Chapter 4

JIT (just in time)

Demand-pull system in which materials are purchased and units manufactured as needed to satisfy demand. In traditional manufacturing settings, products are pushed through the manufacturing process and often end up sitting in work in process inventory or in finished goods

Most important step in ABM

identification and elimination of non-value-added activities

At a minimum, an ABC system should include at least one activity cost pool that captures

non-unit-level activities, such as batch-level, product-level, or facility-level activities.

unit manufacturing cost

MOH per unit + DM cost per unit + DL cost per unit

Total quality management (TQM)

a management approach that aims to improve product quality by reducing and eliminating errors, streamlining activities, and continuously improving production processes.

To receive the true benefits of ABC, managers must go beyond simply measuring costs to find ways to manage or reduce them. This is where cost management approaches—such as _______________(4)—come into play.

activity-based management (ABM) just-in-time (JIT) total quality management (TQM) target costing

Activity Proportion method (2 steps)

1. Take the cost driver for each product and divide by the cost driver for all products combined. For example, take the machine hours required by a product and divide it by the machine hours required for all products. This tells you what percentage of costs from the machining activity pool to apply to that product. 2. Multiply the total activity cost by the activity proportion for each product For example, if we know product A takes 25% of all machine hours and product B takes 75% of all machine hours, and the total cost in the machining activity pool is $100,000, then we have: 0.25 X 100,000 = total MOH from machining applied to product A 0.75 X 100,000 = total MOH from machining applied to product B

Non-volume based cost driver

A non-volume-based cost driver is an allocation base that is not strictly related to the number of units produced or customers served.

Stage 1 vs stage 2 cost driver

A stage 1 cost driver is something that drives the amount of cost assigned to each activity pool. For example, the cost of a plant supervisor's salary would likely be spread out over multiple cost pools (machining and installation, machine set up, etc), but we would need a cost driver to decide how much of the supervisors salary to assign to each pool. The driver in this case could be the amount of time the supervisor spends on each activity. A stage 2 cost driver is something that drives the amount of indirect cost assigned to product inventory from each cost pool. For example, machine hours is the driver for the machining and installation activity. The number of setups is the driver for the machine setup activity.

Value added vs non-value added activities

A value-added activity is one that enhances the perceived value of the product or service to the customer. A non-value-added activity is one that, if eliminated, would not reduce the value of the product or service to the customer.

How can we check our work with the activity rate method?

Add together all the costs applied to products from a single pool. This should add up to the total cost in that activity pool.

Activity-based management (ABM)

All actions that managers take to improve operations or reduce costs based on ABC data.

volume-based cost drivers

Allocation base that is directly related to number of units produced or customers served includes direct labor hours, machine hours, direct materials costs, sales revenue, or any other measure that varies in direct proportion to production or sales volume.

value engineering

An important part of target costing which involves analyzing the functionality of the product to determine which functions add value to the customer and then finding ways to deliver those functions while meeting the target cost.

How many activity rates will we have?

As many as there are activities

Target costing (what is it and related equation) vs cost-plus pricing

Cost management approach that determines what target cost is required to meet the market price and provide a profit for a company's shareholders. the price is set by the market based on what the company believes consumers will be willing to pay for the product or service. The desired profit margin is then subtracted from the market price to determine the target cost.` This is in stark contrast to a cost-plus pricing approach, in which the company first determines how much a product or service costs, and then adds a markup (profit) to arrive at the sales price.

When might a company not find it worth it to implement an ABC cost system?

If a company makes a single product or produces many products that are similar in nature, a more sophisticated cost system such as ABC may not be worth the cost of implementation and data tracking. A simpler cost system may do just fine.

Previously, how were we assigning indirect costs? What is this kind of system called?

In previous chapters, we assigned indirect (overhead) costs to products or services using a single allocation base, or cost driver, such as direct labor hours. This type of cost system is sometimes called a volume-based cost system because the cost driver is related to the volume of units produced or customers served.

