Management Accounting

• Last week

• Activity-based Costing (Ch. 5)

• Absorption costing and Variable costing (Ch.17)

 Reasons to allocate costs

 External reporting / tax reporting

 Inventory valuation and income determination

 Third-party reimbursements

 Decision making and control

 Separate bills?
 Beamer example
 Organizational reasons for cost
allocations
 Cost allocations are a tax system
 Change the mix of factor inputs: (less of the taxed input,
more of the untaxed input)

 Compensate for externalities

 Positive externalities (data in a POS; software add-in on
other software products)
 Negative externalities (purchasing substandard raw
materials; finance department wants to use Macintosh)

 Enhance cooperation
 Cost allocation methods

1. Simultaneous equation
Reciprocal method

2. Specified order of closing

Step down allocation

3. Direct method
 Joint cost, what’s it all about?

mad cow
 processin
g A
Material

processin processin
Labor
g g B
Overhead

Joint Costs Separable Costs

Split-off point
 Allocation methods

• Physical output
– kg, meters, liters
• Relative Sales value
– Market value at split-off point
• Sales revenue
– Selling price x items sold
• Gross margin
– Sales revenue less constant gross margin
• Net sales revenue
– Estimated sales revenue -/- cost incurred after
joint process
 Absorption costing
Cost

Manufacturing cost Non-manufacturing

cost

Material Labor Overhead

Work in progress Finished goods Profit & Loss

stock stock Account
 Variable costing
Cost

Manufacturing cost Non-manufacturing

cost

Material Labor Overhead

Variable Fixed
Overhead Overhead

Work in progress Finished goods Profit & Loss

stock stock Account
 Example (1)

Units January February March April May June

Opening inventory - - 100 - - 400
Production 1.000 1.000 1.000 1.000 1.200 800
Selling 1.000 900 1.100 1.000 800 1.200
Closing inventory - 100 - - 400 -

Selling price 100 €

Material per unit 2 kg
Material unit price 10 €
Fixed cost 50.000 €
Denominator 1.000 units

Product cost VC 20 €/unit

Product cost AC 70 €/unit
 Example (2)
1.000*€100

Variable costing January February March April May June

Sales revenue 100.000 90.000 110.000 100.000 80.000 120.000
Cost of Goods Sold
Opening stock 0 0 2.000 0 0 8.000
Variable cost of products manufactured 20.000 20.000 20.000 20.000 24.000 16.000
Cost of Goods available for sale 20.000 20.000 22.000 20.000 24.000 24.000
Closing stock 0 2.000 0 0 8.000 0
Variable cost of goods sold 20.000 18.000 22.000 20.000 16.000 24.000
Contribution margin 80.000 72.000 88.000 80.000 64.000 96.000

Fixed period cost 50.000 50.000 50.000 50.000 50.000 50.000

Operating profit 30.000 22.000 38.000 30.000 14.000 46.000

1.000*2 kg*€20
400 units * € 20
€100.000-/- € 80.000
 Example (3)
1.000*€100
€ 50.000-/-€ 60.000

Absorption costing January February March April May June

Sales revenue 100.000 90.000 110.000 100.000 80.000 120.000
Cost of Goods Sold
Opening stock 0 0 7.000 0 0 28.000
Variable cost of products manufactured 20.000 20.000 20.000 20.000 24.000 16.000
Fixed cost of products manufactured 50.000 50.000 50.000 50.000 60.000 40.000
Cost of Goods available for sale 70.000 70.000 77.000 70.000 84.000 84.000
Closing stock 0 7.000 0 0 28.000 0
Total cost of goods sold 70.000 63.000 77.000 70.000 56.000 84.000
Sales profit 30.000 27.000 33.000 30.000 24.000 36.000

Adjustment for manufacturing variances 0 0 0 0 -10.000 10.000

Operating profit 30.000 27.000 33.000 30.000 34.000 26.000
1.000*2 kg*€20
100 units * (€20 + €
€ 50.000 / 1.000 units * 50)
1.000 units € 50.000 / 1.000 units *
1.200 units
 Example (4)
Explaining the difference January February March April May June
Operating profit Absorption costing 30.000 27.000 33.000 30.000 34.000 26.000
Operating profit Variable costing 30.000 22.000 38.000 30.000 14.000 46.000
Difference 0 5.000 -5.000 0 20.000 -20.000

Units produced 1.000 1.000 1.000 1.000 1.200 800

Units sold 1.000 900 1.100 1.000 800 1.200
Mutation in units inventory 0 100 -100 0 400 -400
Budgeted fixed manufacturing cost 50 50 50 50 50 50
Mutation in € fixed cost in inventory 0 5.000 -5.000 0 20.000 -20.000
 Absorption versus Variable

