BUSMGT713 Chap.7 Refined costing systems and cost cross-subsidisation
Refined costing systems and cost cross-subsidisation
This chapter follows a Week 3 costing activity in which a supermarket's support costs, first spread across product lines on one broad base, are reassigned through a refined system. In that system support is split into activities such as ordering, delivery, shelf stocking and customer help. Each activity's cost is divided by the quantity of its driver to give a rate, and each line is charged the rate times its own usage.
The workshop shows why this matters: lines use activities in proportions very different from the broad base, so the old system over-costs some lines and under-costs others, which the course calls cost cross-subsidisation. The chapter rebuilds the idea for a garden centre that shares support on revenue.
One line is costed about right, one has been carrying another's costs, and the line management planned to expand turns out to lose money once its heavy receiving and home-delivery use is charged. The lesson is to test any plan to grow, price or cut a line on refined figures before acting on it.
What this chapter covers
- 01
Sharing support costs on a broad base such as revenue
- 02
Activity cost pools, drivers and activity rates
- 03
Charging each product line by its own activity usage
- 04
Comparing margins under the two systems and reconciling the totals
- 05
Cost cross-subsidisation: which line pays for which
- 06
Testing an expansion or pricing plan on refined figures
Worked example · free
Pūriri Garden Centre: is Compost the line to expand?
- +2Revenue-based support = $120,000 x 100,000 / 600,000 = $20,000, so profit = $100,000 minus $64,000 minus $20,000 = $16,000, a margin of 16.0%.
- +2Activity charges = 50 x $24 + 220 x $90 + 600 x $30 = $1,200 + $19,800 + $18,000 = $39,000.
- +2Refined profit = $100,000 minus $64,000 minus $39,000 = -$3,000, a margin of -3.0%, so the expansion plan would grow a loss.
Key terms
- Activity driver
- The measurable event that causes an activity's cost, such as deliveries received or home-delivery runs.
- Activity rate
- An activity's total cost divided by the total quantity of its driver, giving a charge per delivery, hour or run.
- Refined costing system
- An approach that charges support through several activity rates instead of one broad base.
- Over-costed product
- A line that is charged more support cost than its real use of activities justifies, making it look less profitable.
- Under-costed product
- A line that bears less support cost than it causes, so its reported margin is flattered.
Refined costing systems and cost cross-subsidisation FAQ
What is wrong with allocating support costs on a broad base such as revenue?
It assumes each product line uses every support activity in the same proportion as its share of the base. Lines rarely behave that way: a cheap, bulky product can need far more receiving and delivery per dollar of sales than a compact one. Some lines then carry other lines' costs and their margins mislead.
How do I calculate an activity rate?
Divide the activity's budgeted or actual cost by the total quantity of its driver. Ordering cost is divided by the number of orders, delivery cost by deliveries, stocking cost by stocking hours. Then multiply that rate by each line's own driver quantity, and check that the charges across lines add back to the activity's cost.
Why can margins change so much under a refined system?
Because margin depends on how much support cost each line is charged. A line that uses few activities but has a large share of the broad base sees its margin rise once costs are traced, while a heavy user of activities falls, sometimes from a healthy profit into a loss, as bagged compost does in this chapter.
What does cost cross-subsidisation mean?
It describes a costing system in which over-costed products effectively pay for under-costed ones. Total cost is unchanged, but its distribution is wrong, so prices, product emphasis and decisions about which lines to grow or cut are made on distorted information. Spotting it means comparing each line's share of every activity with its share of the allocation base.
How should refined product-line costs change a business plan?
Test every plan against the refined figures before acting. A line chosen for expansion on a broad-base margin may be loss-making once its activity use is charged, and the fix may be a delivery charge or minimum order rather than growth. A line that was carrying others' costs may be the better one to promote.
Assessment move
Lay out a three-column table, one column per product line, before you calculate anything. First compute the old allocation from each line's share of the base and the resulting profits and margins. Next write each activity's rate with its driver unit, then multiply by each line's usage and add the activity charges for every line. Reconcile: the activity charges must sum to the original support total.
Compute refined profits and margins and name the line whose result moves most. Finish with a sentence linking the largest gap between a line's share of the base and its share of an activity to the change, and one recommendation, such as whether a planned expansion still makes sense, backed by a refined figure.
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