Module 2 (Chapter 5) Flashcards
Explain how broad averaging undercosts and overcosts products or services
…it does not measure the different resources consumed by different products and services
Product undercosting—
a product consumes a high level of resources per unit but is reported to have a low cost per unit
Product overcosting—
a product consumes a low level of resources per unit but is reported to have a high cost per unit
What are the strategic consequences of product undercosting and overcosting?
Suppose a manager uses cost info. about products to guide pricing decisions. Undercosted products will be underpriced and may even lead to sales that actually result in losses because the sales may bring in less revenue than the cost of resources they use. Overcosted products will lead to overpricing, causing those products to lose market share to competitors producing similar products. Product undercosting and overcosting cause managers to focus on the wrong products.
Product-Cost Cross-Subsidization:
Product-cost cross-subsidization means that if a company undercosts one of its products, it will overcost at least one of its other products. Similarly, if a company overcosts one of its products, it will undercost at least one of its other products. Product-cost cross-subsidization is very common when a cost is uniformly spread—meaning it is broadly averaged—across multiple products without managers recognizing the amount of resources each product consumes.
1) When does product undercosting or overcosting occur?
Product undercosting (overcosting) occurs when a product or service consumes a high (low) level of resources but is reported to have a low (high) cost. Broad averaging, or peanut-butter costing, a common cause of undercosting or overcosting, is the resrult of using broad averages that uniformly assign, or spread, the cost of resources to products when the individual products use those resources in a nonuniform way. Product-cost cross-subsidization exists when one undercosted (overcosted) product results in at least one other product being overcosted (undercosted).
- Simple Costing System Using a Single Indirect-Cost Pool:*
- Allocates indirect costs using a single indirect-cost rate*
- (steps)*
Step 1: Identify the Products That Are the Chosen Cost Objects
Step 2: Identify the Direct Costs of the Products
Step 3: Select the Cost-Allocation Bases to Use for Allocating Indirect (or Overhead) Costs to the Products
Step 4: Identify the Indirect Costs Associated with Each Cost-Allocation Base
Step 5: Compute the Rate per Unit of Each Cost-Allocation Base.
Budgeted indirect-cost rate= Budgeted total costs in indirect-cost pool
Budgeted total quantity of cost-allocation base
Step 6: Compute the Indirect Costs Allocate to the Products
Step 7: Compute the Total Cost of the Products by Adding All Direct and Indirect Costs Assigned to the Products
- Five-Step Decision-Making Process*
- (steps)*
Step 1: Identify the Problems and Uncertainties
Step 2: Obtain Information
Step 3: Make Predictions About the Future
Step 4: Make Decisions by Choosing Among Alternatives
Step 5: Implement the Decision, Evaluate Performance, and Learn
Refined costing system:
A refined costing system reduces the use of broad averages for assigning the cost of resources to cost objects (such as jobs, products, and services) and provides better measurement of the costs of indirect resources used by different cost objects, no matter how differently various cost objects use indirect resources. Refining a costing system helps managers make better decisions about how to allocate resources and which products to produce.
Present three guidelines for refining a costing system
…classify more costs as direct costs, expand the number of indirect-cost pools, and indentify cost drivers
- Reasons for Refining a Costing Sytstem:*
- Three principal reasons have accelerated the demand for refinements to the costing system.*
- Increase in product diversity.
- Increase in indirect costs.
- Competition in product markets.
- Guidelines for Refining a Costing System:*
- There are three main guidelines for refining a costing system:*
- Direct-cost tracing. Identify as many direct cost as is economically feasible. This guideline aims to reduce the amount of costs classified as indirect, thereby minimizing the extent to which costs have to be allocated rather than traced.
- **Indirect-cost pools. **Expand the number of indirect-cost pools until each pool is more homogenous. All costs in a *homogeneous cost pool *have the same or a similar cause-and-effect (or benefits-received) relationship with a single cost driver that is used as the cost-allocation base.
- **Cost-allocation bases. **Whenever possible, managers should use the cost driver (the cause of indirect costs) as the cost-allocation base for each homogeneous indirect-cost pool (the effect).
2) How do managers refine a costing system?
Refining a costing system means making changes that result in cost numbers that better measure the way different cost objects, such as products, use different amounts of resources of the company. These changes can require additional direct-cost tracing, the choice of more-homogenous indirect cost pools, or the use of cost drivers as cost-allocation bases.
Acitivity-based costing:
Activity-based costing (ABC) refines a costing system by identifying individual activities as the fundamental cost objects.
Activity:
An activity is an event, task, or unit of work with a specified purpose—for example, desinging products, setting up machines, operating machines, and distributing products. They are things that a firm does.
How do ABC systems help to make strategic decisions?
