Activity Based Costing and Activity Based Management Slides

MASTER OF SCIENCE IN BUSINESS ADMINISTRATION

Management Control Systems

2012

Paulo Modesto Pardal

1 1

WORKING PAPERS



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“Cost Accounting : a managerial emphasis – Horngren et all (14th ed.), Chapter 5



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METHODS FOR DETERMINING VALUE

• Δ Size/Complexity

• Δ Pressure for data processing

• Δ Allocation Basis

• Δ Cost centres

Paradox: The More... The Less...

A B C



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Product Cost-Cross Subsidization CASE

Central Bakery

Bread Birthday Cake

• Flour

• Direct Labour (5h/100 Kg)

• Flour

• Eggs

• Milk

• Sugar

• Direct Labour (0,5h/100 Kg)

DIRECT COST

• Salt

• Ferment

• Water

• Energy

• Depreciation

INDIRECT COSTS • Chocolate

• Crumbled almonds

• Cream

• Dry fruits

• Water

• Energy

• Depreciation



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Product Cost-Cross Subsidization CASE

Data:

• Direct Costs of “Bread”: €4/100 Kg

• Direct Costs of “Birthday Cake”: €7/100 Kg

• Indirect Costs: €200.000/month (A)

• Indirect Costs Allocation Basis: Direct Labour hours

• Direct Labour hours/month: 200.000h (B)

• Allocation Rate: €1/h [(A) : (B)]

CENTRAL BAKERY

Bread Birthday Cake

Direct Costs: € 4

Indirect Costs: € 5

Total: € 9

Price: € 10

Margin: € 1

Direct Costs: € 7

Indirect Costs: € 0,5

Total: € 7,5

Price: € 20

Margin: € 12,5



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A-B C / A-B M [ Activity-Based Costing / Activity-Based

Management]

Definition

Alternative methodology to allocate indirect costs to product/services regarding their more accurate evaluation



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THE “LIES” ABOUT A-B C

1. That is the costing system to services

2. That is the process to calculate exact costs

3. That is the ‘magic potion’ to solve all the problems of management control



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A-B C [Activity-Based Costing]

“ ACTIVITIES CONSUME RESOURCES;

PRODUCTS CONSUME ACTIVITIES”



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• CONCEPTUAL REFORMULATION

• Activity

• Cost-Driver

• APPLICATION REVOLUTION

• Unit Cost of the activity/activities

• Fixed Costs viewed from a resource standpoint vs. Variable Costs viewed

from an activity standpoint



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San

sam SPi

SPj SPk

X

Activity

“Treatment of Surfaces”

Legend:

SPi – Painting

SPj – Hot House

SPk – Polishing

sam – Warehouse

sau - Cleaning & Maintenance

X - Overheads



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Operational Advantages

• Unnecessary to divide indirect costs among the 5 sections

• Unnecessary to transfer accumulated costs into 2 auxiliary sections

• Potential availability of information to calculate the unit cost of the activity ‘Treatment of Surfaces’



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A-B C / A-B M [Activity-Based Costing / Activity-Based

Management]

Demonstration Case

Quantity Direct Materials Direct Labour

Lamps 60.000 €1.125.000 €600.000 (30.000h)

Candelabrums 15.000 €675.000 €195.000 (9.750h)

ILUMINEX, S.A.

