L2

Podcast

Play an AI-generated podcast conversation about this lesson

Questions and Answers

What is a primary objective of activity based costing (ABC)?

To replace direct labor with automated systems.

To reduce the overall production costs significantly.

To allocate overheads based on production volume.

To identify core activities and allocate costs based on their consumption. (correct)

Which statement correctly contrasts traditional costing systems with activity based costing (ABC)?

ABC allocates overheads based on product activity consumption rather than production volume. (correct)

Traditional costing relies on automated systems for cost allocation.

ABC ignores production overhead costs altogether.

Traditional costing focuses on high-volume products only.

What has changed in the composition of production costs that makes the traditional costing system less applicable today?

Selling and distribution costs have become consistent across all products.

Direct labor now accounts for more than 50% of total product costs.

The use of automation has significantly decreased direct labor costs. (correct)

Direct materials have become less important than production overheads.

Why might traditional absorption costing be considered outdated?

It emphasizes production volume as the sole cost driver. Signup and view all the answers

How do modern manufacturing practices affect production overhead costs?

They have increased the proportion of overhead costs relative to total production costs. Signup and view all the answers

What limitation does traditional absorption costing impose on businesses producing a wide range of products?

It allocates insufficient costs to low-volume products. Signup and view all the answers

In contemporary costing methods, selling and distribution costs are primarily linked to which factors?

The customer type and distribution channel used. Signup and view all the answers

What primarily determines the support activity costs in manufacturing?

The complexity and range of products manufactured Signup and view all the answers

What is the role of cost drivers in activity based costing (ABC)?

They link activity resource consumption to product outputs Signup and view all the answers

Which of the following statements best describes unit-level activities?

They have a one-to-one relationship with a unit of output Signup and view all the answers

In an ABC system, what is primarily gathered into activity cost pools?

Costs of the various resources consumed by activities Signup and view all the answers

What is a common characteristic of overhead costs in an ABC system?

They are allocated first to activities before being attributed to products Signup and view all the answers

Which of the following activities would likely incur higher costs in a factory producing multiple product types?

Quality testing Signup and view all the answers

If a factory has to set up production runs multiple times for different products, what type of costs will it likely incur more of?

Set-up costs Signup and view all the answers

In activity based costing, what best describes a resource driver?

An activity that causes resource consumption and costs Signup and view all the answers

How are activity costs charged to products in an ABC system?

Based on the number of cost drivers associated with each activity Signup and view all the answers

Which of the following best describes transaction-based cost drivers?

They allocate costs based on specific transactions rather than volume Signup and view all the answers

What is the first step in operating an ABC system?

Identify the major activities of the organization Signup and view all the answers

Within an ABC framework, what does the term 'cost object' refer to?

A product or service that generates demand for activities Signup and view all the answers

Which activity is least likely to be considered a unit-level activity?

Machine set-up for production Signup and view all the answers

What defines a unit-level activity in production?

An activity that must be performed for each item produced Signup and view all the answers

Which type of activity involves actions that relate to multiple units or batches?

Batch-level activities Signup and view all the answers

In the context of Activity-Based Costing (ABC), what is a cost driver?

A factor that influences the overhead assigned to an activity Signup and view all the answers

How is overhead typically allocated in absorption costing?

Using machine hours or direct labor hours as a base Signup and view all the answers

Why might traditional cost accounting techniques be misleading?

They fail to differentiate between low-volume and high-volume products Signup and view all the answers

What is an example of a product-level activity?

Design and development of a new product Signup and view all the answers

If a company expects to have 40 machine setups costing a total of $200,000, what is the cost driver rate per setup?

$5,000 Signup and view all the answers

What is a batch-level activity in an online retail context?

Packaging and shipping orders Signup and view all the answers

How does ABC allocate overhead differently compared to traditional costing?

ABC links overhead to specific activities affecting each product Signup and view all the answers

What is the main flaw of traditional volume-based absorption costing as observed in the content?

Under-allocates overhead costs to low-volume products. Signup and view all the answers

Which of the following actions could be a volume-related cost driver?

