Chapter 5: Activity Based Costing & Activity Based Management

Guidelines for Refining a Costing System

1. Identify as many direct costs as is economically feasible. 2. Expand the number of indirect-cost pools until each pool is more homogeneous. 3. use the cost driver (the cause of indirect costs) as the cost-allocation base for each homogeneous indirect-cost pool (the effect).

Activity Based Management

A method of management decision making that uses activity-based costing information to improve customer satisfaction and profitability.

Reasons for Refining a Costing System

Increase in product diversity. Increase in indirect costs with different cost drivers. Competition in product markets.

Product Overcosting

a product is reported to have a high cost per unit but consumes a lower level of resources per unit

Product Undercosting

a product is reported to have a low cost per unit but consumes a higher level of resources per unit

Cost Hierarchy (4)

categorizes various activity cost pools on the basis of the different types of cost drivers, cost-allocation bases, or different degrees of difficulty in determining cause-and-effect (or benefits-received) relationships.

A manager is deciding whether to use activity-based costing or a single cost pool. In Step 3 of the decision-making process, that manager may ___________.

decide to group all budgeted indirect costs in a single cost pool

Undercosting a particular product or service may result in ________.

higher market share

(1) Output unit level costs

the costs of activities performed on each individual unit of a product or service ex: Machine operations costs (such as the cost of energy, machine depreciation, and repair),

(2) Batch Level Costs

the costs of activities related to a group of units of a product or service rather than each individual unit of product or service. ex: material-handling and quality-inspection costs associated with batches, costs of placing purchase orders, receiving materials, and paying invoices related to the number of purchase orders placed

(4) Facility sustaining costs

the costs of activities that managers cannot trace to individual products or services but that support the organization as a whole.

(3) Product sustaining costs

the costs of activities undertaken to support individual products or services regardless of the number of units or batches in which the units are produced or services provided. ex: design costs, product research and development costs, costs of making engineering changes, and marketing costs to launch new products.

simple costing system

allocates indirect costs using a single indirect-cost rate

Activity

an event, task, or unit of work with a specified purpose— for example, designing products, setting up machines, operating machines, or distributing products

Normally, product design costs are product-sustaining costs. However, when customized goods are produced in groups, product design can be a(n) ________.

batch-level cost

The budgeted indirect-cost rate for each cost pool is computed as ________.

budgeted total ic pool / bud total quant cost alloc base

Which of the following represent the main costs and limitations of an ABC costing system?

implementation measurements

Product-cost cross-subsidization

means that if a company undercosts one of its products, it will overcost at least one of its other products

refined costing system

reduces the use of broad averages for assigning the cost of resources to cost objects (such as jobs, products, and services) and provides better measurement of the costs of indirect resources used by different cost objects, no matter how differently various cost objects use indirect resources.

Activity-based costing (ABC)

refines a costing system by identifying individual activities as the fundamental cost objects