Lecture 4

Conventional and Contemporary Costing Systems

Readings on Moodle
Learning Outcomes
Recognise problems associated with
conventional costing system
Identify common indicators of an outdated
costing system
Understand strategic importance of ABM and
ABC
Compare results using conventional and ABC
costing systems
Introduction
Industrial revolution era costing materials,
labour and overhead
Emphasis on cost of goods manufactured,
income determination and inventory
valuation
1970s rise of service sector
Importance of overhead
Better ways of allocating overhead
Traditional costing volume-based cost
drivers
Complex Nature of Overhead
Overhead indirect costs of responsibility
centres
Manufacturing and non-manufacturing
Overhead allocation
Plant-wide rate and departmental rates
Activity rates from one to a few to many rates
Volume as well as non volume drivers
Resources drivers, activity drivers, root cause
drivers
What causes, moves or brings about costs?
Indicators of Outdated Costing
Systems
Distortion of product costs
Cost/driver mismatch
Over/understatement of cost of products
Competitor price differences
Difference in over/under applied overhead
Winning/losing bids
Cost/benefit issues
Volume-Based Drivers and Limitations
Conventional costing overheads vary with
production volume
Outputs number of units produced
Inputs direct labour hours, direct labour
costs, machine hours, quantity of RM used
Non-Volume Based Drivers
Costs across the entire value chain
Product costs
Period costs
Costs at different levels :
unit level costs- volume drivers
batch level costs- non volume drivers
product level costs- non volume drivers
facility level costs- incurred to run the
entity
 Activity-Based Costing
Indicators of out-dated costing systems
Problems with conventional costing systems
Newer developments:
Activity-Based Costing
Activity-Based Management
High take up rate until 1995
Decline thereafter
Activity-Based Costing
A methodology that can be used to
measure both the cost of cost objects and
the performance of activities
Can help solve problems such as
Distorted product costs
Poor cost control
The form of ABC method adopted depends
on the problems that need to be addressed
The ABC Model
ABC System
From plant-wide rate to departmental rates
and then to activity rates
Indirect nature of overhead applied to cost
objects on a pre-determined basis
Over/under applied overhead and adjustment
A segment many activities, different drivers
for activities
Bill of activities
Activity rate = Budgeted activity costs
budgeted driver
 When to Use ABC?
Overhead costs are a significant proportion of
total cost, and a large part of overhead is not
directly related to production volume
The business has a diverse product range, and
an individual products use of support
resources differs from their use of volume-
based cost drivers
Production activity involves diverse batch
sizes and product complexity
Overall benefits exceed costs
 Lecture Illustration

See Handout - Example

Limitations of ABC
Not suitable for all firms
Significant facility level costs
Inadequate resources
Lack of senior management commitment
constraining diffusion
Problems associated with identifying
activities and their drivers
Cultural issues
ABC and Behavioural Issues
Change as threatening and therefore
resistance to change
Complex operations
Need for a multidisciplinary team not just
accountants
Developing a sense of ownership
Summary and Conclusion
Nature of overhead problematic
Overhead now forms major part of the total cost
Conventional costing volume based drivers for
overhead
ABC - non-volume based drivers
ABC identify activity costs, identify cost driver,
calculate activity rate, assign activity costs to products
ABC facilitates better cost management and control,
cause/effect relationship better understood
ABC can bring about a new culture, note resistance to
change
ABC has limitations
Questions?

Thank you for your attention