chapter 5 from book: activity-based costing Flashcards
why are direct material and direct labor costs the easiest to determine?
because they can be traced directly to the product by examining material requisition forms and payroll time sheets
what is often the most difficult part of calculating accurate unit costs?
determining the proper amount of overhead cost to assign to each product, service, or job
when is it appropriate to allocate overhead costs on the basis of direct labor?
when direct labor is a significant part of the total product cost
when there is a high correlation between direct labour and change in the amount of overhead costs
what has dramatically changed the manufacturing environment in the past years?
advances in computerized systems
technological innovation
global competition
automation
why does the drastic changes in the manufacturing environment cause the need for a change on way we allocate overhead?
we used to base it a lot on direct labor costs
nowadays, the changes has drastically decreases actual direct labor costs
furthermore, overhead costs from depreciation, maintenance, repairs, and utilities, have increased
since there is no more correlation between overhead costs and direct labor with the reduced direct labor hours, what do many companies now use to base their overhead costs?
is it gyu or nah
machine hours
this is not the best tho, it can often be inadequate
activity based costing
an approach to allocating overhead costs
allocates overhead on multiple activity cost pools
then assigns activity cost pools to products and services
how does activity based costing assign activity cost pools to products and services?
by using cost drivers
activity
any event, action, transaction, or work sequence that incurs cost when producing a product or performing a service
activity cost pool
the overhead cost attributed to a distinct activity
ex: ordering materials
ex: setting up machines
cost driver
any factor or activity that has a direct cause-and-effect relationship with the resources consumed
measures the number of individual activities that are performed to produce products or services
what is the basic logic for activity based costing
products consume activities
activities consume resources
what are the 4 steps of activity based costing
- identify and classify the major activities and assign overhead cost to pools
- identify the cost drivers
- calculate the activity based overhead rate for each cost pool
- allocate overhead costs to products
how do you calculate the activity based overhead for each cost pool?
you divide step 1 by step 2
you identify the cost of the major activities, and then you divide by the number influencing the total cost in cost pools (cost drivers)
what happens if there is little to no correlation between the cost drivers and the total cost in the activity cost pools?
there will be inaccurate product costs
indicate if the following is true or false
activity based costing allocates overhead costs in a two stage process?
true
- identify and classify the major activities and assign overhead cost to pools
identify all resource consuming activities that are then identified as the cost pools
allocate the costs to each cost pool
as you add up all the costs of cost pools, it gives the estimated overhead
how ca you estimate the overhead costs?
you add up all the costs of the cost pools
- identify the cost drivers
actual measures of the actual consumption of activity by the various products
must be a high degree of correlation between cost driver and actual consumption
- calculate the activity based overhead rate for each cost pool
dividing estimated overhead per activity by the number of cost drivers estimated
- allocate overhead costs to products
must estimate the use of cost drivers for each product
you then multiply the activity based overhead rates by the corresponding cost drivers for each product
does activity based costing change the amount of overhead costs?
nah boy
overhead just assigned in a more accurate manner
what are the three primary benefits of ABC?
- employs more cost pools and therefore results in more accurate product costing
- leads to enhanced control over overhead costs
- supports better management decisions
advantages of multiple cost pools
costs are allocated more directly on the basis of the cost drivers used to produce each product
how do you gain multiple the full advantage of having multiple cost pools?
costs within the pool must be correlated with the driver
to achieve this, managers characterize activities as
how do you ensure the the costs within the multiple cost pools are correlated with their corresponding drivers?
to achieve this, managers characterize activities as :
unit-level activities
batch-level activities
product level activities
facility level activities
unit-level activities
performed for each unit of production
ex: assembly of cellphone
why is the assembly of cellphone a unit level activity
because the amount of assembly the company performs increases with each additional cellphone made
batch-level activities
performed everytime a company produces another batch of product
ex: setting up machines to process a new batch of ice cream
product level activities
performed every time a company produces a new type of product
facility level activities
required to support or sustain an entire production process
value added activities
activities of a company’s operations that increase the perceived value or service to customers
non value added activities
if eliminated, these activities would not take away any customer perceived value to the product or service
only increase costs, or increase time spent on them
ex: inventory storage
why are activity flowcharts gyu?
they can help you find which activities add value and which dont
should all non value added activities be eliminated?
nah boy
such as inspection
activity based management
extends beyond ABC and helps with reducing costs, improving processes and decision making by becoming comprehensive management tool
what are the main limitations of ABC?
can be expensive to use
more complex to use
does not offer complete accuracy because some arbitrary allocations remain
how does a company know when to use ABC?
there has to be the presence of at least one of the following factors:
product lines differ greatly in volume and manufacturing complexity
product lines are numerous and diverse, requiring various degrees of support services
overhead costs constitute a significant portion of total costs
the manufacturing process of the number of products has changed significantly
production or marketing managers are ignoring data provided by the existing system
classify the following activity as either a unit level, batch level, product level, or facility level activity
engineering design
product level
classify the following activity as either a unit level, batch level, product level, or facility level activity
machine set up
batch level
classify the following activity as either a unit level, batch level, product level, or facility level activity
toy design
product level
classify the following activity as either a unit level, batch level, product level, or facility level activity
interviews of prospective employees
facility level
classify the following activity as either a unit level, batch level, product level, or facility level activity
inspections after each set up
batch level
classify the following activity as either a unit level, batch level, product level, or facility level activity
polishing parts
unit level
classify the following activity as either a unit level, batch level, product level, or facility level activity
assembling parts
unit level
classify the following activity as either a unit level, batch level, product level, or facility level activity
health and safety
facility level
is ABC widely used in service industries?
ye brooo
what sometimes makes the implementation of ABC in service industries difficult?
compared to manufacturers, a larger proportion of overhead costs are company wide costs
they cannot be easily traced so specific services performed by the company
what are three conditions that should be present in order to implement ABC?
The consumption ratios of unit-based and non-unit-based activities must differ
Non-unit-based costs should be a significant portion of total overhead costs
Measurement costs of the identified cost pools must be relatively low
Three ways that ABC leads to more accurate product costs
i) ABC increases the number of cost pools used to accumulate overhead costs
–> costs are accumulated by activity
–> As a result, many pools are created with cost-driving activities that are better related to the incurrence of cost
ii) ABC changes the base used to assign overhead costs to products
–> costs are assigned on a basis of cost-driving activities that can be traced to the product or job involved
iii) ABC changes a manager’s perception that many of the overhead costs are indirect
–> many overhead costs can now be recognized as being traceable to individual products
2 limitations to ABC
can be expensive to use because of the increased cost of identifying multiple activities and applying numerous cost drivers
Certain overhead costs still need to be allocated using some arbitrary volume-based cost driver, such as labour or machine hours