Lamps & Candelabrums

Part A

Present Situation

1. Direct Costs

2. Indirect Costs

Total Indirect Costs ......................... € 2.385.000

Allocation Basis ............................... Direct Labour hours

Total Direct Labour hours ................. 39.750h

Allocation Rate ................................ 60/h

3. Prices

Lamps ............................................ €63/unit

Candelabrums ................................ €137/unit



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Calculations

ITEM

Lamps Candelabrums

TOTAL

Total Value Unit Value Total Value Unit Value

Direct Materials 1.125.000 18,75 675.000 45,00 1.800.000

Direct Labour 600.000 10,00 195.000 13,00 795.000

Total Direct Costs 1.725.000 28,75 870.000 58,00 2.595.000

Allocated Indirect Costs 1.800.000 30,00 585.000 39,00 2.385.000

Total Costs 3.525.000 58,75 1.455.000 97,00 4.980.000

Sales 3.780.000 63,00 2.055.000 137,00 5.835.000

Operational Profit 255.000 4,25 600.000 40,00 855.000

6,75% 29,20% 14,65



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Part B

Implementing A-B C

1. Cost Objectives

(L)amps; (C)andelabrums

2. Direct Costs

Costs with “Cleaning & Maintenance” – 270.000€ - can be “up-graded” to Direct Costs because of their close relation with the number of batches produced (Lamps = 240; Candelabrums = 300)



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ITEM

Lamps Candelabrums

TOTAL


Direct Materials 1.125.000 18,75 675.000 45,00 1.800.000

Direct Labour 600.000 10,00 195.000 13,00 795.000

Cleaning & Maintenance 120.000 2,00 150.000 10,00 270.000

Total Direct Costs 1.845.000 30,75 1.020.000 68,00 2.865.000



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3./4./5. Cost-Pools and Cost-Drivers

Activity Basis Total Costs Level Cost-Driver

Design m2 450.000 100 m2 4.500/m2

Setup Setup hours 300.000 2.000 hours 150/Setup hour

Operations Machine – hours 637.500 12.750 hours 50/Machine hour

Delivery Nr. Loadings 81.000 200 loadings 405/Loading

Distribution m3 391.500 67.500 m3 5,80/m3

Supervision Direct Labour

hours 255.000 39.750 hours

6,4151/Direct Labour hour



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6./7. Costs and Margins

ITEM

Lamps Candelabrums TOTAL


TOTAL DIRECT COSTS (A) 1.845.000 30,75 1.020.000 68,00 28.650.000

INDIRECT COSTS

• DESIGN

Lamps 30 m2*4.500/m2

Candelabrums 70 m2*4.500/m2

135.000

2,25

315.000

21,00

450.000

• SETUP

Lamps 500h*150/h

Candelabrums 1.500h*150h

75.000

1,25

225.000

15,00

300.000

• OPERATIONS

Lamps 9.000 m h*50/m h

Candelabrums 3.750 m h*50/m h

450.000

7,50

187.500

12,5

637.500

• DESPATCH

Lamps 100 load.*405/load.

Candelabrums 100 load.*405/load.

40.500

0,67

40.500

2,70

81.000

• DISTRIBUTION

Lamps 45.000 m3*5,80/m3

Candelabrums 22.500 m3*5,80/m3

261.000

4,35

130.500

8,70

391.500

• SUPERVISION

Lamps 30.000 men-hours*6,4151/h

Candelabrums 9.750 men-hours*6,4151/h

192.453

3,21

62.547

4,17

255.000

TOTAL INDIRECT COSTS (B) 1.153.953 19,23 961.047 64,07 2.115.000

TOTAL [(A)+(B)] 2.998.953 49,98 1.981.047 132,07 4.980.000

SALES 3.780.000 63,00 2.055.000 137,00 5.835.000

OPERATIONAL PROFIT 781.047 13,02 73.953 4,93 855.000

20,67% 3,60% 14,65%



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Comparative Analysis

High-powered information Traditional Costing Methods Cost = (Dir. Mat.; Dir. Lab.; Overheads) where, usually, Overheads = (Direct Costs)

Activity-based Costing Cost = (Dir. Mat.; Dir. Lab.; Overheads) with

Overheads = (Activ. 1; Activ. 2; ...; Activ. N)

A new cost objective: the Activity As a consequence, increased information: the cost-drivers as unit costs of the Activities Planning & Controlling the cost-drivers: A-B B (Activity-Based Budgeting) and A-B M (Activity-Based Management)

A-B C / A-B M [Activity-Based Costing / Activity-Based

Management]

Activity Based Costing and Activity Based Management Slides

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