ch13 Alternative costing principles.pptVIP

CH13 Alternative costing principles Topic list 1. Activity based costing 2. Life cycle costing 3. Target costing Topic1 Activity based costing 1.The assumption of traditional absorption costing Overhead expenditure is connected to the volume of production activity. This assumption was probably valid many years ago, when: (1) Production system were based on labor-intensive or machine-intensive mass production of fairly standard items. (2) Overhead costs were also fairly small relative to direct materials and direct labor costs. The assumption is not valid in a complex manufacturing environment, where Production is based on smaller customised batches of products Indirect costs are high in relation to direct costs A high proportion of overhead activities are not related to production volume 2.What is ABC? Activity based costing is a modern alternative to absorption costing which attempts to overcome the problems of costing in a modern manufacturing environment. The ABC approach is to link overhead costs to the products or services that cause them by absorbing overhead costs on the basis of activities that ‘drive’ costs (costs drivers) rather than on the basis of production volume. Steps of ABC Step1 Identify activities that consume resources and incur overhead costs. Step2 Identify the cost driver for each activity. Step3 Collect the costs of each activity. In this way, each identified activity becomes a cost pool for overhead costs. Step4 Charge support overheads to products on the basis of their usage of the activity. Example: p258 THE assumptions of ABC (1)In the long run, all overhead costs are variable. However, overhead costs do not necessarily vary with production volume or service level. (2) Products incur overhead costs because of the activities in providing the products or services. AND these activities are not necessarily related to the volumes of the product that are manufactured. For example A company manufactures two products, X