Accounting for decision-making

Department Business Management

Faculty of Economics and Business Studies

COURSE GUIDE DOCUMENT

(check updates on online campus)

Prof. D. David Guijarro Melguizo

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 TOPIC 4
THE FULL COST MODEL

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 TOPIC 4
THE FULL COST MODEL

THEORETICAL PROGRAM:
TOPIC 4. THE FULL COST MODEL

4.1. General outline of a full cost model

4.2. Cost management according to activities: ABC (Activity Based Costing) model

• EDUCATIONAL RESOURCES FOR THIS TOPIC (check online campus)

– Teaching guide for this course
– Practical excersises
– Additional documents for this topic

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FULL COST MODEL

• IN A BROAD SENSE:
– The one that INCLUDES ALL THE COSTS generated in the company,
in the valuation of the products: Direct, indirect, variable, fixed,
production, sales, administration and financial.

• STRICTLY SPEAKING (FULL INDUSTRIAL COST or FULL COST):

– Includes ONLY the COSTS related to the PRODUCTIVE ACTIVITY:
• Does not include administrative or financial costs in the valuation
of the products

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 FULL COST MODEL OUTLINE

LOADS NOT
INCORPORTED

PRODUCTS
• STARTING DATA
MAIN
•CONT. FINANCIAL DIRECT C.
LOADS CENTRES
•CONT. ANALYTIC
•COMPANY DATA INCORPORATED BASE
ELEMENT
S
EXTRA INDIRECT C. AUX
CHARGES CENTRES

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 INCOME STATEMENT
(full cost of production model)

CONCEPT Q1 ........ Pn TOTAL

• Net sales x ......... x  (x)
- Full cost of production of goods sold (x) ......... (x)  (x)
= GROSS MARGIN TO FULL COST OF PRODUCTION x ......... x  (x)
- Full cost of Distribution (x) ......... (x)  (x)
= COMMERCIAL MARGIN TO PRODUCTION x ......... x  (x)
- Administration costs (x)
= OPERATING RESULT x
± Financial result ±x
= RESULT OF ORDINARY ACTIVITY x
± Extraordinary result ±x
= NET RESULT FOR THE PERIOD OF THE C. A. x

ANALYTICAL
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 ADVANTAGES AND DISADVANTAGES

• ADVANTAGES

– Allows you to compare cost price with sale price:

• Profitability analysis

– Detailed analysis of cost aggregation phases

– Actual inventory valuation

– Best Method for Pricing in Order Cost Allocation

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 ADVANTAGES AND DISADVANTAGES

• DISADVANTAGES

– Insufficient information for short-term decision making.

– It does not take into account the impact on costs of variations in level of

activity

– Does not facilitate adoption of correct pricing policy

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THE ABC MODEL vs. TRADITIONAL COST MODELS

A) CONVENTIONAL COST SYSTEMS

Allocation of indirect costs

Service Dept. Production Departments Product Lines

Phase 1 Phase 2

Cost allocation taking Cost allocation based on volume

as a basis for a measure of the
service utilization.

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THE ABC MODEL VERSUS TRADITIONAL COST
MODELS
(B) ACTIVITY-BASED COST SYSTEMS

Service departments and

indirect production Ctes Costs of activities Product lines

Phase 1 Phase 2

Allocation of costs to the activities that originate them Allocation of the cost of activities to cost carreirs

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 THE ABC MODEL METHODOLOGY

ACTIVITIES CONSUME RESOURCES

PRODUCTS CONSUME ACTIVITIES

COSTS ACTIVITIES PRODUCTS

COSTS PRODUCTS

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 THE ABC MODEL METHODOLOGY

• A product or service is born as a result of the performance of a series of

successive activities, which determine the consumption of resources;
Therefore, activities are the direct cause of resource consumption and not
products or services.
• It is necessary to control and manage activities, which implies focusing
attention on what is done and how it is done, rather than on what is spent,
that is, moving from cost management to activity management.

COST MANAGEMENT ACTIVITY MANAGEMENT

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 ACTIVITY AND PROCESSES
ACTIVITY:
Set of tasks performed in the company

– Homogeneous and quantifiable in the same unit of measurement.

