Cost Accounting, 14e, Test Bank Ch05

overcosting a particular product may result in:

By calculating the activity-based costing rate for multiple cost pools, a manufacturing company can more accurately determine product cost. Absorption costing assigns costs to individual units, whereas activity-based Costing focuses on company activities as a central cost and then assigns indirect costs to units. Consider the following example where a company manufactures 10,000 units of a particular product with a cost per unit of $10 in direct materials, $8 in direct labor, and $2 in variable manufacturing costs. The company also has fixed manufacturing overhead costs totaling $40,000 per year. Activity cost drivers are used in activity-based costing, and they give a more accurate determination of the true cost of business activity by considering the indirect expenses.

overcosting a particular product may result in:

This can lead to the reapportionment of production work to those facilities incurring lower overhead costs, and possibly the shut-down of unusually high-cost facilities. Use activity drivers to apportion the costs in the secondary cost pools to the primary cost pools. The first step in ABC is to identify those costs that we want to allocate. This is the most critical step in the entire process, since we do not want to waste time with an excessively broad overcosting a particular product may result in: project scope. Generally, the scope of an ABC project should be kept fairly narrow, to make the project easier to manage and more cost-effective. Numerous respondents to the survey stated that they were having trouble implementing ABC because they had other initiatives of higher priority to the organization at the present time. Examples include such priorities as the entering of new products or markets or implementation of new information systems.

Disadvantages Of Activity Based Costing

Manufacturing overhead includes all other expenses incurred during the manufacture of a product that cannot be directly allocated to that product. This might include factory rent, payroll taxes on direct labor wages, and machine maintenance. Manufacturing overhead must be accurately allocated to a product’s cost for manufacturing companies to set product sales prices and determine if products are producing profits. The difference between the traditional method and the ABC method is more complex than simply the number of cost drivers. In absorption costing, all manufacturing costs are included in the product cost. This means direct costs and indirect costs are included in the final product cost. This costing method is used in manufacturing businesses to determine the total cost of each product produced.

overcosting a particular product may result in:

For some companies, the often less-complicated traditional method does an excellent job of allocating overhead. However, overhead allocation is a more complex issue for many products, and an activity-based costing system is more appropriate.

What Is The Difference Between Inventoriable Costs And Period Costs?

Support cost requirements of both products are substantially different from one another. Which of the following statements is true of implementing an ABC system? A) Managers should never compromise on the cause-and-effect relationship of cost drivers and costs.

overcosting a particular product may result in:

Once costs are assigned to activities, the costs can be assigned to the cost objects that use those activities. The system can be employed for the targeted reduction of overhead costs. ABC works best in complex environments, where there are many machines and products, and tangled processes that are not easy to sort out. Conversely, it is of less use in a streamlined environment where production processes are abbreviated, so that costs are easy to assign.

Apr 23 What Is Absorption Costing And How Does It Impact Manufacturing Profitability?

A) They include only financial aspects of a plan and exclude nonfinancial aspects. B) Includes both financial and nonfinancial aspects of management’s plans. Upon completion of the calculations, you will be able to tell Rio Group LLC to allocate $15,120 of overhead to Widget A and $11,880 of overhead to Widget B. Upon completion of the calculations, you will be able to tell Rio Group LLC to allocate $11,250 of overhead to Widget A and $15,750 of overhead to Widget B. Try it now It only takes a few minutes to setup and you can cancel any time.

  • It provides better measurement of the costs of indirect resources used by different cost objects.
  • Which method of allocation probably best estimates actual overhead costs used?
  • IT appears to be an important factor in getting to the usage-stage for the majority of companies surveyed.
  • ABC is used to get a better grasp on costs, allowing companies to form a more appropriate pricing strategy.
  • D) The main advantage of activity-based costing over peanut-butter costing is the accurate distribution of all direct costs to the products.
  • D) Three activity-cost drivers because product costs can be significantly cross-subsidized.

Activity driver analysis identifies and assesses the factors involved in the costing of goods and services and is part of activity-based costing. Calculate the cost activity rates for each pool identified in #1 using the cost drivers in #2. Cost-allocation basis -Identify the preferred cost-allocation base for each indirect-cost pool. Direct-cost tracing -Classify as many of the total costs as direct costs as is economically feasible. As a result, the year after completing the one-time order, the company consistently underbids contracts and winds up with a portfolio of unprofitable or marginally profitable contracts.

Calculation of Total Manufacturing Cost and Gross margin – The only difference between ABC and traditional cost systems is the treatment of indirect costs, or manufacturing overhead. To compute the full manufacturing costs, we still need to add the direct materials and direct labor costs, which do not change as a result of the cost allocation method used. Comparison of Volume-Based and Activity Based Cost Systems – Activity based costing allows for a more allocation of indirect costs that the traditional volume based costing system. This is crucial to allocate costs appropriately for not only reporting purposes, but for the accurate pricing of products.

These costs are later allocated to other cost pools that more directly relate to products and services. There may be several of these secondary cost pools, depending upon the nature of the costs and how they will be allocated. It can help to avoid a large number of cost pools, to reduce the complexity of the ABC system. Activity-based costing is a methodology for more precisely allocating overhead costs by assigning them to activities.

