Chapter 7 Activity Based Costing: A tool to aid decision making

Organization-sustaining activities

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

activity

an event that causes the consumption of overhead resources in an organization

first-stage allocations

are usually based on the results of interviews with employees who have first-hand knowledge of the activities

A systematic approach that can identify improvement opportunities is Blank______. Multiple choice question. process costing benchmarking traditional costing activity analysis

benchmarking

What is something that no set of activity pools will be when comparing a company to other companies?

No activity cost pool will ever be the same because it takes judgments and circumstances unique to that company

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- activity measure for this cost pool is the number of customers the company has on its active customer list- represents a customer-level activity

Two most common types of activity measure

1 Transaction drivers 2. Duration drivers

two types of nonmanufacturing costs that ABC systems assign to products

1. ABC systems trace all direct nonmanufacturing costs to products. ex: commissions paid to salespersons, shipping costs, and warranty repair 2. ABC systems allocate indirect non manufacturing costs to products whenever the products have presumably caused the cost to be incurred

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- unit-level activity because each unit requires some of these resources- activity measure for this cost pool is machine hours

Product Design Cost Pool

- will be assigned all costs of resources consumed by designing products- activity measure for this cost pool is the number of products designed- 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

Other Cost Pool

- will be assigned all overhead costs that are not associated with customer orders, product design, the size of orders, or customer relations- these costs mainly consist of organization-sustaining costs and the costs of unused, idle capacity- will not be assigned to products because they represent resources that are not consumed by products

activity measure

-an allocation base in an activity-based costing system , ideally , a measure of the amount activity that drives the costs in an activity cost pool -cost drive term refer

unused capacity costs

-in traditional absorption costing system, the cost of unused capacity costs is assigned to products (if the budgeted level of activity declines, the overhead rate and unit product costs rise thereby ensuring that the shrinking volume of output absorbs the increasing cost of idle capacity. -in ABC , products are charged only for the cost of capacity they use-not for the cost of capacity use don't use which provides more stable unit product costs and is consistent with the goal assigning to product only the costs of the resource that they use

Product-level activities

Activities that relate to specific products that must be carried out regardless of how many units are produced and sold or batches run. ex: designing a product, advertising a product, maintaining a product managers and staff

ABC model

Cost objects -> Activities -> Consumption of resources -> Cost

Step 1: Define Activities, Activity Cost Pools, and Activity Measures

Customer Orders Cost Pool Activity measures

Define what step 1 is for implementing activity based costing I Defining the activities, activity cost pools and activity measures

Interviewing the major contributors in the overhead departments and determining what their major time consuming activities are which can be a long and complex list of activities The best approach is to treat these as batch level activities, or product level activities

How do you calculate plantwide overhead?

Plantwide overhead rate is = Total estimated manufacturing overhead/total estimated machine hours

What causes traditional and activity-based costing systems to report different product margins? Multiple select question. Traditional cost systems only use volume-related allocation bases. Traditional cost systems assign period costs to all products that are produced during the period. The ABC system assigns nonmanufacturing overhead costs to products on a cause-and-effect basis as appropriate. Traditional cost systems allocate all manufacturing overhead costs to products.

Traditional cost systems only use volume-related allocation bases. The ABC system assigns nonmanufacturing overhead costs to products on a cause-and-effect basis as appropriate. Traditional cost systems allocate all manufacturing overhead costs to products.

Unit-level activities

activities that are performed each time a unit is produced -should be proportional to the number of units produced. ex: providing power to run processing equipment b/c power tend to be consumed in proportion to the number of units produced

