Absorption costing in Ax – Implementation in the Standard AX 2012 Product
The boxes in Green are the sub-processes that are implemented in AX. The boxes in Yellow are implemented in AX but do not fully serve our purpose. The box in Red is the sub-process that is completely missing from standard AX product.
Let us take the sub-processes one by one.
- Finalize budget: Fortunately Dynamics AX 2012 comes with excellent budget related functionality. There is no need to go into the details here.
- Finalize cost pools: Cost pools are nothing but cost groups in the costing sheet (see the screenshot below). We have marked this sub-process as partially implemented since cost drivers which should come naturally with cost pools are not found in standard product.
- Calculate overhead recovery rates: This sub-process aggregates budget figures into cost pools and allocates the amounts to cost centers using cost drivers to calculate recovery rates. This part of absorption costing system is completely missing from Dynamics AX. Anyone who wants to make full use of absorption costing must calculate the rates outside standard AX. This is the root cause of the problem. Since you do not have a link between budgetary amounts and overhead rates (in the system) any meaningful investigation of variance is impossible.
- Use recovery rates in ERP system: This is of course fully implemented in Standard AX. The screen-shot below shows overhead recovery rates being recorded in the system. These rates are per cost group which are in turn assigned to individual work centers.
- Monitor variances: We have marked this process as something which is not fully implemented in AX. This is the direct result of missing step (3). Let us take a simple example. Say our direct labor rate for a lathe machine is $10 per hour and the route specifies that a product (with standard cost) will take 4 hours on the lathe. Imagine that a particular batch of product takes 6 hours. Now we have a negative variance of $20. (2 extra hours multiplied by $10). The product cost will be recorded as $40 and $20 will be recorded as a variance (Click posting button on “cost groups” form for defining variance ledger accounts).
All hunky-dory so far? Here is the problem. What happens if the actual labor cost is higher say $15? How do we figure out the variance in this case? There is no easy (and certainly not automatic) way of calculating this variance since the link from budget to overhead recovery rates (step 3 above) is missing from standard AX. (For non-accounting people: This is a huge problem).
Final Problem is how and when do you re-calculate recovery rates: Continuing our example above, the accountant does not know whether the variances is really due to the higher number of hours or the higher actual labor costs. In fact even comparison with actuals is a very laborious process (another reason why variances are written off without investigation).
I am quite sure that non-accounting people are totally confused by now. In the next post, let us take an example of a simple but complete costing system and everything will be clear (even for non-accounting readers).