Machine hours used in production Signup and view all the answers

Which cost driver is used for set-up costs in the ABC method based on the provided content?

Number of production runs. Signup and view all the answers

In ABC costing, what is the primary relationship between overhead absorption rates and costs?

Rates should be linked to the causes of overhead costs. Signup and view all the answers

Identify the main objective of Activity-Based Costing in production.

To accurately assign costs based on resource usage Signup and view all the answers

How does traditional absorption costing generalize overhead costs to products?

Uses a single absorption basis across all products. Signup and view all the answers

What could be a disadvantage of using a single overhead rate in traditional costing?

It uniformly spreads costs across all products regardless of usage Signup and view all the answers

What problem does marginal costing have when analyzing costs according to the volume of production?

It views all fixed costs as period costs. Signup and view all the answers

Which of the following is not a characteristic of the ABC method as noted in the content?

It absorbs overheads through a single basis. Signup and view all the answers

What aspect does ABC improve in regard to overhead allocation when compared to traditional methods?

Avoids reapportionment of service costs. Signup and view all the answers

Which benefit does ABC provide that traditional costing cannot?

Enhanced accuracy in recognizing product costs. Signup and view all the answers

What approach does marginal costing take towards fixed costs in decision making?

It classifies them as period costs without allocation. Signup and view all the answers

Under what conditions should Activity-Based Costing (ABC) be considered for introduction into an organization?

When the ABC analysis significantly differs from traditional costing Signup and view all the answers

What is a primary advantage of implementing Activity-Based Costing (ABC) compared to traditional costing methods?

ABC provides a realistic assessment of product profitability. Signup and view all the answers

Which type of activity is primarily responsible for costs related to the number of production runs?

Batch level activities Signup and view all the answers

What characterizes facility-sustaining activities in an organization?

They support the organization as a whole Signup and view all the answers

Which of the following activities might be tracked in a department store under ABC?

Creating customer loyalty programs Signup and view all the answers

In Activity-Based Costing, what must management analyze before implementation?

The organization's activities and their occurrence. Signup and view all the answers

If a large portion of overheads relate to batch-level activities, how will the unit product costs derived from ABC compare to those derived from traditional absorption costing?

They will vary significantly Signup and view all the answers

What is the determining factor for product-sustaining activities?

The existence of a product group or line Signup and view all the answers

What might be a disadvantage of using Activity-Based Costing?

It requires complex data analysis. Signup and view all the answers

In a manufacturing environment, what trend affects the allocation of overhead costs to products?

Shorter production runs and higher proportion of costs incurred during design Signup and view all the answers

How does ABC support customer profitability analysis?

By identifying activities and their costs for specific customers. Signup and view all the answers

Which statement correctly describes traditional absorption costing in comparison to ABC?

It aggregates costs based on direct labour hours solely Signup and view all the answers

What is a cost driver in the context of Activity-Based Costing?

A factor that causes costs to increase or decrease. Signup and view all the answers

Which criticism of ABC relates to the arbitrary nature of certain cost allocations?

It still requires some level of cost apportionment. Signup and view all the answers

Which component is essential to analyze when adopting ABC in a service-oriented organization like a bank?

Customer transaction frequency Signup and view all the answers

What is a potential consequence of a decision to reduce production costs without analyzing batch volumes?

It might not effectively decrease costs due to unoptimized batch sizes Signup and view all the answers

What is one reason critics might argue against the implementation of ABC?

The expenses involved can outweigh the benefits. Signup and view all the answers

How does ABC benefit organizations facing a wide variety of products?

It provides a more accurate reflection of costs linked to specific products Signup and view all the answers

Which activity is likely NOT considered under the umbrella of Activity-Based Costing?

Conducting regular financial audits. Signup and view all the answers

What does the term 'activity-based budgeting' refer to?

Budgeting based on the analysis of activities and their costs. Signup and view all the answers

What is the primary purpose of establishing ABC-related costs in non-manufacturing settings?

To understand costs associated with specific customer transactions Signup and view all the answers

What is one limitation of traditional absorption costing regarding overhead allocation?

