Econ 10B Ch 7 Activity Based Costing

activity-based costing does not assign which two types of manufacturing overhead costs to products?

organization-sustaining costs and unused capacity costs also called idle capacity costs

how is an ABC cost calculated?

Activity Rate x Activity

What are the two types of nonmanufacturing costs that ABC systems assign to products?

direct and indirect nonmanufacturing products

explain, best you can, how the amount of overhead costs are assigned from the Customer Orders activity cost pool to the the product standard sanctions when it costs $320 per order and there were 400 orders

$320 per order x 400 orders = 192,000 of overhead costs assigned from the Customer Orders activity cost pool to the product standard sanctions

what are organization-sustaining activities?

they are carried out regardless of which customers are served, which products are produced, how many batched are run, or how many units are made examples: heating the factory, cleaning executive offices, providing a computer network, arranging for loans, preparing annual reports to shareholders

what are customer-level activities?

they relate the specific customers examples: sales calls, catalog mailings, and general technical support that are not tied to any specific product

explain the general structure of the ABC model

1. Cost objects such as products generate activities (a customer order for a custom compass housing requires the activity of preparing a production order) 2. such an activity consumes resources 3. consumption of resources causes costs activity-based costing attempts to trace through these relationships to identify how products and customers affect costs

what are the 5 steps for implementing activity-based costing?

1. define activities, activity cost pools and activity measures 2. assign overhead costs to activity cost pools 3. calculate activity rates 4. assign overhead costs to cost objects 5. prepare management reports

what are the three essential characteristics of a successful activity-based costing implementation?

1. top managers must support the ABC implementation because their leadership is instrumental in properly motivating all employees to embrace the need for change 2. top managers should ensure that ABC data is linked to how people are evaluated and rewarded. If they don't think it is important they will abandon it 3. a cross-functional employees possess intimate knowledge of many parts of an organization's operations that is necessary for designing an effective ABC system. Including them in the implementation process by tapping their knowledge will lessen their resistance

What are the three reasons why the traditional and activity-based costing systems report different product margins?

1. traditional cost system allocated all manufacturing overhead to products. whereas, the ABC system does not assign the manufacturing overhead costs consumed by certain activities if the costs are not assigned by those specific products included 2. traditional cost system allocates all the manufacturing overhead costs using volume-related allocation base that may or may not reflect what actually caused the costs. Whereas the traditional cost system over-cost high-volume products and under-costs low-volume products because they assign batch-level and product-level costs using volume-related allocation bases 3.ABC system assigns the non-manufacturing overhead costs caused by products to those products on a cause-and-effect basis. Traditional cost systems disregard these costs because they are classified as period costs

what are the five levels of activity in activity based costing?

1. unit-level activity 2. batch-level activity 3. product-level activity 4. customer-level activity 5. organization-sustaining activity they do not largely relate to the volume of units produced, only unit-level activities relate to the volume of units, the rest do not

In ABC, any event that causes consumption of overhead resources is an _______.

Actvity

ABC is not used to external reporting because ______ would not be comfortable using allocation based on employee interviews.

Auditors

Why must caution be exercised before taking action based on an ABC analysis?

Because the product and customer margins computed are a useful starting point for further analysis, but managers need to know what costs are really affected before taking any further action such as dropping a product or customer or changing the prices of products or services

True or False: an activity rate is computed for the Other category of costs? Explain.

False. An activity rate is not computed for the Other category of costs because the Other cost pool consist of organization-sustaining costs and unused capacity costs that are not all allocated to products and customers

How does activity-based costing differ from traditional absorption costing?

In activity-based costing: 1. Nonmanufacturing as well as manufacturing costs may be assigned to products, but only on a cause-and-effect basis 2. Some manufacturing costs may be excluded from product costs 3. Numerous overhead cost pools are used, each of which is allocated to products and other cost objects using its own unique measure of activity

Time-driven activity-based costing (TDABC) performs _______ __________ to evaluate employee idle time.

capacity analysis

How do you find the customer margin?

Sales - Costs (direct labor, direct materials, shipping, customer orders, product design, order size, customer relations) = Customer Margin

how do you find the net operating income/loss?

Sales - Total Costs = Product Margins (computed for all the cost pools and then added together for a total product margin) Overhead Costs Not Assigned to Products is then calculated Customer Relations + Other = Total Overhead Costs Not Assigned to Products then to calculate net operating income/loss you do Total Product Margin - Total Overhead Costs Not Assigned to Products = Net Operating Income/Loss

How do you find net operating income/loss in traditional cost systems?