Activity-rate method for calculating overhead (2 steps)

Like the predetermined overhead rate, except that we compute a separate rate for each activity cost pool using the following formula: Total activity cost / total cost driver = activity rate For example, machining is a cost pool. The total indirect cost assigned to this activity cost pool from Stage 1 was $720,000. In Stage 2, we assign this cost to two products on the basis of machine hours. Total machine hours are 10,000. One product used 2,500 hours and the other used 7,500 1. $720,000 / 10,000 = $72.00 from machining and installation per machine hour 2. MOH assigned to first product on basis of machine hours: 2,500 X $72.00 =$180,000 MOH assigned to second product on basis of machine hours = 7,500 X $72.00 = $540,000 These two steps would be repeated for each activity pool.

Do ABC systems only include volume-based cost drivers to assign costs from each pool to products?

Most ABC systems will include both volume-based and non-volume-based cost drivers. If the activity must be performed for each individual unit, a volume-based cost driver, such as the number of units produced, direct labor hours, or machine hours, is appropriate. If the activity is not related to the number of units, a non-volume-based cost driver, such as the number of setups or engineering hours, may be more appropriate.

What kind of information system does ABS costing use?

Most companies that implement ABC use sophisticated information systems, such as an enterprise resource planning (ERP) system. An ERP system is an integrated management information system that cuts across the entire organization (enterprise)

Is product costing easier or harder in a JIT environement?

Product costing is much easier in a JIT environment because there is no need to worry about how much cost should be reported as inventory (an asset) and how much should be reported as cost of goods sold (on the income statement).

Product life-cycle

Represents the life of the product from its infancy (an idea) through design, development, product introduction, growth, maturity, and eventual decline.

Will the two methods of calculating activity based MOH give the same answers?

The end result will be the same as long as there is no rounding error in the activity rates or percentages.

Goal of target costing

The goal of target costing is to determine the target cost of the product before manufacturing begins.

How does this chapter differ from 2 and 3?

The previous two chapters described two systems that can be used to track the total cost of products and services: job order costing and process costing. This chapter provides more detail about how to assign indirect costs to products and services. The methods described here can be used with either job order costing or process costing.

Value chain (what is it and how is it different from a supply chain)

The value chain is the linked set of activities required to design, develop, produce, market, and deliver the product to customers, as well as after-market customer service. The concept of a value chain is related to that of a supply chain, but supply chain typically refers to the flow of products and services from suppliers through to the consumer, the value chain concept begins with the consumer and works backward to ensure that all the activities required to deliver the product to the customer are value-added.

Gross margin

Unit selling price - unit manufacturing cost (or product cost) per unit In other words, Unit selling price - MOH per unit - DM per unit - DL per unit = gross margin

How are costs allocated to activity pools?

While some costs are relatively easy to assign to specific activities, others may relate to multiple activities and must be allocated based on some measure, such as time spent on each activity. For example, facility costs such as rent, utilities, and janitorial services might be allocated based on the number of square feet each activity requires

Volume-based cost systems or traditional cost system

a product costing system when an entity allocates factory overhead costs to a single cost pool (e.g., factory overhead) and then uses volume-based cost drivers to allocate factory overhead costs to individual products or services. The entity uses volume-based cost drivers that depend on the number of units manufactured. Cost bases (or drivers) often used include labor hours, machine hours and labor costs.

Are activity based cost systems used with job order costing or process costing?

both, but only job order in this class

Adopters of JIT tend to rely on ______, but require them to adhere to very strict quality standards.

fewer suppliers;

Does gross margin take into account non manufacturing costs?

gross margin takes into account only the manufacturing costs of the product, before nonmanufacturing costs such as distribution fees; advertising; and other selling, general, and administrative expenses have been deducted.

What is Activity-based costing (ABC)? What is its goal

method of assigning indirect costs to products and services based on the activities they require. goal of ABC is to identify the major activities that place demands on a company's resources and then assign indirect costs to the products and services that create those demands.

3 important questions in ABM

1. What activities does the company perform? Reducing or streamlining activities can either reduce costs (e.g., reduced workforce) or allow more work to be performed for the same cost (e.g., increased efficiency). 2. How much does it cost to perform each activity? Managers can compare the cost of performing key activities with other firms in the industry or to the best performing firms in other industries, a process called benchmarking 3. Does the activity add value to the customer?

For companies with multiple products and services, how does ABC help? How is this information used?

