Costing

The official CIMA Terminology defines management accounting as 'the
application of the principles of accounting and financial management to
create, protect, preserve and increase value for the stakeholders of for-
profit and not-for-profit enterprises in the public and private sectors

The official CIMA Terminology defines cost accounting as 'the gathering
of cost information and its attachment to cost objects, the establishment of
budgets, standard costs and actual costs of operations, processes,
activities or products; and the analysis of variances, profitability or the
social use of funds.

A cost centre is a production or service location, a function, an activity or
an item of equipment for which costs are accumulated

ABC is a form of absorption costing, but, rather than
absorbing overheads on a production volume basis, it firstly allocates them to
cost pools before absorbing them into units using cost drivers.
• A cost pool is an activity that consumes resources and for which
overhead costs are identified and allocated. For each cost pool, there
should be a cost driver.
• A cost driver is a unit of activity that consumes resources. An alternative
definition of a cost driver is a factor influencing (or ‘driving’) the level of
cost

Identifying activities
The main activities that consume overhead resources differ from one
type of business to another. A useful approach to identifying suitable
activities within a business is to consider four different categories of
activity or transaction:
• Logistical transactions. These are activities or transactions
concerned with moving materials or people, and with tracking the
progress of materials or work through the system.
• Balancing transactions. These are concerned with ensuring that
the resources required for an operation are available. For example,
the buying department has to make sure that raw materials are
available to meet production requirements.
• Quality transactions. These are concerned with ensuring that
output or service levels meet quality requirements and customer
expectations. Inspections and handling customer complaints are
both examples of quality transactions.
• Change transactions. These are activities required to respond to
changes in customer demand, a change in design specifications, a
scheduling change, a change in production or delivery methods,
and so on

Relevant
Easy to measure

Transaction drivers
Here, the cost of an activity is affected by the number of times a
particular action is undertaken. Examples would include number of set-
ups, number of power drill operations, number of batches of material
received, number of purchase orders, etc.

Duration drivers
In this case, the cost of the activity is not so much affected by the
number of times the action is undertaken as by the length of time that it
takes to perform the action, e.g. set-up costs may not be related to the
number of set-ups so much as to the set-up time, because some
products involve more complicated and time consuming set-ups than
others.

Intensity drivers
In this case, efforts would be directed at determining what resources
were used in the making of a product or service, e.g. rather than
charging all purchase orders with the same cost per order, we might
determine that overseas orders involve more work than home orders
and apply a weighting to the overseas orders to reflect the extra work.

Step 1 Group produciton overheads into activities, according to how they are driven
A cost pool is the grouping of costs relating to a particular activity
which consumes resources and for which overhead costs are
identified and allocated.

Step 2 Identify cost drivers for each activity, i.e. what causes these
activity costs to be incurred.
A cost driver is a factor that influences (or drives) the level of cost.
There may be multiple cost drivers associated with an activity and so
it will be necessary to choose the most appropriate.

Step 3 Calculate a cost driver rate for each activity.
The cost driver rate is calculated in the same way as the absorption
costing OAR. However, a separate cost driver rate will be calculated
for each activity, by taking the activity cost and dividing by the cost
driver information.

Step 4 Absorb the activity costs into the product.
The activity costs should be absorbed by applying the cost driver rate
into the individual products.

Step 5 calculate the full production cost and/or the profit or loss.
Some questions ask for the production cost per unit and/ or the profit
or loss per unit.
Other questions ask for the total production cost and/or the total profit
or loss. Therefore be sure to read the question requirement carefully
before answering.

ABC is a more expensive system to operate than traditional costing, due to the
time involved in collecting the additional information, and so it should only be
introduced when it is appropriate to do so. Activity-based costing could provide
much more meaningful information about product costs and profits when:
• overheads are high relative to direct costs
• products or services are complex
• there is diversity in the product range
• products or services are tailored to customer specifications
• some products or services are sold in large numbers but others are sold in
small numbers

~ Improved accurancy of product costs
~ Better understanding of overhead costs and the factors that drive them
~Fairer allocation of costs to products and services
~ Facilitates better cost control
~ Can be used in complex situations
~ Can be applied beyond production
~ Can be used in service and digital industries

~ Not always relevant
~ Still need arbitrary cost allocations
~ Need to choose appropriate drivers and activities
~ Complex
~ Expensive to operate
~ Not allowed under IAS 2 so have to convert back to absorption costing for financial reports

Digital costing systems use technology to allow them to understand and ‘read’
product designs and plans in order to find the best components to achieve
product goals. They can gather and feed information into manufacturing times
to make the entire operation more efficient, flexible and effective

Real-time up-to-date information

Digital costing systems gather information from the internet in real time. This is
done by linking systems with those of suppliers and marketplaces. This allows
the system to automatically compare prices and suppliers, giving the
organisation access to the cheapest (or best lead times, if that is what is
desired) components available. This can give significant cost savings to the
organisation.

Access to a wider variety of resources
The organisation will have access to more suppliers. This can bring other
benefits (outside of cost savings) such as quicker lead times and access to
more variety of resources. It can also help alleviate scarcity problems for
organisations who face a shortage of resources in the short term.

Reduced operational costs
Although digital costing systems can be expensive to implement when they are
up and running they have low operational costs. Because the process is fully
automated there is no time burden for cost accountants. The time saved by cost
accountants in the long term can vastly outweigh the cost of implementing the
system

Better understanding of costs
Digital costing systems have built in analytics and intelligence capabilities. They
can analyse changes over time, supplier flexibility etc. This can allow
organisations to better understand the changing nature of costs, and provide a
more detailed split of semi-variable costs so that organisation’s better
understand the costs which are truly variable.
These systems allow for the calculation of cost per customer, cost per location
etc. This allows better customer profitability evaluation which can lead into
customer decision making such as offering discounts to particular customers or
setting prices for bespoke products or services

More accurate costing
The organisation will receive better, more up-to-date information on the cost of
its product(s). This will include better knowledge of drivers and absorption of
costs to products. Digital costing systems will automate this process and their
better understanding of cost drivers should result in a more accurate and useful
product cost.
Digital costing allows for a more detailed break-down of overheads with more
personalised cost drivers. This can help in cost control and pricing decisions.
Other organisations may use a system known as target costing. This system is
used when the selling price is less controllable so that profit is very much
dependent on meeting a target cost rather than adjusting selling prices. A digital
costing system can determine whether (and how) a target cost can be achieved
in order to reach a target level of profit.

Improved communication/faster decision making
Digital costing systems are fully integrated systems and make large use of
micro services. For example, the technology might have a micro service that
computes lead times, another that tells the factory manager to make provisions
for the delivery, another that tells the finance department when and who to pay
etc. (The micro services can be built in-house, bought in as off-the-shelf
packages or, for larger organisation, purchased as bespoke, personalised
services from developers). This all happens digitally so that there is much less
bureaucracy and the entire system is quicker, easier and cheaper to operate.

Improved cost control
Standards are being regularly updated, whereas with more traditional systems
the standards would be updated less frequently, resulting in potentially out of
date standards where prices are changing.
Where these standards are used to calculate variances and measure the
performance of managers (such as the procurement or production manager), it
is important for values to reflect current market conditions.
As a result of the standards being real time there should be no planning
variances and any operational variances will arise because the manager is not
acting in accordance with the current environment. For example, instead of
holding a procurement manager responsible for a large price variance based on
an out of date standard, the performance of this manager can be assessed
against the current standard and through detailed information about how, for
example, the cost of the raw material is being controlled over time.