Controllership

WEEK 11
(Class 19)

Prof. Bianca Quirantes Checon

CLASS 19 (OCTOBER 25)
CVP analysis (V): production constraints
ABC system (I): first concepts
Exercises
Before we start (1)

• October 28 (Saturday, 9 – 10:30 a.m.): monitored activity

as a remote session to cover the first steps of the master
budget.

https://fgv-
br.zoom.us/j/95098043340?pwd=ZllkYUpmSWFKSHpwVXdOVklCOVJGdz
09
Meeting ID: 950 9804 3340
Passcode: 089695
Before we start (2)

• November 17 (Friday, 9 – 10:40 a.m.): remote session due

to FGV’s unified entry exam.

https://fgv-
br.zoom.us/j/95566052510?pwd=Vk4zTUx6ekRmNUIvY01ySnplMlpnZz0
9
Meeting ID: 955 6605 2510
Passcode: 116014
CVP analysis: sales mix and the contribution
margin (Class 18)

• The break-even point analysis

– Excel®: Company AB example (GAR).
SALES MIX AND PRODUCTION
RESTRAINTS
Marginal costing: sales mix and the
contribution margin

• Not having restraints on production resources is a rare

case.
– e.g., restraints on machine-hours, direct labor-hours, raw materials,
and so on...

How can we consider producing resources

restraints on the sales mix decision?
Marginal costing: sales mix and the
contribution margin

• Not having restraints on production resources is a rare

case.
– e.g., restraints on machine-hours, direct labor-hours, raw materials,
and so on...

How can we consider the restraint of

production resources to optimize
the sales mix decision?
Marginal costing: sales mix and production
resources restraint

A: We need to check how much the product

generates of Contribution Margin, but per each
unit of the restrained resource!
Marginal costing: sales mix and production
resources restraint

A: We need to check how much the product generates of

Contribution Margin, but per each unit of the restrained
resource!

Steps:
1. Calculate the Contribution Margin (CM);
2. Divide the CM by the product’s consumption level of the
restrained resource;
3. Prioritize the production of products with the highest CM
computed in (2).
Problem #36

Mato Grosso do Sul S.A. is an industry focused on producing

blankets and quilts. The manufacturing costs are stated as
follows:

Direct labor R$ 170.00/unit

Direct materials R$ 200.00/wool kg
Sales commissions 10% of the selling price
Fixed product costs (80%) and period
costs (20%): R$ 653,000.00
Problem #36

The company assigns fixed costs (both product and period

ones) by the time spent to produce each of the four products
during a one-month period. The most relevant information is
as follows:
Time spent Number of wool kg Number of Selling
Products consumed units produced price
(hours per
unit) (kg per unit) (n) ($ per unit)
Blankets - double 12.0 3.5 12,000 1,500
Quilts - double 11.5 2.8 6,000 1,300
Blankets - single 9.0 2.5 8,000 1,260
Quilts - single 5.0 1.5 4,000 1,000
Problem #36

In February, the company received less 6.000 kg of direct

materials than its January consumption. Thus, it has produced less
units from those products which had the lowest CM per unit.
In both months (Jan & Feb), the company has sold all its finished
goods inventory.

Required:
(a) Calculate how much is the CM considering a no-restraint scenario.
(b) Calculate how much is the CM per restrained direct material. Compare
with the results from (a).
ABC: FIRST CONCEPTS
ABC: first concepts

• Activity-based costing (ABC): designed to provide managers

with cost information for strategic and other decisions that
potentially affect capacity, and, therefore, “fixed” as well variable
costs.

• Companies (ideally) have two costing systems:

(a) For external financial reporting (absorption costing); and
(b) Managerial decision-making (such as the ABC).
ABC: first concepts

• 19th century and most of 20th century: assignment of

overhead costs to products by using overhead rates.

