A traceable cost is acost where us a direct-cause and effect associated with a customer, product, process, geographical location or other cost objects. If the cost is taken away, the traceable cost associated with it also goes away. Examples of traceable costs includeadvertising, rent, liability insurance, etc. On the other hand, a common cost is a cost which is associated with any given cost objectlike a process or product. Example of a common cost is wages.
This is because if the costs are allocated to the segments, the cost of the segments would be overstated but the cost margin understated. This may make segments to be unprofitable making business owners or managers to eliminate them.If the segment is removed due to arbitrarily located common cost, the company will experience a decline in the overall profitby the segment marginsince the common cost would remain.
An incremental cost is considered as the change in cost resulting from specific proposed actions. It is the total change that an organization experiences in its balance sheet or income state as a result of production or even the sale of an additional unit of product. For example, if the total cost of a company increases from $400,000 to $500,000 because of increased machine hours from 10,000 to 11,000, the incremental cost of the 1,000 machine hours is $100,000.
Opportunity cost is the benefit that is given up or missed when an individual, business, or investor chooses an option over another. For example, the cost of choosing to buy a home instead of starting a business, hence missing profits.
Sunkcost is the cost already incurred and cannot be recovered. For instance, after paying rent, you cannot recover the money back.
To decide whether to drop the product or not, it is essential to create an income statement divided in to segments. For unprofitable product, develop a product line income statement to determine where the unprofitability comes from. If the product has a positive contribution margin, the business should consider common and fixed costs, freed capacity, and the impact on the sale of other products. If there are positive outcomes, the company should keep the product.
When the total contribution margin is maximized, profits will be maximized particularly when we assume that the fixed cost is not affected.An organization can increase its contribution margin by concentrating on products with a significant contribution margin per unit of the resource constrained.
Flight costs are often considered as a sunk cost. The number of passengers on the flight is not considered. Whether the airplane is full of passengers or not, the cost of fueland wages of the attendants and personnel are the same. As a result, reducing the fares at some times of the week to add more passengerswhen the seats would otherwise be empty would have little impact on the total cost of preparing the flight, but it would increase the overall profit and contribution.
Management offers the leadership required to effectively motivate all the employees to embrace the ABC system approach. With the support of the top management, it would be easy to link the ABC data to the employee reward and evaluation system. The senior management also knows operations required to design the ABC system effectively. At the same time, using the support of the top management would reduce resistance to the ABC system.
Organization-sustaining costs should be excluded from product costs. These are the cost incurred from the maintenance of a business operation. For instance, the payment of property taxes, insurance, and utilities. ABC treats them as period expenses instead of product costs
This is because product-level costs are spread across productsby the use of labor hoursor a different allocation base associated with the volume. Consequently, high volume products are given the bulk of the costs. In ABC, product level costs and batchlevel costs are often appropriately assigned, making the product level costs to shift back to the products causing and far from the high volume products.
ABC is mostly applicable to businesses using system orders. It is suitable for vertical companies with a high level of complexity in their processes, different product mix, and high post-sale efforts coupled with different kinds of customers and sale channels. It works best in the manufacturing business with high amounts of overhead costs, multiple products, complex products, complex production system, and with a significant difference in volume between low and high products.
Activity-based costing determines all the activities that are associated with production and assigns a cost to the activities, then establish the cost of the product. It differs with traditional costing where costs are allocated to products based on the average overhead rate. It collects all the indirect cost in production and equally applies the cost across the board.
Yes. This is because the direct link between overhead and direct labor no longer exists. Direct labor is being replaced by machines and a decrease in direct labor results to an increase in overhead. It is important to note that overhead costs are driven by factors like product volume, complexity, and diversity.
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