Activity Based Costing Flashcards
Why do organisations need to identify the cost of their products?
To value inventory
To identify profitability of products
To help plan and control performance
To provide information for decision making
What are the two main differences between absorption and activity-based costing?
In the first stage, absorption costing allocate overheads to cost centres, whereas ABC allocates to activities.
In the second stage, absorption costing absorbs overheads using a small range of volume related bases, whereas ABC absorbs overheads using a wide range of cost drivers (volume and non-volume related).
What are the 5 steps in ABC?
1 Identify the different activities of the organisation
2 Create cost pools by calculating the total cost of each.
3 Identify a cost driver for each
4 Calculate the cost driver rate
(Total budgeted overhead in activity / total budgeted no of cost drivers for activity)
5 Attach the activity costs to products according to their demand for each activity.
What are the 4 activity hierarchies?
1 Unit Level Activities - each time a unit is produced. Absorption costing assumes all activities are unit level.
2 Batch Level Activities - each time a batch is produced. Fixed for all units within one batch.
3 Product-sustaining activities - performed to allow the production of a particular model. Cost is unrelated to number of batches and units.
4 Facility-sustaining activities - performed to support the general operations of the organisation. Not related to products and can therefore be treated as fixed costs.
How can ABC highlight the cost of unused capacity?
Because ABC measures the cost of resources consumed not the cost of resources supplied.
Cost of resources supplied = Cost of resources used + cost of unused capacity
What is unused capacity?
Where resources cannot be immediately flexed to match the demand for them. This is because some are acquired in fixed amounts. Therefore reducing the cost driver would not lead to a saving unless they reduce the resource supplied.
Why did the limitations of absorption costing become apparent?
They were developed when companies produced a narrow range of products and overhead was small, therefore inaccurate proportion wasn’t a problem. However business environment changed with wider range of products, flexible systems, fast development and increased competition. Therefore poor decisions and apportionment are more damaging.
Which Harvard Business School alumni promoted ABC?
Cooper and Kaplan (1991)
Why is ABC particularly appropriate for service organisations?
1 Low levels of direct material and direct labour
2 Traditional costing would treat their cost as fixed as the ability to provide the service has to be supplied in advance of the service being demanded.
3 If customers are the cost object then ABC can provide information on customer profitability
4 Service organisations traditionally rely on basic costing systems, therefore incremental benefits of ABC can be considerable.
What are the usage rates of ABC?
Innes et al (2000) found 18%, less than 21% from five years before.
Large businesses, especially in the finance sector, are more likely to use ABC.
What variables did Shields (1995) associate with successful ABC implementation?
Top management support for the system Linkage to competitive strategy Linkage to performance evaluation and compensation Training in ABC implementation Non-accounting ownership of the system Adequate resources being available
What did Shields (1995) note as a cause of problems with ABC?
Too much emphasis on technical aspects of the system rather than behavioural, cultural, organisational and political issues raised by implementing ABC.
What four measures do Foster and Swanson (1997) use to measure the success of ABC?
Its use in decision making
Its impact on managers’ decisions
Its financial impact on the firm
Managers’ satisfaction with it
What are the benefits of ABC?
More accurate basis for apportioning overhead costs than absorption costing
Improvement in unit costs leads to improved decision making
Identification of cost drivers provides a mechanism for reducing costs
What are the criticisms of ABC?
Only a marginal improvement on absorption.
Unrealistic assumptions about cost behaviour
Apportionment will be arbitrary
Time consuming
Expensive
Disruptive
Managers may manipulate information
Management fashion as opposed to a technical advance
Overall adoption is low, therefore perception is that costs outweigh benefits.
