1.7 The implications of switching to ABC
　　The use of ABC has potentially significant commercial implications:
　　§ Pricing can be based on more realistic costs data.
　　- The traditional method of absorption of overheads into unit costs on a volume basis may be misleading, with the result that product costs can, potentially, be materially under/overstated.
　　- Thus, where cost plus pricing is in use, products that have been materially under-costed may be priced at levels that generate a loss whilst products that have been materially over-costed many be priced at levels that are uncompetitive.
　　§ Sales strategy can be more soundly based.
　　- More realistic product costs as a result of the use of ABC may enable sales staff to:
　　- target customers that appeared unprofitable using absorption costing but may be profitable under ABC
　　- stop targeting customers or market segments that are now shown to offer low or negative sales margins.
　　- Front line sales staff will be able to negotiate prices with greater confidence
　　- ABC can be used to review the profitability of products and services with a view to focussing the efforts of sales staff upon those products and services which offer the highest sales margins.
　　§ Performance management and decision making can be improved
　　- Research, production and sales effort can be directed towards those products and services which ABC has identified as offering the highest sales margins.
　　- ABC can influence decisions as to which:
　　- new products/services to develop
　　- existing products/services to curtail or drop
　　- products/services should be promoted
　　- overhead costs to target.
　　Expandable text
　　Possible applications for management of ABC information:
　　§ Product costs and product profitability are measured more realistically.
　　§ It identifies ways of reducing overhead costs in the longer-term. This is because ABC shows the nature of resource-consuming activities, the costs incurred by each activity and the cost drivers for those activities.
　　§ It identifies activities and costs that do not add value. If an activity does not contribute to the final product or service, the driver of the non-value-adding cost can be identified and eliminated.
　　§ It can be used to analyse the profitability of individual customers or categories of customer, as well as the profitability of products or services.
　　§ If products or jobs are priced on a cost-plus basis, ABC can help management to make sensible pricing decisions.
　　§ ABC can be used as a basis for budgeting and longer-term forward planning of overhead costs.
　　Test your understanding 5
　　A manufacturing business makes a product in two models, model M1 model M2. details of the two products are as follows.
　　Model M1Model M2
　　Annual sales8,000 units8,000 units
　　Number of sales orders60250
　　Sales price per unit$54$73
　　Direct material cost per unit$11$21
　　Direct labour hours per unit2.0 hours2.5 hours
　　Direct labour rate per hour$8$8
　　Special parts per unit28
　　Production batch size2,000 units100 units
　　Setups per batch13
　　Issues of material for each batch11
　　Overhead analysis$Cost driver
　　Setup costs97,600Number of setups
　　Material handling costs42,000Number of batches
　　Special part handling costs50,000Number of special parts
　　Customer invoicing costs31,000Number of sales orders
　　Other overheads108,000Direct labour hours
　　328,600
　　A customer has indicated an interest in placing a large order for either model M1 or M2, and the sales manager wishes to try to sell the higher-priced model M2.
　　（a） Calculate the profit per unit for each model, using ABC.
　　（b） Using the information above indicate what advice you would give to the sales manager on the basis of the information provided by your ABC analysis.
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