Cost measuring is crucial for every business

1. MEASURING
COSTS
RIGHT
STRATEGIC
MARKETING
MANAGEMENT
ARTICLE 29
YESIM BALKAYA
FARUK SHABAN

2. INTRO
Miscalculation on margin, cost and profit
will cause to take wrong strategic
decision
Most of accounting system designed for a
few variety of product manufacturing
companies whose majority of cost driven
from direct labor and materials
FOR A COMPANY WHAT ELSE
COULD BE MORE CRUCIAL THAN
MAKING THE WRONG COSTING?

3. ABC - ACTIVITY BASED SYSTEM
ABC aroused to solve blind costing problem by creating wide view
of profitability margin and cost for various product lines.
Contrary to Conventional system, ABC creates reliable cost
system by adjusting variables like changing customer preferences,
design and mix…
All activities like making, marketing and managing support
production and delivery of goods should be considered as product
cost.
THEORY OF ABC

4. DESIGN OF ABC
1) Focus on expensive resources of marketing, distribution, and service costs by
product lines, channels, customers, and regions including demands made on
engineering, product improvement, and process development by their different
products and product lines
2) Look for diversity of product line, processing technologies, customer base,
marketing channels, supplier
3) Focus on resources whose demand are irrelevant with traditional allocation
units such as direct labor, machine hours and materials.

5. RESOURCES ACTIVITIES PRODUCT
ABC PROCESS

6. SOLUTIONPROBLEM
All costs relevant with below departments except
R&D and excess production cost should be
assigned first to activities then to product
Below activities costs can be divided and traced to
individual products
Logistics, Production, Marketing, Sales
Distribution, Service, Technology, Financial
Administration Information Resources, General
Administration
Conventional cost system leads
redundant cost for direct labor hours,
metarials, machine hours for high volume
product concurrently underestimating
cost of low volume product.

7. Accurate data on direct
labor and materials costs
Analyze demands of
particular products on
indirect resources
2 STEPS OF ABC
SYSTEM

8.
Expensive ones that new cost system
could makes huge difference on
Consumption varies more one to
another product
Ones have no relation
with conventional cost measures like
direct labor, machine hours,
production metarials
RESOURCES TO BE
FOCUSED ON

9. Conventional economics and management
accounting treat costs as variable only if they
change in short term in output.
However cost varies with changes over a period
of years in the design, mix, and range of a
company’s products and customers.
ABC system measures product costs by
identifying this complexity.
Globalization made impossible for companies to
survive without sensitive indeed accounting
system lead accurate product cost information
.
Most Company's managers notice the loss after
realizing decreased profitability and
competitiveness
ALERT FOR
MANAGERS

10.
20% of the valves generated 80% of
total revenues
60% of the products generated 99% of
the revenues
Management was enthusiastic about the
40% of its products that generated only
1% of revenues.
According to cost system, these items
had the best gross margins
More than 75% of this company’s
products (mostly the low-volume items)
were losing money
The products that did make money
(fewer than one in four) generated more
than 80% of sales and 300% of net
profits.
HYDRAULIC VALVE COMPANY
BEFORE ABC AFTER

11. cheap & powerful personal computers
spreadsheets
data-base
Companies don’t have
to adopt whole
accounting system
into activity-based
costing!
HOW TO ADOPT
ABC

12. Decisions about pricing,
marketing, product design,
and mix are among the
most important ones
managers make
None of them can be made
effectively without accurate
knowledge of product costs
ADV OF ABC

13. PLANT 1
PLANT 2
PEN PRODUCER
One Year Production: 1 million blue pen One Year Production: 100.000 blue pen
To fill the plant, keep the work force busy, and absorb
fixed costs
60,000 black pens
12,000 red pens
10,000 lavender pens and so on …
Plant II produces up to 1,000 product variations with
volumes ranging between 500 and 100,000 units

14. PLANT 1
PLANT 2
DIFFERENCES OF PRODUCERS
One Year Production: 1 million blue pen
Product cost is less than Plant 2
Higher margin with less production cost
For all activities need much large number of support
staff to schedule machines, perform setups,
inspect incoming materials etc…
Product cost of blue pen is higher than specialty pen.
Low margin on blue pen

15. ALLOCATING COSTS UNDER AN ABC
WITH AN EXAMPLE
Product A
1,000 Units/Year
10 Production Runs
200 Purchased Parts Shipment
50 Raw Material Shipments
1,000 Direct Labor Hours (400,000
Total Factory’s Hours)
Conclusion:
The 230% cost difference between the two systems reflects the fact that the
complex, low-volume Product A demands a much greater share of inventory
control resources than its share of factory direct-labor hours.
1) Labor-Based Allocation System
$500,000/400,000 × 1,000 = $1,250
$1.25 Cost/Unit
2) Activity-Based Allocation System
$10 × 200 + $12.50 × 50 + $25 × 10 = $2,875
$2.88 Cost/Unit

16. BEFORE ABC AFTER ABC
ROI BUMPED UP

17. WHERE DOES ACTIVITY-BASED COSTING STOP?
1st: COSTS OF EXCESS CAPACITY
The cost of excess or idle capacity should be
treated as a separate line item—a cost of the
period, not of individual products.
Otherwise, such a procedure causes product
costs to fluctuate erratically with changes in
assumed production volume and can lead to
the ‘‘death spiral.’’ A downturn in forecast
demand creates idle capacity.
2nd: R&D FOR ENTIRELY NEW PRODUCTS AND LINES
R&D Costs:
1) Relate to improvements and modifications of existing
products and lines. Can and should be traced to the
products that will benefit from the development effort.
Otherwise, the costs will be spread to products and lines
that bear no relationship to the applied R&D program.
2) Relate to entirely new products. Companies engaged
in extensive R&D for products with short life cycles
should measure costs and revenues over the life cycle of
their products. Any periodic assessment of product
profitability will be misleading, since it depends on the
arbitrary amortization of investment expenditures
including R&D.

18. STRATEGIC IMPLICATIONS
1) Once executives are armed with more reliable cost information, they can ponder a
range of strategic options.
-Dropping unprofitable products.
-Raising prices, perhaps drastically.
-Strategic options for high-volume products.
2) Encourage companies to redesign products to use more common parts.
3) Change how managers evaluate new process technologies: A more accurate
understanding of the costs of specialized products may also make computer-integrated
manufacturing (CIM) look more attractive, since CIM is most efficient in high-variety, low-
volume environments.

19. FINAL WORDS...
Activity-based costing is not designed
to trigger automatic decisions.
It is designed to provide more accurate
information about production and
support activities and product costs so
that management can focus its
attention on the products and
processes with the most leverage for
increasing profits.
It helps managers make better
decisions about product design, pricing,
marketing, and mix, and encourages
continual operating improvements.

20. QUESTIONS ?
YESİM BALKAYA FARUK SHABAN
THANK YOU