Chapter 17

ABC's four steps:

1. identify and classify the activities; assign OH to cost pools 2. identify the cost driver 3. compute the activity-based OH rate 4. Allocate OH costs to products

determine cost drivers: 1. Materials handling 2. Machine setups 3. Factory machine maintenance 4. Factory supervision 5. Quality control

1. number of requisitions 2. number of setups 3. machine hours used 4. number of employees 5. number of inspections

ABC has *three primary benefits:*

1.ABC leads to more cost pools and therefore more accurate product costing. 2.ABC leads to enhanced control over overhead costs. 3.ABC leads to better management decisions.

determine cost drivers 1.Manufacturing 2.Setups 3.Purchase ordering 4.Product development 5.Property and plant

1.machine hours 2.number of setups 3.number of purchase orders 4.products developed 5.square footage

estimated overhead per activity/ expected use of cost drivers per activity=

activity-based OH rate

The reason behind ABC cost allocation:

products consume activities; activities consume resources

Activity-based costing allocates overhead costs in a two-stage process.

true 1 stage=step 1 2 stage=steps 2-4

determine cost drivers: 1. inventory control 2. machine setups 3. employee training 4. quality inspections 5. materials ordering 6. drilling operations 7. building maintenance

1. # of parts 2. # of setups 3. # of employees 4. # of inspections 5. # purchase orders 6.# of machine hours 7.# of sq. ft.

determine cost drivers 1. purchasing- 2. storing- 3. machining- 4. supervising-

1. # of purchase orders 2. amount of square footage 3. # of machine hours 4. # of employees

ACTIVITY COST POOL

The overhead cost attributed to a distinct activity (e.g., ordering materials or setting up machines). -activities that cause costs to increase

Activity-based costing (ABC)

A costing system that allocates overhead to multiple activity cost pools and assigns the activity cost pools to products or services by means of cost drivers. -primary benefit: more *accurate* product costs*

Value-added activity

An activity that increases the perceived value of a product or service to a customer. -ex: engineering design, machining, assembly, and painting

Non-value-added activity

An activity that, if eliminated, would not reduce the perceived value of a company's product or service. -ex: inventory storage, moving materials, work in process, or finished goods from one location to another in the plant during the production process; waiting for manufacturing equipment to become available; inspecting goods; and fixing defective goods under warranty.

ACTIVITY

Any event, action, transaction, or work sequence that incurs costs when producing a product or performing a service.

COST DRIVER

Any factor or activity that has a direct cause-effect relationship with the resources consumed. In ABC, cost drivers are used to assign activity cost pools to products or services.

ABC has a two stage process:

STAGE 1: *step 1*- IDENTIFY AND CLASSIFY ACTIVITIES AND ASSIGN OVERHEAD TO COST POOLS *step 2*-IDENTIFY COST DRIVERS STAGE 2: *step 3*-COMPUTE ACTIVITY-BASED OVERHEAD RATES (estimated overhead per activity/ expected use of cost drivers per activity) *step 4*-ALLOCATE OVERHEAD COSTS TO PRODUCTS (multiply the activity-based overhead rates per cost driver by the number of cost drivers expected to be used per product)

-Often, the most difficult part of computing accurate unit costs is determining the proper amount of *overhead cost* to assign to each product, service, or job. -Unlike direct materials and direct labor costs which can usually be easily traced to the product, overhead is an indirect or common cost that generally cannot be traced to a product.

True