Cost Accounting Exam #2

What are cost drivers? What is their role in an activity-based costing system?

- a characteristic of an event or activity that results in the incurrence of costs by that event or activity - the most significant cost drivers are identified - a database is created that shows how these cost drivers are distributed across products (used to assign costs to the various products depending on the extent to which they use each cost driver)

Activity based costing system

- a two-stage process of assigning costs to products - in stage one, activity cost pools are established - in stage two, a cost driver is identified for each activity cost pool - then the costs in each pool are assigned to each product line in proportion to the amount of the cost driver consumed by each product line

Why do product-costing systems based on a single, volume-based cost driver tend to over cost high-volume products? What undesirable strategic effects can such distortion of product costs have?

- because all overhead costs are combined into one pool and distributed across all products on the basis of only one cost driver - this simple averaging process fails to recognize the fact that a disproportionate amount of costs often is associated with low-volume or complex products - the result is that low-volume products are assigned less than their share of manufacturing costs, and high-volume products are assigned more than their share of the costs

Explain the concept of a pool rate in activity-based costing

- calculated by dividing the budgeted amount of an activity cost pool by the budgeted total quantity of the associated cost driver - is the cost of a particular activity that is expected per unit of the associated cost driver

How is the distinction between direct and indirect costs handled differently under volume based versus activity-based costing systems?

- in volume-based costing systems, only direct material and direct labor are considered direct costs - in activity-based costing system, an effort is made to account for as many costs as possible as direct costs of production (any cost that can possibly be traced to a particular product line is treated as a direct cost of that product)

What is the role of activity dictionary in an ABC project?

- lists all of the activities identified and used in an activity-based costing analysis - provides for consistency in the terminology and level of complexity in the ABC analysis in the organization's various subunits

Traditional, volume-based product-costing system

- only a single predetermined overhead rate is used - all manufacturing-overhead costs are combined into one cost pool and applied to products on the basis of a single cost driver - most used cost drivers: direct-labor hours, direct-labor dollars, machine hours, and units of production

Three factors that are important in selecting cost drivers for an ABC system

1. degree of correlation between consumption of an activity and consumption of the cost driver 2. cost of measurement of the cost driver 3. behavioral effects (how the cost driver selected will affect the behavior of the individuals involved in the activity related to the cost driver)

Explain two factors that tend to result in product cost distortion under traditional, volume-based product costing systems

1. non-unit level overhead costs: Many overhead costs vary with cost drivers that are not unit-level activities. Use of a unit-level cost driver to assign such costs tends to result in cost distortion. 2. product diversity: When a manufacturer produces a diverse set of products, which exhibit different consumption ratios for overhead activities, use of a single cost driver to assign costs results in cost distortion.

Four broad categories of activities identified in stage one of an activity-based costing system

1. unit-level activities: must be done for each unit of production. 2. batch-level activities: must be performed for each batch of products. 3. product-sustaining activities: needed to support an entire product line. 4. facility-level (or general-operations-level) activities: required for the entire production process to occur.

Are activity-based costing systems appropriate for the service industry? Explain.

Activity-based costing is just as appropriate in the service industry as in the manufacturing industry. Just as in manufacturing firms, diverse services typically consume support activities in varying degrees. ABC systems are more accurate in tracking the usage of these support activities to the services (products) that are produced than are traditional, volume-based costing systems.

Explain why a new product-costing system may be needed when line managers suggest that an apparently profitable product be dropped

Line managers are close to the production process and may realize that a complex product, which is difficult to manufacture, is under-costed by a traditional, volume- based costing system

Explain why a manufacturer with diverse product lines may benefit from an ABC system

Diverse products typically consume support activities (such as purchasing, material handling, engineering, and inspection) in differing degrees. When there are significant differences among product lines in the ways that they consume support services (and thereby cause overhead costs), a traditional, volume-based costing system may distort product costs. Some products are over costed; others are under costed. An ABC system can eliminate (or at least alleviate) such cost distortion.