Financial Analysis in Operations Management
COST DEFINITIONS
Fixed Cost – expenses that remain constant over a wide range of output volumes
Variable Costs – expenses that vary proportionately with changes in output.
Sunk Costs – expenses already incurred that have no salvage value
Opportunity Costs – profits lost when one alternative is chosen over another that would have provided greater financial benefits.
Avoidable Costs – expenses resulting from poor productivity incurred if an investment is not made.
Out-of-Pocket Costs – actual cash flow associated with a particular alternative.
Cost of Capital – usually expressed as percentage rate, it reflects the cost of the money invested in a project.
Comparisons:
The cost of borrowing money to finance the project.
Interest lost on short-term notes.
Opportunity cost of forgoing one of several other projects that require funding.
ACTIVITY-BASED COSTING
An accounting technique that allocates overhead costs in actual proportion to the overhead consumed by the activity.
Stage 1 : Assign overhead costs to activity pools
Stage 2: Assign costs from pools to activities.
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TRADITIONAL AND ACTIVITY-BASED COSTING
Traditional Costing Activity-Based Costing
Labor-hour allocation Pooled based on activities
Cost-driver allocation
OVERHEAD ALLOCATION by Activity Approach
Basic Data Events or Transactions
Activity Traceable Costs Total Product A Product B
Machine setups $230,000 5,000 3,000 2,000
Quality inspections 160,000 8,000 5,000 3,000
Production orders 81,000 600 200 400
Machine-hours worked 314,000 40,000 12,000 28,000
Material receipts 90,000 750 150 600 ------------ $875,000
Overhead Rates by Activity
(a) (b) (a) / (b)
Traceable Total Events Rate per Event
Costs or Transactions or Transaction
Machine setups $230,000
Fixed Cost – expenses that remain constant over a wide range of output volumes
Variable Costs – expenses that vary proportionately with changes in output.
Sunk Costs – expenses already incurred that have no salvage value
Opportunity Costs – profits lost when one alternative is chosen over another that would have provided greater financial benefits.
Avoidable Costs – expenses resulting from poor productivity incurred if an investment is not made.
Out-of-Pocket Costs – actual cash flow associated with a particular alternative.
Cost of Capital – usually expressed as percentage rate, it reflects the cost of the money invested in a project.
Comparisons:
The cost of borrowing money to finance the project.
Interest lost on short-term notes.
Opportunity cost of forgoing one of several other projects that require funding.
ACTIVITY-BASED COSTING
An accounting technique that allocates overhead costs in actual proportion to the overhead consumed by the activity.
Stage 1 : Assign overhead costs to activity pools
Stage 2: Assign costs from pools to activities.
Page 1
TRADITIONAL AND ACTIVITY-BASED COSTING
Traditional Costing Activity-Based Costing
Labor-hour allocation Pooled based on activities
Cost-driver allocation
OVERHEAD ALLOCATION by Activity Approach
Basic Data Events or Transactions
Activity Traceable Costs Total Product A Product B
Machine setups $230,000 5,000 3,000 2,000
Quality inspections 160,000 8,000 5,000 3,000
Production orders 81,000 600 200 400
Machine-hours worked 314,000 40,000 12,000 28,000
Material receipts 90,000 750 150 600 ------------ $875,000
Overhead Rates by Activity
(a) (b) (a) / (b)
Traceable Total Events Rate per Event
Costs or Transactions or Transaction
Machine setups $230,000