Chapter 4 Activity Base Costing

In ABC, an *Activity* is?

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

In regards to the ABC Method what is a *Cost Driver*?

Any factor or activity that has a direct cause/effect relationship with the resources consumed.

When overhead cost allocation systems were first developed, ________ made up a large part of total manufacturing cost.

Direct Labor

what is the activity-based overhead rate formula?

Estimated Overhead Per Activity/Expected used of Cost Drivers per Activity= Activity-Based Overhead Rate

True of False:Traditional costing systems allocate overhead using multiple bases.

False

True or false: The simple a product's manufacturing operations the more activity and cost drivers it is likely to have.

False- the more complex-

true or false: Before costs are allocated to the activity cost pools, the cost drivers for each activity cost pool must be identified. To achieve accurate costing, a high degree of correlation must exist between the cost driver and the actual consumption of the overhead costs in the cost pool.

False-After Cost-

True or False: Activity Cost Pool is Any factor or activity that has a direct cause-effect relationship with the resources consumed?

False-Cost Driver-

True or False: Cost Driver is the The overhead attributed to a distinct type of activity or related activities?

False.-Activity Cost Pool-

What is an *activity cost pool* in regards to the ABC Method?

Is a distinct type of activity such as ordering materials or setting up machines.

True of False: under a traditional cost system many companies now use machine hours as the overhead allocation base in an automated manufacturing environment.

True

True or False: Activity Based Costing is A costing system that allocates overhead to multiple activity cost pools and assigns the activity cost pools to products or services.

True

True or False: Activity is Any event, action, transaction or work sequence that incurs costs when producing a product or performing a service.

True

True or false: Current trends in manufacturing include less direct labor and more overhead cost.

True

True or false: Products consume activities and activities consume resources.

True

True or false:A well-designed activity-based costing system starts with an analysis of the activities needed to manufacture a product or perform a service. This analysis should identify all resource-consuming activities.

True

true or false:ABC shifts costs from high-volume products to low-volume products.

True *The shift occurs because low-volume products are often more customized and require more special handling*.

True or False: under a traditional cost system Companies that continue to use plantwide predetermined overhead rates based on direct labor, where the correlation between direct labor and overhead no longer exists, experience significant product cost distortions.

True.

Unlike direct materials and direct labor costs which can be easily traced to the product Overhead is? a. Indirect cost that can't be traced to a product b. Indirect cost that can be traced to a product

a. Indirect cost that can't be traced to a product

What are the steps involved in the Activity Based Costing Method?

1. *Identify and classify the activities* involved in the manufacture of specific products and *allocate overhead to cost pools*. 2. *Identify the cost driver* that has a strong correlation to the costs accumulated in each cost pool and estimate total annual cost driver usage. 3. *Compute the activity-based overhead rate* for each cost pool. 4. *Assign overhead costs to products* using the overhead rates determined for each cost pool and each product's use of each cost driver.

What are the stages in which ABC assigns overhead?

1. Overhead is assigned to *activity cost pools*, each of which is a distinct type of activity, 2. Overhead in the cost pools is allocated to products using *cost drivers* which represent and measure the number of individual activities undertaken or performed to produce products or render services.

What is the simple reasoning behind the ABC cost allocation?

1. Products consume activities 2. activities consume resources.

Activity-based costing (ABC)

A method of allocating overhead to multiple activity cost pools and assigns the activity cost pools to production by means of cost drivers.

Digger Inc. sells a high-speed retrieval system for mining information. It provides the following information for the year. *Budgeted*: Overhead cost-$1,333,200, Machine hours-56,300, Direct labor hours-101,000 *Actual*: Overhead Cost-$1,307,200 Machine hours-49,000, Direct Labor Hours-97,800 Overhead is applied on the basis of direct labor hours. a. Compute the predetermined overhead rate. b.Determine the amount of overhead applied for the year.

a. Predetermined overhead rate of $13.2 per direct labor hour b. Amount of overhead applied is $1,290, 960.

Under a traditional costing system, a single predetermined overhead is used which can be based on direct labor. a. True b. False

a. True

What overhead allocation basis is used by many companies with automated manufacturing processes to reduce product cost distortions? a. direct labor b. direct materials c. machine hours d. units produced

c. machine hours

Bangor Company manufactures two products, Velveeto and Fondant. Bangor has estimated overhead costs as follows: setting up machines ($160,000), machining ($300,000) and inspecting ($100,000). Information on the two products follows: Direct labor hours: Velveeto- 60,000 Fondant-100,000. Machine setups: Velveeto-2,400, Fondant-1,600 Machine hours: Velveeto-96,000, Fondant-104,000 Inspections: Velveeto 3,200, Fondant-2,800 Overhead is applied to Fondant using direct labor hours. What is the total amount of overhead charged to this product line using traditional costing? a. $105,000 b. $210,000 c. $280,000 d. $350,000

d. $350,000 Step1: Compute the Predetermine rate using traditional method: Overhead rate per direct labor hours= Total overhead cost/ total direct labor hours 160k+300k+100k/60k+100k =$3.5 Step2: compute overhead applied to the prouduct fondant based on traditional costing method- Applied overhead=(Direct labor hours)(Overhead rate) =100k($3.5) =$350K