Absorption Costing vs.

Variable Costing:

Absorption Costing: This method includes all the costs associated with the manufacturing of a
product. It involves allocating all of the direct costs associated with manufacturing a product to
the cost of goods sold (COGS). This includes any variable costs directly associated with
manufacturing, such as the cost of raw materials and hourly cost of labor. Absorption costing
also entails allocating fixed overhead costs to all units produced for an accounting period. [1]

Variable Costing: This method includes only the variable costs directly incurred in production
and none of the fixed costs. Variable costing includes all of the variable direct costs in COGS but
excludes direct, fixed overhead costs. Variable costing can provide a clearer picture of per-unit
cost and inventory value because it excludes the fixed overhead cost. [1]

Contribution Margin vs. Segment Margin:

Contribution Margin: This is the amount remaining from sales revenue once all variable costs
have been removed. It is the difference between a company’s sales and variable expenses. [2]

Segment Margin: This is the margin available after a segment has covered all of its costs. It’s one
of the best ways to determine the long-term profitability of a segment. It is calculated as segment
revenues minus variable costs minus avoidable fixed costs. The segment margin is what remains
after deducting traceable fixed costs from the contribution margin. [2]

The process of JIT inventory management helps to minimize total inventory costs:

Advances in technology have contributed to shorter life cycles for products, and product
diversity has increased. These competitive pressures have led many firms to abandon the EOQ
model in favor of a just-in-time (JIT) approach. [3] JIT inventory management helps minimize
total inventory costs by reducing the amount of inventory that is stored and maintained.
Inventory costs include ordering costs, holding costs, and shortage costs. Ordering costs are the
expenses associated with placing and receiving orders from suppliers. Holding costs are the
expenses associated with storing and maintaining inventory, such as rent, insurance,
depreciation, and spoilage. Shortage costs are the opportunity costs of not having enough
inventories to meet demand, such as lost sales, customer dissatisfaction, and production delays.
By ordering inventory only when it is needed, JIT reduces ordering and holding costs, as well as
the risk of obsolescence and waste. JIT also reduces shortage costs by improving the efficiency
and quality of production and delivery processes. [4]
References:

[1] Absorption Costing vs. Variable Costing: What's the Difference?.

https://www.investopedia.com/ask/answers/052515/what-are-differences-between-absorption-
costing-and-variable-costing.asp.

[2] Segment Margin differs from Contribution Margin - Explain - QS Study.

https://qsstudy.com/segment-margin-differs-contribution-margin-explain/.

[3] Text book page 335.

[4] https://www.forbes.com/advisor/business/just-in-time-inventory/
  Value of Activity-Based Customer Costing (ABC): ABC is a costing method that assigns
overhead and indirect costs to related products and services. This accounting method
recognizes the relationship between costs, overhead activities, and manufactured
products, assigning indirect costs to products less arbitrarily than traditional costing
methods. ABC enhances the reliability of cost data, producing nearly true costs and better
classifying the costs incurred by the company during its production process. It is used to
get a better grasp on costs, allowing companies to form a more appropriate pricing
strategy. [1]
 ABC and Identifying Low-Cost Suppliers: ABC can help a firm identify its true low-cost
suppliers by providing a more accurate and detailed understanding of how resources are
used and costs are incurred. [2] It allows businesses to make more informed decisions
about which products to produce or find cheaper methods of production. [3]

Driver Analysis in Process-Value Analysis: Driver analysis, also referred to as root as cause
analysis, seeks to identify why activities are performed. It is part of process value analysis, which
emphasizes activity management with the intent of maximizing system-wide performance.
Driver analysis helps managers understand different ways to carry out certain important activities
efficiently and discard activities that do not generate customer value. [4]

Value-Added and Non-Value-Added Activities: Value-added activities are all actions that
produce actual value for your customers. Such actions move your product or service one step
closer to satisfying your customer’s expectations. Non-value-added activities are everything a
customer would not be willing to pay for, hence they bring waste (inefficiencies) to your process.
However, there is a third category of activities called "non-value-added but essential" or
"business value-adding activities". These activities are non-value adding from the customer's
perspective but are necessary for the business. [5]

Cost Reduction Activity management carries with it the objective of cost reduction.
Competitive conditions dictate that companies must deliver customer desired products on time
and at the lowest possible cost. These conditions mean that an organization must continually
strive for cost improvement. Activity management can reduce costs in four ways: [6]

1. Activity Elimination: Activity elimination focuses on non-value-added activities.

Once activities that fail to add value are identified, measures must be taken to rid the
organization of these activities. For example, the activity of inspecting incoming parts
seems necessary to ensure that the product using the parts functions according to
specifications. Use of a bad part can produce a bad final product.
 2. Activity Selection: Activity selection involves choosing among different sets of activities
that are caused by competing strategies. Different strategies cause different activities.
Different product design strategies, for example, can require significantly different
activities. Activities, in turn, cause costs. Each product design strategy has its own set of
activities and associated costs. All other things being equal, the lowest-cost design
strategy should be chosen. In a continual-improvement environment, redesign of existing
products and processes can lead to a different, cheaper set of activities. Thus activity
selection can have a significant effect on cost reduction.
3. Activity Reduction: Activity reduction decreases the time and resources required by an
activity. This approach to cost reduction should be primarily aimed at improving the
efficiency of necessary activities or a short-term strategy for improving non-value-added
activities until they can be eliminated. Setup activity is a necessary activity that is often
cited as an example for which less time and fewer resources need to be used. Finding
ways to reduce setup time—and thus lower the cost of setups—is another example of the
concept of gradual reductions in activity costs.
4. Activity Sharing: Activity sharing increases the efficiency of necessary activities by
using economies of scale. Specifically, the quantity of the cost driver is increased without
increasing the total cost of the activity itself. This lowers the per-unit cost of the cost
driver and the amount of cost traceable to the products that consume the activity. For
example, a new product can be designed to use components already being used by other
products. By using existing components, the activities associated with these components
already exist, and the company avoids the creation of a whole new set of activities.

References:

[1] Activity-Based Costing (ABC): Method and Advantages ... - Investopedia.

https://www.investopedia.com/terms/a/abc.asp.

[2] Activity-Based Costing: Pros, Cons, and Examples - Circuit.

https://getcircuit.com/teams/blog/activity-based-costing.

[3] Value Added vs. Non Value Added Activities & Necessary Waste? - Kanbanize.
https://kanbanize.com/blog/value-adding-vs-non-value-adding-activities.

[4] 4 Cost Control Measures That Will Help Your Company - Robert Half.
https://www.roberthalf.com/us/en/insights/management-tips/4-cost-control-measures-you-cant-
live-without.
[5] Activity-Based Costing (ABC): Definition, Example & Process - FreshBooks.
https://www.freshbooks.com/en-gb/hub/accounting/activity-based-costing.

[6] Text book page 286.