page: 1 - Controlling - CPUT University of Applied Sciences Prof Dr Carsten Berkau, 2010

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1 page: 1 ABC by Carsten Berkau 1.1

2 page: 2 Controlling FH Osnabrück 1.2

3 page: 3 1.3

4 page: 4 Osnabrück 1.4

5 page: 5 (1) FH Osnabrück ( (2) Controlling Department (3) Teaching Controlling (4) EDP (4.1) Case Study (4.2) SAP System R/3 (4.3) SAP System BW (4.4) Planspiel 1.27

6 page: 6 Struktur des Bachelorstudiengangs MASTER Master CFO: Prozess- und Projekt-Ctrl., Strat. Ctrl. mit SEM, Corporate Finance, Financial Management and Accounting, Risk Management, Financial Control mit BW M3: Reporting in Einzel-U. und Konzernen BACHELOR M2: Kostencontrolling und Budgetierung M1: Strategisches und Projektcontrolling Controlling Grundlagen des Controlling und der Kosten- und Leistungsrechnung Rechnungswesen/Accounting (IFRSs und HGB) Rechnungswesen 1 - Propädeutikum 1.28

7 page: 7 Controlling-Website 1.29

8 page: 8 Becoming a CFO (Controlling&Finance in Osnabrück)

9 page: 9 CFO-Master 1.31

10 page: 10 (1) FH Osnabrück ( (2) Controlling Department (3) Teaching Controlling (4) EDP (4.1) Case Study (4.2) SAP System R/3 (4.3) SAP System BW (4.4) Planspiel 1.33

11 page: 11 Cost Accounting System Financial Accounting G/L Accounts Cost Element Accounting Direct Costs Overheads Cost Center Accounting CCe XXX prop. fixed Rate, Variance CCe YYY prop. fixed Calculation Unit costs Profitability Analysis Contribution margin Profit 1.36 Berkau, C.: Activity Based Management. Part 2: ABC-Costing. 2nd edition. Enschede 2001, pg. 13

12 page: 12 SAP Introduction Login and FB

13 page: 13 Contents - Activity based costing vs. traditional ManAcc - Level of ABC costing - Business Process Modelling (BPM) - German prozesskostenrechnung - Software solutions - Case Studies 1.49

14 page: 14 Part (12): Activity Based Costing (ABC-Costing) Costing) 1.50

15 page: 15 Business Example INSTEEL INDUSTRIES INSTEEL INDUSTRIES manufactures concrete reinforcing steel, industrial wire, and bulk nails. The company implemented an ABC system in its manufacturing plant in Andrews, South Carolina, and immediately began using ABC data to make strategic and operating decisions. In terms of strategic decisions INSTEEL dropped some unprofitable products, rises prices on others, and in come cases even discontinued relationships with unprofitable customers. INSTEEL realized that simply discontinuing products and customers does not improve profits. The company needed to either redeploy its freed-up capacity to increase sales or to reduce costs. INSTEEL used its ABC system to identify which new business opportunities to pursue. In terms of operational improvements the ABC system revealed that its 20 most expensive activities consumed 87% of the plant s $21,400,000 in cost. Almost $4,900,000 was being consumed by non-value-added activities. Teams were formed to reduce scrap costs, material handling and freight costs, and maintenance costs. Within on year scrap and maintenance costs had been cut by $1,800,000 and freight costs by $550,000. Overall, non value-added activity costs dropped from 23% to 17% of total costs. 1.51

16 page: 16 ABC System Activity-based costing is a costing method that is designed to provide managers with cost information for strategic and other decisions that potentially affect (1) capacity and therefore (2) fixed as well as (3) variable costs. An ABC system is ordinary used as a supplement to, rather than a replacement for, a company s usual costing system. 1.52

17 page: 17 Further Consideration Traditional absorption costing is designed to provide data for external financial reports. In contrast, ABC is designed to be used for internal decision making. MAIN DIFFERENCES: (1) In ABC nonmanufacturing as well as manufacturing costs may be assigned to products, but only by a cause-and-effect basis (2) Some manufacturing costs may be excluded from product costs (see example CLASSIC BRASS coming up). (3) Numerous overhead cost pools are used, each of which is allocated to products and other cost objects using its own unique measure of activity. 1.53

18 page: 18 Conditions changed In most of the 20 th century cost system design were simple. Only few cost pools (departments) were in use. Overheads were allocated on a labor-hour or machine-hour bases. Labor was a common overhead allocation base because it represented a large component of product costs. Now, these conditions have changed. As a percentage of total cost, direct labor, declined and overhead increased. By using more machines direct labor got replaced by depreciation, from the view of view of cost elements. Companies produce a huge variety of products. Managing and sustaining this product diversity requires to invest in more overhead resources. This requires an ABC system to not distort product cost by too simple cost allocations. 1.54