To help make strategic decions, ABC systems identify activites in all functions of the value chain, calculate costs of individual activities, and assign costs to cost objects such as products and services on the basis of the mix of activities needed to produce each product or service.
Distinguish between simple and activity-based costing systems
…unlike simple systems, activity-based costing systems calculate costs of individual activities to cost products
3) What is the difference between the design of a simple costing and an activity-based costing (ABC) system?
The ABC system differs from the simple system by its fundamental focus on activities. The ABC system typically has more-homogenous indirect-cost pools than the simple system, and more cost drivers are used as cost-allocation bases.
cost heirachy:
A cost heirachy categorizes various activity cost pools on the basis of the different types of cost drivers, cost-allocation bases, or different degrees of difficulty in determining cause-and-effect (or benefits-received relationships.
ABC systems commonly use a cost heirachy with four levels to identify cost-allocation bases that are cost drivers of the activity cost pools:
(1) output unit-level costs
(2) batch-level costs
(3) product-sustaining costs
(4) facility-sustaining costs
Describe a four-part cost heirachy
…a four-part cost heirachy is used to categorize costs based on different types of cost drivers—for examples, costs that vary with each unit of a product versus costs that vary with each batch of products.
Output unit-level costs:
are the costs of activities performed on each individual unit of a prodcut or service
Batch-level costs:
are the costs of activites related to a group of units of a product or service rather than each individual unit of product or service.
Product-sustaining costs (service-sustaining costs):
are the costs of activities undertaken to support individual producst or services regardless of the number of units or batches in which the units are produced.
Facility-sustaining costs:
are the costs of activities that managers cannot trace to individual prodcuts or services but that support the organization as a whole.
4) What is a cost heirachy?
A cost heirachy categorizes costs into different cost pools on the basis of the different types of cost-allocation bases or different degrees of difficulty in determining cause-and-effect (or benefits-received) relationships. A four-part heirachy to cost products consists of output unit-level costs, batch-level costs, product-sustaining costs or service-sustaining costs, and facility-sustaining costs.
How do you cost products or services using activity-based costing?
…use cost rates for different activities to compute indirect costs of a product
5) How do managers cost products or services using ABC systems?
In ABC, costs of activiites are used to assign costs to other cost objects such as products or services based on the activities the proucts or services consume.
Evaluate the costs and benefits of implementing activity-based costing systems
…measurement difficulties versus more accurate costs that aid in decision making when products make diverse demands on indirect resources
What are some of the telltale signs of when an ABC system is likely to provide the most benefits?
- Significant amounts of indirect costs are allocated using only one or two cost pools.
- All or most indirect costs are identified as output unit-level costs (few indirect costs are described as batch-level costs, product-sustaining costs, or facility-sustaining costs).
- Products make diverse demands on resrouces because of differences in volume, process steps, batch size, or complexity.
- Products that a cmpany is well-suited to make and sell show small profits, whereas products tha a company is less suited to make and sell show large profits.
- Operations staff has substantial disagreement with the reported costs of manufacturing and marketing products and services.
What are some of the behavioral issues that managers and management accountants must be sensitive to when implementing an ABC system?
- Gaining support of top management and creating a sense of urgency for the ABC effort.
- Creating a guiding coalition of managers throughout the value chain for the ABC effort.
- Educating and training employees in ABC as a basis for employee empowerment.
- Seeking small short-run successes as proof that the ABC implementation is yielding results.
- Recognizing that ABC information is not perfect because it balances the need for better information against the costs of creating a complex system that few managers and employees can understand.
6) What should managers consider when deciding to implement ABC systems?
ABC systems are likely to yield the most decision-making benefits when indirect costs are a high percentage of total costs or when products and services make diverse demands on indirect resources. The main costs of ABC systems are the difficulties of the measurements necessary to implement and update the systems.
Explain how managers use activity-based costing systems in activity-based management
…such as pricing decisions, product-mix decisions, and cost reduction
Activity-based management:
is a method of management decision making that uses activity-based costing information to improve customer satisfaction and profitibality. We define ABM broadly to include decisions about pricing and product mix, cost reduction, process improvement, and product and process design.
7) How can ABC systems be used to manage better?
Activity-based management (ABM) is a mangement method of decision making that uses ABC information to satisfy customers and improve profits. ABC systems are used for such management decisions as pricing, product-mix, cost reduction, process improvement, product and process redesign, and planning and managing activities.
Compare activity-based costing systems and department costing systems
…activity-based costing systems are a refinement of department costing systems into more-focused and homogenous cost pools
8) When can department costing systems be used instead of ABC systems?
Activity-based costing systems are a refinement of deparment costing systems into more-focused and homogenous cost pools. Cost information in department costing systems approximates cost information in ABC systems only when each department has a single activity (or a single activity accounts for a significant proportion of department costs) or a single cost driver for different activities or when different products use the different activities of the department in the same proportions.