A "bucket" in which costs are accumulated that relate to a single activity measure in the ABC system is a(n) Blank______. Multiple choice question. duration driver activity cost pool transaction driver activity measure

activity cost pool

In ABC, the term cost driver is used to refer to a(n) __________ __________ because it should "drive" the cost being allocated

activity measure

Activity based costing provides managers with information that potentially affects Blank______. Multiple choice question. only variable costs Reason: ABC provides information for decisions about capacity and therefore includes fixed as well as variable costs. both fixed and variable costs only fixed costs neither fixed nor variable costs

both fixed and variable costs

ABC does not conform to GAAP because it Blank______. Multiple select question. excludes some manufacturing costs includes some nonmanufacturing costs includes direct materials and direct labor excludes some nonmanufacturing costs

excludes some manufacturing costs includes some nonmanufacturing costs

ABC

expand the definition of overhead to include all indirect costs- manufacturing and nonmanufacturing -the overhead costs that are caused by products are allocated to them whereas any overhead costs are are not caused by products are treated as period cost. -treat direct nonmanufacturing costs as product costs rather than period cost

Traditional cost systems tend to undercost standard products and overcost specialty products. True false question.TrueReason: The opposite is true - traditional systems undercost specialty products that tend to consume more overhead. False

false

ABC cost calculation

include all direct costs that can be traced to products and all indirect costs that are caused by products.

Organization-sustaining costs

include costs such as the factory security guard;s wages, the plant controller salary, and the cost of supplies used by the plant manager's secretary are assigned to products in traditional absorption costing system even though they are totally unaffected by which products are made during a period. ABC treats this as period expenses rather than arbitrarily assign them to products

Activity-based costing is not used for external reporting because Blank______. Multiple select question. it is difficult to make changes in the existing accounting system external reports are less detailed than internal reports it would not disclose enough information about products Reason: ABC would disclose too much information about individual products. ABC does not comply with GAAP

it is difficult to make changes in the existing accounting system external reports are less detailed than internal reports ABC does not comply with GAA

Traditional absorption costing

manufacturing costs are assigned to products, nonmanufacturing costs are not assigned to products

n activity-based costing, Blank______ are different from those calculated using traditional costing. Multiple choice question. sales Reason: In varying systems, different costs are deducted from sales to arrive at the product margin. product margins net operating incomes Reason: In varying systems, different costs are deducted from sales to arrive at the product margin. direct labor costs Reason: In varying systems, different costs are deducted from sales to arrive at the product margin.

product margins

select all that apply Costs that can be easily traced to individual products include Blank______. Multiple select question. factory supervisor's salary shipping costs sales commission warranty repair costs

shipping costs sales commission warranty repair costs

traditional cost systems allocate all manufacturing costs using Blank______ allocation base(s). Multiple choice question. activity-related materials-related volume-related overhead-related

volume related

Customer Orders Cost Pool

will be assigned all costs of resources that are consumed by taking and processing customer orders, including costs of processing paperwork and any costs involved in setting up machines for specific orders- activity measure for this cost pool is the number of customer orders received- batch-level activity because each order generates work that occurs regardless of whether the order is one unit or 1,000 units

Steps for implementing ABC

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 using the activity rates and activity measures 5. Prepare management reports

Activity based costing differs from traditional absorption costing in 3 ways (in activity based costing):

1. Non Manufacturing as well as manufacturing costs may be assigned to products, but only on cause and effect basis. 2. Some manufacturing costs may be excluded from product costs. 3. Numerous overhead cost pool are used, each of which is allocated to products, and other cost objects using its own unique measure of activities

what causes traditional and activity-based costing systems to report different product margins?

1. The ABC system assigns nonmanufacturing overhead costs to products on a cause-and-effect basis as appropriate 2. Traditional cost systems allocate all of the manufacturing overhead costs to products using a volume-related allocation base. 3. Traditional cost systems allocate all manufacturing overhead costs to products.

