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Under what two conditions should a company research refining its cost allocation system? Specifically, revert to using Departmental overhead rates.
- 1: Different departments have different amounts and types of moh costs.
- 2: Different products us the departments to a different extent.
What is ABC costing?
Activity Based Costing: charges for actual resources being used, rather than one overhead rate being applied.
What are the steps in creating an ABC system?
- 1: ID and classify activities (cost hierarchy)
- 2: Estimate the total indirect costs associated with each activity
- 3: ID the allocation base for each of the activities identified
- 4: Estimate the total qty/volume of each allocation base
- 5: Compute cost driver rates (Activity cost/Activity Volume=Cost Driver rate)
- 6: Assign Activity costs (Allocation rate x Actual qty or volume of cost allocation base used)
What is ABC for Decision making-activity based management?
Companies manage activities to improve the value of their product, help cut costs, and increase the profit achieved by providing this value.
What are 4 benefits of using ABC for decision making?
- Measures the effectiveness of key business processes & activities
- IDs how processes can be improved to increase value to customers while reducing cost
- Improves management focus to value-added activities and continuous improvement methods
- Assists with operations (Pricing/Product decisions, Cutting costs, Routine planning/Control decisions)
What are 2 drawbacks of using ABC for decision making?
- ABC costing is more complex to create and implement
- Need to consider cost/benefits of implementing and maintaining the ABC system
What are 5 signs that a company should implement an ABC system?
- Losing competitive bids
- Competitors with similar products are able to price their products lower but still earn an acceptable profit margin
- Costs reported do not seem "right"
- Company has diversified its products but has not concidered the effects on oh costs with diversification
- Company has "re-engineered" its production process but has not changed how it allocates oh in response to the change
What is lean production? List 7 distinguishing factors.
- Lean production is a business strategy that emphasizes manufacturing without waste:
- Eliminates waste by carrying small amts of inventory
- JIT system ("pull")
- Machines grouped in "production cells" to eliminate stops in production due to movement of materials
- Small batches
- Shortened set-up times
- Supply chain management
- Emphasis on quality (product made right the 1st time!)
What is Total Quality Management?
The idea that each function in the value chain continually tries to improve quality & value (and eliminate waste and defects) at the lowest possible cost. Continual improvement!!!
What are Costs of Quality?
The costs incurred to provide quality products at lowest possible cost to customers
Name some Preventative Costs:
- Highest in company w/good quality output
- Training Personnel
- Evaluating potential suppliers
- Using better materials
- Preventative maintenance
- Improved equipment
- Redesigning product or process
Name some Appraisal Costs:
- Costs incurred to detect poor quality products
- Inspection of incoming materials
- Inspection at various stages of production
- Inspection of final products or services
- Product testing
- Cost of inspection equipment
Name some Internal Failure Costs:
- Costs incurred when a product is finished (or almost finished) but company spends money to rework or correct the defect before the product is sold
- Production loss caused by downtime
- Abnormal quantities of scrap
- Rejected product units
- Disposal of rejected units
- Machine breakdowns
Name some External Failure Costs:
- Costs incurred for defective products that have already reached consumers
- Lost profits from lost customers
- Warranty costs
- Service costs at customer sites
- Sales returns & allowances due to quality problems
- Product liability claims
- Cost of recalls
Where is Internal & External Failure costs found to be the highest?
In companies with poor workings.
What is CVP and how is it used?
- Cost-Volume-Profit Analysis helps managers make business decisions by expressing relationships between costs, volume and profits. Examples of how CVP aids:
- Setting prices for products and services
- Consider introducing new products or services
- Assess whether a given product should be made within the firm or outsourced
- Replacing or refurbishing equipment
- Performing strategic "what if" analysis to make better decisions
What is the primary assumption associated with CVP analysis?
That a change in VOLUME is the only factor that affects costs.
What is the Unit Contribution Margin and how is it found?
- In units:
- Sales Revenue per unit - Variable costs per unit = Contribution Margin per unit (Amount that will go to fixed costs!)
- Contribution Margin per unit - Fixed Costs per unit = NI per unit
How do you find the Contribution Margin ratio?
Contribution margin $ / Sales revenues = Contribution margin ratio
What $ is Breakeven?
Point at which company has covered all fixed costs but has $0 net income.
Target Net Income?
Amount of sales needed to cover all fixed costs, plus NI desired by company
What is a sales mix?
Sales mix is the amount of each product sold, and how each product affects overall profitability of the company. Have to calculate the weighted average contribution margin per unit!
What is the Margin of Safety?
Excess of expected sales over breakeven sales.
What is a company's Operating Leverage?
- Amount of fixed vs. variable costs. If has high operating leverage, the company is locked into more fixed costs (high contribution margin ratios) making company more risky.
- = Contribution Margin / Operating Income
What are the Rules for making Short Term Business decisions?
- Ignores costs and revenues that will not differ between alternatives
- Ignore past or sunk costs
- Ignore fixed costs unless they are impacted by the short term decision. Then only consider the fixed costs that are impacted.
- Make sure contribution margin per unit is positive. If so, go with alternative where the company will be "best off"
- Make sure to consider any qualitative aspects (customer service & satisfaction, long term effects, product quality...)
List 6 types of Short Term Decisions.
- Special Order
- Dropping or Adding a Product Line
- Product Mix Decisions
- Making or Buying a Product
- Sell or Process Further (Joint Costing)
- Regular Pricing Decisions (pricing products)
What does a company want to consider when debating whether or not they should take a Special Order?
They should accept if contribution margin per unit is positive and they have the productive capacity to accept the order. Also wany to make sure that regular sales will not be affected in the long run by this special order being filled. Profits will increase by amount of contribution margin per unit is positive X 3 of units being produced.
What is the general rule when deciding to Drop or Add a product line?
Drop when CM per unit is negative, Add or Keep if CM per unit is positive. Also consider whether the freed up capacity could be used to produce something that is in greater demand.
What is the rule for making PMix decisions?
- If resources are limited, need to choose the alternative with the maximum CM per CRITICAL FACTOR.
- Labor, Materials, Demand, Time could all be constraints.
What is the general rule concerning Make/Buy decisions? What else should be taken into consideration?
- Buy if can purchase at a cheaper price (must consider fixed costs and how they will be affected). Make if can make more cheaply, or for other qualitative reasons.
- Other considerations: Quality, Cost, Guest perception.
What is the general rule for determining whether to Sell or Process further? (Joint Costing)
Ignore joint costs incurred up until the split off! Only look at Net Realizable Value for each product both at split off and if process further! Only consider additional costs to process further when making decision.
What are some considerations taken into account when making Regular Pricing Decisions?
Target profit, how much customers will pay, and how the market dictates the price of the product. (ie. Price Setters vs. Price Takers)