Questions
1. Describe the difference between contribution margin and gross margin, and illustrate the difference with an example. From a management perspective, indicate which margin figure would be most useful for product pricing and which would be most useful for overall profit prediction.
2. Compare the assignment of under/over applied overhead costs at year end utilizing the allocation-rate approach, the proration approach, and the write-off approach. Create a numerical example to illustrate the proper handling of each case.
3. Using this week's lecture, describe cost objects, cost drivers (activities), and cost pools and give an example of each that relates to the others. Include a discussion on cost hierarchies and how this relates to the other terms you describe.
Lecture:
ABC costing takes basic cost data generated out of either job costing or process costing systems and attempts to associate direct costs and overhead costs to specific activities performed. The activities, then, are tied to a specific product. Many firms have adopted ABC costing as a way to get more accurate costing of products and/or activities. However, the process is time consuming and can be expensive to implement. It is also not recognized by GAAP, so it is strictly for internal analysis. In short, ABC is all about information for decision making, not for publishing financial statements. ABC refines pools of cost into smaller groups which are then analyzed for what drives the cost (cost driver). What this amounts to is we may have multiple overhead pools that are allocated to products based on different allocation bases (remember, not all costs are driven by labor hours or machine hours, right?).
Here is a real life example. The firm is a manufacturer of plastic bags for the meat packers like Hormel, IBP and Excel. The firm printed customer logos, safe handling instructions and so forth on the plastic sheet stock before cutting it into bags with a heat seal. For years jobs were priced based on the amount of direct labor hours estimated for the job. Over the years the firm seemed to be getting more and more short run multi-color jobs (small quantities like 5000 bags for example), which are not nearly as profitable as the long running jobs (250,000 bags or more). When the firm really analyzed the process via ABC, it discovered that the true cost of the job was actually driven by the number of colors in the job, because each color of ink required a separate print head, printing plate and print dryer. Anyone who knows something about colors knows that each layer of color must go on in a particular sequence and it must be completely dry before it gets to the next print head where another color will be applied. The setup process for each color was very labor intensive. Once the setup was completed one operator could run the job. So the producer was pouring lots of labor hours into each setup but only charging for the amount of labor needed to run that job. Once the firm figured this out they changed the product pricing to be based on the number of job colors and then added an upcharge for the length of the job to cover that labor cost. Almost immediately the small multi-color jobs disappeared and the long-run single or two-color jobs started showing up. Profitability increased substantially because of the change in pricing structure.
Let us look at a couple of videos that demonstrate the ABC process:
Activity Based Costing (Cost Hierarchy Categories, Cost Allocation Bases, ABC System Setup, etc.)
Activity Based Costing (Overview of ABC System Overhead Allocation Based on Resource Consumption
4. Discuss the concept of overhead in terms of flexible budgeting, overhead cost variances and how each relates to a manager's ability to control various aspects of their operation. Include in your discussion each of the possible overhead variances and why they need to be analyzed.
ALL QUESTIONS ARE 200 - 250 WORDS EACH