Slide Set 4

Question 1

Name two traditional costing systems.

What are examples for the activity base?

Answer 1

1. Job order costing (direct labor cost)

2. Process costing (machine hours)

Question 2

What does a costing system?

Answer 2

Allocates overhead using a predetermined rate.

Question 3

Why is there a need to switch from the traditional costing system to activity-based costing (ABC)?

Answer 3

1. Change in manufacturing and service industries
2. Decrease in amount of direct labor usage
3. Significant increase in total overhead costs
4. Inappropriate to use plant-wide predetermined overhead rates when a lack of correlation exists
5. Complex manufacturing processes may require multiple allocation bases

Question 4

What is the ABC approach?

Answer 4

An approach for allocating overhead costs

1. Allocates overhead to multiple activity cost pools
2. Assigns the activity cost pools to products or services by means of cost drivers

Question 5

ABC has a key concept:
Activity, Activity cost pool and cost driver
Explain each word.

Answer 5

Activity: Any event, action, transaction or work sequence that incurs costs when producing a product or performing a service
Activity cost pool: The overhead cost attributed to a distinct activity
Cost driver: Any factor or activity that has a direct cause-effect relationship with the resources consumed

Question 6

What are the four steps of Activity-Based Costing?

Answer 6

1. Identify and classify the activities involved in the manufacture of specific products and assign overhead to cost pools.
2. Identify the cost driver that has a strong correlation to the costs accumulated in each cost pool.
3. Compute the activity-based overhead rate for each cost pool.
4. Allocate overhead costs to products using the overhead rates determined for each cost pool.

Question 7

ABC allocates overhead in a two-stage process.

Name the Stages and the corresponding steps.

Answer 7

Stage 1: Overhead costs are assigned to activity cost pools (Step 1).
Stage 2: Allocates overhead assigned to the activity cost pools to products, using cost drivers (Steps 2-4).

Question 8

Link between cost drivers and complex operations.

The more complex a product’s manufacturing operation…

Answer 8

….the more activities and cost drivers are likely to be present.

Question 9

Cost driver must accurately measure…

Answer 9

….the actual consumption of the activity by the various products.

Question 10

How to compute an activity-based overhead rate

per cost driver?

Answer 10

Estimated overhead per activity/Expected use of cost driver per activity

Question 11

What are likely consequence of differences in assigning overhead(overstated, understated)?

Answer 11

Overpricing one product and possibly losing market
share to competitors.
Sacrificing profitability by underpricing the second product.

Question 12

what are the three primary benefits of ABC?

Answer 12

1. More cost pools, therefore more accurate product costing.
2. Enhanced control over overhead costs.
3. Better management decisions.

Question 13

CLASSIFICATION OF ACTIVITY LEVELS

The Advantage of Multiple Cost Pools

Answer 13

1. Unit-Level (Performed for each unit of production/ Example: Assembly of cell phones)
2. Batch-Level ( Performed every time a company produces another batch of a product/ Example: Batch of ice cream)
3. Product-Level ( Performed every time a company produces a new type of product/ Example: Time spent testing a new drug by a pharmaceutical company)
4. Facility-Level ( Required to support or sustain an entire production process/Example: A hospital)

Question 14

Describe and give examples for Value-Added Activities and Non-Value-Added Activities.
(These are the Advantage of Enhanced Cost Control)

Answer 14

1. Increase the perceived value of a product or service to customers, such as:
   Manufacturing Company
   Engineering design, Machining services, Assembly, Painting
   Service Company
   Performing surgery, Legal research, Delivering packages
2. Adds cost to, or increases the time spent on, a product/service without increasing its perceived value, such as:
   Manufacturing Company
   Storage of inventory, Moving of inventory, Inspections, Fixing defective goods, Set up machines
   Service Company
   Taking appointments, Reception, Bookkeeping and billing, Traveling, Ordering supplies, Advertising

Question 15

What is Activity-based management (ABM)?

Advantage of Better Management Decisions

Answer 15

a management tool that focuses on reducing costs and improving processes and decision-making.

Question 16

Managers use ABC via ABM for what?

Answer 16

1. for both strategic and operational decisions or perspectives
2. to help managers evaluate employees, departments, and business units
3. to establish performance standards, as well as benchmark against other companies

Question 17

What are limitations of ABC?

Answer 17

1. Expensive to use

2. Arbitrary allocations remain

Question 18

Knowing When to use ABC

Answer 18

1. Product lines differ in volume and manufacturing complexity
2. Product lines are numerous and diverse
3. Overhead costs constitute a significant portion of total costs
4. Manufacturing process or the number of products has changed significantly
5. Production or marketing managers are ignoring data

Question 19

Explain just-in-time (JIT)

Answer 19

JIT manufacturing is dedicated to having the right amount of materials, parts, or products just as they are needed.

Question 20

Objective of JIT Processing

Answer 20

To eliminate all manufacturing inventories.

Question 21

Elements of JIT Processing

Answer 21

1. Dependable suppliers
2. Multi-skilled work force
3. Total quality control system

Question 22

Benefits of JIT Processing

Answer 22

1. Significant reduction or elimination of manufacturing inventories
2. Enhanced product quality
3. Reduction or elimination of rework costs and inventory
   storage costs
4. Production cost savings from the improved flow of goods through the processes

Question 23

Apply activity-based costing to service industries

Answer 23

Identify key activities that generate costs and keep track of how many of those activities are completed for each service performed.

1. General approach is to identify activities, cost pools, and cost drivers
2. Labeling of activities as value-added or non-value-added