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1、Author: Collins Qian,Reviewer: Bob Armacost,bc,Cost Accounting,March 1998,Copyright 1998 Bain & Company, Inc.,1,CU7030298IMB,Importance of cost allocation Client example Definitions direct vs. indirect, fixed vs. variable breakeven volume Exercises cost allocation breakeven volume Key takeaways,Agen
2、da,2,CU7122397ECA,Importance of cost allocation Client example Definitions direct vs. indirect, fixed vs. variable breakeven volume Exercises cost allocation breakeven volume Key takeaways,Agenda,3,CU7122397ECA,Which products are profitable? What is the breakeven volume by product? Which products re
3、quire cost reduction efforts? How should we price our products? Which customer segments are most profitable?,It is critical to have accurate and complete cost data to make sound strategic and tactical management decisions.,Why Allocate Costs?,4,CU7122397ECA,Historically, only 20% of manufacturing co
4、sts were “shared” across product lines. Today, typically 50% of costs are “shared” across products. Shared costs might include rent, freight, and administrative costs. For simplicity, accounting tracks costs by function (e.g., materials, salaries, benefits) rather than by the activity devoted to pro
5、duct lines (e.g., maintenance of product A, freight for product B) For costs that are not easily assigned to individual product lines, companies normally select the most convenient way to assign them, not necessarily the best way for example, companies tend to allocate rent costs based on something
6、that is easy to measure, such as direct labor dollars for each product line. A better allocation method, however, might be the actual space resource demands of each product line,Most companies lack accurate cost data by product.,Why Costs Are Often Not Allocated Correctly,5,CU7122397ECA,Importance o
7、f cost allocation Client example Definitions direct vs. indirect, fixed vs. variable breakeven volume Exercises cost allocation breakeven volume Key takeaways,Agenda,6,CU7122397ECA,Middle America Manufacturing, a Bain client, believed that all three of its product lines were profitable.,Return on sa
8、les:,10.0%,2.4%,1.6%,Sales:,$250MM,$100MM,$75MM,Middle America Manufacturing - Estimated Profitability,7,CU7122397ECA,After a thorough evaluation, the Bain team found that $8.0MM in costs had been allocated incorrectly among the three products.,Middle America Manufacturing - Cost Allocation,8,CU7122
9、397ECA,The Bain team also determined that an additional $18.8MM in costs should be allocated to the three products.,Middle America Manufacturing - Additional Costs,9,CU7122397ECA,Bains analysis indicated that both bicycles and walking mowers were unprofitable. Middle America then began to investigat
10、e whether to exit or fix these two businesses.,Return on sales:,7.2%,(3.0%),(6.9%),Sales:,$250MM,$100MM,$75MM,Middle America Manufacturing - Actual Profitability,10,CU7122397ECA,Importance of cost allocation Client example Definitions direct vs. indirect, fixed vs. variable breakeven volume Exercise
11、s cost allocation breakeven volume Key takeaways,Agenda,11,CU7122397ECA,Definitions:,Costs that do not vary directly with changes in output,Costs that vary directly with changes in output,Costs incurred directly in the production or delivery of a firms product or service. These costs can easily be i
12、dentified with, or assigned to, a particular product,Costs generally incurred by the firm outside of the production process. These costs cannot easily be identified with, or assigned to, a particular product,All costs can be broken down along two dimensions.,Fixed,Variable,Direct,Indirect,vs.,vs.,Ex
13、amples:,Equipment depreciation Rent Advertising,Raw materials Production labor Delivery costs,Direct labor Dedicated equipment Raw materials,SG&A Office supplies Plant manager,Rule of thumb:,If a particular cost changes when production increases or decreases, the cost is variable.,If a particular co
14、st “goes away” when a product is dropped from the product line, the cost is direct.,Types of Costs,12,CU7122397ECA,All costs are variable over a very long time horizon (i.e., for very large increases in volume) Costs to run and maintain a computer system that tracks product orders are clearly fixed
15、for a small change in volume, such as that associated with a slightly busy month. However, they are variable for a large change in volume, such as that associated with a new plant. Most costs are semi-variable (i.e., they tend to be added in lumps as volume increases) Supervisory labor tends to be c
16、onsidered fixed because it is unlikely that additional supervisors would have to be added to handle a small increase, say 10%, in volume. But the workforce can only increase so much before an additional supervisor is needed. In theory, production labor is variable. However, in many client situations, restraints placed by unions and difficulty in hiring and firing people in response to short-term volume fluctuations make it, in practice, semi-variable.,Defining the appropriate ti