Sales - cost of goods sold (DM, DL, MOH) = Product Margin - Selling and Administrative costs = Net operating income/loss

True or False: an ABC system does not conform to generally accepted accounting principles (GAAP)?

True

True or False: All of the calculations required in activity-based costing can be done by hand?

True but setting up an ABC costing system on an Excel spreadsheet can save a lot of work

what is an activity cost pool

a "bucket" in which costs are accumulated that relate to a single activity measure in the ABC system

What is Activity-based Costing?

a costing methods that is designed to provide managers with cost information for strategic and other decisions that potentially affect capacity and therefore "fixed" as well as variable costs to calculate unit product costs for the purposes of managing overhead and making decisions

The Customer Relations cost pool will be assigned all costs associated with maintaining relations with customers, including the costs of sales calls and the costs of entertaining customers. The activity measure for this cost pool is the number of customers the Page 319company has on its active customer list. What type of level of activity is this?

a customer-level activity

what is a product margin?

a function of the product's sales and the direct and indirect costs that the product causes

what is a duration driver?

a measure of the amount of time required to perform an activity, such as time spent preparing individual bills for customers

what is benchmarking?

a systematic approach to identifying the activities with the greatest room for improvement it is based on comparing the performance in an organization with the performance of other, similar organizations known for their outstanding performance

In ABC, each cost pool accumulated costs that relate to a single _________ measure in the BC system.

activity

once the percentage distributions of resource consumption across activity pools have been established, what is easy to do next?

allocate costs to the activity cost pools

what is an activity measure?

an allocation used in activity-based costing system also called cost driver

in activity-based costing, what is an activity?

any event that causes the consumption of overhead resources

how does activity-based costing treat organization-sustaining costs

as period expenses

what are activity rates used for?

assigning overhead costs to products and customers they produce average figures

customer orders is what type of level of activity?

batch-level activity

shipped orders is what type of level of activity?

batch-level activity

why does the total amount of overhead assigned to products not match the total amount of overhead cost in the ABC system?

because ABC system does not assign customer-level activity and organization-sustaining activity to products because neither activity is caused by a product

why do the number and definitions of the activity cost pools and activity measures used by companies vary considerably?

because it is unlikely that two companies would use the exact same activity costs pools and activity measures. They will vary because of the amount of judgement involved

activity based costing provides managers with information that affects what type(s) of costs?

both fixed and variable costs

how do ABC teams compare its traditional and ABC product costs?

by comparing the differences between the traditional and ABC product margins

which types of costs can be excluded from the activity-based allocation of indirect costs and why?

direct materials, direct labor, and shipping expenses because the existing cost system can accurately trace those costa to products so there is no need to incorporate these direct cost in the activity-based allocations of indirect costs

What does the product profitability report not include? why?

does not include the cost pools that are not caused by the product Customer Relations are costs caused by customers, not products Other costs are also not caused by any particular product and are considered organization-sustaining costs and unused capacity costs

between duration drivers and transaction drivers, which are most accurate, more effort, used more often in practice?

duration drivers are more accurate measures of resource consumption than transaction drivers, but they take more effort to record. for that reason, transaction drivers are often used in practice

Activity-based costing uses assigns costs to cost pools in _______ allocation.

first-stage

what do product and customer profitability reports do?

help companies channel their resources to their most profitable growth opportunities while at the same time highlighting products and customers that drain profits

Is activity-based costing used for internal or external decision making?

internal decision making

how does a traditional cost system assign costs?

it assigns only manufacturing costs to products this includes direct materials, direct labor, and manufacturing overhead Selling and administrative costs are not assigned to products, instead to period costs

what is an activity-based management?

it involves focusing on activities to eliminate waste, decrease processing time, and reduce defects

what is first-stage allocation

it is the process of assigning functionally organized overhead costs derived from a company's general ledger to the activity cost pools

The greater the number of activities in an ABC system the (more/less) costly it is for the company to develop?

more

What is the next step after the first-stage allocations to the activity cost pools have been completed?

next step is to compute the activity rates

Do the ABC system and traditional cost system treat sales, direct materials, direct labor differently?

no they treat these pieces of revenue and cost data identically

what are the most common management reports prepared with ABC data?