19 page: 19 Some Definitions DEFINITIONS: (1) Activity An activity is any event that causes the consumption of overhead resources. (2) Activity cost pool An activity cost pool is a bucket in which costs are accumulated that relate to a single activity measure in the ABC system. (3) Activity measure An Activity measure is an allocation bases. The term cost driver is also in use. There are (a) transaction drivers and (b) duration drivers. (4) Levels of activity In an ABC system there are 5 levels of activities related to the reason causing the activity occurrence: (I) unit-level activities, (II) batch-level activities, (III) product-level activities, (IV) customer-level activities, and (V) organization-sustaining activities 1.55

20 page: 20 ABC Model Cost Objects Activities Consumption of resources Cost 1.56

21 page: 21 CLASSIC BRASS Case Study CLASSIC BRASS is a production firm. The company produces 2 products lines for parts for luxury yachts: (1) standard stanchions and (2) custom compass housings. During 20X5 the business made a loss, see I/S provided below for fiscal year 20X5: CLASSIC BRASS INCOME STATEMENT for 20X5 Item [$] [$] Sales ,00 less: Cost of goods sold Direct materials ,00 Direct labor ,00 Manufacturing overhead ,00 ( ,00) Gross margin ,00 less: Shipping and admin expenses Shipping expenses ,00 Marketing expenses ,00 General admin expenses ,00 ( ,00) Net operating income (1.250,00) 1.57

22 page: 22 Steps for Implementing ABC STEPS: (1) Define activities, activity cost pools, and activity measures (2) Assign overhead costs to activity cost pools (3) Calculate activity rates (4) Assign overhead costs to cost objects using the activity rates and activity measures (5) Prepare management reports 1.58

23 page: 23 Cost Flow in CLASSIC BRASS ABC System Direct materials Direct labor Shipping cost Overhead cost (manufacturing and non-manufacturing) 1,810, traced traced traced Customer orders 320, Product design 252, Order size 380, Customer relations 367, Other 490, per order per design per MH 1, per customer Cost objects: products, customer orders, customers unallocated 1.59

24 page: 24 Activities identified CLASSIC BRASS identified the activities below. Note, there is a remaining cost pool. For ABC costing start with less activities to reduce complexity and effort to gather data! ACTIVITY COST POOLS Acitivity cost pool Activity measure Customer orders Number of customer orders Product design Number of product designs Order size Machine-hous Customer relations Number of active customers Other Not applicable 1.60

25 page: 25 Steps for Implementing ABC STEPS: (1) Define activities, activity cost pools, and activity measures (2) Assign overhead costs to activity cost pools (3) Calculate activity rates (4) Assign overhead costs to cost objects using the activity rates and activity measures (5) Prepare management reports 1.61

26 page: 26 Annual Overhead Costs to Cost Pools The ABC team at CLASSIC BRASS ran interviews with the departmental responsibles. No direct labor, direct materials or shipping expenses were assigned to cost pools. CLASSIC BRASS OVERHEADS for 20X5 Item [$] [$] Production department Indirect factory wages ,00 Factory equipment depreciation ,00 Factory utilities ,00 Factory building lease , ,00 General administrative department Administrative wages and salaries ,00 Office equipment depreciation ,00 Administrative building lease , ,00 Marketing department Marketing wages and salaries ,00 Selling expenses , ,00 Total overhead cost ,

27 page: 27 Results of Interviews (8-4) Customer orders Product design Activity Cost Pools Order size Customer relations Other totals Production department Indirect factory wages 25% 40% 20% 10% 5% 100% Factory equipment depreciation 20% 0% 60% 0% 20% 100% Factory utilities 0% 10% 50% 0% 40% 100% Factory building lease 0% 0% 0% 0% 100% 100% General Administrative department Administrative wages and salaries 15% 5% 10% 30% 40% 100% Office equipment depreciation 30% 0% 0% 25% 45% 100% Administrative building lease 0% 0% 0% 0% 100% 100% Marketing department Marketing wages and salaries 22% 8% 0% 60% 10% 100% Selling expenses 10% 0% 0% 70% 20% 100% 1.63

28 page: 28 First Stage Allocations (8-5) Customer orders Product design Activity Cost Pools Order size Customer relations Other totals Production department Indirect factory wages , , , , , ,00 Factory equipment depreciation ,00 0, ,00 0, , ,00 Factory utilities 0, , ,00 0, , ,00 Factory building lease 0,00 0,00 0,00 0, , ,00 General Administrative department Administrative wages and salaries , , , , , ,00 Office equipment depreciation ,00 0,00 0, , , ,00 Administrative building lease 0,00 0,00 0,00 0, , ,00 Marketing department Marketing wages and salaries , ,00 0, , , ,00 Selling expenses 5.000,00 0,00 0, , , ,00 Total , , , , , ,

