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Chapter 04 - Alternative costing methods - Coggle Diagram
Chapter 04 - Alternative costing methods
Activity-based costing
Is a method of costing which involves identifying the cost of the main support activities and the factors that 'drive' the costs of each activity
Steps to calculate ABC:
Identify activities in the org that cause costs
Identify cost pool
Identify cost driver
Calculate absorption rate per cost driver
Charge overheads to products for each activity
When ABC should be used
When production overheads > prime cost relatively (eg service sector
When there is a whole diversity of product range
When there are considerable differences in the use of resources by products
When the consumption of resources is not driven by volume
Arguments for using ABC
Accurate cost calculation (fair distribution of overheads)
Accurate selling price (better costing info)
Better cost control
Better decision making for whether to continue in case of loss
Better planning-activity base budgeting
Better performance measurement
Argument against ABC
Time consuming and expensive
Judgmental decisions still required in the construction of ABC system
Selection of cost driver is not easy
Cost of implementing ABC may exceed benefits
Reduced benefits if company only produce one product or a range of products with similar costs
Arbitrary apportionment may still exist
If management not used info from ABC, traditional absorption costing is fine
Target costing
Involves setting target cost by subtracting a desired profit margin from a target selling price
Target cost = target selling price - target profit margin
Target cost gap = Estimated cost - target cost
Value Engineering techniques - to reduce costs not add value - where value are made up of both:
Use value
Esteem value
Target costing in service industry
Five majority characteristic of service industries:
Intangibility
Inseparability
Variability
Perishability
No transfer of ownership
Problems with target costing
Intangibility: no material content -> hard to reduce cost to target level
Variability
Product life cycle
Five phases: Development -> Introduction -> Growth -> Maturity -> Decline
Components of a product cost over its life cycles
R & D costs: Design cost, Cost of making a prototype, Testing costs, Production process and equipment (develop and investment)
Inventory costs
Retirement and disposal costs
Benefits of life cycle costing
Help to assess profitability over full life of products
Useful for org which develop short life products because it is possible to estimate sale volumes and price reasonably
Life cycle concepts result in earlier action to generate more revenue
Better decisions
Encourage long-term thinking and forward thinking
Maximize returns over product's life cycle
Careful design of products
Minimize time to market
Minimize break-even time
Maximize the length of life span
Minor change in technology
Through heavy advertising at maturity level
Four principal lessons from life cycle costing
All costs should be considered
Attention to all costs will reduce cost per unit
Many costs will be linked
Costs are committed and incurred at different times