Activity-Based Costing

Question 1

What is Activity-Based Costing?

Answer 1

Activity-Based Costing (ABC) is a method that assigns overhead costs to products or services based on the activities that drive those costs. It provides more accuracy than traditional costing by identifying cost drivers and tracing costs directly to activities and cost objects like products, customers, or services.

Question 2

Why is Activity-Based Costing important?

Answer 2

ABC is essential because traditional costing methods often allocate overhead using a single cost driver, like labor hours or machine hours, which can lead to distorted costs. By using ABC, we ensure that costs are allocated based on actual resource consumption, making it easier to identify inefficiencies and improve profitability.

Question 3

How does Activity-Based Costing differ from traditional costing on the basis of overhead allocation?

Answer 3

Traditional costing allocates overhead based on a single, volume-based measure such as direct labor hours, machine hours, or units produced.

Activity-Based costing allocates overhead based on activities that drive costs. Uses multiple cost pools and different activity measures.

Question 4

How does Activity-Based Costing differ from traditional costing on cost allocation accuracy?

Answer 4

Traditional costing is less accurate because it tends to over-allocate costs to high-volume products and under-allocate costs to low-volume products.

Activity-Based costing provides more accurate cost information by linking overhead costs to the specific activities that generate them.

Question 5

How does Activity-Based Costing differ from traditional costing on number of cost pools?

Answer 5

Traditional costing typically uses a single cost pool for overhead.

Activity-Based costing uses multiple cost pools, each representing a different activity.

Question 6

How does Activity-Based Costing differ from traditional costing on inclusion of non-manufacturing costs?

Answer 6

Traditional costing focuses mainly on manufacturing costs and excludes non-manufacturing overhead from product cost calculations.

Activity-Based costing Includes both manufacturing and non-manufacturing costs in product costing if these costs are related to product activities.

Question 7

How does Activity-Based Costing differ from traditional costing on cost drivers?

Answer 7

Traditional costing uses a single volume-based cost driver, like direct labor hours or machine hours.

Activity-Based costing uses multiple activity-based cost drivers, which can vary for each activity.

Question 8

How does Activity-Based Costing differ from traditional costing on complexity and implementation?

Answer 8

Traditional costing is simpler and less costly to implement since it uses fewer cost pools and a single allocation base.

Activity-Based costing is more complex and expensive to implement and maintain due to the need to identify and track multiple activities and cost drivers.

Question 9

How does Activity-Based Costing differ from traditional costing on capacity focus?

Answer 9

Traditional costing does not differentiate between used and unused capacity, which may lead to inaccurate cost information.

Activity-Based costing explicitly accounts for unused capacity and the costs of idle resources, allowing better capacity management.

Question 10

What are the 6 main steps in Activity-Based costing?

Answer 10

1. Identify Activities and Activity Pools
2. Trace Costs to Activities
3. Assign Costs to Activity Pools
4. Calculate Activity Rates
5. Assign Costs to Cost Objects
6. Prepare Management Reports

Question 11

How is step 1 in ABC done?

Answer 11

We start by identifying the key activities in the production or service process. These are grouped into activity pools, such as machine setups, order processing, or product design. Activity pools are combining activities on the same level

Activities could include:
* Unit-level activities
* Batch-level activities
* Product-level activities
* Customer-level activities
* Organization-sustaining activities

Question 12

How is step 2 in ABC done?

Answer 12

We assign overhead costs to these activities. Some costs, like shipping, can be directly traced, while others need to be allocated.
Formula:

Cost assigned to Activity Pool=
Total Overhead Costs ∙ Proportion of Resources Consumed

Question 13

How is step 3 in ABC done?

Answer 13

Overhead costs are divided among the activities based on their cost drivers.
For instance, setup costs might be allocated based on the number of setups, while order processing costs are allocated based on the number of orders processed.
The resource consumption share of each activity is also computed in this step.

Question 14

How is step 4 in ABC done?

Answer 14

Here, we calculate how much each activity costs per unit of the cost driver.
Formula:
Activity Rate=(Total Cost in Activity Pool)/(Total Activity Driver Units)

Question 15

How is step 5 in ABC done?

Answer 15

This is where the costs from activity pools are allocated to specific cost objects, like products, customers, or orders.
Using the activity rates calculated in Step 4, we multiply the activity rate by the activity driver units consumed by each cost object.
Formula:
Cost Assigned to Cost Object=
Activity Rate ∙ Activity Drive for Cost Object

Question 16

How is step 6 in ABC done?

Answer 16

This step involves summarizing the costs for each cost object and analyzing them to support decision-making. Management reports typically include:
* Total cost for each product or customer.
* Cost breakdown by activities.
* Profitability analysis for each product or service.

Question 17

What is Time-Driven Activity-Based costing?

Answer 17

Time-Driven Activity-Based Costing (TD-ABC) is a simplified version of ABC. Instead of focusing on multiple cost drivers, it uses time as the primary cost driver.
TD-ABC calculates costs by estimating the time required for activities and the cost per time unit.

Question 18

Why use Time-Driven Activity-Based costing?

Answer 18

TD-ABC is easier to implement and maintain than traditional ABC. It’s especially useful for organizations with limited resources or for processes where time is a dominant cost driver.

Question 19

What are the 4 overall steps to Time-Driven Activity-Based costing?

Answer 19

1. Determine Total Cost of Resources Supplied
2. Calculate the Cost per Time Unit
3. Estimate Time Required for Activities
4. Assign Costs to Cost Objects

Question 20

How is step 1 in TD-ABC done?

Answer 20

We start by calculating the total cost of resources available for an activity, such as labor, equipment, or overhead.

Question 21

How is step 2 in TD-ABC done?

Answer 21

This step involves dividing the total cost of resources by their practical time capacity.
Formula:
Cost per Time Unit=
(Total Cost of Ressources Supplied)/(Practical Capacity in Time Units)

Practical Capacity includes the total available time minus time lost to non-productive activities like breaks, sick leave, or training.

Question 22

How is step 3 in TD-ABC done?

Answer 22

We estimate how much time is needed to perform each activity for a cost object (e.g., products, customers, or services).
This is the activity driver in TD-ABC.

Question 23

How is step 4 in TD-ABC done?

Answer 23

Finally, we assign costs by multiplying the time required for an activity by the cost per time unit.
Formula:
Cost Assigned to Cost Object=
Time Required for Activity ∙ Cost per Time Unit

Question 24

What are the key advantages of TD-ABC

Answer 24

1. Simpler Implementation:
   Reduces the need for detailed data collection.
   Focuses on a single driver—time.
2. Dynamic and Scalable:
   Easily adjusts to changes in activity times or costs.
3. Improved Accuracy:
   Eliminates distortions caused by unused capacity.

Question 25

What are the limitations of TD-ABC?

Answer 25

1. Time Dependency:
   Assumes all costs are time-driven, which may not always hold true.
2. Data Reliability:
   Requires accurate estimates of time for activities.