Chapter 5: Activity-based Costing Flashcards
What is the main difference between traditional costing and activity-based costing (ABC)?
Traditional costing allocates overhead costs based primarily on a single measure like direct labor hours, while ABC assigns costs based on multiple activities that drive overhead, aiming to more accurately reflect the resources consumed by products or services.
Why might traditional costing not be the best approach for allocating overhead in modern environments?
Traditional costing may not accurately reflect the use of resources because the correlation between direct labor and overhead costs has weakened with technological advancements, automation, and a decrease in direct labor due to increased efficiency.
What is a predetermined overhead rate and how is it used in traditional costing?
A predetermined overhead rate is an estimated charge per unit of the allocation base (like direct labor hours) used to assign overhead costs to products throughout the year in traditional costing systems.
How does activity-based costing (ABC) differ in overhead cost allocation compared to traditional costing?
ABC uses multiple cost drivers to allocate overhead costs, representing a variety of activities that consume resources, rather than relying on a single base such as direct labor or machine hours.
What are some benefits of activity-based costing?
ABC provides more accurate cost information, helps identify non-value added activities, and supports performance management and decision-making by highlighting the true cost of products or services.
What are the limitations of activity-based costing?
ABC can be more complex and costly to implement, requires more data collection, and may not always provide additional insights if products are similar or overhead costs are not significant.
How is ABC applied in manufacturing?
In manufacturing, ABC is applied by identifying and classifying activities, determining cost drivers, calculating overhead rates for each activity, and then assigning these overhead costs to products based on their consumption of activities.
How is ABC applied in service industries?
In service industries, ABC allocates costs by identifying activities that consume resources and assigning costs to services based on the extent to which each service consumes these activities.
What is Activity-Based Costing (ABC)?
ABC is an approach for allocating overhead costs that allocates overhead to multiple activity cost pools, then assigns the activity cost pools to products and services using cost drivers.
What is an activity in the context of ABC?
An activity is any event, action, transaction, or work sequence that incurs costs when producing a product or performing a service.
What is an activity cost pool?
An activity cost pool is the overhead cost attributed to a distinct activity, such as ordering materials or setting up machines.
What is a cost driver?
A cost driver is any factor or activity that has a direct cause-effect relationship with the resources consumed.
What are the four steps of activity-based costing?
The four steps are
(1) Identify and classify activities and allocate overhead to cost pools,
(2) Identify cost drivers,
(3) Calculate activity-based overhead rate, (4) Assign overhead costs to products.
What type of companies would benefit from ABC?
Companies with complex processes and those where there is little or no correlation between traditional cost drivers like machine hours or direct labor and the overhead costs.
How does ABC differ from traditional costing?
Unlike traditional costing, which often uses one or two volume-based cost drivers, ABC uses multiple cost drivers to allocate costs more accurately based on actual activities.
Why might a company need to use multiple allocation bases in ABC?
Multiple allocation bases are used to calculate accurate product costs, especially when products consume activities and resources differently.
What is the purpose of applying activity-based costing (ABC) in manufacturing?
The purpose is to allocate overhead costs to products more accurately by using multiple activity cost pools and cost drivers, which reduces distortion compared to traditional overhead cost allocation.
What is the first step in applying ABC to a manufacturer?
The first step is to identify and classify the major activities involved in the manufacture of specific products and allocate overhead costs to cost pools.
What is the second step in the ABC process?
The second step is to identify the cost driver that has a strong correlation with the costs accumulated in each cost pool.
How do you calculate the activity-based overhead rate in ABC?
Calculate the activity-based overhead rate for each cost pool by dividing the estimated overhead per activity by the estimated use of cost drivers per activity.
What is the final step in the ABC process?
The final step is to assign overhead costs to products using the overhead rates (cost per driver) determined for each cost pool and each product’s use of each cost driver.
How does ABC differ from traditional costing regarding overhead allocation?
Unlike traditional costing, which often allocates overhead based on a single cost driver like machine hours or direct labor, ABC uses multiple cost drivers that are more closely related to the actual resources consumed by each product.
Why is a high degree of correlation between cost drivers and actual consumption important in ABC?
A high degree of correlation ensures that the overhead costs allocated to a product reflect its actual resource consumption, leading to more accurate and relevant cost information.
What does applying activity-based costing (ABC) to a manufacturer involve?
Applying ABC involves identifying and classifying activities, assigning overhead costs to cost pools, identifying cost drivers, calculating overhead rates, and assigning overhead costs to products.