29 page: 29 Steps for Implementing ABC STEPS: (1) Define activities, activity cost pools, and activity measures (2) Assign overhead costs to activity cost pools (3) Calculate activity rates (4) Assign overhead costs to cost objects using the activity rates and activity measures (5) Prepare management reports 1.65

30 page: 30 Computation of Activity Rates (8-6) Activity cost pools (a) Total cost (b) Total activity (a)/(b) Activity rate Customer orders , orders 320 per order Product design , designs 630 per design Order size , MHs 19 per MH Customer relations , customers 1470 per customer Other ,00 Not applicable Not applicable 1.66

31 page: 31 Steps for Implementing ABC STEPS: (1) Define activities, activity cost pools, and activity measures (2) Assign overhead costs to activity cost pools (3) Calculate activity rates (4) Assign overhead costs to cost objects using the activity rates and activity measures (5) Prepare management reports 1.67

32 page: 32 Product Data STANDARD STANCHIONS: (1) This product line does not require any new design resources (2) 30,000 units were ordered during the year, comprising 600 separate orders (3) Each stanchion requires 35 min of machine time for a total of 17,500 machine hours. CUSTOM COMPASS HOUSING (1) This is a custom product that requires new design resources (2) There were 400 orders for custom compass housings. Orders for this product are paced separately from orders for standard stanchions. (3) There were 400 custom designs prepared. One custom design was prepared for each order (4) Since some orders were for more than one unit, a total of 1,250 custom compass housings were produced during the period. A custom compass housing requires an average of 2 machine hours (MHs) for a total of 2,500 MHs. 1.68

33 page: 33 Assigning Overhead Costs to Products (8-8) 8) Overhead cost for the standard stanchions (a) (b) (a) (b) Activity cost pools Activity rate Activity ABC cost Customer orders 320 per order 600 orders ,00 Product design 630 per design 0 design - Order size 19 per MH MH ,00 Total ,00 Overhead cost for custom compass housing (a) (b) (a) (b) Activity cost pools Activity rate Activity ABC cost Customer orders 320 per order 400 orders ,00 Product design 630 per design 400 design ,00 Order size 19 per MH 2500 MH ,00 Total ,

34 page: 34 Customer Data WINDWARDS YACHTS (1) The company placed a total of 3 orders. (a) Two orders were for 150 standard stanchions per order, (b) one order was for a single custom compass housing unit. (2) A total of 177 machine hours were used to fulfill the tree customer orders. (a) The 300 standard stanchions required 175 machine-hours. (b) The custom compass housing required 2 machine-hours. (3) WINDWARDS YACHTS in one of 250 customers served by CLASSIC BRASS. 1.70

35 page: 35 Assigning Overhead Costs to Customers (8-9) Overhead cost for WINDWARD YACHTS Activity cost pools (a) Activity rate (b) Activity (a) (b) ABC cost Customer orders 320 per order 3 orders 960,00 Product design 630 per design 1 designs 630,00 Order size 19 per MH 177 MHs 3.363,00 Customer relations per customer 1 customer 1.470,00 Total OH assigned to customer 6.423,

36 page: 36 Steps for Implementing ABC STEPS: (1) Define activities, activity cost pools, and activity measures (2) Assign overhead costs to activity cost pools (3) Calculate activity rates (4) Assign overhead costs to cost objects using the activity rates and activity measures (5) Prepare management reports 1.72

37 page: 37 Direct Product Cost Data STANDARD STANCHION (1) Sales 2,660, EUR (2) Direct cost (a) Direct materials (b) Direct labor (c) Shipping 905, EUR 263, EUR 60, EUR CUSTOM COMPASS HOUSING (1) Sales 540, EUR (2) Direct cost (a) Direct materials (b) Direct labor (c) Shipping 69, EUR 87, EUR 5, EUR 1.73

38 page: 38 Product Margins (8-10) Product margins-abc Standard stanchions Custom compass housing Sales , ,00 Costs: Direct materials , ,00 Direct labor , ,00 Shipping , ,00 Customer orders (8-8) , ,00 Product design (8-8) 0, ,00 Order size (8-8) , ,00 Total cost , ,00 Product margin , ,

39 page: 39 Customer Margin (8-11) Customer margin-abc WINDWARD YACHTS Sales ,00 Costs: Direct materials 2.123,00 Direct labor 1.900,00 Shipping 205,00 Customer orders (8-9) 960,00 Product design (8-9) 630,00 Order size (8-9) 3.363,00 Customer relations (8-9) 1.470,00 Total of costs (10.651,00) Customer margin 699,

40 page: 40 Product Margins Traditional Costing System (8-12) Product margins - traditional costing system Standard stanchions Custom compass housing Total Sales Cost of goods sold Direct materials Direct labor Manufacturing overhead ( ) ( ) ( ) Product margin Selling and admin expenses ( ) Net operating income (1.250) 1.76