Three essential characteristics of a successful activity based costing implementation

1. Top managers must strongly support the ABC implementation because their leadership is instrumental in properly motivating all employees to embrace the need to change 2. Top managers should ensure that ABC data is linked to how people are evaluated and rewards 3. A cross-functional team should be created to design and implement the ABC system. Team should include representatives from each area that will use ABC data, such as marketing, production, engineering and accounting departments

ABC defines 5 level activities

1. Unit level activities 2. Batch level activities 3. Product level activities 4. Customer level activities 5. Organization- sustaining activities *the costs and corresponding activity measures for until level activities do relate to the volume of units produced

ABC generally provides more accurate product costs than traditional costing method, it in infrequently used for external reports for a number of reasons:

1. external reports are less detailed than internal reports prepared for decision making (on external reports , the individual product costs are not reported . COGS and inventory valuation are disclosed, but they are not broken down down by products) 2. its often very difficult to make changes in a company's accounting system. 3. ABC system does not conform to GAAP because product costs exclude some manufacturing costs and include some nonmanufacturing costs. 4. Auditor are likely uncomfortable with allocation that are based on interview w/ the company's personnel

ABC systems purposely do not assign 2 types of manufacturing overhead costs to products:

1. organization sustaining costs 2. unused capacity costs

Margins are calculated in three steps

1. the sales, direct materials, and direct labor cost data are the same used by the ABC team to prepare, ABC system treats these 3 pieces of revenue and cost date identically 2. the traditional cost system uses plantwide overhead rate to assign manufacturing overhead cost to products. 3. The sales minus the COGS equal the product margin

Batch-level activities

Activities that are performed each time a batch of goods is handled or processed , regardless of how many units are in the batch. The amount of resource consumed depends on the number of batches run rather than on the number of units in the batch. ex: placing purchase orders, setting up equipment , arranging for shipments to customers (they are incurred once for each batch *Costs at batch level depends on the number of batches processed rather than on the number of units produced, the number of units sold , or other measures of volume ex: the costs of setting up a machine for batch processing is the same regardless of whether the batch contains one or thousands of items

What is the most important thing to consider when you are combining activities together?

Making sure that those activities are highly correlated with each other within a specific activity level

Describe the third step in implementing an ABC system Calculating Activity Rates

The activity rate is found by dividing the total cost for each activity by its total activitiesThe results are average costs

What is a first stage allocation in an ABC system?

The first stage allocation in an ABC system is the process of assigning functionally organized overhead costs from a company's general ledger to the activity cost pools

Which of the following items are the same under both ABC and traditional costing? Multiple select question. Total sales Product margins Total costs Net operating income

Total sales Total costs Net operating income

Which costing system does not assign selling and administrative costs to products when computing product margin? Multiple choice question. Both traditional and activity-based Neither traditional nor activity-based Activity-based Traditional

Traditional

Which costing method assigns only manufacturing costs to products? Multiple choice question. Both traditional absorption and activity-based costing Traditional absorption costing Neither traditional absorption nor activity-based costing Activity-based costing Reason: Activity-based costing assigns both manufacturing and nonmanufacturing cost to products.

Traditional absorption costing

How do you describe the 5th step of the implementation of ABC building management reports?

You build a customer profitability report that helps companies channel their resources to their most profitable growth opportunities, as well as products that drain profits

How do you apply overhead costs to a product?

You multiply the activity rate by the number of that cost pool

Describe the second step of the implementation of activity based costing Assigning overhead costs to activity cost pools

You need to utilize the general ledger into annual overhead costs by departmentyou divide the different types of overhead among the activity pools created using the allocation process called first stage allocation

activity cost pool

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

Activity Based Costing

a costing method based on activities that is designed to provide manager with cost information for strategic and other decisions that potential affect capacity and therefore fixed as well as variable costs

activity based management

a management approach that focuses on managing activities as a way of eliminating waste and reducing delays and defects is used in the organizations as diverse as manufacturing companies, hospital and us marine corps

duration driver

a measure of the amount of time required to perform an activity ex: the time spent preparing individual bills to customers -are more accurate measure of resource consumption than transaction drivers, but they take more effort to record.

transaction driver

a simple counts of number of times an activity occurs. ex: the number of bills sent out to customers -often used in practice

Benchmarking

a systematic approach to identifying the activities with the greatest potential for improvement

Customer-level activities

activities that are carried out to support customers, but that are not related to any specific product ex: sales calls , catalog mailings, general technical supports

