Week 4

Question 1

Costing system

Answer 1

Process of accumulating, classifying, and assigning direct materials, direct labour and factory overhead costs to cost objects. There is need for accurate cost information, especially for firms that employ a cost leadership strategy, as increased profitability will come from minimizing unnecessary and workable costs. The overall costing system used should match the competitive strategy and nature of the firm. There are three components of the costing system that a firm must decide on:

• Cost accumulation method
• Cost measurement method
• Overhead application method

Question 2

Cost accumulation method

Answer 2

• Job costing entails that costs can be accumulated by tracing them to a specific product or service. In this type of system, the jobs consist of individual or batches of products or services. When direct cost allocation can take place, job costing is most relevant for the firm. Also, some firms operate with a push method, in which products are produced based on forecasts of consumer demand, and others use a pull method, in which production occurs when customers order some quantity of product;
• Process costing entails that costs can be accumulated at the department level and then allocated from the departments to the products or services. Process costing is commonly found in firms that produce one or few homogeneous products or services.

Question 3

Cost measurement method

Answer 3

• An actual costing system uses actual costs incurred for all product costs, including direct materials, direct labour and factory overhead;
• A normal costing system uses actual costs for direct materials and direct labour, but uses normal costs for factory overhead. Normal costing consists of estimating a portion of overhead to be assigned to each product as t is produced. It provides a timely estimate of the cost of producing each product or job;
• A standard costing system uses standard costs and quantities for direct materials, direct labour and factory overhead. Standard costs are expected costs the firm should attain. It provides a basis for cost control, performance evaluation, and process improvement.

Question 4

Overhead application method

Answer 4

• Volume based costing, with volume based cost drivers;
• Activity based costing, using both volume and non-volume based cost drivers to provide a more accurate allocation of overhead costs to products.

Question 5

Strategic Role of Costing

Answer 5

Firms need accurate cost information to be able to compete successfully. And to get this information, firms need to choose a cost system that is a match for their competitive strategy. For example, a cost leadership firm is more likely to use process costing systems, based on activity.

Question 6

Job Costing: The Cost Flows

Answer 6

Job costing is a product costing system that accumulates and assigns costs to specific jobs, customers, projects, or contracts.

A basic supporting element to the system is the job cost sheet, which records and summarizes the costs of direct materials, direct labour, and factory overhead for a job.

The job cost sheet shows the materials, labour and overhead required for the production batch of 20 units for a firm called TFI.

Question 7

Overhead application

Answer 7

Process of allocating factory overhead costs to jobs, involving the allocation of indirect costs to cost objects. There are two approaches: actual costing and normal costing.

• The previously discussed actual costing system uses actual costs for direct materials and direct labour, and records actual factory overhead for the jobs. Actual factory overhead costs are incurred each month for indirect materials, indirect labour, and other indirect factory costs (e.g. factory rent, insurance, etc.). Usually, the total amount of actual overhead is not known until the end of the accounting period, when all relevant figures are in.
• A normal costing system uses actual costs for direct materials and direct labour, and applied factory overhead to jobs by using a predetermined rate. This system avoids the fluctuations in cost per unit under actual costing, which originate from changes in the month-to-month volume of units produced and consequently changes in overhead costs.

Question 8

The predetermined factory overhead rate

Answer 8

Estimated rate used to apply factory overhead dost to a specific job. The amount of overhead applied to a job using the rate is called factory overhead’ applied. Four steps are necessary:

1. Estimate total factory overhead costs for the upcoming operating period;
2. Select the most appropriate cost driver for applying the factory overhead costs;
3. Estimate the total amount of the chosen cost driver for the upcoming operating period;
4. Divide the estimated factory overhead costs by the estimated amount of the chosen cost driver.

Question 9

Overapplied overhead

Answer 9

The amount of factory overhead applied that exceeds the actual factory overhead cost incurred.

Question 10

Underapplied overhead

Answer 10

The amount by which actual factory overhead exceeds factory overhead applied.

Question 11

Operation costing

Answer 11

Hybrid costing system that uses a job costing approach to assign direct
material costs to jobs and a process costing approach to assign conversion costs to products or services.
It is used in manufacturing operations, whose conversion activities are very similar across different product lines, but whose direct materials’ usage differs significantly.

