5

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 TOWIP

E O/H R/M

R/M TRANSFERSDIR. LABORMFG OVERHEADMANUFACTURINGCOSTS

COST OF GOODSMANUFACTURED(COGM)

E O/H WIP

COGM

COST OF GOODSSOLD(COGS)

E O/H F/GP&L

Advanced Cost Management-Fall 2002 6

Learning Curve Analysis

• Aircraft industry based• Practice make perfect--or at least more

efficient• Experience curve• Cumulative unit-time learning model

• x% unit reduction as volume doubles• Used in pricing, financial plans & stds.

• Softech example

Advanced Cost Management-Fall 2002 7

Learning Curve Applications

• Make vs. buy• Construction contracts• C-V-P• Standard cost development• Management control

Advanced Cost Management-Fall 2002 8

Learning Curve Limitations

• Requires repetitive tasks• Assumes constant rate of

learning• Productivity not effected only

by learning

Advanced Cost Management-Fall 2002 9

Regression Analysis

• Basic equation y = a + bx• Consider statistical relevance• Use common sense

Advanced Cost Management-Fall 2002 10

Activity Based Costing (ABC)

Advanced Cost Management-Fall 2002 11

Contemp. Mfg. Environment

• JIT• Kanban• Work cells• CAD/CAM• FMS• CIM

Advanced Cost Management-Fall 2002 12

Trad. Costing Limits

• Overall purpose: accounting values

• Volume• Size• Complexity

Advanced Cost Management-Fall 2002 13

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

Advanced Cost Management-Fall 2002 14

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

Advanced Cost Management-Fall 2002 15

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

Advanced Cost Management-Fall 2002 16

Ansari: IDC

• Strategic Implications•Quality: IDC draw together activities

that ensure quality (ie. supervision for medication administration)

•Cost: IDC are a major part of the total cost package and s/b managed

• Time: IDC reflect the impact of time based decisions (ie. hours of operation)

Advanced Cost Management-Fall 2002 17

Indirect Cost Definition

• IDC are costs that are common to more than one cost objective.

Advanced Cost Management-Fall 2002 18

IDC Sources

• Corporate overhead• Group overhead• Factory overhead• Marketing• Development• Other joint costs• See Ansari: IDC pg. IC-5

Advanced Cost Management-Fall 2002 19

Basis of Allocation is Key

• Controllable costs: users choice

• Attributable costs: users situation

• All indirect costs• REGARDLESS--all IDC’s must be

recovered

Advanced Cost Management-Fall 2002 20

Ansari: IDC

• Attribute Implications• Technical: Improves decision

relevance and work process knowledge

•Behavioral: Must determine how the IDC system will impact people’s behavior

•Cultural: Allocation methods used will reflect the imbedded cultural values

Advanced Cost Management-Fall 2002 21

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.

Advanced Cost Management-Fall 2002 22

Remember...

• ABC does NOT yield “true” costs!

Advanced Cost Management-Fall 2002 23

ABC/ABM Case-Gulfstream RecreationGulf 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:

Racer CruiserDirect Material $35 $50Direct Labor 25 13Machine 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 ActivityP.O.'s (#) $300K 2000 1250 750 Purchasing

Rework Hrs. (Hrs) $200 450 200 250 Quality ControlInvoices (#) $200 600 150 450 BillingChange 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.

Advanced Cost Management-Fall 2002 24

Gulfstream Recreation Solution

Standard Overhead Rate:$850K/70K Mhrs. = $12.14 per machine hour

Traditional Cost Structure:Racer

CruiserDirect materials $35 $50Direct labor $25 $13Overhead $24 $12

Total $84 $75

Advanced Cost Management-Fall 2002 25

Gulfstream Solution, continuedABC Overhead Rate:

Racer CruiserPurchasing $187.5 $112.5Quality control $ 88.9 $111.1Billing $ 50.0 $150.0Mfg. Engineering $ 75.0 $ 75.0

Total $401.4 $448.6Per unit $40.10 $ 8.97

ABC Cost Structure:Racer Cruiser

Direct materials $35 $50Direct labor $25 $13Overhead $40 $ 9

Total $100 $72

Advanced Cost Management-Fall 2002 26

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

Advanced Cost Management-Fall 2002 27

Implementation Strategy

• Involve management and employees

• Parallel system approach• Find a winner• KISS• Incentivize• Education users