ACCT201B Chapter 4
what characteristics must a company have to benefit from activity based costing?
-Products differ substantially in volume, batch size, and in the activities they require. -Conditions have changed substantially since the existing cost system was established. -Overhead costs are high and increasing and no one seems to understand why. -Management does not trust the existing cost system and ignores cost data from the system when making decisions.
When companies use departmental overhead rates what is different about their overhead rate?
The allocation base depends on the nature of the work performed in each department. In the machining department, overhead may be based on machine-hours, but in the assembly department, overhead may be based on direct labor-hour
How does ABC improve the accuracy of product costing?
1. Increasing the number of cost pools used to accumulate overhead costs. 2. Using activity cost pools that are more homogeneous than departmental cost pools. 3. Assigning overhead costs using activity measures that cause those costs, rather than relying solely on direct labor-hours. 4. Activity-based costing also highlights activities that could benefit most from process improvement efforts.
Why might direct labor not be a satisfactory base for allocation of overhead?
1. Most companies sell a large variety of products that consume differing amounts of overhead. 2. As a percentage of total costs, direct labor has been declining and overhead has been increasing. Many of these growing overhead costs may not be correlated with direct labor. 3. Technology advancements have reduced the cost and complexity of gathering diverse sources of data. 4. A plantwide overhead allocation system may not be optimal for many companies in today's business environment.
what is an activity cost pool?
A "bucket" in which costs are accumulated that relate to a particular activity are accumulated
define activity rate
A predetermined overhead rate for each activity cost pool
what are the benefits of activity based costing?
Activity-based costing improves the accuracy of product costs, helps managers to understand the nature of overhead costs, and helps target areas for improvement through benchmarking and other techniques
what is an activity in activity-based costing?
An activity in activity-based costing is an event that causes the consumption of overhead resources examples: Maintaining equipment. Ordering materials or supplies. Stocking shelves at a store. Admitting patients to a hospital. Scheduling production.
what is an activity measure?
Expresses how much of the activity is carried out and is used as the allocation base for applying overhead costs
when is it okay to combine activities and costs?
In general, activities and costs should be combined in the activity-based costing system only if they fall within the same level in the cost hierarchy.
when assigning overhead costs which method is the simplest, refined, and most complex?
The simplest method plantwide overhead rate A slightly more refined approach departmental overhead rates The most complex and accurate method is activity-based costing
what is a plantwide overhead rate?
a single overhead rate that is used throughout an entire factory
Define Activity Based Costing (ABD)
a technique that attempts to assign overhead costs more accurately to products
what are the activities and activity measures of facility level?
activities: general factory administration and plant building and grounds activity measures: direct labor hours direct labor hours
what are the activities and activity measures of batch level?
activities: processing purchase orders, processing production orders, setting up equipment, and handling material activity measures: purchase orders processed, production orders processed, number of setups/setup hours, and pounds of material handled/number of times material moved
what are the activities and activity measures of unit level?
activities: processing unites on machines, processing units by hand, and consuming factoring supplies activity measures: machine hours, direct labor hours, and unit produced
what are the activities and activity measures of product level?
activities: testing new products, administering parts inventories, and designing products activity measures: hours of testing time, number of part types, and hours of design time
what is an activity dictionary?
defines each of the activities that will be included in the activity- based costing system and how the activities will be measured.
what is activity based management?
it focuses on managing activities to eliminate waste and reduce processing time and defects
what are the disadvantages to using a departmental overhead rate?
it will not correctly assign overhead costs in situations where a company has a range of products and complex overhead costs.
what are some examples of activities for Activity Based Costing?
setting up machines, admitting hospital patients, billing customers, and opening a bank account
what are the hierarchy of activities?
unit level batch level product level facility level
When cost systems were developed in the 1800s, the emphasis was on simplicity because:
◦ Cost and activity data had to be collected by hand and all calculations were done with paper and pencil. ◦ Most companies produced a limited variety of similar products, so there was little difference in the overhead costs consumed by each product.
why is direct labor most often used as the allocation base for overhead?
◦ Direct labor information was already being recorded. ◦ Direct labor was a large component of product costs. ◦ Managers believed direct labor and overhead costs were highly correlated.
