CHAPTER REVIEW
Traditional Costing And Activity-Based Costing
1.(L.O. 1) Often the most difficult part of computing accurate unit costs is determining the proper amount of overhead cost to assign each product, service or job. For job order costing we assumed the direct labor cost was the relevant activity base for assigning overhead costs to a job and for process costing we assumed that machine hours was the relevant activity base.
2.Activity-based costing (ABC) allocates overhead to multiple activity cost pools and assigns the activity cost pools to products and services by means of cost drivers. In ABC, an activity is any event, action, transaction, or work sequence that incurs costs when producing a product or performing a service. A cost driver is any factor or activity that has a direct cause-effect relationship with the resources consumed.
3.ABC allocates overhead in a two-stage process: In the first stage, overhead costs are allocated to activity cost pools, rather than to departments or jobs. Each is a distinct type of activity. In the second stage, the 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.
4.Activity-based costing involves the following four steps:
a.Identify and classify the activities involved in the manufacture of specific products and assign overhead to cost pools.
b.Identify the cost driver that has a strong correlation to the costs accumulated in each cost pool.
c.Compute the activity-based overhead rate for each cost pool.
d.Allocate overhead costs to products using the overhead rates determined for each cost pool.
Unit Costs Under ABC
5.(L.O. 2) A well designed activity-based costing system 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.
6.After costs are allocated to the activity cost pools, the cost drivers for each cost pool must be identified. The cost driver must accurately measure the actual consumption of the activity by the various products. 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.
7.An activity-based overhead rate per cost driver is computed by dividing the total estimated overhead per activity by the number of cost drivers expected to be used per activity. The formula for this computation is as follows:
Estimated Overhead Per Activity / = / Activity-BasedExpected Use of Cost Drivers Per Activity / Overhead Rate
8.In assigning overhead costs, it is necessary to know the expected use of cost drivers for each product. 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.
Benefits of ABC
9.(L.O.3) The primary benefit of ABC is more accurate product costing because:
a.ABC leads to more cost pools.
b.ABC leads to enhanced control over overhead costs.
c.ABC leads to better management decisions.
Classification of Activity Levels
10.The recognition that some activity costs are not driven by unit-based cost drivers has led to the development of a classification of ABC activities consisting of four levels. The four levels are classified and defined as follows:
a.Unit-level activities. Activities performed for each unit of production.
b.Batch-level activities. Activities performed for each batch of products rather than each unit.
c.Product-level activities. Activities 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.Facility-level activities. Activities required to support or sustain an entire production process.
Value-Added Versus Non-Value-Added Activities
11.In developing an ABC system, managers increase their awareness of the activities performed by the company in its production and supporting processes. This helps managers classify activities as value-added or non-value-added.
a.Value-added activities increase the worth of a product or service to customers. Examples include engineering design, machining, assembly, painting, and packaging.
b.Non-value-added activities are product- or service-related activities that simply add cost to, or increase the time spent on, a product or service without increasing its market value. Examples include repair of machines, the storage of inventory, the moving of raw materials, assemblies, and finished product; building maintenance; inspections; and inventory control. Examples for service enterprises might include taking appointments, reception, bookkeeping, billing, traveling, ordering supplies, advertising, cleaning, and computer repair.
12.Activity-based management (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.The purpose of ABM is to reduce or eliminate the time and cost devoted to non-value-added activities.
Limitations of ABC and When to Use ABC
13.Although ABC systems often provide better product cost data than traditional volume-based systems, there are the following limitations:
a.ABC can be expensive to use.
b.Some arbitrary allocations continue.
14.The presence of one or more of the following factors would point to possibly using ABC:
a.Product lines differ greatly in volume and manufacturing complexity.
b.Product lines are numerous, diverse, and require differing degrees of support services.
c.Overhead costs constitute a significant portion of total costs.
d.The manufacturing process or the number of products has changed significantly.
e.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.