Some manufacturing costs may be excluded from product costs when using Blank______ costing. Multiple choice question. activity-based traditional absorption Reason: Traditional absorption costing includes all manufacturing costs. either traditional absorption or activity-based Reason: Traditional absorption costing includes all manufacturing costs. neither traditional absorption nor activity-based Reason: Activity-based costing assigns costs on a cause-and-effect basis. Some manufacturing costs may be excluded.

activity-based

In activity-based costing, the consumption of overhead resources is caused by Blank______. Multiple choice question. direct labor overhead an activity material purchase

an activity

In activity-based costing, nonmanufacturing and manufacturing costs are assigned to products on a(n) Blank______ basis. Multiple choice question. cause-and-effect compare-and-contrast day-to-day as needed

cause-and-effect

Traditional absorption costing

designed to provide data for external financial reports

Costs assigned and/or traced when computing product margin in a traditional cost system are Blank______. Multiple select question. direct material selling and administrative Reason: Traditional cost systems include only manufacturing costs. direct labor manufacturing overhead

direct material direct labor manufacturing overhead

An activity cost pool accumulates costs for Blank______ activity measure(s). Multiple choice question. one or more multiple exactly one

exactly one

ABC

is ordinary used as a supplement to, rather than a replacement for, a company's usual costing system. -have two costing system 1. the official costing system that is used to preparing external financial reports 2. the activity based costing system that is used for internal decision making and for managing activities

ABC

many nonmanufacturing costs relate to selling, distributing , and servicing specific product -include manufacturing and nonmanufacturing costs when calculated the entire cost of a product rather than its manufacturing cost

Under activity-based costing, nonmanufacturing costs Blank______. Multiple choice question. are always assigned to products, regardless of cause Reason: ABC only assigns costs on a cause and effect basis. may be allocated to products based on cause are always treated as period costs are never assigned to products

may be allocated to products based on cause

Under activity-based costing, nonmanufacturing costs Blank______. Multiple choice question. are never assigned to products are always assigned to products, regardless of cause Reason: ABC only assigns costs on a cause and effect basis. may be allocated to products based on cause are always treated as period costs

may be allocated to products based on cause

under activity-based costing, nonmanufacturing costs Blank______. Multiple choice question. are always treated as period costs are always assigned to products, regardless of cause Reason: ABC only assigns costs on a cause and effect basis. are never assigned to products may be allocated to products based on cause

may be allocated to products based on cause

Compared to traditional systems, activity-based costing uses ______ cost pools and unique measures of activity. Multiple choice question. the same number of fewer more

more

Usually, traditional costing Blank______ high-volume products and Blank______ low-volume products. Multiple choice question. undercosts; overcosts overcosts; undercosts

overcosts; undercosts

The basis of benchmarking is comparing Blank______. Multiple choice question. performance in different industries traditional and ABC systems performance within the same industry manufacturing and nonmanufacturing costs

performance within the same industry

Activity-based management is focused on Blank______. Multiple select question. increasing processing time reducing defects eliminating waste pricing decisions

reducing defects eliminating waste

Describe the fourth step of implementing the ABC system

the 4th step is second stage allocation

A reason that activity-based costing is not often used for external reporting is Blank______. Multiple choice question. auditors prefer to base allocations on personnel interviews the ABC system may not conform to GAAP ABC product costs exclude nonmanufacturing costs individual product costs need to be reported on external reports

the ABC system may not conform to GAAP

What is a product margin?

the amount of profit from a product -It is a function of the product's sales and the direct and indirect costs that the product causes -You must gather the direct costs outside of the ABC costing system -Don't use costs in the customer relations and other due to it not being directly related to product volume

What is the second stage allocation

the process in which activity rates are used to apply costs to products and customers in activity based costing

the most common management reports prepared with ABC data are product and customer profitability reports

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

Which costing method assigns only manufacturing costs to products? Multiple choice question. Neither traditional absorption nor activity-based costing Both traditional absorption and activity-based costing Activity-based costing Reason: Activity-based costing assigns both manufacturing and nonmanufacturing cost to products. Traditional absorption costing

traditional absorption

TAC

treats all manufacturing costs as product cost and all the nonmanufacturing costs as period costs