Cost Management

We have one company that operates two businesses. They both manufacture and sell their product. One specializes in unicycles and the other bicycles. Total sales of both businesses are $170 million, $150 million for the unicycle and $20 million for the bicycle. They share a warehouse of 100,000 square feet, 25,000 square feet for the bicycle and the remaining for the unicycle. Total costs were split 50-50. The total warehouse cost is $3 million and the total advertising cost is $5 million.

Unicycle Bicycle

Total Sales 150,000,000 20,000,000

Advertising 2,500,000 2,500,000

Rent 1,500,000 1,500,000

The costs of advertising and rent for both businesses within the company are the same based on the traditional method. Both businesses have an expense of $4 million.

The unicycle business takes up 75% of the warehouse and makes 88.24% of the total sales for the company. The bicycle business company uses 25% of the warehouse and brings in 11.76% of the total sales for this company. In allocating the expenses between these two businesses one will need to implement a new accounting system. The ABC (activity based costing) system will work well within this company. This system will first take into account all indirect resource costs for the company. It will then assign costs of activities within the two businesses. (Horngren, Sundem, and Stratton, 2005) Looking more closely at the company one sees that things need to be taken a step further by utilizing the two-stage ABC System. This system will use “two stages in allocation to get from the original indirect resource cost to the final product or service cost.” (Horngren, Sundem, and Stratton, 2005) Breaking down the costs within an ABC system can show a company where each cost is. It enables the company to be better able to make decisions based on financial data. There are three major differences between the traditional system and the ABC system.

1. “In traditional cost accounting it is assumed that cost objects consume resources whereas in ABC it is assumed that cost objects consume activities.”

2. “Traditional cost accounting mostly utilizes volume related allocation bases while ABC uses drivers at various levels.”

3. “Traditional cost accounting is structure-oriented whereas ABC is process-oriented.” (Emblemsvag, 2000)

Activity-Based Management (ABM) enables a company to utilize another type of driver, a cost driver. (“The underlying cause of costs and activities, measured by non-financial performance measures.”) (Emblemsvag, 200) This can be demonstrated through the use of a Balanced Scorecard. It is thought to be the most difficult driver to identify.