Question 12

Resource consumption cost drivers

Answer 12

Measure the amount of resources consumed by an activity.

Question 13

Activity consumption cost drivers

Answer 13

Measure the demand cost objects place on resources. Understanding the fundamental difference between the two is necessary when discussing costing systems.

Question 14

Two-stage cost assignment procedure

Answer 14

Assigns resource costs to activity cost pools and then to cost objects to determine the amount of resource costs for each of the cost objects.

Question 15

Volume-based costing systems

Answer 15

Assign factory overhead costs first to plant or departmental cost pools, and then to products and services. Therefore, in the first stage: factory overhead
costs are combined into a single plant cost pool, or several departmental cost
pools. In the second stage: a volume-based rate, in terms of units produced or hours used in production, is then used to apply overhead to each of the cost objects.

Volume based costing may lead to the aggregation error, as different departments and products may use varying degrees of support systems and indirect costs.

Question 16

ABC systems

Answer 16

Link usage of resources to activities, whose costs are then linked to products, services or customers.

In the first stage, factory overhead costs are assigned to activities by using appropriate resource consumption cost drivers.

In the second stage, the costs of activities are assigned to cost objects, using appropriate activity consumption cost drivers that measure the demands cost objects have for the activities.

The use of cost drivers in both stages provides more accurate measures of product costs for the cost of activities that are not proportional to the volume of outputs produced.

Question 17

Benefits of Activity-Based Costing

Answer 17

ABC methods have been increasingly adopted since the 1980s. Among the major benefits firms have experienced are:

• Better profitability measures;
• Better decision-making;
• Process improvement;
• Improved planning;
• Reduced cost of unused capacity, which involves maintaining a separate - accounting system for unused capacity cost, typically present with firms affected by seasonal and cyclical fluctuations.

Question 18

Activity-based management (ABM)

Answer 18

Manages resources and activities to improve the value of products or services to customers and increase the firm’s competitiveness and profitability. ABM relies on ABC methods as its major source of information and focuses on the efficiency and effectiveness of key business processes and activities. Through ABM, ways to improve operations, reduce costs, etc. can be found. Two categories can be identified:

1. Operational ABM, enhancing operational efficiency and asset utilization and lower costs;
2. Strategic ABM, focusing on choosing appropriate activities for operation and selecting the most profitable customers.

Question 19

Activity Analysis

Answer 19

Firms ideally perform activities for the following reasons:

• It is required to meet the specification of a product or service, or satisfy demand;
• It is required to sustain the organization
• It is deemed beneficial for the firm.

Question 20

Value-Added Analysis

Answer 20

A process map is a diagram that identifies each step in making a product or providing a service. It helps ensure that no activities are missed in the value-added analysis.

• A high-value-added activity increases the value of the product or service for the customer;
• A low-value-added activity consumes time, resources, or space, but adds little in regard to satisfying customer needs (e.g. moving parts between processes).

Question 21

Customer Profitability Analysis (CPA)

Answer 21

Looks at the profitability of each individual customer or customer group by identifying cost drivers and customer service activities like advertising, sales calls and delivery, all of which are required to complete the sales process. Building understanding of customers and customer groups allows the firm to become more competitive.

Question 22

The three major extensions of ABC

Answer 22

1. Multi-stage ABC, in which resource costs are first assigned to activities, which are then assigned to other activities before being assigned to final cost objects. Costs may first be assigned to support activities, then product activities and cost objects.
2. Resource consumption accounting, which is an approach that calls for integration and all-inclusive accounting based on an operational view of the organization to provide managers with financial information about the firm’s activities. It relies on primarily on four concepts:
   a. Attributable cost, in which costs can only be attached to a cost object when there is clear causality;
   b. View of resources as suppliers of capacity, so capacity is a function of available resources;
   c. Operational view of the organization, in which inputs and output units have a causal, quantity-based relationship;
   d. Cost behaviour, where cost characteristics are inherent to underlying resources and resource consumption.
3. Time-driven ABC (TDABC), which uses the cost per time unit of supplying a resource to directly allot resource costs to objects. This contrasts with traditional ABC, as costs are not first assigned to activities, and then to cost objects. TDABC relies on accurate, standardized estimates of costs per time unit of an activity, which gives a better framework for costing excess capacity.