Broad Averaging
BROAD AVERAGING--
describes a costing approach that uses broad averages for assigning the cost of resources uniformly to cost object
Consequences of Broad Averaging on cost=
by ignoring the variation in the consumption of resources by different cost objec
Define undercosting and overcosting and why these problems occur.
*UNDERCOSTING--
can result in companies selling products on which they are in fact losing money, even though they incorrectly believe them to be profitable (uses a lot of our resources, but we're not allocating a lot to it)
*OVERCOSTING--
may result in co
Key reason for product cost differences between simple costing systems and ABC systems?
ABC approach attempts to use cost drivers as the allocation base for indirect costs, whereas simple costing system generally does not
What is costing system refinement? Describe 3 guidelines for refinement.
*COSTING SYSTEM REFINEMENT--
means making changes to a simple costing system that reduces the use of broad averages for assigning the cost of resources to cost objects and provides better measurement of overhead resources used by different cost objects
Th
Does increasing the number of indirect-cost pools guarantee an increase in the accuracy of product or service costs?
No--if the existing cost pool is already homogeneous, increasing the number of cost pools will not increase accuracy
No--if the existing cost pool is not homogeneous, accuracy will increase only if the increased cost pools themselves increase in homogenei
What is an activity-based approach to designing a costing system?
*ACTIVITY-BASED APPROACH--
refines a costing system by focusing on an individual activities as fundamental cost objects
--it uses the cost of these activities as the basis for assigning costs to other cost objects such as products or services
Why is it important to classify costs into a cost hierarchy?
*because costs in different cost pools relate to different cost-allocation bases and not all cost-allocation bases are unit-level
example: an allocation base like setup hours is a batch-level allocation base, and design hours is a product-sustaining base-
Describe four levels of a cost hierarchy
1. OUTPUT UNIT-LEVEL COSTS--
--costs of activities performed on each individual unit of product or service
2. BATCH-LEVEL COSTS--
--costs of activities related to a group of units of products or services rather than to each individual unit of product or s
Department indirect-cost rates are never activity-cost rates". Do you agree? Explain.
No--department indirect costs are similar to activity cost rates if:
1. A single activity of department accounts for a sizable fraction of the department's cost
2. If allocation base of different activities are the same and significant cost is incurred
3.
Describe four decisions for which ABC information is useful
1. Pricing and Product Mix
2. Cost reduction and process improvement
3. Product design
4. Decisions for planning and managing activities
*integrating all of these throughout all parts of firm for improvement
*Activity based management--method of managemen
Describe 4 signs that help indicate when ABC systems are likely to provide the most benefits
1. Products make diverse demands on resources because of differences in volume, process steps, batch size, or complexity
2. Products that a company is well suited to make and sell show small profits; whereas products that a company is less suited to produ
What are the main costs and limitations of implementing ABC systems?
The measurements necessary to implement it require many calculations and can be costly to operate
ABC systems only apply to manufacturing companies". Do you agree? Explain.
No--ABC is most commonly used method of overhead allocation in the management accounting.
ABC method helps in the identification of the activities involved in the manufacturing process, organization and assignment of the cost to each of the individual act
ABC is the wave of the present and the future. All companies should adopt it." Do you agree? Explain.
No--ABC is not suitable for all the companies even though it has significant advantages over traditional costing methods.
According to ABC, the costs and resources are allocated to activities and the drivers are assigned to each activity.
Therefor, the co
Increasing the number of indirect-cost pools is guaranteed to sizable increase the accuracy of product or service costs." Do you agree? Why?
No--increasing the number of indirect-cost pools does not guarantee increased accuracy of product or service costs.
-->If the existing cost pool is already homogeneous, increasing the number of cost pools will not increase accuracy.
--> if the existing co
Review:
Cost Accumulation
Cost Measurement
OH Assignment Method
Cost Accumulation-- job costing vs. process costing
Cost Measurement--actual, normal, standard costing
OH Assignment Method--Volume-based vs. ABC
Plantwide Overhead Rate
BMOR =
[Total Estimated OH] / [Total Estimated Cost Driver]
or:
AMOR=
[Total OH] / [Total Cost Driver]
(department overhead rate: similar concept except OH cost pools and selected base are obtained by department)
Accuracy/ Simplicity Trade-off
Most Simple less accurate- Plantwide OH Rate (least refined) (traditional volume based cost systems)
Middle- Departmental OH Rates (traditional volume based cost systems)
More Complex More Accurate- Activity Based Costing (most refined)
CROSS SUBSIDIZATION
* results of overcosting one product and undercosting another
*the overcosted product absorbs too much cost, making it seem less profitable than it really is
*the undercosted product is left with too little cost, making it seem more profitable than it rea
Cost Assignment--ABC vs. Volume
*cost assignment approach for indirect (support) costs: resource costs such as factory OH are assigned to cost pools and then to cost objects (jobs, clients, products, patients, etc)
--volume-based: assign factory OH to a single plant or departmental cost
Classify following activities into one of cost hierarchy categories:
a) Quality testing performed in each individual unit
b)Creating and testing prototype models
c)Supervising the entire manufacturing operation
d)Machine setup cost incurred to produce a b
a) Quality testing performed in each individual unit
--Output Unit-Level
b)Creating and testing prototype models
--Product
c)Supervising the entire manufacturing operation
--Facility
d)Machine setup cost incurred to produce a batch
of units
--Batch-level
Activity Rates
*Activity rates are very similar to the predetermined overhead rate computed in traditional costing methods
[ACTIVITY RATE] =
[total activity cost] / [total activity driver]
Comparison of Traditional and ABC
*high volume products usually over-costed
*volume-based costing tends to under-cost low volume products and over-cost high volume products, a situation often referred to as PRODUCT COST CROSS-SUBSIDIZATION
Signals the suggest that ABC implementation could help a firm
1. Significant amounts of indirect costs are allocated using only one or two cost pools
-----could be plantwide, dept. wide
2. All or most indirect costs are identified as output unit-level costs
-----almost impossible for all to be unit-level
3. Products
Volume-Based or ABC
-Each method is mathematically correct
-Each method is acceptable
-Each method yields a different cost figure, which will lead to different gross margin calculations
-Only overhead is involved.
>total costs for entire firm remain same (DM
and DL)-- they a
Rationale for selecting a more refined costing system
-increase in product diversity
-increase in indirect costs
-competition in product markets
> advances in informational technology
(increase competitions and need for accuracy)
>Competition in foreign markets/ increased
competition
Behavioral Issues in Implementing ABC
1. Gain the support of top management and create a sense of urgency
2. Create a guiding coalition of managers throughout the value chain for the ABC effort
3. Educate and train employees in ABC as a basis for employee empowerment
4. Seek small short-run s