Lecture 3 - Activity based costing

Question 1

Importance of overhead allocation

Answer 1

Decision making
Managing costs
Profitability

Question 2

Activity based costing

Answer 2

Allocates costs by focusing on the activities and resources consumed In the production of a product, as opposed to volume of production

Question 3

Cost driver

Answer 3

A measure that exerts the major influence on the cost of a particular activity for example number of purchase orders or number of production runs

Question 4

How is ABC different from traditional absorption costing?

Answer 4

Absorption rates based on purely volume measures such as direct labour hours may be unrepresentative of the complex relationships between activities and output

It must make sense to use the activity cost driver as the absorption rate given that it is the underlying cause of the cost being absorbed

Activity based costing aims to better measure the non - uniformity in the use of an organisation’s overhead resources by products and services

Question 5

ABC main ideas

Answer 5

Assigns overheads to each activity not departments

Uses non output drivers such as production runs, material issues, purchase orders

Uses greater number of cost centres

Question 6

The ABC process

Answer 6

1. Identify the major activities performed by the business
2. Assign costs to cost pools/ cost centres for each activity
3. Determine the cost driver for each major activity
4. Assign part of the cost of each activity to different products based on the extent to which each product has caused that activity to occur

Question 7

Situations where activity based costing is beneficial

Answer 7

If significant overheads allocated using only one or two cost pools

If products make diverse demands on resources due to volume, process, batch size

If there are staff disagreements over costs

Question 8

Advantages of ABC

Answer 8

Accurate product costing
Accurate information for planning and control

Question 9

Limitations of ABC

Answer 9

Resource costs and activity cost drivers have to be estimated
Choice of cost driver not always clear cut
Costs of implementing and operating significantly higher than traditional systems and may not be appropriate

Question 10

Evaluate Blanket OAR in comparison to ABC method. Advantages and disadvantages

Answer 10

Blanket OAR is quick and easy to calculate, but, fails to identify costs associated with products that vary in volume. Costs are not always related to volume and quantity.
ABC allows products to be charged for relevant costs, providing accurate results, pricing leading to product strategy decisions