2. Activity Based Costing

Question 1

Why is Activity Based costing useful in the modern production environment?

Answer 1

Overhead costs make up a large proportion of production costs and so traditional absorption methods are less accurate, and so ABC avoids one product subsiding another

Question 2

What is Activity Based Costing?

Answer 2

An approach to the costing and monitoring of activities which involves tracing resource consumption and costing final outputs. Resources are assigned to activities and activities to cost objects based on consumption estimates.

Question 3

What is a cost driver?

Answer 3

A factor influencing the level of cost

Question 4

What is a cost pool?

Answer 4

Grouping of costs relating to a particular activity in an activity based costing system

Question 5

What is the hierarchy of activities?

Answer 5

A classification of activities by level of organisation, for example unit, batch, product sustaining and facility sustaining

Question 6

What are the 4 steps needed to calculate the overhead cost per unit in ABC?

Answer 6

1. Analyse overhead costs into cost pools
2. Establish cost driver basis for each cost pool
3. Work out the OAR for each cost driver
4. Use the OAR calculated to absorb costs from each pool into cost units

Question 7

What are the 4 categories of activity and cost driver when considering the activities of the organisation as a hierarchy?

Answer 7

1. Product level (volume)
2. Batch level (no. batches)
3. Product sustaining (no products)
4. Facility sustaining

Question 8

What are the 4 categories of activity when considering what the activity is aiming to achieve?

Answer 8

1. Logistical (moving people/inventory)
2. Balancing (ensuring availability of resources)
3. Quality (meeting standards)
4. Change (dealing with internal or external change)

Question 9

What are the 3 types of cost driver?

Answer 9

1. Transaction (no. of times)
2. Duration
3. Intensity (amount of resource used)

Question 10

What category of activity does traditional absorption costing focus on?

Answer 10

Product level

Question 11

What categories of activity are more important in today’s environment?

Answer 11

Batch and product sustaining level

Question 12

What are the 6 advantages of ABC?

Answer 12

1. Assesses costs of individual activities, based on their use of resources
2. Enables accurate costing of all activities to be obtained throughout an organisation
3. Easy to identify where high costs are being incurred and the cause
4. Valuable for process improvement
5. Helps with future product planning
6. Enables fair assessment of performance

Question 13

What are the 3 disadvantages of ABC?

Answer 13

1. It may be difficult to set up and establish, particularly if an organisation is using more traditional accounting methodologies
2. Can be time consuming if all activities are to be costed
3. May provide too much detail - obscuring the bigger picture