– Aimed at obtaining a product or service, from a series of inputs.
– Performed by one or more individuals.
– Aimed at satisfying an external or internal customer.

•Production planning
•Price negotiation with suppliers
•Launch of an advertising campaign
•Issuance of invoices (billing process)
•Storage of products (warehouse)
ACTIVITIES •Request for orders
•Preparation of payroll
•Preparation of the operating budget

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 ACTIVITY AND PROCESSES

PROCESS:
Set of activities that, through facilities, machines, materials and workers,
achieve the obtaining of a specific output, in a given time:

PROCESS ACTIVITIES

Personnel selection •Reviewing staff needs

•Describe open positions
•Design the selection process
•Receive and analyze CVs
•Interviewing candidates
•Propose the chosen candidate

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 CLASSIFICATION OF ACTIVITIES

ACTIVITIES COSTS

ACTIVITIES AT UNIT LEVEL Costs derived directly from the volume of

production.

BATCH-LEVEL ACTIVITIES Costs related to orders or lots.

ACTIVITIES RELATED TO PRODUCT Costs related to the continuous

MAINTENANCE improvement of manufacturing and
marketing processes.

INFRASTRUCTURE ACTIVITIES Costs necessary for the sustenance of the

entire organization.

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 COST INDUCTOR AND COST-DRIVER

TRADITIONAL COST SYSTEMS

INDIRECT COSTS CENTRES PRODUCTS

KEYS OF UNITS OF
DISTRIBUTION WORK

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 COST INDUCTOR AND COST-DRIVER

ABC SYSTEM

INDIRECT COSTS
INDIRECT CTES CENTRES

CENTRE X
CENTRE Y
KEYS OF
DISTRIBUTION CENTRE Z

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 COST INDUCTOR AND COST-DRIVER

ABC SYSTEM
CENTRE X

INDIRECT COSTS ACTIVITIES PRODUCTS

INDUCTORS OF
COST-DRIVER
COST

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 COST INDUCTOR AND COST-DRIVER

• The cost-drivers in the ABC model, are equivalent to the

units of work or transfer of traditional cost systems,
however you have some fundamental differences:

– They are not directly related to the volume of production.

– They are associated with the number of times a given operation

occurs, with the number of times an operation is repeated.

– There will be as many cost-drivers as there are activities, leading

to a greater degree of correlation.

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 COST INDUCTOR AND COST-DRIVER
CENTER ACTIVITY COST-DRIVER
PROCUREMENT • Issuance of purchase orders • Number of orders issued
• Quality control inspection of
material orders • Time/order
• Storage of raw materials
• Days of stay/square
meters occupied

PRODUCTION • Machinery tuning • Number of set-ups

• Internal transport of materials • Meters traveled
• Quality control • Controls carried out
• Foundry • Hours/Machine.

DISTRIBUTION • Issuance of sales orders • Number of orders issued.

• Nº of packed lots
• Packing • Number of campaigns.

• Advertising • Days of
permanence/square
• Product Storage meters occupied.

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PREMISES AND OBJECTIVES OF THE ABC MODEL

PREMISES:

• ACTIVITIES ARE THE CAUSE OF RESOURCE CONSUMPTION.

• IT TRIES TO COVER THE ENTIRE PROCESS FROM DESIGN TO AFTER-

SALES SERVICE.

• IT IS A MANAGEMENT PHILOSOPHY.

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PREMISES AND OBJECTIVES OF THE ABC MODEL
OBJECTIVES:

• MANAGE ACTIVITIES.

• ELIMINATE SUPERFLUOUS ACTIVITIES.

• PERMANENT IMPROVEMENT IN THE UNDERTAKING OF

ACTIVITIES.

• DETAILED STUDY OF THE PRODUCTION PROCESS.

• USE COST-DRIVERS UNRELATED TO PRODUCTION

VOLUME.

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PREMISES AND OBJECTIVES OF THE ABC MODEL

OBJECTIVES:

• USE AS MANY COST-DRIVERS AS ACTIVITIES ARE

PERFORMED.

• INCREASE THE COMPETITIVENESS OF COMPANIES

THROUGH:
– COST REDUCTION.
– INCREASING QUALITY.
– THE OPTIMIZATION OF TIMES IN THE COMPANY.

