Chapter 19 Activity Based And Target Costing
Activity Based Costing <ul><li>Activity based costing (ABC) is an accounting methodology that assigns costs to activities ...
Activity Based Costing <ul><li>Activities  can  be  defined  as  a  named process, function, or task that occurs over time...
Basis Of ABC <ul><li>Identifying major activities and their costs </li></ul><ul><li>Determining the cost drivers </li></ul...
Basis Of ABC <ul><li>Resources  are people and machines. </li></ul><ul><li>Resource drivers  are the measure of the freque...
How To Use ABC? <ul><li>ABC is used to determine the cost and benefits associated with reengineering processes and systems...
Benefits Of ABC  Over Absorption Costing <ul><li>More realistic product costs may be produced, </li></ul><ul><li>Managemen...
Other Concepts Related To ABC <ul><li>Activity Based Management </li></ul><ul><ul><li>It  is  a  systematic  method  of pl...
Other Concepts Related To ABC <ul><ul><li>Activity Based Budgeting </li></ul></ul><ul><ul><li>It is a systematic method of...
Target Costing <ul><li>Target costing is defined as ‘a market-based cost that is calculated using a sales price necessary ...
Traditional Cost System VS Proactive Cost Management System <ul><li>Traditional cost systems were designed in an era of be...
Basics Of Target Costing <ul><li>Most firms define competitors as ‘firms that make things similar to what we make’ which a...
What Is Target Cost? <ul><li>A target cost is the maximum amount of cost that can be incurred on a product and still earn ...
Setting Target Costs <ul><li>Cost Reductions </li></ul><ul><ul><li>Cost reductions are associated with a cost leadership s...
Phases In Target Costing <ul><li>Planning Phase </li></ul><ul><li>Development Phase </li></ul><ul><li>Production Phase </l...
Streamlining The Process <ul><li>Target costing is the true form of  design for cost. </li></ul><ul><li>Value engineering ...
Computing overall target costs <ul><li>Once a target cost has been calculated for a new product, the design team has to di...
Benefits Of Target Costing <ul><li>The process of target costing provides detailed information on the costs </li></ul><ul>...
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Chp 19 ab&tc

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Chp 19 ab&tc

  1. 1. Chapter 19 Activity Based And Target Costing
  2. 2. Activity Based Costing <ul><li>Activity based costing (ABC) is an accounting methodology that assigns costs to activities rather than products or services. </li></ul><ul><li>This enables resources and overhead costs to be more accurately assigned to the products and the services that consume them. </li></ul><ul><li>ABC is based on the principle that ‘products consume activities.’ </li></ul>Management Accounting By Paresh Shah Oxford University Press
  3. 3. Activity Based Costing <ul><li>Activities can be defined as a named process, function, or task that occurs over time and has recognized results. Activities use up assigned resources to produce products and services. Inputs are transformed into outputs under the parameters set by controls performed by the organization’s employees and their tools. </li></ul>Management Accounting By Paresh Shah Oxford University Press
  4. 4. Basis Of ABC <ul><li>Identifying major activities and their costs </li></ul><ul><li>Determining the cost drivers </li></ul>Management Accounting By Paresh Shah Oxford University Press
  5. 5. Basis Of ABC <ul><li>Resources are people and machines. </li></ul><ul><li>Resource drivers are the measure of the frequency and intensity of the demands placed on resources by activity. </li></ul><ul><li>Activities are the processes performed by the people and machine. </li></ul><ul><li>Activity drivers measure the frequency and intensity of the demands placed on activities by cost objects enabling costs to be assigned to cost objects. </li></ul><ul><li>Cost objects are the products and/or services produced. </li></ul><ul><li>Cost drivers are the factors that affect the cost of an activity, e.g. poor quality.   </li></ul>Management Accounting By Paresh Shah Oxford University Press
  6. 6. How To Use ABC? <ul><li>ABC is used to determine the cost and benefits associated with reengineering processes and systems. </li></ul><ul><li>This cost and benefit analysis will then become part of the overall business case for the project. </li></ul><ul><li>ABC approach will account for </li></ul><ul><ul><li>Activities or processes </li></ul></ul><ul><ul><li>Frequency and cost of the activity </li></ul></ul><ul><ul><li>The do-nothing scenario </li></ul></ul><ul><ul><li>Which process provides value </li></ul></ul><ul><li>Determine cost drivers for activities </li></ul><ul><li>Estimate application rates for each activity driver </li></ul><ul><li>Applying costs to products </li></ul>Management Accounting By Paresh Shah Oxford University Press
  7. 7. Benefits Of ABC Over Absorption Costing <ul><li>More realistic product costs may be produced, </li></ul><ul><li>Management will be more aware of the link between activity and cost behaviour </li></ul><ul><li>Cost reduction activities are more likely to be successful </li></ul><ul><li>It may become apparent that costs are not driven solely by output volumes </li></ul><ul><li>It facilitates the preparation of an activity-based budget </li></ul><ul><li>It helps in decision-making. </li></ul><ul><li>Identification of non-value adding activities helps the management to control cost. </li></ul>Management Accounting By Paresh Shah Oxford University Press
