Activity Based Costing

Question 1

OVERHEADS

Answer 1

All costs which are not direct materials, direct labour or direct expenses.

Usually divided by function
e.g. production overheads
s&d overheads
R&D overheads
Administration o/h
Can be fixed, variable or semi variable

Question 2

What are the four main steps in dealing with overheads in a “traditional system”?

Answer 2

1. Collection
2. Classification
3. Allocation and Apportionment
4. Absorption

Question 3

Step 3 of allocating overheads: ALLOCATION AND APPORTIONMENT

Answer 3

Must decide how to divide overheads among department (cost centres or cost pools).

Question 4

ALLOCATION

Answer 4

Where whole items of cost ca be charged to a cost centre.

Question 5

APPORTIONMENT

Answer 5

Where overheads must be shared between more than one cost centre.

Question 6

Describe the format for charging overheads to departments.

Answer 6

Six stages:

1. List overheads as rows.
2. Show cost centres (production and service departments or cost centres) as columns.
3. Allocate overheads where amounts and cost centres are known.
4. Decide basis of apportionment and apportion remaining overheads.
5. Total overheads for all cost centres.
6. Reallocate and reapportion service cost centres to production cost centres.

Question 7

Step 4 of allocating overheads. ABSORPTION

Answer 7

How to share production departments’ costs by charging overheads to individual cost units through the production departments
Need to find absorption and base rate
Bases of absorption should reflect demands made by cost unit on production facilities.

Examples of possible bases:

• Direct labour hours
• Direct machine hours
• Direct materials
• Direct wages
• Number of cost units
• Prime cost

Question 8

How are absorption rates calculated?

Answer 8

Total cost centre overhead / overhead base
Can have a blanket overhead (whole factory)
For each production centre department (departmental overhead rate)

Question 9

When are traditional costing systems appropriate?

Answer 9

1. Direct costs were the dominant costs
2. Indirect costs (overheads) were relatively small.
3. Information costs were high.
4. There was a lack of intense global competition.

Question 10

ACTIVITY BASED COSTING

Answer 10

Developed when new technology meant that overhead costs can be much higher than direct labour costs, therefore traditional methods are inappropriate.

ABC collects overheads into cost pools (or cost centres).

ABC charges costs to the products or services according to the consumption of the activity (cost driver) which causes (thus the allocation and absorption processes capture costs in a different way).

Attempts to absorb o/h costs more accurately in order to reflect the resources consumed by producing the product or service.

Question 11

ACTIVITY

Answer 11

An action or an aggregation of actions performed within an organisation.

Question 12

RESOURCE

Answer 12

An economic element needed or consumed in performing activities

Question 13

COST DRIVER

Answer 13

An activity or characteristic that consumes resources.

Question 14

COST CENTRE/COST POOL

Answer 14

Used to describe allocation to which overhead cost are initially assigned.
Costs from activity cost pools are assigned to cost objects using cost drivers.

Question 15

When should ABC be implemented?

Answer 15

1. The cost of measuring the activities and their costs is reduced, perhaps because of computerised scheduling systems on the production floor.
2. Stronger competition increases the cost of errors caused by erroneous pricing.
3. Product diversity is high in volume, size, or complexity.

Question 16

Benefits of ABC

Answer 16

• Provides more accurate and informative product costs.
• It provides more accurate measurements of activity driving costs.
• It helps managers identify ad control the cost of unused capacity.

Question 17

Limitations of ABC

Answer 17

• Some costs may require allocations to departments and products based on arbitrary volume measures.
• Some costs that can be identified with specific products are omitted.
• Expensive to develop and implement, it is also very time consuming.