Operations costs are primary recurring costs associated with central operations other than cost of goods sold that are incurred in order to generate sales. They include depreciation on factory equipment, depreciation on factory building, cost of repairing parts improperly manufactured in the machining department, supplies for the machining department, electricity for the assembly department, lost materials (scrap) in a machining department, direct labor in the assembly department, supplies for production scheduling, cost of repairing parts improperly manufactured in the machining department, heat, light, and power for the factory.
Sales costs are incurred directly in the selling of the health products. They are also referred as charges to customers for the goods or services provided to them during the period. The sales costs for Glaser Health Products include: advertising manager's salary, salespersons' salaries, salespersons' travel expenses, advertising supplies used, and supplies for the sales office, sales commissions and packing supplies.
Administrative costs are also known as general expenses and are incurred in the administration or general operations of the company. The administrative costs for Glaser Health Products include: depreciation on office equipment, cost of hiring new employees, payroll fringe benefits for workers in the shipping department and leasing of computer equipment for the accounting department.
Costs with the Appropriate Activity Levels
Unit-level activities are performed each time a unit is produced and are generally considered variable cost. Crosson & Needles (2010) says that unit-level costs include the direct material cost and direct labor costs. When costing is concentrated at the unit level, it makes sense that the number of units produced should be correlated with the amount of overhead costs allocated to each unit. Glaser Health Products unit level costs include: supplies for the machining department, depreciation on factory equipment, heat, light, and power for the factory, cost of repairing parts improperly manufactured in the machining department, supplies for production scheduling and depreciation on factory building.
Product-level activities are performed to support a particular product line. They are incurred only when a new product is introduced (Jackson, Sawyers & Jenkins, 2008). In the case Glaser Health products, product level costs include assembly foreman's salary, cost of hiring new employees and paint for the assembly department.
Batch-level activities are performed each time a batch or production run of goods is produced. For Glaser Health Products batch-level costs include advertising manager's salary, salespersons' salaries, salespersons' travel expenses, sales commissions, payroll fringe benefits for workers in the shipping department and packing supplies.
Facility-level activities are performed to sustain the overall manufacturing processes. These types of costs do not vary with the number or type of products produced and they are generally fixed costs (Crosson & Needles, 2010). The costs include depreciation on factory building, assembly foreman's salary and electricity for the assembly department.
Cost Driver for Tracing Costs Associated with the Various Levels of Activities
Cost drivers should cause or drive the incurrence of costs. Unit, batch and product level activities are assigned to products by using cost drivers that capture the underlying behavior of the costs that are being assigned. Allocation of facility-level costs depends on the use of arbitrary cost drivers such as square footage, number of employees, labor hours and machine hours (Jackson, Sawyers & Jenkins, 2008). Jawahar (2009) says that cost drivers in unit level activities include direct labor hours, machine hours and power used each time a unit is produced.
The cost drivers at batch level activities include number machine setups, number of inspections and number of schedules. At product level activities the cost drivers entail number of change orders, number of tests, number of products and the number of new or revised products (Jawahar, 2009). At facility level activities the cost drivers include the number of employees managed within the factory and square footage. The Table1 below shows the various cost drivers associated with different activity levels for Glaser Health Products.
How Individual Items of Costs will be traced to Activity Groupings.
Activity based costing will be used to allocate overhead costs. Plant wide allocation uses one pool for the whole plant and department allocation uses one cost pool for each department (Heisinger, 2009). Activities related to sales and administrative costs are required by the controller to produce products. Heisinger (2009) noted that the cost of activities should be allocated to products based on the products use of the activities. Individual items of costs will be traced to activity groupings through the following three steps.
The first step is to identify costly activities required to complete products. The goal is to understand all the activities required to make the company’s products from sales and administrative costs perspective. The need to narrow down the activities to those that have the greatest impact on overhead costs cannot be ignored (Heisinger, 2009). Glaser Health Products should identify the following unit level activities as having the greatest impact on sales costs; advertising manager's salary, salespersons' salaries, salespersons' travel expenses, advertising supplies used, and supplies for the sales office, sales commissions and packing supplies. Cost repairing parts improperly manufactured in the machining department should be considered as product level activity related to sales costs.
On the other hand administrative costs would include cost of hiring new employees, payroll fringe benefits for workers in the shipping department and leasing of computer equipment for the accounting department. Cost of hiring new employees, payroll fringe benefits for workers in the shipping department should be considered as batch level activities related administrative costs (Heisinger, 2009).
The second step is to assign sales and administrative costs to the activities identified in the first step. A portion of total administrative and sales costs must be assigned to each activity identified in step one. Heisinger (2009) argues that a cost pool will be established for each activity. At this step the most important and costly activities required to make products have been identified and the sales and administrative costs assigned to each of the activities (Heisinger, 2009). The nest step is to find an allocation base that drives the cost of each activity. The mapping from the previous two steps is indicated in the table below.
The third step involves identifying the cost driver for each activity. Heisinger (2009) says that the goal of this step is to identify the best cost driver for each activity identified in step one. After a care scrutiny of the process required for each activity, Glaser established the following cost drivers. In the context of activity based costing, resources used are linked to activities by resource drivers and activities are linked to costs by cost drivers (Heisinger, 2009).
How the Costs should be Related to Products
Primary stage cost drivers sees the production process as a set of activities that are required to make a product. All costs associated with a particular activity are grouped together and are allocated to all products that use the particular activity during the production process (Drury, 2004). While using primary stage cost drivers when a particular product uses an activity more than other products, that product is allocated a larger share of the costs for that activity. This implies that costs will be more fairly divided between the various products.
The cost drivers are measurable in a way that enables it to be identified with individual products. This implies that if the set-up hours are selected as a cost driver, for Glaser there must be a mechanism for measuring the set-up hours consumed by each product. Drury (2004) noted that if the number of set-ups is selected as the cost driver measurements by products are not required since all products that require a set-up are charged with a constant set-up cost.
Why it is Necessary to use Preliminary Stage and Primary Stage Cost Drivers
Firstly, the use preliminary stage and primary stage cost drivers give more accurate information which in turn leads to better decisions. This allows management to better decisions in areas such as product pricing, product line changes that is adding products or eliminating products and product mix decisions (Heisinger, 2009).
Secondly, the preliminary and primary stage cost drivers leads to increased knowledge of production activities, process improvements and reduced costs. Heisinger (2009) says that primary stage cost drivers provides management with a better view of the detailed activities involved such as purchasing materials, machine setups and the cost of each activity. Heisinger (2009) argues managers are more likely to focus on improving efficiency in most costly activities thereby reducing costs
In conclusion, activity based costing uses a multitude of cost drivers that relate costs more closely to the resources consumed and activities occurring. This type of costing is appropriate for Glaser Health Products because it improves product costing procedure and it appreciates that many so called fixed overhead costs vary in proportional to changes other than production units. Through establishing a link between these cost drivers and fixed overhead costs, Glaser can trace individual products. This will enable the company to trace costs to areas of managerial responsibility, processes, customers, departments besides the product costs.