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 PHASES IN THE IMPLEMENTATION OF THE MODEL

STAGE 1: ALLOCATION OF INDIRECT COSTS TO THE DIFFERENT CENTRES

CENTER 1 CENTER 2 CENTER N

WAGES AND SALARIES

LEASES
SUPPLIES
AMORTIZATIONS
TOTAL

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 PHASES IN THE IMPLEMENTATION OF THE MODEL

2ND STAGE: DESIGN OF THE ACTIVITY MAP

CENTER 1 CENTER 2 CENTER N

ACTIVITY 1
ACTIVITY 2
ACTIVITY 3
ACTIVITY N
TOTAL

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 PHASES IN THE IMPLEMENTATION OF THE MODEL

3RD STAGE: ALLOCATION OF COSTS TO EACH ACTIVITY THROUGH COST

INDUCTORS

ACTIVITY 1 ACTIVITY 2 ACTIVITY N

WAGES AND SALARIES

LEASES
SUPPLIES
AMORTIZATIONS
TOTAL

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 PHASES IN THE IMPLEMENTATION OF THE MODEL
4TH STAGE: DEFINITION OF COST-DRIVERS

ACTIVITIES COST-DRIVERS

AT UNIT LEVEL Man-hours, Machine-hours, Raw materials consumption.

AT BATCH LEVEL Nº OF INSPECTIONS, Nº OF PURCHASE ORDERS,

KM. TRAVELED

AT THE LEVEL OF PRODUCT MAINTENANCE Nº OF CUSTOMERS, Nº OF SALES ORDERS

AT THE INFRASTRUCTURE LEVEL ??????

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 PHASES IN THE IMPLEMENTATION OF THE MODEL

5TH STAGE: GROUPING OF ACTIVITIES THAT HAVE THE SAME COST-DRIVERS

6TH STAGE: CALCULATION OF THE UNIT COST OF COST-DRIVERS

UNIT COST = TOTAL CTES OF EACH ACTIVITY/NUMBER OF COST-DRIVERS

STAGE 7: ALLOCATION OF ACTIVITY COSTS TO OUTPUTS

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 ADVANTAGES AND DISADVANTAGES OF THE MODEL

ADVANTAGES:

• IT PROVIDES A MORE LOGICAL AND UNDERSTANDABLE BASIS FOR CALCULATING COSTS.

• IMPROVES UNDERSTANDING OF INDIRECT COST BEHAVIOR.

• IT TAKES INTO ACCOUNT CERTAIN COST FACTORS THAT ARE NOT DIRECTLY RELATED TO THE VOLUME
OF PRODUCTION.

• IN THOSE PROCESSES WITH LITTLE RELEVANCE OF THE DIRECT LABOUR A MORE EQUITABLE
ALLOCATION OF COSTS IS MADE.

• USES MULTIPLE COST-DRIVERS.

• IT ALLOWS TO DETECT SUPERFLUOUS ACTIVITIES AND THEREFORE THE COSTS ASSOCIATED WITH
THEM.

• ITS APPLICATION WILL BE MORE OPERATIONAL IN THOSE COMPANIES WITH A WIDE VARIETY OF
INDIRECT COSTS AND PRODUCTS.

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ADVANTAGES AND DISADVANTAGES OF THE MODEL
DISADVANTAGES:

• FULL COLLABORATION OF THE STAFF OF THE ORGANIZATION IS NECESSARY.

• IT REQUIRES ADEQUATE INFORMATION FLOWS.

• SERIOUS OPERATIONAL PROBLEM IF AN EXCESSIVE NUMBER OF ACTIVITIES IS

DETERMINED.

• THE ALLOCATION OF INFRASTRUCTURE COSTS REMAINS UNRESOLVED, AS THE

CORRESPONDING COST-DRIVERS CANNOT BE DETERMINED.

• PROBLEMATIC GROUPING OF ACTIVITIES.

• IT IS A REFINEMENT OF A FULL-COST MODEL.

• OPERATIONAL DIFFICULTIES IN DETERMINING COST DRIVERS AS WELL AS COST

INDUCTORS.

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