Activity-Based Costing in Service Industries
15.(L.O.4) The general approach to identifying activities, activity cost pools, and cost drivers is the same for service companies and for manufacturers. Also, the labeling of activities as value-added and non-value-added, and the attempt to reduce or eliminate non-value-added activities as much as possible is just as valid in service industries as in manufacturing operations.
16.Implementation of activity-based costing in service industries is sometimes more difficult because there is a larger proportion of overhead costs which are company-wide costs that cannot be directly traced to specific services provided by the company.
Just-In-Time Processing
*17.(L.O.5) Just-in-time (JIT) manufacturing is dedicated to having the right amount of materials, products, or parts at the time they are needed. Under JIT processing, raw materials are received just in time for use in production, subassembly parts are completed just in time for use in finished goods, and finished goods are completed just in time to be sold.
*18.A primary objective of JIT is to eliminate all manufacturing inventories. Inventories are considered to have an adverse effect on net income because they tie up funds and storage space that could be made available for more productive purposes.
*19.There are three important elements in JIT processing:
a.A company must have dependable suppliers who are willing to deliver on short notice exact quantities of raw materials according to precise quality specifications. This may even include multiple deliveries within the same day.
b.A multiskilled work force must be developed.
c.A total quality control system must be established throughout the manufacturing operations.
*20.The major benefits of implementing JIT processing are:
a.Manufacturing inventories are significantly reduced or eliminated.
b.Product quality is enhanced.
c.Rework costs and inventory storage costs are reduced or eliminated.
d.Production cost savings are realized from the improved flow of goods through the processes.
20 MINUTE QUIZ
Circle the correct answer.
True/False
1.Even in today’s automated environment, direct labor is sometimes the appropriate basis for assigning overhead cost to products.
TrueFalse
2.In the first stage of activity-based costing, overhead is assigned to products using cost drivers.
TrueFalse
3.The first step in activity-based costing is to identify and classify the major activities
involved in the manufacture of specific products, and allocate manufacturing overhead to the appropriate cost pools.
TrueFalse
4.Before costs are allocated to the cost pools, the cost drivers for each cost pool must be identified.
TrueFalse
5.Under ABC, overhead costs are shifted from the high-volume product to the low-volume product.
TrueFalse
6.Activity-based costing does not change the amount of overhead costs, but it does allocate those costs in a more accurate manner.
TrueFalse
7.Overhead costs are not allocated by means of arbitrary volume-based cost drivers under ABC.
TrueFalse
8.Value-added activities increase the worth of a product or service to customers and
involve resource usage that customers are willing to pay for.
TrueFalse
9.Product-level activities in ABC are required to support or sustain an entire production process.
TrueFalse
*10.Just-in-time processing strives to eliminate inventories by using a “pull approach” in manufacturing.
TrueFalse
Multiple Choice
1.The last step in activity-based costing is to
a.identify the major activities involved in the manufacture of specific products.
b.compute the overhead rate per cost driver.
c.identify the cost driver that has a strong correlation to the costs accumulated in the cost pool.
d.assign manufacturing overhead costs for each cost pool to products.
2.Machine hours would be an accurate cost driver for
a.assembly costs.
b.inspecting costs.
c.machining costs.
d.machine setup costs.
3.All of the following are benefits of ABC except it leads to
a.elimination of all arbitrary cost allocations.
b.more accurate cost data.
c.enhanced control over overhead costs.
d.better management decisions.
4.The level of ABC activities performed in support of an entire product line are classified as
a.batch-level activities.
b.facility-level activities.
c.product-level activities.
d.unit-level activities.
*5.Just-in-time processing strives to eliminate inventories by using a
a.just in case approach.
b.pull approach.
c.push approach.
d.process approach.
ANSWERS TO QUIZ
True/False
1. True 6.True
2. False 7.False
3. True 8.True
4. False 9.False
5. True *10.True
Multiple Choice
1. d.
2. c.
3. a.
4. c.
*5. b