Week 4- Costing systems: traditional and activity based costing Flashcards
What are costing systems all about?
Allocating overheads ie.indirect costs
when were traditional costing systems invented?
when manufacturing processes were labour intensive
why was the traditional costing system used for labour-intensive processes?
A single company-wide overhead rate based on direct labour hours may be used to allocate overhead to products
how do you work out the selling price of a product?
Multiply total cost by the markup what you want to acheive eg.25% = £100 *1.25 = £125
what is activity-based costing?
A costing system that identifies the activities performed within the organisation as it delivers its goods and services
what does stage 1 of activity-based costing involve?
The activities are based into cost pools eg. Machinery cost pool, electricity cost pool.
The cost pools fall into the following categories which are known as a cost hierarchy: Unit level: Example- machinery cost pool Batch level: Example- Setup cost pool Product line: Engineering cost pool Distribution channel Customer level Facility sustaining: Facility cost pool
what does Stage 2 of ABC identify?
The cost driver eg. the number of machine hours used
what should firms consider when selecting a cost driver?
The degree of correlation, The cost measurement or behavioural effects
what are the main differences between traditional and ABC?
- Trad only uses one cost driver to assign to overhead cost to products where as ABc uses more than cost driver
- ABC can be used for inventory valuation
what are the similarities between trad and ABC?
Direct and unit-level costs are allocated the same
does traditional costing understate or overstate the cost of complex, low volume products?
understate
does traditional costing understate or overstate the cost of simple, high volume products?
overstate
what is the impliaction of unerstating or overstating the cost of a product or service?
may mean that they under or overcharge for a product
what are the disadvantages of ABC?
ABC requires more monitoring, this will have an impact on:
Time to identify and measure activities
Meetings to resolve disputes over activity drivers
ABC shifts decision making rights over activity drivers to lower-level managers with specialised knowledge of the relation between costs and activities
Departmental managers could pick cost drivers that maximise their performance rewards
when should ABC be used?
- Indirect costs are significant in proportion to direct costs
- Goods are complex requiring many inputs and processes
- Sales are increasing but profits are declining
- Product line profit margins are difficult to explain
- Different departments think costs are assigned inaccurately
- The operation system has changed but the costing system hasn’t
