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1(a) For below table, please fill up the following values

(i)   Overhead per cost driver unit

(ii)  Total Overhead per product per activity

(iii) Cost per item

Question

1(b): What is a cost driver unit, what do you understand by the term “cost driver unit”. Give an example for each activity listed in the above table.

SUGGESTED SOLUTION:

Part 1(a) is a simple illustration to identify all of the steps necessary to do the numerical part of an ABC question.

Answer 1(b)

A cost driver is “an activity which generates cost”, such as number of quality inspections, or number of deliveries. The cost driver unit, therefore is one inspection, one delivery and so forth. Hours or weight may be cost driver units, depending upon the cost driver in question

Examples for each of the activities in the table are as follows:

Activity                                Possible cost driver unit

Machinery set-ups              Number of set-ups

Material handling                Kilograms of material handled

Quality control                    Inspection hour

Supervision                        Number of work teams

Maintenance                      Maintenance staff hours

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Business or Corporate Strategy Using The Bolton Group Consulting Matrix

The Bolton Consulting Group (BCG) matrix is a model which basically enables one to plan for strategies at each stage at which an individual product-market is perceived be in terms of market growth and the firm’s relative strength (market share).

Before going further, let’s look at the features of this BCG matrix.

The BCG matrix focuses on the following two variables and four quadrant/category/area: ( see above picture)

TWO VARIABLES AND FOUR QUADRANT/CATEGORY/STAGE

The two variables are:

On the vertical scale:-

• Rate of growth of the product-market area which signifies the global indicator of the attractiveness of the market . This rate of growth measure the market attractiveness because of the opportunity that market growth gives for individual business expansion.

On the horizontal scale:-

• Market share in that area held by the firm relative to that of its competitor which summarizes the overall strength the firm in that product-market area relative to its competitor. Note that the relative market share possessed by a firm is not only a measure of the success of an individual business in competition  with other sellers but also indicates the extent of likely benefits to the firm in terms of the increased profitability arising from the lower unit costs and enhanced market power associated with dominant market share.

The four quadrant/categories are( see above picture):

Brief explanation of the characteristic of each quadrant:

Question mark stage

• Products in this category can enjoy a high rate of growth on the basis of the high market growth rate but the firm’s present market share is low.
• At this stage, the firm experiences a competitive disadvantage associated with low market share and a smaller scale of operations than its major competitors combined with the need for large cash injection if it is to keep pace with the overall market growth.

Star stage

• Products in this category can enjoy a high rate of growth on the basis of the high market growth  rate and also the cost advantages associated with increased scale and growth
• At this stage, profitability is likely to be high, but at the same time cash flow requirements will also be great because of the high market growth rate.

Cash Cow stage

• As the product market itself reaches maturity or the plateau of the product, the life-cycle, Star products become Cash Cows.
• At this stage, profitability continue and because of the relative absence of new investment requirements cash flow should be strongly positive.

Dog stage

• Market areas in which the firm is not one of the leaders and in which the market as a whole is not expanding
• The firm here suffers from twin diadvantages of operating at a low level of output and likely to be at a cost disadvantage in comparison with the market leader, combined with minimal growth in the market.

[ Click here for Part 2 re: Strategies At Each Stage Of The Bolton Consulting Group Matrix (Part2) ]

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(a) Computation of the activity based overheads

Step 1: Compute cost per unit of cost driver

= Cost pool / cost driver volume

Step 2: Compute the volume of cost drivers consumed by Product XX

Step 3: Compute the Activity Based Overheads cost for Product XX

(b) Computation of budgeted overheads costs for Product XX using absorption costing

Budgeted overheads

=($75,000+$96,000+$112,000+$70,000+$150,000)

=$503,000

Budgeted absorption cost/machine hour

=$503,000/50,000

=$10.06

Budgeted machining hours for Product XX=1,500

Budgeted absorbed overhead

=1,500 x $10.06

=$15,090

© Ways in which the company can reduce the ABC for product XX:

• Reduce the number of batches by increasing the batch size which will then reduce the setting overhead, materials handling and inspection costs.
• Reduce the number of purchase orders
• Innovate ways of speeding up production so that the machining hours are reduced.

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The following are Product XX’s data for next year budget:

Required:

(a) Calculate the budgeted overhead costs using activity based costing principles

(b) Calculate the budgeted overhead costs using absorption costing (absorb overhead using machine hours)

(c) How can the company reduce the ABC for Product XX

[Refer Answer]

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Data as follows:

Annual Budgeted overheads as follows:

Required:

(a) Calculate the activity based costs and profits for each contract

(b) Calculate the profit for each job using Absorption costing. Absorb overheads using moulding hours.

[Refer Answer]

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Why is then the  necessity to know the “true” cost of a product?

Some of the reasons includes the following:

• To identify money makers/money losers;
• To finding an economic break-even point;
• To compare different options;
• To discover opportunities for cost improvement;
• To prepare and actualize a business plan and
• To improve strategic decision making.

Interestingly, the aforesaid “true” products( e.g. total manufacturing costs) have only a minor importance in final market price determination which are more dependent on competitions and customer value.

Append below an illustration of a scenario on both Traditional Cost Accounting and Activity based costing:

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In this article, the overview approach is given to implement the activity based costing procedure of a company:

1. First study the organization to identify all those activities which support production. Some of these support activities are inspection, setting up machineries, moving materials around the factory and purchasing materials. Note that support activities need not be single department. An activity may involve several different departments like purchasing materials can involve the Buying Department and the Inspection Department, Legal and Accounting departments. Some departments may carry out several activities for example human resources department may be responsible for recruitment, keeping staff records, industrial relations and training. Another multi-tasking department is the accounts department;
2. Identify the specific costs of each activity ie thse costs which the activity actually causes. Collect the total costs of an activity into a “cost pool” which is similar to a cost centre in an absorption costing system. Note that the activity based cost pool WILL NOT contain any apportioned costs.
3. Find out what causes the value of the cost pool to increase. The factor which cases the value of the cost pool to change is called its ” cost driver”. For example the number of purchase orders goes up, then purchase orders wil be the cost driver. A single unit increase in the quantity of a cost driver will have no effect on costs. However a large and permanent increase in the volume of a cost driver will cause the cost driver in that period.
4. Identify the number of units of each cost driver that are used to make each product and
5. Use the number of units of each cost driver that are used to make each product to attach(attribute) the cost of each activity to products.

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Remember that activity based costing is basically a ” one-step attribution system” as costs are NOT APPORTIONED between activities-the costs of each activity are RELATED DIRECTLY to products. Cost attribution is the process of relating cost to cost centres or cost units using cost allocation or cost apportion.

HOWEVER,

remember that for Absorption costng- it is a MULTI-STEP cost attribution system. Many overhead costs for example a human resource department may be apportioned to overhead cost cntre which are THEN apportioned to production costs centres before being absorbed by products.

AND

Marginal costing MAKES NO ATTEMPT to attribute overhead costs to products.

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