Activity Based Costing (ABC)

Question 1

What are the problems with traditional costing?

Answer 1

• The largest cost of production is indirect overheads, but these are categorise together which lacks detail
• Cost control is more difficult as management does not know the components of the largest production cost (in direct overheads)
• allocation of costs is unrepresentative as it does not take into consideration the relationship between products and indirect overheads
• poor pricing and decision-making result because Costa inappropriately shared between products

Question 2

What is ABC costing about?

Answer 2

ABC costing is different due to its treatment of indirect overhead costs. the direct costs can be allocated straight to the product where as indirect overheads based on costs pools which are then absorbed into cost drivers.

This make sure that each product gets a fair amount of the overhead costs instead of splitting it equally as per traditional methods .

Question 3

What is an activity cost pool?

Answer 3

It is an activity that incurs costs. The cost the length the activity accurately and from the activity to the cost unit.

An example of a cost would be quality costs

Question 4

What is a cost driver?

Answer 4

This is the casual link between the activity and the cost unit. They describe exactly how the production of units in costs with the activitty.

The overhead is linked to the cost unit using a cost driver rate

For example, if the cost Pool was quality costs, then the cost driver could be number of inspections

Question 5

What is the ABC hierarchy of costs?

Answer 5

Unit level
Activity where the consumption of resource is strongly correlated with number of units produced . For example, direct material and direct labour.

Batch level
These activities consume resources in proportion to the number of batches produced rather than units . For example, set up or batch inspection.

Product level
Activities performed to sustain a particular product line for example administration or product specification

Facilities level
Cost simply related to being in business and not related in any way to the production . For example, ground maintenance or property taxes.

Question 6

What are the steps to calculate the full production cost per unit using ABC?

Answer 6

1. Identify activities.
2. Estimate cost pools.
3. Identify cost drivers.
4. Calculate cost driver rate.
5. Charge overhead products via cost driver rate.

Question 7

Advantages of ABC

Answer 7

• Costs are understood better
  -costs are absorbed better
• Cost control can be improved
• Pricing decisions can be improved
• decision-making can be improved
• ABC can be used in service industries

Question 8

Disadvantages of ABC

Answer 8

• Not everything fits into costs and cost drivers
• It can be costly to implement
• The choices of activities and cost drivers might be inappropriate

Question 9

What are the favourable conditions for ABC?

Answer 9

• Production overheads are high relative to direct costs
• Diversity in the product range
• Diversity of overhead resource input products
• Consumption of overheads not primarily driven by volume