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Accounting 410 Final: Chapter 17

Terms in this set (26)

What is assumed for job order costing?
We assumed the direct labor cost was the relevant activity base for assigning overhead costs to a job.
What is assumed for process costing?
We assume that machine hours was the relevant activity base.
What does Activity-based costing (ABC) allocate overhead to?
ABC allocates overhead to multiple activity cost pools and assigns the activity cost pools to products and services by means of cost drivers
In Activity-based costing, what is considered as an activity?
an activity is any event, action, transaction, or work sequence that causes the incurrence of cost in producing a product or providing a service
what is a cost driver?
a cost driver is any factor or activity that has a direct cause-effect relationship with the resources consumed
How does ABC allocate overhead in two stage process?
1. Overhead costs are allocated to activity cost pools, rather than to departments or jobs. Each is a distinct type of activity.

2. Overhead allocated to the activity cost pools is assigned to products using cost drivers which represent and measure the number of individual activities undertaken or performed to produce products or provide services
ABC involves the following four steps:
1. Identify and classify the major activities involved in the manufacture of specific products, and allocate manufacturing overhead costs to the appropriate cost pools.

2.Identify the cost driver that has a strong correlation to the costs accumulated in the cost pool.

3. Compute the overhead rate for each cost driver.

4. Assign manufacturing overhead costs for each cost pool to products, using the overhead rates (cost per driver).
What happens in a well designed activity-based costing system?
It starts with an analysis of the activities performed to manufacture a product or provide a service.

This analysis should identify all resource-consuming activities.

It requires a detailed, step-by-step walk through of each operation, documenting every activity undertaken to accomplish a task.
What happens after costs are allocated to the activity cost pools?
Cost drivers for each cost pool must be identified.
What must the cost driver do?
The cost driver must accurately measure the actual consumption of the activity by the various products.
How is accurate costing achieved?
a high degree of correlation must exist between the cost driver and the actual consumption of the overhead costs in the cost pool.
How is an activity-based overhead rate per cost driver computed?
it is computed by dividing (total estimated overhead per activity) by (number of cost drivers expected to be used per activity)
When assigning overhead costs, what is necessary to know?
it is necessary to know the expected use of cost drivers for each product
what is needed to assign overhead costs to each product?
The activity based overhead rates are multiplied by the number of cost drivers expected to be used per product.
What are the 4 benefits of ABC
1. primary benefit of ABC is more accurate product costing
2. ABC leads to more cost pools
3. leads to enhanced control over overhead costs
4. lead to better management decisions
What are the 2 limitations of ABC
1. ABC can be expensive to use
2. some arbitrary allocations continue
When are the 5 times to use ABC?
1. product lines differ greatly in volume and manufacturing complexity
2. product lines are numerous, diverse, and require differing degrees of support services
3. overhead costs constitute a significant portion of total costs
4. the manufacturing process or the number of products has changed significantly
5. Production or marketing managers are ignoring data provided by the existing system and are instead using "bootleg" costing data or other alternative data when pricing or making other product decisions
What is Activity-Based Management (ABM)?
ABM extends the use of ABC from product costing to a comprehensive management tool that focuses on reducing costs and improving processes and decision making
In ABM, what does Value-added activities do?
it increases the worth of a product or service to customers. Examples: engineering design, machining, assembly, painting, and packaging.
In ABM, what are non-value-added activities?
They are product or service related activities that simply add cost to or increase the time spent on, or product or service without increasing its market value

Examples include repair machines, storage of inventory, the moving of raw materials, etc.
What is the purpose of ABM?
to reduce or eliminate the time and cost devoted to non-value-added activities
What is the classification of Activity Levels? (4)
a. Unit Level Activities... performed for each unit of production
b. Batch-level activities... performed for each batch of products rather than each unit
c. performed in support of an entire product line, but are not always performed every time a new unit or batch of products is produced
d. activities required to support or sustain an entire production process
Have you flown since airline baggage fees have been implemented? Baggage handling is extremely labor intensive. The tagging, sorting, loading on carts, loading in planes, unloading, etc., adds up to about $9/bag. Then there's equip-ment costs and storage facilities ($4/bag) and $2 fuel cost.

Why do airlines charge even higher rates for heavier bags, bags that are odd shapes, and bags with hazardous materials in them?
Each of these factors increases the costs to the airlines.

Heavier baggage is more difficult to handle, thus increasing labor costs. It also uses up more fuel. Bags that are odd shapes complicate handling both for humans and machines.

In addition, odd shapes take up more space in the cargo area.

Finally, hazardous materials require special handling and storage procedures.

All of these factors should be considered by an airline when it decides how much to charge for special baggage.
Although most ABC applications are in manufacturing companies, small service businesses can apply it also. Mahany Welding Supply used ABC to determine the cost of servicing customers and feasible cost reduction opportunities. Application of ABC at Mahany provided information about the five employees who were involved in different activities of revenue generation. Managers applied activity cost pools to the five revenue-producing employees using relevant cost drivers.

What positive implications does application of ABC have for the employees of Mahany Welding Supply?
ABC will make these employees more aware of which activities cost the company more money.

They will be motivated to reduce their use of these activities in order to improve their individual performance.
Production line technicians from General Mills flew to North Carolina to observe first-hand how race-car pit crews operate. In a NASCAR race the value-added activity is driving toward the finish-line. General Mills technicians were able to reduce setup time from 5 hours to just 20 minutes from what they learned at the car race.

What are the benefits of reducing setup time?
Setup time is a non-value-added activity. Customers are not willing to pay extra for more setup time.

By reducing the time spent on setups, the company can reduce non-value-added costs.

Also, by reducing setup time the company can switch from producing one product to producing a different product more quickly.

This enables it to respond to customers' demands more quickly, thus avoiding stock-outs.
SURVEYS SHOW THAT APPROXIMATELY 50% OF COMPANIES ACTUALLY USE ABC. AT THE SAME TIME, A WORLD-WIDE SURVEY OF ALMOST 350 COMPANIES SHOWED THAT 87% OF RESPONDENTS SAID THAT THEIR IDEAL COSTING SYSTEM WOULD INCLUDE SOME FORM OF ABC.

What are some of the reasons that explain why so many companies say that ideally they would use ABC, but haven't yet adopted it?
Implementation of an ABC system can be very expensive. It may be difficult to justify an expenditure for a system that allocates overhead costs more accurately.

The benefits of more accurate costing may not be as obvious as some of the other things a company might spend its money on, such as a machine that produces goods more efficiently.
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