CASE:

Komplex GmBH has four production lines, each of which operates for 8,000 hours a year. Each line makes a number of products, which are based on size and color. Therefore, many changeovers are required, each incurring installation and maintenance costs.

Traditionally, maintenance costs have been allocated on a machine-hour basis, so each production line is charged equally. This year, the $1 million maintenance budget has been divided into four, so each line is charged $250,000. Sales and marketing are concerned that certain products are losing market share, and this is due to pricing relative to the competition.

All departments have been instructed to investigate costs and suggest improvements. How can activity-based costing improve this situation? By identifying the maintenance cost driver, in this case the number of changeovers, costs can be allocated to each production line on this basis.

Costs are allocated to the activity that generates them, thus avoiding cross-subsidization. The results are illustrated in Table 3.4. Maintenance costs have been transferred to the production lines that incur the activity.

For example, line costs D line costs have been doubled to $500,000, while D line costs have been reduced to $50,000. ABC in this example has not taken the process cost but has reallocated the costs to give a better understanding of the cost base.

Komplex GmBH is now in a better position to make decisions that affect the cost competitiveness of the product range.