Chapter 4- Activity based costing systems

Question 1

Traditional costing systems

Answer 1

• were created when manufacturing processes were labor intensive
• a single company-wide overhead rate based on direct labor hours may be used to allocate overhead to products in these labor intensive processes

Have led to under-costing and over-costing because it doesn’t reflect reality

Question 2

Activity based costing

Answer 2

A costing method that identifies the activities performed within the organization as it delivers its goods and services.

• direct labor hours
• process setups
• design time
• machine hours
• customer contact

Question 3

Steps for ABC

Answer 3

1. Identify and classify the activities related to the company’s products or services
2. Estimate the cost of each activity identified in 1.
3. Calculate a cost-driver rate for each activity
4. Assign activity costs to products using the cost-driver rate

Question 4

ABC vs traditional costing

Answer 4

Traditional:

Resource costs –> Directly traced or allocated –> Cost pools: Plants or departments –> Predetermined overhead rate –> Cost objects

ABC:

Resource costs –> Directly traced or allocated –> Cost pools: Activities or activity centers–> Cost driver rates for each activity–> Cost objects

Question 5

Classify activities

Answer 5

1. Unit-level activities
2. Batch- level activities
3. Product-level activities
4. Customer-level activities
5. Facility-level activities

Question 6

Unit-level activities

Answer 6

Resources acquired and activities performed for individual units of product

Question 7

Batch-level activities

Answer 7

Resources acquired and activities performed for a group or batch of similar products or services

Question 8

Product-level activities

Answer 8

Resources acquired and activities performed to produce and sell a specific product or service

Question 9

Customer-level activities

Answer 9

Resources acquired and activities performed to serve specific customers

Question 10

Facility-level activities

Answer 10

Resources acquired and activities performed to provide general capacity to produce goods or services

Question 11

Methods for identifying and classifying activities

Answer 11

1. Top down approach
2. Recycling approach
3. Interview or participative approach

Question 12

Top down approach

Answer 12

ABC teams of people from top levels of management generate the activity dictionary.

Question 13

Recycling approach

Answer 13

Reuses documentation of processes used for other purposes

Question 14

Interview or participative approach

Answer 14

ABC teams include or interview operating employees

Question 15

Cost driver rate =

Answer 15

Activity cost + activity volume

Question 16

ABC profitability measures

Answer 16

Now that we havemeasured productcosts accurately,we see how profitableeach product really is.

Activity-based analysis canbe used to track the costsof serving customers andthose customers’contribution to company profits.

Question 17

When to use ABC?

Answer 17

• Indirect costs are significant in proportion to direct costs.
• Goods are complex, requiring many inputs and processes.
• Complex, low-volume products are profitable while standard, high-volume products are not.
• Different departments believe costs are assigned inaccurately.
• The company loses bids it thought were low, and wins bids it thought were high.
• Operations have changed significantly, but the costing system has not changed.
• Introduction of new models result in higher sales, apparent profits per unit, but an overall income decline.