ABC and Digital Costing Flashcards
What is absorption costing?
An accounting method used to determine the full production cost per unit
What are the two types of costs considered in calculating the full production cost of a unit?
Direct costs and indirect costs
Define direct costs in the context of product costing.
Costs that can be directly linked back to a unit of production, such as ingredients and labor
What are indirect costs?
Costs that are necessary for the business to operate but cannot be directly attributed to a single unit of production
What is a cost centre?
A part of an organisation which can have particular costs charged to it
What is the process of sharing overhead costs between production departments called?
Apportionment
What is the overhead absorption rate (OAR)?
The rate calculated by dividing production overhead by the activity level
How is the pre-determined overhead absorption rate calculated?
Budgeted overhead / Budgeted activity level
What does over-absorption mean?
When the overhead absorbed is greater than the actual overheads incurred
What is the main limitation of traditional absorption costing in modern production?
It may oversimplify the cost allocation process and not accurately reflect how costs are incurred
What is activity-based costing (ABC)?
A costing method that allocates overhead costs based on specific activities rather than production volume
Why is ABC considered more accurate than traditional costing methods?
It recognizes that costs are incurred through specific activities rather than just production volume
What are the two steps in the traditional absorption costing process?
- Allocate production overheads
- Calculate gross profit per unit
How do you calculate the overhead cost per machine hour?
Total production overhead / Total machine hours
What is the formula for calculating gross profit per unit?
Gross profit / Units sold
What are cost pools in activity-based costing?
Groups of costs associated with specific activities
What is the primary benefit of using ABC over absorption costing?
Provides a more accurate method of allocating costs in complex production environments
Fill in the blank: The overhead absorption rate is calculated by dividing __________ by the activity level.
Production overhead
True or False: Indirect costs can be directly linked to a specific unit of production.
False
What is the first step in implementing Activity-Based Costing (ABC)?
Determine cost pools and cost drivers
Identify the main activities in the manufacturing process and their cost drivers.
How do you calculate the number of tests for a product?
Multiply the number of tests per production run by the number of production runs
True or False: Under absorption costing, the Custom model is the most profitable product.
True
Why do the two costing systems produce different results?
Absorption costing allocates overheads based on machine hours, which may not reflect actual costs incurred.
What does ABC allow businesses to trace?
Each overhead cost to its individual driver
What is a key advantage of using ABC?
Improved pricing
Fill in the blank: ABC is most effective in environments where overhead costs are high in comparison to _______.
direct costs
What is a disadvantage of ABC?
It is not easy to implement and can be time-consuming and expensive.
What type of products benefit most from ABC?
Products that are highly customized and diverse
How does ABC improve profitability analysis?
Provides more accurate costing information
What should be considered when pricing the Custom model to make it profitable?
Increase the selling price
What is the gross profit for the Platinum model under absorption costing?
£10,63
When is ABC not required according to IAS?
When only an appropriate amount of absorption of fixed overheads is needed
What is the impact of ABC on decision-making?
Provides new information to help improve profitability
What does ABC help optimize in production?
Product mix
Fill in the blank: Digital products include apps, e-books, online music, and _______.
software systems
What is a key characteristic of digital products regarding production?
Once made, they require no further production for each sale
What are digital products?
Digital products include apps, e-books, online music, and software systems, stored and purchased for online use.
How do the production costs of digital products differ from physical products?
Most costs for digital products are incurred upfront, unlike physical products which incur costs for each unit sold.
What should be used in pricing digital products?
Upfront, overhead costs should be used in pricing, unlike traditional costing which relies on marginal costs.
What is the marginal cost of a physical product like a mug?
The marginal cost includes the cost of labor, materials, and machine time for making one unit.
How is the cost of producing a digital product like a mobile game determined?
All overhead costs must be considered over the expected life of the game to settle on a unit value.
What are some specific costs associated with digital products?
Costs include design, research and development, platform types, marketing, testing and support, functionality, and royalties.
What are design, research and development costs considered in digital products?
They are overhead costs incurred before the product’s release and not dependent on sales.
What unique costs do digital products incur that traditional products do not?
Operating system costs and functionality costs are unique to digital products.
What type of costs are marketing expenses for digital products classified as?
Marketing costs are considered overhead as they are not tied to sales volumes.
What are royalties in the context of digital products?
Royalties are ongoing variable costs paid for copyrighted features and can add up significantly.
What is a significant difference regarding inventory costs between digital and traditional products?
Digital products do not incur inventory storage and valuation costs like traditional products.
Fill in the blank: One of the key takeaways of digital costing is that costs are not ______ dependent, with the exception of royalties.
sales
What difficulties are encountered in costing digital products?
Difficulties include shared resources, shared features, calculating product life, a rapidly changing market, standard costing, cost timings, and marginal costs.
What are some benefits of digital costing systems?
- Component value
- Time saved
- Money saved
- Easy to use
- Better information
- Cost behaviour
- Streamlines overall processes
- Flexible pricing
- Meeting target costs
Why is calculating the useful life of a digital product difficult?
Rapid technological advancements and saturated digital markets make it hard to predict.
True or False: Most costs associated with digital products are fixed in nature.
True
What do digital costing systems enable companies to do?
They allow companies to collect, analyze, and allocate relevant data for informed production and pricing decisions.
What type of company is most likely to benefit from investing in digital costing systems?
Larger companies manufacturing complex products with many components.
How does a digital costing system work?
Links a business’s digital systems with those of its suppliers, customers, and the market to gather real-time cost information.
This integration allows businesses to make informed decisions based on up-to-date data from various sources.
What type of information can a digital costing system supply?
- Where costs are being incurred
- Time taken in production
- Current purchase prices for materials and components
- Wastage levels
This information helps businesses manage costs more effectively and make informed pricing decisions.
List some benefits of using a digital costing system.
- Better lead times and prices from suppliers
- Regular updates to standards
- Improved variance reporting
- No planning variances
- Better understanding of cost drivers
- Improved pricing decisions
These benefits enhance the overall efficiency and accuracy of cost management in businesses.
True or False: Digital costing systems do not require real-time data.
False
What are some differences in costing digital products compared to traditional products?
- Digital products lack physical form
- Minimal reproduction costs
- Significant up-front design and development costs
- Lower ongoing costs compared to physical products
- High labor costs for design and development
- No inventory
These differences create unique challenges in cost estimation and management.
What are some difficulties associated with costing digital products?
- Knowledge of costs and sales volume is required
- Difficult to predict sales volume and lifespan
- Ongoing costs are hard to estimate
- Need for market knowledge and technology impact
- Determining allocation of indirect costs
These difficulties complicate pricing strategies and overall financial planning for digital products.
Fill in the blank: A digital costing system links a business’s digital systems with that of its _______.
[suppliers, customers, and the market]
What is a significant challenge in establishing a standard unit cost for digital products?
Knowledge of creation and maintenance costs, sales volume, lifespan, and future technologies.
What type of costs are often low for digital products?
Material costs
In contrast, labor costs for initial design and development can be high, especially when using freelance staff.
What does improved knowledge of costs and prices impact?
- Standards
- Variances
- Pricing
- Profit
- Managing costs
This knowledge is crucial for effective decision-making in financial management.