product and customer profitability reports

what will happen if plantwide overhead costs to not move in tandem with plantwide direct labor-hours or machine-hours

product costs will be distorted

products designed is what type of level of activity?

product-level activity

Activity-based costing uses activity rates to apply to overhead costs to products in _______ allocation.

second-stage

what is the 4th step in the implementation of activity-based costing called?

second-stage allocation

what is a transaction driver?

simple counts of the number or times an activity occurs, such as the number of bills sent out to a customer

how do you calculate the total overhead costs

subtotal of overhead costs assigned to products + subtotal of overhead not assigned to products

when combining activities in the ABC system what must you make sure of?

that activities are grouped together at appropriate levels batch-level activities should not be combined with unit-level activities or product-level activities with batch-level activities and so on

in activity based costing, products are charged for only what

the capacity they use, not for the capacity they don't use (unused capacity costs) this provides more stable unit product costs and is consistent with the goal of assigning to products only the costs of the resources they use

what is needed to compute a product's profit (product margin)? How do you calculate it?

the product's sales, direct costs and overhead costs sales - total costs = product margin

what are first-base allocations usually based on?

the results of interviews with employees who have first-hand knowledge of the activities those who are interviewed must thoroughly understand what the activities encompass and what is expected of them in the interview it is more accurate if the employees who are classified as indirect factory workers (e.g. supervisors, engineers, and quality inspectors) are asked to estimate what percentage of their time is spent dealing with customer orders, with product design, with processing units of production (i.e. order size), and with customer relations in addition, department managers are typically interviewed to determine how the non personnel costs should be distributed across the activity cost pools

what are unit-level activities?

they are performed each time a unit is produced. the cost of unit-level activities should be proportional to the number of units produced example: providing power tends to be consumed in proportion to the number of units produced

when identifying the activities that will form the foundation of the ABC system, what might be done to reduced a lengthy list of activities?

they may combine similar activities example: several actions may be involved in handling and moving raw materials- from receiving raw materials on the loading dock to sorting them into the appropriate bins in the storeroom. All of these activities might be combined into a single activity called material handling

what are product-level activities?

they relate to specific products and typically must be carried out regardless of how many batches are run or units of product are produced or sold example: activities such as designing a product, advertising a product, and maintaining a product manager and staff are all product-level activities

what are batch-level activities?

they're performed each time a batch is handled or processed, regardless of how many units are in the batch they are incurred once for each batch (or customer order) depend on the number of batches produced rather than on the number of units produced, number of units sold, or other measures of volume Example: tasks such as placing orders, setting up equipment, and arranging for shipments to customers

A customer orders cost pool can be assigned all costs of resources that are consumed by taking and processing customer orders. This includes costs of processing paperwork and any costs involved in setting up machines for specific orders. The activity measure for this cost pool is the number of customer orders received. What type of level of activity is this and why?

this is a batch-level activity because each order generates work that occurs regardless of whether the order is for one unit or 1,000 units

The Product Design cost pool will be assigned all costs of resources consumed by designing products. The activity measure for this cost pool is the number of product designs. What type of level of activity is this and why?

this is a product-level activity because the amount of design work on a new product does not depend on the number of units ultimately ordered or batches ultimately run

The Order Size cost pool will be assigned all costs of resources consumed as a consequence of the number of units produced, including the costs of miscellaneous factory supplies, power to run machines, and some equipment depreciation. The activity measure for this cost pool is machine-hours. What type of level of activity is this and why?

this is a unit-level of activity because each unit requires some of these resources

The Other cost pool will be assigned all overhead costs that are not associated with customer orders, product design, the size of the orders, or customer relations. What type of level of activity is this and why?

this is an example of organization-sustaining activities and the cost of unused, idle capacity. these costs will not be assigned to products because they represent resources that are not consumed by products

After second-stage allocation is complete what is the next step?

to create reports that would help explain the company's net operating income/loss

how are activity rates computed?

total cost for each activity / its total activity example: the $320,000 total annual cost for the Customer Orders cost pool is divided by the total of 1,000 customer orders per year to arrive at the activity rate of $320 per customer order

what are the two common types of activity measures for ABC

transaction drivers and duration drivers

True or False: Activity-based costing generally provides more accurate product costs than traditional costing methods?

true

power to run machines is what type of level of activity?

unit-level activity

what is second-stage allocation?

when activity rates are used to apply overhead costs to products and customers