It often overlooks the impact of batch-level activities on costs Signup and view all the answers

Which of the following could cause complexities within an ABC system?

Excessive cost pools and cost drivers. Signup and view all the answers

In which situation is ABC most useful?

In highly competitive markets with diverse offerings. Signup and view all the answers

What is the overall goal of implementing ABC in an organization?

To enhance profitability through informed decision-making Signup and view all the answers

Which of the following statements about ABC is correct?

ABC can help in identifying inefficient activities. Signup and view all the answers

What type of costs are product-sustaining activities linked to?

They are determined by the existence of a product or service Signup and view all the answers

How does ABC influence cost control?

By enabling control over identified cost drivers. Signup and view all the answers

How does Activity Based Costing (ABC) determine the allocation of overheads to products?

According to each product's consumption of core activities. Signup and view all the answers

What is a key characteristic of costs identified through Activity Based Costing?

They represent long-run average costs. Signup and view all the answers

What role do cost drivers play in Activity Based Costing?

They influence the level of costs and resource consumption. Signup and view all the answers

What is one of the criticisms of using marginal costing in decision making?

It inaccurately reflects cost behaviors related to production volume. Signup and view all the answers

What is the fundamental difference in how absorption costing and ABC approach overhead absorption?

ABC absorbs costs based on activity consumption. Signup and view all the answers

What type of decision is Activity Based Costing particularly beneficial for?

Evaluating the feasibility of new product development. Signup and view all the answers

Which of the following best explains what a resource driver is?

A factor causing the consumption of resources and incurring costs. Signup and view all the answers

How does Activity Based Management (ABM) utilize the information from ABC?

To enhance profitability through efficient activity performance and resource allocation. Signup and view all the answers

What type of costs does Activity Based Costing specifically focus on managing?

Costs related to activities that drive production and overhead. Signup and view all the answers

Which of the following activities is NOT likely included in Activity Based Costing?

General administrative overheads not linked to specific activities. Signup and view all the answers

Why might organizations hesitate to implement ABC?

The additional information it provides may not guarantee enhanced profitability. Signup and view all the answers

What type of cost is associated with overheads that may vary with other activities rather than volume?

Transaction-based cost drivers. Signup and view all the answers

Which level of activities in Activity Based Costing is specifically linked to supporting the production of individual products?

Product sustaining activities. Signup and view all the answers

How does ABC contribute to developmental decision-making in an organization?

By providing insights into efficient delivery methods. Signup and view all the answers

What impact does ABC typically aim to have on departmental efficiency and costs?

Identify and optimize activities to reduce waste and improve efficiency. Signup and view all the answers

Study Notes

Introduction to Activity Based Costing (ABC)

Traditional costing assumes products consume resources based on production volumes, leading to misallocation of overheads.
High-volume products may receive an excessive share of overheads; low-volume products may incur too little.
ABC identifies core activities for production and allocates overheads based on actual consumption of activities, not just production volume.
Historical cost accounting favored direct labor and materials, with overheads seen as minimal and driven by labor hours.
Advanced manufacturing technology (AMT) shifts costs significantly towards production overheads, reducing the relevance of direct labor costs.
Diverse delivery methods necessitate that selling and distribution costs be assessed based on customer channels rather than just sales volume.

Core Concepts of Activity Based Costing (ABC)

ABC traces resource consumption to specific activities, using activity cost pools to gather resource costs.
Each activity's cost is assigned to products through cost drivers, which correlate the activity to its resource usage.
Activities include ordering, production scheduling, and quality testing. These are categorized as resource drivers.
Cost drivers vary by activity; for example, inspection frequency for quality control or number of orders for materials.

ABC System Operations

ABC systems follow a multi-step process: identifying activities, gathering costs into activity cost pools, determining cost drivers, and allocating costs to products.
Unit-level activities relate directly to each product unit; batch-level activities apply to multiple units together.
Product-level activities support the overall existence of a product but aren't influenced by the number of units or batches produced.

