Joint Cost

Characteristics of a successful ABC implementation

- strong top management support Without leadership from top management, some managers may not be motivated to embrace the need to change. - linked to how people are evaluated and rewarded If employees continue to be evaluated and rewarded using traditional non abc cost data, they will quickly get the message that abc is not important and they will abandon it. - cross functional teams should be created Cross-functional employees possess intimate knowledge of operations that is necessary for designing an effective ABC system.

The pitfalls of allocation

-Joint costs are traditionally allocated among different products at the split-off point. A typical approach is to allocate joint costs according to the *relative sales value* of the end products. -Although allocation is needed for some purposes such as balance sheet inventory valuation, allocations of this kind are very dangerous for decision making.

Five limitations of ABC

1. Substantial resources required to implement and maintain 2. Resistance to unfamiliar numbers and reports 3. Desire to fully allocate all costs to products 4. Potential misinterpretation of unfamiliar numbers 5. Does not conform to GAAP. Two costing systems may be needed

product margin calculations

1. gather each product's sales and direct cost data 2. incorporate the previously computed activity-based cost assignments pertaining to each product so Direct costs such as direct labor, direct materials and shipping, plus ABC cost assignments, customer orders, design changes, order size, etc. 3. deduct each product's direct and indirect costs from sales product margin. Less costs not assigned to products and "other" costs.

product margins computed using the traditional cost system

1. gather products sales and direct cost data -direct materials and labor 2. compute plantwide overhead rate. examples: indirect factory wages factory equipment depreciation'factory utilties factory building lease divide by total machine hours to get overhead cost per machine hour 3. allocate manufacturing overhead to each product based on the amount of machine hours used in each 4. actually compute product margin , subtract selling and admin costs such as shipping expenses, marketing expenses, general admin expenses, etc. to find net operating income or loss.

customer margin calculation

1. gather sales and direct cost data 2. incorporate previously computed activity based cost assignments. 3. compute customer margin by deducting all direct and indirect material coss from sales. sales (-) minus direct and indirect abc costs equals customer margin

activity cost pool

A "cost bucket" in which costs related to a single activity measure are accumulated example: Customer orders design changes order size customer relations other

Duration driver

A common type of activity measure A measure of the amount of time needed for an activity.

Transaction driver

A common type of activity measure. A simple count of the number of times an activity occurs.

Joint Costing

A system of assigning joint costs to joint products whose overall sales values are relatively significant.

How does Activity based accounting differ from traditional cost accounting?

ABC differs from traditional cost accounting because numerous overhead cost pools are used. each ABC cost pool has its own unique measure of activity, while traditional cost systems usually rely on direct labor hours and or machine hours to allocate all overhead costs to products Direct labor hours and machine hours work correctly when changes in the quanitity of the base are correlated with changes in the overhead costs being assigned using the base. Relying exclusively on direct labor hours and or machine hours to assign overhead costs to products has come under increased scrutiny since, on an economy wide basis. direct labor hours and overhead costs have been moving in opposite directions and the variety of products produced by companies has increased

Chapter 7

Activity based costing

Activity measure

An allocation base in an activity based costing system. The term cost driver is also used to refer to an activity measure. example: number of customer orders number of design changes machine hours number of active customers not applicable

activity cost pool and activity measure examples

Customer orders - number of customer orders design changes - number of design changes order size - machine hours customer relations- number of active customers other - not applicable

sell or process further decision: To find if it is Financial advantage or disadvantage to further process

Final sales value after further processing (-) minus Sales value at the split off (=) EQUALS Incremental Revenue from further processings (-) minus cost of further processing (=) EQUALS Financial advantage, or disadvantage, of further processing. disadvantage is negative

How costs are treated under activity-based costing

In ABC costing, nonmanufacturing as well as manufacturing costs may be assigned to products, but only on a cause and effect basis. ABC systems can assign: sales commissions shipping costs warranty repair costs to specific products. Some manufacturing costs may be excluded from product costs ABC excludes organization sustaining costs and idle capacity costs from product cost.

Joints Products

In some industtries, a number of end products are produced from a single raw material input. When two or more products are produced from a common input.

Joint costing: Sell or process further decision

Joint costs are irrelevant in decisions regarding what to do with a product from the split off point forward. Therefore, these costs should not be allocated to end products for decision making purposes. With respect to sell or process further decisions, it is profitable to continue processing a joint product after the split off point so long as the incremental revenue from processing exceeds the incremental processing costs incurred after the split off point. If financial advantage, positive, process further if financial disadvantage, negative, sell at split off. cost of further processing should be lower than incremental revenue from further processing.

ABC defines five levels of activity that largely do not relate to the volume of units produced:

Manufacturing companies Unit-level activity Batch level activity product level activity organization sustaining activity customer level activity

Differences between traditional and ABC Product costs

There are three reasons why the reported product margins for the two costing systems differ from one another. 1. traditional costing allocates all manufacturing overhead to products. ABC costing only assigns manufacturing overhead costs consumed by products to those products. 2. Traditional costing allocates all manufacturing overhead costs using a volume related allocation base. ABC costing also uses non volume related allocation bases. 3. Traditional costing disregards selling and administrative expenses because they are assumed to be period expenses. ABC costing directly traces shipping costs to products and includes nonmanufacturing overhead costs caused by products in the activity pools that are assigned to products.

Assign overhead costs to activity pools

Total resource (x) times distribution percentage will determine consumption across activity cost pools.

Undercosting

a product consumes a high level of resources but is allocated low costs per unit high level resources, low cost per unit

Overcosting

a product consumes a low level of resources but is allocated high costs per unit low level resources, high costs per unit

Activity-based costing (ABC)

a technique to assign product costs based on links between activities that drive costs and the production of specific products A costing method designed to provide managers with cost information for strategic and other decisions that potentially affect capacity and therefore, fixed , as well as variable costs. It is ordinarily used as a supplement to , rather than as a replacement for, the company's usual costing system.

Traditional cost systems rely exclusively on..

allocation bases that are driven by the volume of production.

Activity

an event that causes the consumption of overhead resources in an organization

Joint cost

describes cost incurred up to the split off point. Joint cost are common costs incurred to simultaneously produce a variety of end products.

Direct materials, direct labor and shipping costs are..

excluded because existing cost systems can directly trace costs to products or customer orders. remember abc is usually supplement, and does not replace usual cost system

split-off point

the point in the manufacturing process at which the joint products can be recognized as separate products. for example: pretoleum refining industry a large number of products are extracted from crude oil, including gasoline, jet fuel, home heating oil, etc.

Compute Activity Rates

total cost (/) divided by total activity other, or organization sustaining costs are not assigned to products or customers so not applicable and activity rate not determined.

Two common types of activity measures

transaction driver and duration driver