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Questions and Answers
What is the primary objective of Activity-Based Costing (ABC)?
What is the primary objective of Activity-Based Costing (ABC)?
What is a major advantage of using ABC costing?
What is a major advantage of using ABC costing?
What is an example of an activity that consumes overhead resources in ABC?
What is an example of an activity that consumes overhead resources in ABC?
What is a challenge of using ABC costing?
What is a challenge of using ABC costing?
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What is the result of using ABC costing for product cost estimation?
What is the result of using ABC costing for product cost estimation?
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What is a primary benefit of using Activity-Based Costing (ABC)?
What is a primary benefit of using Activity-Based Costing (ABC)?
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What is a limitation of using Activity-Based Costing (ABC)?
What is a limitation of using Activity-Based Costing (ABC)?
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When is it suitable to use Activity-Based Costing (ABC)?
When is it suitable to use Activity-Based Costing (ABC)?
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What is an 'activity' in the context of Activity-Based Costing (ABC)?
What is an 'activity' in the context of Activity-Based Costing (ABC)?
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What is a 'cost driver' in the context of Activity-Based Costing (ABC)?
What is a 'cost driver' in the context of Activity-Based Costing (ABC)?
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Study Notes
Introduction to ABC Costing
- Activity-Based Costing (ABC) is an overhead allocation method that uses multiple overhead rates to track indirect costs by the activities that consume those costs.
- ABC uses multiple activity bases (or cost drivers) to apply overhead costs to products.
- Examples of activities that consume overhead resources include purchasing and storing materials, supervising direct labor, machine runs, electricity consumption, and equipment maintenance.
Advantages and Disadvantages of Using ABC
- Advantages of ABC:
- Fair allocation of manufacturing overhead costs
- Recognizes that manufacturing overhead costs are not all related to production and sales volume
- More accurate and reliable estimation of product costs
- Selling prices are reliably determined
- Provides sufficient and accurate information of costs to identify inefficient products or services
- Helps control manufacturing overhead costs by managing cost drivers
- Disadvantages of ABC:
- Difficult to apply and identify overall activities that drive costs
- Challenging to select the most suitable cost driver
- Not suitable for small manufacturing companies
- Too costly and time-consuming to collect and enter data
- Limited benefits if factory overhead costs are primarily volume-related or small in proportion to total manufacturing costs
- Does not conform to generally accepted accounting principles, requiring maintenance of two cost systems and accounting books
Primary Benefits of ABC
- More accurate product costing
- Leads to more cost pools and direct assignment of costs based on cost drivers
- Enables enhanced control over overhead costs by tracing indirect costs directly to activities
- Contributes to better management decisions through accurate product costing and informed selling prices
Limitations of ABC
- Can be expensive to use due to increased cost of identifying multiple activities and applying numerous drivers
- Some arbitrary allocation of overhead costs remains, despite more accurate assignment through ABC
When to Use ABC
- Product lines differ greatly in volume and manufacturing complexity
- Multiple product lines require differing degrees of support services
- Overhead costs constitute a significant portion of total costs
- Manufacturing process or product lines have changed significantly (e.g., from labor-intensive to capital-intensive)
- Managers are ignoring existing data and using alternative costing data for pricing and product decisions
Terms Related to ABC
- Activity: any event, action, transaction, or work sequence that incurs costs when producing a product
- Activity Cost Pool: a set of costs attributed to a distinct type of activity
- Cost Driver: any factor or activity that has a direct cause-and-effect relationship with resources consumed
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Description
Learn about Activity-Based Costing, an overhead allocation method that tracks indirect costs by activities. Understand how ABC uses multiple overhead rates and activity bases to apply overhead costs to products.
