Module 2A

Develop activity-based costs (ABC)

 Refines the way indirect costs are allocated to
production
 Focuses on costs incurred by each production
activity
 Each activity has its own cost driver

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Activities: Cost Drivers:
Material purchasing ?
Material handling ?
Production scheduling ?
Quality inspections ?
Photocopying ?
Warranty service ?

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 Identify the
Identify each
cost driver for Compute the Allocate
activity and
each activity cost allocation indirect costs
estimate its
and estimate rate for each to the cost
total indirect
the quantity of activity object
cost
each driver

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 ?
Cost
allocation
rate
?

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Allocated activity cost

? ?

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 Activity Budgeted Allocation Estimated Cost
Cost base base allocation
activity rate
Materials $6,000 Number of 3,000 ?
handling parts
Machine 3,300 Number of 20 ?
setup setups
Insertion of 54,000 Number of 3,000 ?
parts parts
Finishing 80,000 Finishing 2,000 ?
direct labor
hours

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Activity Cost Activity per Indirect cost
allocation 1,000 allocated
rate bumpers
Materials $2 per part 3000 parts $6,000
handling
Machine setup $165 per setup 20 setups $3,300
Insertion of $18 per part 3000 parts $54,000
parts
Finishing $40 per hour 2,000 hours $80,000
Total indirect costs allocated to 1,000 bumpers $143,300
Indirect cost for one bumper $?

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Use activity-based management (ABM) to achieve
target costs
 Uses ABC to make decisions that increase profits
while meeting customer needs

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 Reevaluating activities to reduce costs
 Requires cross-functional teams
 Setting sales prices based on target prices

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 Target Pricing Traditional
Cost-based Pricing

Target Sales Price Full product cost

minus plus

Desired profit Desired profit

equals equals

? ?

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Describe a just-in-time (JIT) production system,
and record its transactions
 Materials purchased and goods completed “just in
time” for delivery

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Demand- Receive order from customer
pull
system Schedule production

Defect-free materials are delivered by

suppliers just in time for production

Finished product is delivered to customer

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shaping
smoothing

cutting
grinding Finished Goods

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 Lost sales can occur if materials do not arrive on
time or if the materials are of poor-quality
 Strong relations with quality materials’ vendors are
essential
 Some JIT companies have small inventories of
critical materials

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 Traditional Just-in-time

Recording ? ?
production activity

Inventory accounts ? ?

Manufacturing costs ? ?

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(a) Products produced in large batches Traditional
(b) Large stocks of finished goods protect against lost sales Traditional
(c) Suppliers make frequent deliveries of small quantities of JIT
materials
(d) Long setup times Traditional
(e) Employees do a variety of jobs JIT
(f) Machines are grouped into self-contained in production cells JIT
(g) Machines are grouped according to function Traditional
(h) Suppliers can access the company’s intranet JIT
(i) The final operation in the production sequence “pulls” parts Traditional
from the preceding operation
(k) Management works with suppliers to ensure defect-free JIT
materials

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