Lecture 5 - ABC

Question 1

How does activity-based costing work?

Answer 1

Activities is a type of task or function performed in an organisation.

Cost view through an activity lens.

Activity based process:

1. Cost of overhead resources assigned to activity cost pools
2. Activity costs allocated to individual products or services

Costs of various activities are used to compile total costs for products or other cost objects/pools

Allocation works based on cost pools

1. Calculate the total costs incurred by the pool
2. Identify the total cost driver
3. Identify cost per cost driver (activity cost rates)

Question 2

Under what circumstances does inaccurate allocation occur?

Answer 2

1. Few direct costs categories
2. Limited number of cost pools
3. Cost driver and allocation bases are centred around volume (e.g. number of sales)
   
   1. Specifically more complex environment (e.g. multiple products, small lot sizes, complex customer demands)

Question 3

Cost hierarchy

6 levels of activities.

Answer 3

1. Organisation sustaining
   
   • Admin
2. Facility Sustaining
   
   • Maintenance, depreciation, insurance.
3. Customer Sustaining
   
   • Sales rep salaries
4. Product Sustaining
   
   • Product advertising
5. Batch Level
   
   • shopping cost for batches
6. Unit Level

• materials

Question 4

Why is the allocation base not always the same as a cost driver?

Question 5

4 Benefits of ABC

Answer 5

1. Accuracy: better cost information so long as it is executed well.
2. Employees: focus on value adding activities
3. Help to identify activites that are non value adding or inefficient
4. Activity based management - identify the profitibility of each segment and highlight strengths and weaknesses in the current process.

Question 6

4 costs of ABC

Answer 6

1. Systems design costs
   
   1. Modification of accounting and information system to captured additional information
2. Employees trainings to use ABC system effectively
3. Misinterpretation of activity analysis.
4. Judgement and estimates
   
   1. Denominator levels of cost drivers are estimates
   2. Judgement required to determined activities, and cost pools.

Question 7

Why may uncertainties arise from the choice of cost driver

Answer 7

Due to judgement required in identifying cost drivers.

• Activity costs may have multiple drivers
• E.g. shipping costs could be driven by: number of shipments, distance of shipments, express vs normal

Or inspection costs: number of units, size of units, unit complexity.

Question 8

What are 3 primary uses for ABC information?

Answer 8

1. Pricing/product emphasis decisions
   
   1. Allow over priced units to be sold at a more competitive price.
2. Product design decisions
   
   1. Identify costs that could be reduced
3. Process improvements
   
   1. Areas for more efficiency
   2. Reduce non-value-added activities.

Conduct a CVP analysis (identify highest CM products)

ABC creates cost pools with stronger links to cost drivers.

Resource consumption reduction in the short term with the aim of overall cost reduction in the longer term.