Chegg Products And Services

Report on voew of business_analysis Business Analysis of Ford in China Ford Motor Company is looking forward to celebrating its 100th anniversary. In the …Report on voew of business_analysis PURPOSE OF REPORT I hereby present an analysis of the challenges and the suggestions regarding the issues faced by Nirula… Unit activities – activities that must be performed for each individual unit. Batch activities – activities performed for a group of units all at once.

That is where; the ABC had to take birth to refine the costing system from the curses like averaging as far as possible. Inventoriable costs can be defined as costs which become part of inventories such as raw material, work in progress and finished goods inventory present in the balance sheet of any business. Period costs are those costs which are incurred and expensed in Profit and Loss Statement in the period they are incurred. Estimate an amount for the cost-driver for the appropriate period (laborhours per quarter, etc.). Hearst Newspapers participates in various affiliate marketing programs, which means we may get paid commissions on editorially chosen products purchased through our links to retailer sites. The following charts are based on 178 responses from one of the surveys in this study.

  • This result supports one trend that everything “will happen naturally” if ABC is included in the budgeting process.
  • However, because all equity issued by the company is included in the weighting process, it is not as favorable as other weighting methods.
  • This makes absorption costing more accurate in determining the actual cost of manufacturing a product.
  • One needs to choose the appropriate activity (machine hours , Setup time , direct labor hours , and quality inspections ) that best describes the activity pool.
  • All or most costs are identified as output unit-level costs (unlikely to be true!).
  • Many of the companies that have implemented ABC found it more difficult to adopt than as first suggested.
  • By calculating the activity-based costing rate for multiple cost pools, a manufacturing company can more accurately determine product cost.

Form Activity Cost Pools and Assign Indirect Costs to Each Activity – When the activities have been identified and classified , the next step is to combine similar activities into activity cost pools. To keep the cost system manageable, we must simplify the number of activities by grouping like or similar activities together. The goal is to create as few cost pools as possible while still capturing the major activities identified in the previous step. When allocating costs to each activity, one will need to come up with a uniform cost drivers that relate to each activity.


Which of the following is a reason that has accelerated the demand for refinements to the costing system? A) The declining demand for customized products has led managers to decrease the variety of products and services their companies offer. B) The use of product and process technology has led to an increase in indirect costs and a decrease in direct costs. C) The increased of automated processes has led to the increase in direct manufacturing cost leading to a decrease in breakeven point.

Traditional costing is more simplistic and less accurate than ABC, and typically assigns overheadcosts to products based on an arbitrary average rate. This method first assigns indirect costs to activitiesand then assigns the costs to products based on the products’ usage of the activities. Which of the following statements is true of a peanut-butter costing system?

The formula for activity-based costing is the cost pool total divided by cost driver, which yields the cost driver rate. The cost driver rate is used in activity-based costing to calculate the amount of overhead and indirect costs related to a particular activity. Absorption costing has remained popular because of its simplicity in calculating and implementing. However, cost accounting professionals must not be comfortable with easy. There is only one overhead cost pool and a single measure of activity, such as direct labor hours, making the traditional method simple and less costly. The predetermined overhead rate is based on estimated costs at the budgeted activity level. Therefore, the overhead rate is consistent across products, but overhead may be over-or underapplied.

  • These inflated numbers represent misallocations of costs in the ABC system, sometimes by quite substantial amounts.
  • The ABC system has more homogeneous indirect cost pools than the simple system, and more cost drivers are used as cost-allocation base.
  • This problem can be avoided by designing the system to only need information from the most supportive managers.
  • Both methods have pros and cons, but ultimately, it’s up to each manufacturing company to decide which method is best.
  • However, during one troublesome year, a strike occurs at its primary customer, decreasing sales to $9 million.
  • The organization anticipates the sales drop will only be temporary, so they maintain their routine management and support structure throughout the period.
  • By including all manufacturing costs, businesses can better understand the actual cost of producing their goods.

In some cases, absorption costing can lead to a product being assigned too much overhead, which artificially decreases the profit of that product. In other cases, absorption costing can lead to a product being assigned too little overhead, which artificially increases the profit of that product.

Activity based costing is a method of assigning indirect costs to products and services based on the activities they require. ABC is a two-stage process in which indirect costs are first assigned to activities and then to individual products and services based on their activity requirements. One significant advantage of activity-based Costing is that it allows companies to understand the cost and profitability of individual units produced or services rendered.

A) Single direct labor-hours cost driver because it is best to allocate total costs uniformly to individual jobs. B) Single direct labor-hours cost driver because it is easiest to analyze and interpret. C) Three activity-cost drivers because they best reflect the relative consumption of resources. D) Three activity-cost drivers because product costs can be significantly cross-subsidized.

These companies could use the information in negotiations with suppliers for cost reduction efforts. A) The costing results for chess pieces under the new system depend on the adequacy and quality of the estimated cost drivers and costs used by the system. An overhead rate is a cost allocated to the production of a product or service.

The maximum cost to develop, produce, and deliver the product or service and earn the desired profit. Investopedia requires writers to use primary sources to support their work. These include white papers, government data, original reporting, and interviews with industry experts. We also reference original research from other reputable publishers where appropriate. You can learn more about the standards we follow in producing accurate, unbiased content in oureditorial policy. Timothy Li is a consultant, accountant, and finance manager with an MBA from USC and over 15 years of corporate finance experience.

Absorption costing is typically required for financial and income tax reporting purposes. 14) Explain how traditional cost systems, using only unit level cost drivers, distort product costs.

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