Chapter 3: Activity Based Costing

Question 1

What are some problems caused by traditional costing methods?

Answer 1

Too little details on the most significant cost
Cost control is more difficult
The allocation of costs is unrepresentative
Poor pricing and decision making can result

Question 2

What is an activity cost pool?

Answer 2

An activity that incurs cost
Costs are linked to the activity accurately and from the activity to the cost unit
Knowledge of the activity is key to the application of ABC

Question 3

What is an activity cost driver?

Answer 3

Casual link between the activity and the cost unit
Costs drivers describe exactly how the production of units incur costs within the activity
The overhead is linked to the cost unit using a cost driver rate

Question 4

How can activity level be classified?

Answer 4

Unit level
Batch level
Product level
Facility level

Question 5

What are the five steps to calculating an ABC?

Answer 5

Identify activities
Estimate cost pools
Identify cost drivers
Calculate cost driver rate
Charge overheads to products via cost driver rate

Question 6

What are the advantages of ABC?

Answer 6

Costs understood better
Costs 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 7

What are the disadvantages of ABC?

Answer 7

Arbitrary cost apportionments are still required
Costly to implement
The choice of activities and cost drivers might be inappropriate

Question 8

What are the favourable conditions for ABC?

Answer 8

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