COSTING CONCEPTS

Laura HamrickJoe HepworthKenneth HolmesBeygum KahnPeter Kelleher

Professor Jason CadeApplied Management AccountingColorado Technical University

EEC Potential Costing Methods

• Full Costing/ Absorption Costing• Variable Costing• Target Costing• Life-Cycle Costing• Activity-Based Costing

Full Costing/Absorption Costing

Accumulates fixed and variable costs associated with a production process and portions them out to individual products in inventory.

Used to record the value of inventory in financial statements.

Full Costing/Absorption Costing Benefits

Allows the product to absorb the full range of fixed and variable costs into the overhead.

Costs are not seen as expenses, and they remain in inventory as assets until the inventory is sold; at that point, they are charged to the cost of goods sold.

Allows overhead accounts to absorb heavy or unexpected production costs until the volume ratchets up.

How EEC Would Apply Full CostingProject and Forecast EEC’s allocation

of funds to cover the variable and fixed costs that comprise the manufacturing overhead. The costs’ valuation will remain in the inventory until the products are sold.

Over absorb materials’ rising cost during peak demand periods and under absorb ebbing material cost during low demand periods.

Variable Costing

Separates the fixed costs from variable costs.

Fixed costs are expensed as a period cost.

Only the variable manufacturing costs are captured in the product cost.

Variable Costing Potential BenefitsEase of use for managementAide in decision making for production

levelProvides contribution marginAssists with management

performance.

How EEC Would Apply Variable CostingUse this method for high volume

productionUse the contribution ratio as decision

making toolAdjust production levels based on

contributionFocus on sales of products to match

the production levels

Target Costing

Target costing ◦ Determines the market price requirement, then

subtracts the target profit to arrive at the target cost, then develops a prototype that can be profitably made for the maximum target cost.

◦ Formula for Target Costing Anticipated selling price – Mandated profit

Industries most applicable for◦ Companies that compete by continually issuing a

stream of new or upgraded products into the market place (consumer goods).

◦ Target costing is an excellent tool for planning a suite of products that have high levels of profitability.

Target Costing Potential Benefits

Achieve greater cost efficiencyProactive approach to cost

managementOrients ECC toward its customersBreaks down department barriersFoster’s employee awareness and

empowermentFoster partnerships with suppliersEncourages production of cost

effective productsReduced time to marketImproves global competitiveness

How EEC Would Apply Target CostingConduct researchCalculate maximum costDetermine target costEngineer the productOngoing activitiesShelf if necessaryMore precise review approach

Life-Cycle Costing

Tracks, analyzes, and interprets the costs occurred over a product’s life time

Products tend to have -◦ High costs in their earlier phases (Development,

Intro, Growth)◦ Low costs as product nears end of life-cycle

(Maturity & Decline)Phases of Life-Cycle Costing

◦ Development◦ Introduction◦ Growth◦ Maturity◦ Decline

Life-Cycle Costing Potential BenefitsPlanning / ForesightBetter grasp of product expectationAware that new product development

will be neededKeeps companies relevant in the

market & industryIncreased advertisingBetter budgetingIncrease in research and development

How EEC Would Apply Life-Cycle Costing

Develop new products while previous products are in early introduction phase

Modifications to current products in order to increase sales revenues and profit

Budget for product advertisementConduct consumer surveys of

popularity of productUnderstand when life-cycle begins to

dropUnderstand need for new innovation in

timely manner

Activity-Based Costing

Assigns costs to activities based on the resources used in the production process

Direct approach to allocating overhead costs in the production process

Two Stages of Allocation◦ Allocation to Activities◦ Allocation to Production

Activity-Based Costing Benefits

More accurate costing of products/services, customers, SKUs, distribution channels.

Better understanding overhead.Easier to understand for everyone.Utilizes unit cost rather than just total cost. Integrates well with Six Sigma and other continuous

improvement programs.Makes visible waste and non-value added activities.Supports performance management and scorecardsEnables costing of processes, supply chains, and

value streamsActivity Based Costing mirrors way work is doneFacilitates benchmarking”

Identify activities in the production processClassify each activity according to the cost

hierarchy Identify and accumulate total costs of each activity Identify most appropriate cost driver or each activityCalculate total units of the cost driver relevant to

each activityCalculate the activity rate Apply the cost of each activity to product base

How EEC Would Apply Activity-Based Costing

CONCLUSIONBased on the five costing methods target costing is the best approach:• Target costing is most appropriate• Each product assigned a team and

continually reduces cost and updates the product.

• Price, profit and cost are fixed.• Requires all aspect of production to be

cost efficient.• Makes all departments part of the

process by breaking down department barriers.

• EEC would use market research to develop product line, making them more competitive.

References

Activity-Based Costing - ABC. (2015). Retrieved from Investopedia: http://www.investopedia.com/terms/a/abc.asp

Advantages and disadvantages of variable costing. (2014). Retrieved from Accounting For Management :

http://www.accountingformanagement.org/advantages-and-disadvantages-of-variable-costing/

Ahmed, S. (2014). Advantages, Disadvantages and Limitations of Activity Based Costing (ABC) System. Retrieved from

http://www.accounting4management.com/limitations_of_activity_based_costing.htm

Cade, J. (2015, January 23). Applied Managerial Accounting [live chat]. Retrieved from Colorado Technical University,

ACCT614-1501A-04 : Applied Managerial Accounting: https://campus.ctuonline.edu

Colorado Technical University. (2015). Cost Behavior Patterns and Concepts.{Presentation}Retrieved February 2nd,

2015. From: https://campus.ctuonline.edu/courses/ACCT614/p2/hub1/7376.pdf

Cromwell, J. (2015). What Are the Two Stages of Allocation in Activity-Based Costing? Retrieved from

http://smallbusiness.chron.com/two-stages-allocation-activitybased-costing-34760.html

Farid, S. (2015). Target Costing Approach To Pricing. Retrieved from Accounting4Management.com:

www.accounting4management.com>Costing

References

Johnson, R. (2015). Traditional Costing Vs. Activity-Based Costing. Retrieved from

http://smallbusiness.chron.com/traditional-costing-vs-activitybased-costing-33724.html

Leahy, T. (1998, January 1). The Target Costing Bull's-eye, Part One of a Series/ BPM. Retrieved from

www.businessfinancemag.com./bpm/target-costing-bullseye-part-one-series

Malonis, J. A. (Ed.). (2000). Encyclopedia of Business (2nd ed.). Farmington Hills, MI: Gale Group, Inc.

http://skillport.books24x7.com/toc.aspx?bookid=50321

Management Accounting. (n.d.) What is Life Cycle Costing? Retrieved February 2nd, 2015. From: http://managerial-

accounting.blogspot.com/2012/06/what-is-life-cycle-costing.html

N.A. (2015). Target Costing. Retrieved from AccountingTools.com: www.accountingtools.com/target-costing

Variable costing versus absorption costing. (2014). Retrieved from Accounting For Management :

http://www.accountingformanagement.org/variable-vs-absorption-costing/