7/27/2010 C-V-P Ice Cream $ Volume C-V-P Ice Cream $ Volume Cost Drivers 1 7/27/2010 Activity Based Costing Activity Based Costing ABC = ƒ (technology) (both production and administration) Activity Based Costing All costs are variable costs (ie all costs are driven). The issue is to find the driver, then the cost per driver. Activity drives cost. Manage the activity, and you manage the costs. 2 7/27/2010 Full costing requires overhead allocation Direct Variable Labour Direct Material OH is a very small part of total costs Even with 100% misstatement, total costs are out 1 or 2%. 2% Use the largest cost to allocate the smallest cost BR = OH$ / Volume Overhead BR = OH$ / Volume called the pooling method Direct Variable Labour Peanut Butter Costing Assumes a single driver of cost. ie Volume Direct Material May have multiple pools to account for product and geographical differences Overhead Industrial Revolution Direct Variable Labour Served business and accountants well for nearly two centuries. Direct Material Overhead 3 7/27/2010 Industrial Revolution Direct Variable Labour Modern “Manufacturing” Overhead Direct Material Direct Material Overhead DV Lab Industrial Revolution Direct Variable Labour Modern “Manufacturing” Overhead Using a single denominator (ie assuming a single driver) creates huge distortions. distortions BRs of 1000% to 5000% Direct Material Direct Material Overhead DV Lab For example: By applying the CVP (ie single driver model) to post secondary education, we create obvious costing inaccuracies. V i bl / denominator Variable d i = number b off students d if a cost is not variable, it is therefore, Fixed (constant, relative to volume) 4 7/27/2010 For example: Cost Drivers in Post Secondary Ed: Number of students Number of sections Number of programs Number of divisions Number of campuses and time. (eg President’s salary) Modern “Manufacturing” Overhead Direct Material DV Lab Modern “Manufacturing” The math is the same: ABC uses the pooling method to determine the cost per unit of driver. Overhead 1 Overhead 2 Overhead 3 Product cost is determined by the quantity of driver that each product uses, multiplied by the cost per driver. Overhead 4 Overhead 5 ABC di divides id the th overhead h d section ti off cost Overhead 7 Overhead 6 Direct Material DV Lab 5 7/27/2010 Exam exposure: • Fairly high • Look L k ffor multiple lti l products d t with ith multiple lti l grades d off each h • Expect to be repetitive (as is the nature of ABC) • Just because it is costing, doesn’t mean it is ABC Exam exposure - look for: • Are the drivers given? • Are A th the aggregate t costs t and/or d/ driver di volumes l given? i ? • Are the costs per driver given? • Has the product cost been calculated? Integration: ABC & Regression Analysis Traditional Costing Model assumes a single driver of cost ie VOLUME Cost Y = a + bX Volume Where: Y = total cost X = volume a = fixed costs b = variable costs 6 7/27/2010 Integration: ABC & Regression Analysis Traditional Costing Model assumes a single driver of cost ie VOLUME Cost Volume Under the CVP model, model costs are considered driven by volume (ie variable) or not driven at all (ie fixed) Integration: ABC & Regression Analysis Activity based costing methodology suggests that all costs are driven. The essence of cost management then becomes identifying the driver, managing the activity defining the driver and costs will, will by default, default be managed. managed Activity based costing methodology explains the predictive equation as follows: a - the amount of unallocated costs b - the cost per unit of driver x - the driver of y Integration: ABC & Regression Analysis The q quality y of driver is measured by r2. 7 7/27/2010 Integration: ABC & Regression Analysis Multiple regression is a natural tool to use when identifying cost drivers. Integration: ABC & Regression Analysis Scooter Company is an example of a question involving multiple regression/driver identification. Integration: ABC & Regression Analysis Scooter Company identifies 3 drivers that explain 86.1% 86 1% of cost changes. 8