PERFORMANCE MANAGEMENT

Exam format
• Computer-based Examination
• Time:
- 10 minutes reading time
- 3 hours + 20 minutes
• Types of question
- Objective test questions: 15 questions x 2 mark
- Objective test case questions: 3 cases x 5 OT question x 2
mark
- Constructed response questions: 2 cases x 20 marks
(decision making, budgeting, performance measurement)
 PART A

SPECIALIST COST AND

MANAGEMENT ACCOUNTING
TECHNIQUES
 Chapter 1.
ACTIVITY BASED COSTING
RECAP OF ABSORPTION COSTING
 RECAP OF ABSORPTION COSTING

• Possible bases of absorption:

• Percentage of direct material cost
• Percentage of direct labor cost
• Percentage of prime cost
• Rate per machine hour
• Rate per direct labor hour
• Rate per unit
• Percentage of a factory cost (for admin overhead)
• Percentage of sales (for sales overhead)
 RECAP OF ABSORPTION COSTING
• A blanket OAR is an absorption rate used
throughout a factory and for all jobs and units
of output irrespective of the department in
which they were produced
• A departmental OAR is a separate absorption
rate for each department
 RECAP OF ABSORPTION COSTING
Feature:
• Manufacture produced narrow range of
products
• Product: similar operations and similar
proportions of overheads
• Direct cost accounted for the largest
proportion of total costs (overhead costs were
only a small fraction of production costs)
 Activity based costing
Reasons for the development of ABC
• Information technology more developed
• Overheads become larger proportion of total
production cost
• Direct labor may account for small proportion of
production cost
• Wider range and more complex of products
• Many resources used in non-volume related support
activities due to advanced manufacturing technology
 Activity based costing
Definition:
Method involves identifying the costs of the main support activities
and the factors that ‘drive’ the costs of each activity Support
overheads are charged to products by absorbing cost on basis of the
product’s usage of the factor driving the overheads
Major ideas:
• Activities cause costs
• Manufacturing products creates demand for the support activities
• Costs are assigned to a product on the basis of the product's
consumption (usage) of these activities
 Activity based costing
Traditional absorption costing assigns a large share of overhead to large volume items
and small share to small volume items

In high-technology production and in service operations there are many “support”

activities that are not related to output

Activities cause costs

The costs of an activity are caused or driven by factors known as cost drivers

The costs of an activity are assigned to products on the basis of the number of cost
drivers
 Activity based costing
Calculating product costing using ABC
• Step 1: Identify an organisation’s major activities (support
manufacture of products or provision of services)
• Step 2: Identify factor cause the cost of activities (cost drivers)
• Step 3: Collect cost of each activity in to cost pool
• Step 4: Charge support OH to products on the basic of their
usage of the activity.
ABC absorption rate = Cost pool/Total number of activity or cost
driver
Allocate overhead cost = ABC absorption rate x Activity consumed
Product’s usage of an activity is measured by the quantity of the
activity’s cost driver it generates
 Activity based costing
• Activity is the series of tasks performed in
harmony for which customers are willing to
pay.
• Cost driver is the reason for performing an
activity and therefore, reason for cost
associated with activity.
• Cost pool is the group of all costs related to
particular activity.
 Activity based costing
Production No. of production
OAR
set up costs set ups

Machine oil
No. of machine
& machine OAR
hours
repairs

Supervisor’s No. of labour hours

OAR
Salary

COST POOLS COST DRIVERS

 Activity based costing
Suppose that Cooplan manufactures four products: W, X, Y and Z. Output and cost data
for the period just ended are as follows.

Direct labour cost per hour is $5. Overhead costs are as follows.

Required
Calculate product costs using the following approaches.
(a) Absorption costing
(b) ABC
 Activity based costing
Solution
Using a conventional absorption costing approach and an absorption rate for
overheads based on either direct labour hours or machine hours, the product
costs would be as follows.

* $30,800 / 440 hours = $70 per direct labour or machine hour

Using activity based costing and assuming that the number of production runs is the cost
driver for set-up costs, production and scheduling costs and materials handling costs and
that machine hours are the cost driver for short-run variable costs, unit costs would be as
follows.
 Activity based costing

Workings
1 $3,080 / 440 machine hours = $7 per machine hour
2 $10,920 / 14 production runs = $780 per run
3 $9,100 / 14 production runs = $650 per run
4 $7,700 / 14 production runs = $550 per run
 Activity based costing

The figures suggest that the traditional volume-based absorption costing system is
flawed.
(a) It underallocates overhead costs to low-volume products (here, W and X with ten
units of output) and overallocates overheads to higher-volume products (here, Z in
particular).
(b) It underallocates overhead costs to less complex products (here, W and Y with just
one hour of work needed per unit) and overallocates overheads to more complex
products (here, X and particularly Z).
 Advantages of ABC
• More realistic costs.
• Better insight into cost drivers, resulting in better cost control.
• Particularly useful where overhead costs are a significant
proportion of total costs.
• ABC recognises that overhead costs are not all related to
production and sales volume.
• ABC can be applied to all overhead costs, not just production
overheads.
• ABC can be used just as easily in service costing as in product
costing.
 Criticisms of ABC
• It is impossible to allocate all overhead costs
to specific activities.
• The choice of both activities and cost drivers
might be inappropriate.
• ABC can be more complex to explain to the
stakeholders of the costing exercise.
• The benefits obtained from ABC might not
justify the costs.
• Question 1 (6/2015)- Beckley hill (BH)