• Production = Sales => AC = VC

• Production > Sales => AC > VC
• Production < Sales => AC < VC
 Denominator level

• Theoretical maximum capacity

• Practical capacity
• Normal activity level
• Budgeted activity level
 Arguments in support of VC

• More useful information for decision

making
• Effects of inventory changes not in
profit
• Avoids fixed overheads being
capitalized in unsaleable stocks
 Arguments in support of AC

• Does not understate the importance of

fixed costs
• Avoids fictitious losses being reported
• Fixed overheads are essential for
production
• Consistency with external reporting
Explaining the existence of absorption
costing

• Product costing for inventory valuation

(financial accounting)
• Resistance to change (sociological)
• Opportunity costs (economical)
• Uncertainty reduction and learning
(behavioral)
 Costs
Plant Protection

Maintenance

Quality Control
Warehouse Botlek

Plant management
Cost Pool DLH

Personnel
Process Enginering

Aux.Buildings

Medical & Clothing

Canteen

Project Engineering
Cost Pool MH

Purchasing

Plant Analysis

Training

Office Services
Traditional costing system

Waste Water
C

AMD/DER Plant
Cost Pool MAT

CSP/AVENGE Plant
 Activity Based Costing system

Maintenance Quality Control Warehouse Botlek

Activity 4
Activity 2

Activity 3

Activity n
Activity 5
coming material
Triggers Inspection In- Products

Costdrivers

C
 Complexity as cost driver
FORD (US) 1965 - 1982
10
Average cost per unit

5
0 20 40 60 80 100 120 140 160
Volume per model
ABC in p ractice : t ra ditional c ost in g
Direct costs Overhead costs
42% 58%
24% 7% 32% 17% 9%
11%

DLH
MU
MH
Batch
Parts
Prod.Orders
Sales Orders
Site visits
Productgroup
Plant sustaining

Products
ABC in p ractice

Direct Costs Overhead Costs: 58%

42 % Activities
11% 24% 7%

16%
Activity Cost Pools

DLH
MU
MH
Batch
Parts
Prod.Orders
Sales Orders
Site visits
Productgroup
Plant sustaining

Products
All ocatio n o f o verhead at ABC c orp.
Corporation ABC produces several products. Direct labour and material cost are
assigned to the cost objects: products and services. Indirect overhead is allocated to
the cost objects by using a tariff. Determination of the tariffs is subject of discussion.
There are two groups within the company: one group favours the use of direct labour
hours as a basis of allocation. The other group has arguments for using the number
of products manufactured.
The total overhead cost is as follows:
Department Overhead cost
Service support $ 1,225,000
Service Delivery (overhead $ 175,000
only) $ 1,400,000
Total
The information concerning products and usage of direct labour is as follows:

Products quantity dir. labour

hrs
Product A 10,000 25,000
Product B 2,000 10,000
Product C 50,000 140,000
Total 62,000 175,000

Discuss whether the total overhead cost should be allocated to the services on a basis
of labour hours or quantity.

Determine the overhead cost for Product A, B and C using the allocation base that
came out of the discussion as “most favourite”
All ocatio n o f o verhead at ABC c orp.:
Solutio n
Products quantity allocated
overhead
Using quantity as Product A 10/62*1.400.000 225,807
an allocation Product B 2/62*1.400.000 45.161
basis: Product C 50/62*1.400.000 1.129.032
Total 62/62*1.400.000 1.400.000
Department Overhead cost
Service support $ 1,225,000
Service Delivery (overhead $ 175,000
only) $ 1,400,000
Total
The information concerning products and usage of direct labour is as follows:

Products quantity dir. labour

hrs
Product A 10,000 25,000
Product B 2,000 10,000
Product C 50,000 140,000
Total 62,000 175,000
Products direct labour allocated
overhead
Using direct Product A 25/175*1.400.000 200.000
labour as an Product B 10/175*1.400.000 80.000
allocation basis: Product C 140/175*1.400.000 1.120.000
Total 175/175*1.400.000 1.400.000
Us in g A BC fo r a llo catio n o f o verhead
 
The company determined that it performed four major activities in the Service
Support department. These activities, along with their budgeted costs are as
follows:
Production Support Activities Budgeted
Order Acquisition costs
$ 428,750
Set-up $ 245,000
Service Control $ 183,750
Materials Management $ 367,500
Total $ 1,225,000
 