– One plantwide overhead “cost pool” or # departmental

overhead “cost pools” relying on allocation bases such as
machine-hours or direct labor-hours.
ABC: first concepts

Production processes of many years ago were much more

labor intensive than today. Hence, direct labor-hours (or
machine-hours) worked just fine as an allocation base:
- Large component of product costs
- Easily traceable
- Highly correlated with number of units produced and overhead
costs (i.e., “move together”)

+ Low variety on sales mix (assigning overhead costs between

similar products would not generate big distortions)
ABC: first concepts

Production processes of many years ago were much more

labor intensive than today. Hence, direct labor-hours (or
machine-hours) worked just fine as an allocation base:
- Large component of product costs
- Easily traceable
- Highly correlated with number of units produced and overhead
costs (i.e., “move together”)

+ Low variety on sales mix (assigning overhead costs between

similar products would not generate big distortions)
ABC: first concepts

• Nevertheless, as technology evolved, so did production

processes:

- More automated equipment;

- Less direct labor;
- More products sharing the same machines and manufacturing
area.
ABC: first concepts

• Nevertheless, as technology evolved, so did the production

processes:

- More automated equipment;

- Less direct labor;
- More products sharing the same machines and manufacturing
area.
Leads to an increase on overhead costs!

• A more dynamic sales mix generates more overhead costs

(such as production schedulers and design engineers) →
aiming to control indirect costs also creates more indirect costs...
ABC: first concepts

Continuing to rely exclusively on a limited number of overhead

cost pools and traditional allocation bases poses the risk that
reported unit product costs might be distorted.
ABC: first concepts

Continuing to rely exclusively on a limited number of overhead

cost pools and traditional allocation bases poses the risk that
reported unit product costs might be distorted.

Potential solution: assign overhead costs by tracing activities

that CAUSE overhead costs consumption!
Absorption costing, marginal costing, and ABC

• The main difference is how each costing system categorizes and

treats overhead costs:

More accuracy

Absorption costing Marginal costing Activity-based costing

(a) (b) (c)
Absorption costing, marginal costing, and ABC

More accuracy

Absorption costing Marginal costing Activity-based costing

(a) (b) (c)

(a) Assign all manufacturing overhead to products; product

(direct/indirect) vs. period costs.
(b) Assign only variable manufacturing overhead to products; product
(variable) vs. period costs.
(c) Assign overhead that is driven by an activity related to produce a
product; no distinction between manufacturing/nonmanufacturing
costs.
ABC: Assigning costs to products

• Many nonmanufacturing costs relate to selling,

distributing, and servicing specific products.
– In this sense, ABC includes manufacturing and
nonmanufacturing costs when calculating the entire cost of
a product (“cause-and-effect”)!
ABC: Assigning costs to products

• Two types of nonmanufacturing costs are assigned to

products:

(I) DIRECT (e.g., shipping costs and commissions to

salesperson) and
(II) INDIRECT (as long as the products have presumably
caused the costs to be incurred)
ABS: Assigning costs to products

• ABC does not assign two types of manufacturing overhead

costs to products:
– Organization-sustaining costs (e.g., factory security guard’s
salary, plant controller’s salary) → treated as period expenses!

– Unused capacity costs (“idle capacity costs”) → only used

resources are allocated to products!
ABC: main concepts

• Activity: any event that causes the consumption of overhead

resources.

Levels:
(1) Unit-level activities
(2) Batch-level activities
(3) Product-level activities
(4) Customer-level activities
(5) Organizing-sustaining activities
ABC: main concepts

• Activity: any event that causes the consumption of overhead

resources.

Levels:
(1) Unit-level activities
(2) Batch-level activities
(3) Product-level activities
(4) Customer-level activities
(5) Organizing-sustaining activities
ABC: main concepts

• Activity cost pool: “bucket” in which costs are accumulated that

relate to a single activity measure in the ABC system.

• Activity measure (or cost driver): allocation base in the ABC

system.
– How many times an activity occurs (transaction drivers)**
– How long it takes to perform an activity (duration drivers)
ABC: main concepts

Cost objects
(products/customers)

generates...

Activities

Consumption of resources

causes...

Cost
ABC: steps for implementation

(A) Define activities, activity cost pools, and activity measures

(cost drivers)
(B) Assign overhead costs to activity cost pools (1st. stage)
(C) Calculate activity rates
(D) Assign overhead costs to cost objects (2nd. stage)
(E) Prepare management reports
ABC VS. ABSORPTION COSTING
Extra exercise
Extra exercise (ABC)

• Check e-class for Excel

file

• 5 minutes to read the

exercise (we are solving it
together).
For next class (October 27)

• Problems (ABC)
– #42 (Cooper Pen)

• Readings (ABC)
– GAR, Ch. 7

+ Problems (CVP analysis) → to prepare for the final exam

– #34 (outsourcing)
– #35, 37 (export decisions)
– #38 (discountinuation)
– #40 & #41 (variable costing)
 Thank you!
bianca.checon@fgv.br