For companies that produce a variety of products, ABC can supply useful information about the cost of the activities required to produce those products and services. Managers can then use this information to: make decisions (e.g., set prices), change the way the company does business (e.g., eliminate unnecessary activities), and ultimately improve performance (e.g., reduce costs or increase sales).

ABC activity hierarchy (4)

Facility-level activities: most general category and are performed to benefit the organization as a whole, as opposed to specific products, customers, units, or batches. applies primarily to manufacturing activities, but all company-wide activities should be included, such as S&A and corporate support functions. Although GAAP does not allow the nonmanufacturing activities to be included in cost of goods sold or inventory for external reporting purposes, managers may find it useful to assign these costs to individual products and customers for internal decision making. examples: plant supervision, human resources Product-level activities: performed for a specific product line or type of service offering. After the product-level activities are performed, the company can make numerous units and batches of the product without repeating these activities. Examples: designing a new product, creating and testing prototype models, creating metal casts that will be used to make the product. Batch-level activities: performed for a group or batch of units all at once. These activities vary with the number of batches produced but are independent of the number of units in each batch. These activities must be performed each time a batch or group of units is produced, but do not have to be repeated for each individual unit in the batch. examples: performing quality control for each batch (but not each unit), ordering and receiving raw materials. Unit-level activities: performed for each individual unit or customer. These activities vary in direct proportion to the number of units produced or the number of customers served. Examples: installation of automobile components such as the frame, body, engine, and tires, quality testing performed on each individual unit as it passes through the assembly process.

are overhead allocations only made for manufacturing overhead or are they used for corporate overhead too?

Often the indirect cost we need to allocate or assign to products is manufacturing overhead. But the same approach can be used for any indirect cost, including administrative or corporate overhead.

2 stages in ABC cost system (and 2 steps within each stage)

Stage 1: A. Identify and classify activities -----Activities may be grouped using the ABC hierarchy of activities B. Form activity cost pools and assign indirect costs to each pool -----Indirect costs may be clearly linked to each activity pool. Others may apply to multiple pools, and a stage 1 cost driver will need to be used to assign these costs in the correct proportion to each pool the cost applies to. Stage 2: A. Select a cost driver for each activity cost pool. This is anything that can be used to directly assign costs from the cost pools to product inventory. B. Assign indirect costs to each product or services based on their activity demands. This can be done using the rate or the proportion method.

Disadvantage of volume-based (traditional) cost systems

Systems that assign indirect costs based solely on the basis of volume tend to overcost high-volume products and undercost low-volume products.

How is the hierarchy used with ABC costing?

To keep the cost system manageable, we must simplify the number of activities by grouping like or similar activities together. One way to combine activities is based on the activity hierarchy. For example, unit-level activities can be grouped together; batch-level activities can be grouped together, and so on. This does not mean that an ABC system must have an activity cost pool for every level of the hierarchy, but it provides a framework for combining similar activities together.

cost of quality report (and 4 associated costs)

part of TQM, summarizes the costs incurred to prevent, detect, and correct quality problems. This report should include details about the following quality costs: Prevention costs are incurred to keep quality problems from happening in the first place. Examples include statistical process control and quality training. Appraisal or inspection costs are incurred to identify defective products before they get to the customer. Unfortunately, inspection activities do not address what's causing the defect, which means the defect could continue to occur. Most managers now realize it is better to prevent mistakes than to find them. Internal failure costs result from the defects that are caught during the inspection process. These costs include scrapped or discarded products, the cost of repairs (rework), and the opportunity cost of downtime created by quality problems. The more effective a company's appraisal (inspection) activities, the better its chance of catching defects internally. Although costly, internal failures are preferred over external failures. External failure costs occur when a defective product is discovered only after the product has made its way into the customer's hands. These costs include warranty costs, recalls, product replacement, legal fees, and damage to the company's reputation due to poor quality. External failure costs represent the worst-case scenario, and can prove to be extremely costly

Non-value added activities examples

reworking faulty units, storing units in inventory, moving parts or products from one place to another, expediting orders, and scheduling production runs

The real benefit of activity-based costing comes from...

the information it provides to managers to pursue cost management.