Session 4: Activity-based costing

Question 1

With Traditional Overhead aborsption costing, how are overheads allocated?

Answer 1

The overheads or indirect costs are all allocated uniformly to cost units using one cost driver e.g. direct labour hours or sometimes machine hours ) and it is a blanket rate.

Question 2

What is a problem of using a blanket rate for assigning overheads to different departments?

Answer 2

A department might have mutliple products and different level of specilaisation.

Question 3

If a product is less specialised and simple to use, then what ?

Answer 3

There shouldn’t be a lot of expenditure absorbed per unit for that product compared to a product more specialised. This may lead to a situation of undercosting highly speicialised products and overcosting easy, high volume products.

Question 4

In traditional overhead absroption costing, what is the problem with low end mass market, high volume products?

Answer 4

They absorb most of the overheads, even though they dont cause them,

Question 5

So as in TBC those products with the highest volumes, but not complexed are charged the most what does costing system solves this problem?

Answer 5

ABC, as TBC leads to wrong decision making.

Question 6

How are costs allocated with TBC compared to ABC?

Answer 6

ABC methods expand the number of indirect cost pools (these are expressed in activities)that can be allocated to specific products. The traditional method takes one pool of a company’s total overhead costs to allocate universally to all products.

Question 7

What are the steps of the allocation of indirect costs?

Answer 7

Question 8

Answer 8

Answer is C if not used in product, then don’t allocate it.

Question 9

Is there an exception for excess capacity?

Answer 9

Exceptions for strategic excess capacity that is deliberately procured
for a particular product

Question 10

Answer 10

Question 11

Complete this.

Answer 11

Question 12

What does ABC do?

Answer 12

ABC creates new visibilites for decisions

Question 13

What do ABC do to specific types of costs?

Answer 13

categorises costs based on the different levels of cost drivers. ABC uses a four-part cost hierarchy.
The 4 cateogries are:
1) Unit level costs
2) Batch level costs
3) Product level costs
4) Facility level costs.
( SO BASICALLY THE ABC HIERACHY GUIDES THE CHOICE OF COST DRIVER.
The cost driver should refelct whether the activity causes unit level, batch level, product level and facility level costs .

Question 14

What are unit level costs and what should the cost driver be and give example?

Answer 14

Costs of activity that increase with each additional unit of output
produced. E.g., machine usage and repair. Cost drivers should vary with no. of units so like DLH, DMH, No. of units.

Question 15

What are batch level costs and what should the cost driver be and give example?

Answer 15

Costs that vary depending on the number of batches instead of each individual
unit produced. E.g., purchase ordering, material handling. Cost drivers should be like Number of purchase orders, Number of material moves.

Question 16

What are product level activites and what should the cost driver be and give example?

Answer 16

Costs that are incurred to support individual products or services. E.g.,
design cost. e.g. product design, engineering changes. Cost drivers should be number of product designs and number of changes.

Question 17

What are Facility level activities, what should be the cost driver and give example?

Answer 17

Costs incurred to support the organisation as a whole and cannot be traced to
individual products. E.g., general administration cost. e.g. plant management salaries. Cost drivers should be like number of employees managed

Question 18

When establishing direct costs for example airline what does this depend on?

Answer 18

It depends on what you define as output.

Question 19

Idenfity the costs relating to the cost hierachy for airlines?
and also answer this.

Answer 19

1) Unit level costs - jet fuel, aircrew salaries.
2) Batch level costs - insurance, airport fees, maintence ( all depends on what you define what a batch is.
3) Product level - check in facilities, customer service.
4) Faciility level costs - General management, office rent.

B answer

Question 20

What is the assumption when you pick a cost driver?

Answer 20

For each activity-cost pool, cost drivers serve as the cost allocation base. Each allocation base has a cause-and-effect relationship with costs in the cost pool. Although, this relationship does not necessarily mean it’s perfectly proportional but has a strong enough correlation. Cause and effect might come in several ways:

1) Physical relationship between cost and cost driver
2) Contractual arragnement
3) Logic and knowledge of operations,

Question 21

What is activity based management?

Answer 21

Activity-based management is a method of identifying and evaluating activities that a business performs, using activity-based costing to carry out a value chain analysis

Question 22

What sort of descions does ABM using ABC deal with?

Answer 22

○ Pricing and product-mix decisions
○ Cost reduction and process improvement decisions
○ Design decisions
○ Planning and managing activities

Question 23

With activity based management lets say we slice and dice ‘number of sales orders’ and we identify cost drivers like make sales calls, ship products, process invoices, what can ABM allow us to do, supposing sales order is a batch level activity?

Answer 23

You might want to eliminate orders which are below a certain freshhold and evaluate sales managers based on ability to increase size and reduce number of orders.
THUS ABC HELPS TO IDENTIFY VALUE ADDED VS NON VALUE ADDED ACTIVITIES.

Question 24

What are 2 advantages of ABC?

Answer 24

1) Can make the cost of excess capcity visble

2) can give better information about how costs arise and are related to products.

Question 25

When is ABC particularly useful?

Answer 25

If there are large indirect costs
If the full ocst is showing very minor differences between produces that are easy and difficult to make
if you are operating in a very compeititve industry ( so you dont over price goods)

Question 26

What are 2 disadvantages of ABC?

Answer 26

1) The costing system can become very complicated with a very large number of activites and cost drivers.
2) Assumption of linear cost behaviour (because we apply cost driver rate just as OAR, what about EOS)

Question 27

When comparing ABC and TBS what can you infer?>

Answer 27

You can determine whether, one is more expensive than the other and define what whether products were under or over costed.