Cost Drivers and Examples

Resource drivers cause an organization to incur costs; cost drivers link this consumption to product output.
Activity cost pools categorize costs related to the same activity, simplifying management and allocation.
Examples of cost drivers include the number of production runs, inspection frequency, and order handling counts.

Comparison of Absorption Costing and ABC

Absorption costing typically uses labor or machine hours as the basis for overheads, leading to potential inequitable cost division.
ABC uses multiple cost drivers linked to specific activities, aiming for a more accurate overhead distribution based on actual resource utilization.
Traditional costing can inaccurately allocate costs, often overloading high-volume products and underpricing low-volume items.

Introducing an ABC System

Organizations should implement ABC only when it yields information that improves profitability.
ABC defines four activity levels: product-level, batch-level, product-sustaining, and facility-sustaining, helping to manage costs more effectively.
The transition to ABC involves understanding its benefits in decision-making over traditional cost accounting approaches, particularly for complex production environments.### Activity-Based Costing (ABC) Introduction
ABC is beneficial when additional information supports actions to enhance organizational profitability.
Significant differences between ABC and traditional absorption costing occur when:
- Production overheads are high relative to direct costs.
- Overhead resources vary not just with production volume.
- There is a diverse range of products.
- Overhead consumption fluctuates across product lines.

Analysis of Activities in ABC

ABC links costs to the level of activities performed.
Activities are classified into four hierarchical levels:
- Unit level
- Batch level
- Product-sustaining level
- Facility-sustaining level
Cost drivers vary based on activity type and include:
- Unit level: Volume of production
- Batch level: Number of production runs
- Product-sustaining: Existence of a product line
- Facility-sustaining: General organization maintenance

Cost Behavior and Product Costing

Product-sustaining costs depend on the presence of products rather than output volume.
The distinction between ABC and absorption costing lies in overhead cost distribution, particularly for batch and product-level activities.
Example illustrates different overhead costs per product based on production run requirements:
- Product D overhead: $5
- Product E overhead: $20
ABC captures the resource intensity of different products more accurately than absorption costing.

ABC in Service and Retail Sectors

ABC, though initially for manufacturing, is applicable in non-manufacturing environments like banking.
Key retail activities and their potential cost drivers include:
- Unit level: Accept cash (Number of transactions)
- Batch level: Closing cash desk (Number of close outs)

Advantages of ABC

ABC mirrors the simplicity of traditional costing once information is collected.
It accounts for modern complexities in manufacturing, including:
- Diverse product ranges and shorter life cycles.
- Recognition of non-production overhead costs (e.g., design, quality control).
Facilitates better cost management and visibility over resource usage.
Enhances understanding of customer profitability by analyzing costs associated with individual customers.
Useful in competitive markets with diverse products and significant overheads.

Disadvantages of ABC

ABC may require arbitrary cost allocation, particularly for shared costs like rent.
Complexity may arise with excessive cost drivers and pools.
Cost drivers must correlate meaningfully with activities to be useful.
If not utilized effectively, the implementation of ABC can be redundant compared to traditional systems.

Planning, Control, and Decision-Making with ABC

ABC supports informed planning, budgeting, and staffing decisions by providing a detailed activity database.
Cost control becomes feasible by managing underlying activities rather than outputs.
Facilitates strategic decision-making like pricing, product development, and discontinuation by offering reliable cost data.

Key Points to Remember

Traditional costing assumes uniform resource consumption across products based on volume, often misrepresenting costs.
ABC accurately assigns costs based on actual resource usage, challenging the assumptions of traditional methods.
Resource drivers and activity cost pools are essential for effective ABC implementation.
ABC aids in identifying non-value-adding activities for potential elimination or modification, optimizing organizational profitability.

Studying That Suits You

Use AI to generate personalized quizzes and flashcards to suit your learning preferences.

Description

This quiz delves into the principles of Activity Based Costing (ABC) and contrasts it with traditional costing systems. It highlights how ABC provides a more accurate allocation of overhead costs by recognizing the different resource consumption patterns of products. Understand how ABC can benefit businesses in accurately assessing product profitability.

L2

Choose a study mode