  8. 8. Other Concepts Related To ABC <ul><li>Activity Based Management </li></ul><ul><ul><li>It is a systematic method of planning, controlling, and improving labour and overhead cost. ABM is based on the principle activities consume costs . </li></ul></ul><ul><li>Activity Accounting </li></ul><ul><li>It is a system that defines and reports the activities, costs, activity, characteristics, and outputs of each department, cost center, or group of employees in an organization. </li></ul>Management Accounting By Paresh Shah Oxford University Press
  9. 9. Other Concepts Related To ABC <ul><ul><li>Activity Based Budgeting </li></ul></ul><ul><ul><li>It is a systematic method of planning and budgeting the resources of an organization. In essence, ABB is activity accounting in reverse, e.g. start ABB at the bottom of the activity accounting spreadsheet. Define the cost per output target and planned activity workloads to determine headcount and expense budgets. </li></ul></ul>Management Accounting By Paresh Shah Oxford University Press
  10. 10. Target Costing <ul><li>Target costing is defined as ‘a market-based cost that is calculated using a sales price necessary to capture a predetermined market share.’ </li></ul><ul><li>Business entities need to stand on their feet, to eliminate inefficiencies, cut down costs and improve productivity. </li></ul><ul><li>Fittest will survive. </li></ul>Management Accounting By Paresh Shah Oxford University Press
  11. 11. Traditional Cost System VS Proactive Cost Management System <ul><li>Traditional cost systems were designed in an era of benign environment, when product life cycles were long. </li></ul><ul><li>In those days, when competition was not as keen, most price decisions were based on cost-plus pricing </li></ul><ul><li>Proactive cost management system puts emphasis on resources consumed in performing the organization’s significant activities. </li></ul><ul><li>This emphasis, sometimes called activity accounting </li></ul><ul><li>Traditional cost system utilizes a single basis </li></ul><ul><li>Rather than relying on a single basis to distribute costs, ABC assigns costs to activities and product based on how the costs (resources) are actually consumed by the process or product </li></ul>Management Accounting By Paresh Shah Oxford University Press
  12. 12. Basics Of Target Costing <ul><li>Most firms define competitors as ‘firms that make things similar to what we make’ which are the producers’ view of competition. </li></ul><ul><li>In target costing, competitors are defined from the customers’ perspective: ‘I am about to make a purchase, so what are my options?’ </li></ul><ul><li>Target costing is a cost-management technique that lets a firm manage its costs by determining how much customers are willing to pay for a product </li></ul><ul><li>Product strategy defines the customers that a firm wants to target, the features that these customers want in the product, and the prices they are willing to pay for each feature and for the product as a whole. </li></ul>Management Accounting By Paresh Shah Oxford University Press
  13. 13. What Is Target Cost? <ul><li>A target cost is the maximum amount of cost that can be incurred on a product and still earn the required profit margin from that product. </li></ul><ul><li>Target Cost = Sales Price – Desired Profit </li></ul>Management Accounting By Paresh Shah Oxford University Press
  14. 14. Setting Target Costs <ul><li>Cost Reductions </li></ul><ul><ul><li>Cost reductions are associated with a cost leadership strategy </li></ul></ul><ul><li>Cost Adjustments </li></ul><ul><ul><li>Cost adjustments are associated with differentiation and time-to-market strategies. </li></ul></ul>Management Accounting By Paresh Shah Oxford University Press
  15. 15. Phases In Target Costing <ul><li>Planning Phase </li></ul><ul><li>Development Phase </li></ul><ul><li>Production Phase </li></ul>Management Accounting By Paresh Shah Oxford University Press
  16. 16. Streamlining The Process <ul><li>Target costing is the true form of design for cost. </li></ul><ul><li>Value engineering consists of generating ideas for cost reduction without compromising the features or extending the development period of the product. </li></ul><ul><li>Computing overall target costs </li></ul><ul><li>Making it work </li></ul><ul><li>Calls for business process reengineering </li></ul>Management Accounting By Paresh Shah Oxford University Press
  17. 17. Computing overall target costs <ul><li>Once a target cost has been calculated for a new product, the design team has to divide it up among the product’s various functions. How much can the team spend on one function as against all the others? </li></ul><ul><li>For target costing to succeed, targets must not only be valid, managers must also see them as valid. The market analysis that yields the target prices, the financial analysis that generates the target costs, and the segregation procedures that allocate costs among components and sub- assemblies – all must be trusted. The target-costing process must, therefore, be highly transparent. </li></ul>Management Accounting By Paresh Shah Oxford University Press
  18. 18. Benefits Of Target Costing <ul><li>The process of target costing provides detailed information on the costs </li></ul><ul><li>Target costing reduces the development cycle of a product. </li></ul><ul><li>The internal costing model, using ABC, can provide an excellent understanding of the dynamics of production costs </li></ul><ul><li>The profitability of new products is increased by target costing </li></ul><ul><li>Target costing is also used to forecast future costs </li></ul>Management Accounting By Paresh Shah Oxford University Press
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