ABC estimated the following activities-base usage quantities for each of its
three products:
Products Quantity Dir. Set-ups Acquisiti Inspection Material
labour on s requisitio
hours activities ns
Product A 10,000 25,000 80 80 35 320
Product B 2,000 10,000 40 40 40 400
Product 50,000 140,000 5 5 0 30
C 62,000 175,000 125 125 75 750
Total

Determine the overhead cost for Product A, B and C using an ABC

system.
Us in g A BC fo r a ll ocatio n o f o verhead:
So lutio n
 
The company determined that it performed four major activities in the Service
Support department. These activities, along with their budgeted costs are as
follows:
Production Support Activities Budgeted
Order Acquisition costs
$ 428,750 /125 = 3.430 per acquisition
Set-up $ 245,000 /125 = 1.960 per set up
Service Control $ 183,750 /75 = 2.450 per inspection
Materials Management $ 367,500 /750 = 490 per requisition
Total $ 1,225,000
 
ABC estimated the following activities-base usage quantities for each of its
three products:
Products Quantity Dir. Set-ups Acquisiti Inspection Material
labour on s requisitio
hours activities ns
Product A 10,000 25,000 80 80 35 320
Product B 2,000 10,000 40 40 40 400
Product 50,000 140,000 5 5 0 30
C 62,000 175,000 125 125 75 750
Total

Determine the overhead cost for Product A, B and C using an ABC

system.
Us in g A BC fo r a ll ocatio n o f o verhead:
So lutio n
 
The company determined that it performed four major activities in the Service
Support department. These activities, along with their budgeted costs are as
follows:
Production Support Activities Budgeted
Order Acquisition costs
$ 428,750 /125 = 3.430 per acquisition
Set-up $ 245,000 /125 = 1.960 per set up
Service Control $ 183,750 /75 = 2.450 per inspection
Materials Management $ 367,500 /750 = 490 per requisition
Total $ 1,225,000
 
ABC estimated the following activities-base usage quantities for each of its
three products:
Products Set- Acq. Insp Mat. Overhead allocated on a ABC basis
ups act. . req.
Product 80 80 35 320 80*3.430 + 80*1.960 + 35*2.450 +
A 40 40 40 400 320*490
Product 5 5 0 30 40*3.430 + 40*1.960 + 40*2.450 +
B 125 125 75 750 400*490
Product 5*3.430 + 5*1.960 + 0*2.450 +
C
30*490
Total Determine the overhead cost for Product A, B and C using an ABC
125*3.430 + 125*1.960 + 75*2.450 +
system. 750*490
All ocatio n o f o verhead at ABC c orp.:
Conclusio n
Products quantity allocated
overhead
Using quantity as Product A 10/62*1.400.000 225,807
an allocation Product B 2/62*1.400.000 45.161
basis: Product C 50/62*1.400.000 1.129.032
Total 62/62*1.400.000 1.400.000

Overhead allocated on a ABC basis allocated

overhead
80*3.430 + 80*1.960 + 35*2.450 + 320*490 + 698.750
25.000 519.600
40*3.430 + 40*1.960 + 40*2.450 + 400*490 + 181.650
10.000 1.400.000
5*3.430 + 5*1.960 + 0*2.450 + 30*490 +
140.000
125*3.430 + 125*1.960
Products + 75*2.450 + direct
750*490 +
labour allocated
175.000 overhead
Using direct Product A 25/175*1.400.000 200.000
labour as an Product B 10/175*1.400.000 80.000
allocation basis: Product C 140/175*1.400.000 1.120.000
Total 175/175*1.400.000 1.400.000
Advantages of ABC
 Increased precision for cost allocation to
products and customers.
 Better calculation of internal and external
tariffs
 Effective cost control
 Reason behind cost allocation
 Increased planning opportunities
 Simulation options for impact from future
changes in assortment and sales mix
 Valuation possibilities for process
improvement
Disadvantages of ABC
 First model is rough overview of that
moment
 System cost
 Only signaling, no improvement
 Everything is variable
 Action control => updating
 Impact on people
Objections against ABC :
 ABC not suitable for decision support on
short term
 No attention for capacity
 All cost are variable and therefore
controllable
 Current production is starting point
 Resource consumption = resource
spending
 Decision support information
Sales Volume
Estimate:

ABC-model

Markets
Products,
Customers,
Channels,
Cus
Markets tom n nels
ers a
Ch
Resource Human Tangible Non-Tangible
Consumption:
Internal
External

Production Characteristics: Resource

Availability
Human Tangible Non-Tangible

Internal
Triggers, Cost Drivers External