Agenda

 Brief overview of -
Week Four  Activity based costing
 Job-order costing and Process costing
 Cost allocation - processes used to allocate costs to Dept‐
discuss benefits and limitations
Costing Systems  Use of Standard Costing and reconciliation

 Explain Target Costing – discuss benefits limitations in

comparison to traditional costing

 Factors involved in selecting costing systems

Activity based costing – A quick review

 ABC is - a system of costing that focus on activities.  ABC system follow two-stage procedures:
 The classification of activities in ABC:
 Unit-level activities  (i) identifies significant activities and then trace and
 Batch-level activities assigns overhead cost to each activity based on
 Product-level activities resources it uses,
 Facility-level activities

 (ii) established activity cost driver rates and assign

 ABC is designed to provide managers with cost information
for strategic and other decisions that potentially affect
capacity and therefore affect fixed as well as variable costs.
costs to cost objects using these rates.
 The overhead costs are allocated from each activity
cost pool to each product line in proportion to the
amount of the cost driver consumed by the product
line.

Stage One
Overhead costs are assigned to activity cost
ABC identification
pools associated with significant activities
of activity cost pools
 Q- When should a firm use ABC?

Overhead costs are ACP-1 ACP-2 ACP-3 ACP-4

assigned to activities
 Q- What factors to be taken into account for successful
Overhead costs are allocated from each activity cost pool to each
implementation of ABC system?
Stage Two production job in proportion to its consumption of the activity. Each
activity has its own cost driver.

Overhead cost
Production jobs consumes production-related
are Assigned to
activities
production jobs

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 Job-Order Costing and Process Costing –  COST FLOWS IN A JOB-ORDER COSTING SYSTEM

A Quick Review Raw Materials

Debited for the Credited for direct
cost of materials materials added to
purchased Work in Process
 Following Two major types of costing systems are used in
manufacturing and many service companies: Credited for indirect
Work in Process
materials added to
 1. Job-Order Costing. Manufacturing Debited for the Credited for the
Overhead cost of direct cost of goods
 2. Process Costing. materials, direct manufactured
labour, and man-
Salaries and Wages Payable
ufacturing
Credited for direct overhead applied
Job–Order Costing labour added to
Work in Process
 An accounting system that assigns costs to products produced Credited for indirect
Finished Goods
for individually specific jobs. labour added to Debited for the Credited for the
Manufacturing cost of goods cost of goods
Process Costing Overhead manufactured sold

 Is an accounting system that assigns costs to products

Manufacturing Overhead
produced in a series of processes Debited for actual Credited for over- Cost of Goods Sold
overhead costs head cost applied to Debited for the
incurred Work in Process cost of goods
 Q. What are the Differences between job-order and Underapplied Overapplied
sold

process costing? overhead cost overhead cost

Types of Processing
Sequential Processing
 Q- What is Equivalent unit?
Process 1 Process 2 Process 3 Finished Goods

Parallel Processing  Q - How should beginning WIP be treated? Which

method is better and why?
Process 1 Process 2
Finished
Assembly
Goods
Process 3 Process 4

Note that: In a process costing system - manufacturing costs are

accumulated in processing departments - where work is performed and
where materials, labour, and overhead costs are added to the product.

Cost Allocation – A Quick Review Stages of Allocation Process

Stage Two (Overhead absorption
 Reasons for Allocating Support/Service Department Costs Stage One (Secondary to product or service)
Distribution)
Operating departments cost plus
 Basic guidelines of allocation support department costs: Service department cost are allocated service department costs,
assign to Operating are applied to products and services
departments by means of pre-determined
 Cost drivers (causal factors) should be used.
departmental overhead rates.
 Budgeted or expected costs, not actual costs, should be Service Department
allocated. (e.g. cafeteria)
 Costs should be allocated by behaviour Operating
Department -1
 Q. Why can’t a support department have an overhead Service Department Product
rate to assign to products? (e.g. cost Accounting) or
Service
Operating
Service Department Department-2
(e.g. personnel)

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Support Department Cost Allocation
 There are three approaches to allocating the costs of service
departments:
 direct method, step method, and reciprocal method.
 Q – How accurate this product cost is?
Standard Costing – A Quick Review
 Standard costing systems – product costing using the
standard system
 Q - What is a Standard? What is the difference
between ideal and attainable standards?

Allocation of Joint Costs to Products

Q- What is joint cost to products  Q- Are standards the same as budgets?
 Accounting for Joint Product Costs – Methods are-
 Physical units: joint costs distributed on basis of physical units
 Sales-value-at-split-off: joint costs distributed on basis of sales
value at split-off
 Net realizable value: joint costs distributed on basis of
hypothetical sales value
 By-products: because insignificant sales value, no joint cost
allocation

Variance Analysis Cycle

Q - Why standard cost systems are adopted and how Take
does it serve management purpose?
Identify Receive corrective
questions explanations actions

Q - What is mean by Management by Exception?

 Deviations from standard if significant are brought to the
attention of management, a practice known as Conduct next
management by exception. Analyze
period’s
variances
operations
Q - What should we do when we find variances?
Prepare standard
Begin
cost performance
report

 Q- Why Price and quantity standards are determined Your poor scheduling
separately? I am not responsible for sometimes requires me to
this unfavorable material rush order material at a
quantity variance. higher price, causing
 Q - What are the limitations of using price variance in You purchased cheap unfavorable price variances.
performance evaluation? material, so my people
had to use more of it.
 Remember: The materials variances are not always
entirely controllable by one person or department.

Production Manager Purchasing Manager

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Q- who is Responsibility for Labour
Variances
I think it took more time
I am not responsible for
the unfavorable labour
efficiency variance!
You purchased cheap
material, so it took more
time to process it.
Overhead Variances
Fixed and Variable overhead variance
 Total fixed and variable overhead variance can be decompose
to process the into Spending and Efficiency Variances
materials because the
Maintenance Fixed overhead spending variance - is the difference between
Department has poorly actual and budgeted fixed overhead.
maintained your Fixed overhead efficiency variance -measures the effect of
equipment. actual output differing from output used to compute
predetermined standard fixed overhead rate.
Variable overhead spending variance -measures aggregate
effect of actual variable overhead rate with standard rate.
Variable overhead efficiency variance -measures change in
variable overhead consumption because efficient (inefficient)
use of direct labour hours.

A Statistical Control Chart Life-cycle Cost Management

Q - How do I know which variances to investigate?
A Statistical Control Chart
Warning signals for investigation
 It focuses on managing value chain activities so that a long
term competitive advantage is created.
 To achieve this – managers must balance a product’s whole
–life cost, methods of delivery, innovativeness and various
product attributes (including performance, features, reliability,
conformance, durability, aesthetics and perceived quality)

• •
 Whole life product cost - is the life-cycle cost of product
Favorable Limit plus its post purchase costs (operation, support, maintenance

• • • and disposal etc).

Life-cycle costs – Nonrecurring costs (planning designing and
•

Desired Value
• testing); manufacturing cost; logistic support costs (advertising,
distribution, warrant etc.);
Unfavorable Limit •  Life-cycle cost management emphasises cost reduction rather

1 2 3 4 5 6 7 8
•9 than cost control. Therefore, Target costing is a useful tool for
achieving cost reduction goal.
Variance Measurements