Activity-Based Costing (ABC) and Traditional Product Costing

Activity-Based Costing (ABC) and Traditional Product Costing
Chapter 4 questions
5. What are the principal differences between activity-based costing (ABC) and traditional product costing?
The difference between activity based costing and traditional product costing is in the complexity and accuracy (Machlup, 559). Traditional costing is simple and less accurate and assigns overhead expenses to product based on arbitrary average rate. On the other hand, ABC is complex and accurate.
6. What is the equation for computing activity-based overhead rates?
Est. OH per activity / est. use of cost drivers per activity
7. What steps are involved in developing an activity-based costing system?
Step 1- Identifying the cost pool,
Step 2-Identifying the cost driver
Step 3- Calculate the rate
Step 4- Use the rate to allocate overhead
9. What is an activity cost pool?
This is the Cost related to a specific activity
10. What is a cost driver?
This is a unit of an activity that causes the change in activity's cost.
13. What are the primary benefits of activity-based costing?
ABC has a high number of OH rates and this is what makes it more accurate.
14. What are the limitations of activity-based costing?
It is expensive because it requires a lot of work.
Chapter 5 questions
1 What is cost behavior analysis?
Cost behavior analysis is the attempt to understand how operating cost adjusts in connection to a change in the level of activity in an organization.
Why is cost behavior analysis important to management?
Cost behavior analysis assist managers to determine if any cost will increase or decrease in case there is a change in business in activities.
3. Contrast the effects of changes in the activity level on total fixed costs and on unit fixed costs.
Total fixed costs remains the same in total despite the changes in the level of activity. In contrast, fixed costs per unit differ inversely with activity. When volume increases, fixed costs per unit decreases and vice versa (Jiambalvo, 56). It is important to note that the average range is the range of activity an organization expects to operate in a year.
7. How should mixed costs be classified in CVP analysis? What approach is used to effect the appropriate classification?
When it comes to CVP analysis, missed costs are classified into their variable and fixed elements (Lin). The high low method that is used to effect the appropriate classification. The approach entail taking the highest level of activity and the lowest level of activity and comparing the total of each.
Chapter 6 questions
1. What is meant by CVP analysis?
CVP analysis is a way of analyzing how adjustments in fixed and variable costs impacts the profit of an organization. CVP is used to check how many units a company needs to sell to reach a particular minimum profit margin or break even.
3. Distinguish between a traditional GAAP income statement and a CVP income statement.
CVP statement is prepared for internal use while traditional GAAP statement is used for external reporting. Additionally, CVP statement classifies expenses and costs as fixed or variable, while GAAP statement classifies costs and expenses by function (Li, Zhu & Chen, 300).
7. What is meant by the term sales mix? How does sales mix affect the calculation of the break-even point?
It is important to note that in a multi-product environment, computing the break-even point is complex and is calculates using a composite unit, which symbolizes the sales mix of a business (Jiambalvo, 87). In case the sales mix of an organization changes, the break-even point also adjusts, despite the fact that the total sales dollars adjusts or not.
12. What is meant by “cost structure?” Explain how a company’s cost structure affects its break-even point.
Cost structure is the relative proportion of fixed costs versus variable costs a form incurs. It is important to note that firms that rely heavily in fixed costs have a higher risk of break-even points.
13. What is operating leverage? How does a company increase its operating leverage?
Operating leverage is the cost-accounting formula that is used to estimate the degree to which a company can increase the operating income by increasing revenue. For an organization to increase its operating leverage, it should generate sales with a high gross margin and low variable costs.
Chapter 4 numerical problems:
E4.6 (LO 2), AN Santana Corporation manufactures snowmobiles in its Blue Mountain, Wisconsin, factory.The following costs are budgeted for the first quarter's operations.
Machine setup, indirect materials $ 4,000
Inspections 16,000
Tests 4,000
Insurance, factory 110,000
Engineering design 140,000
Depreciation, machinery 520,000
Machine setup, indirect labor 20,000
Property taxes on factory 29,000
Factory heating 19,000
Electricity, factory lighting 21,000
Engineering prototypes 60,000
Depreciation, factory 210,000
Electricity, machinery 36,000
Machine maintenance wages 19,000
Instructions
Classify the above costs of Santana Corporation into activity cost pools using the following: engineering, machinery, machine setup, quality control, factory costs. Next, identify a cost driver that may be used to assign each cost pool to each line of snowmobiles.
Solution
Machine setup, indirect materials- Machine Setup
Inspections- Quality Control
Tests – Quality Control
Insurance, factory- Factory utilities
Engineering design- Engineering
Depreciation, machinery - Machinery
Machine setup, indirect labor- Machine setup
Property taxes on factory- Factory utilities
Factory heating – Factory utilities
Electricity, factory lighting – Factory utilities
Engineering prototypes - Engineering
Depreciation, factory – Factory utilities
Electricity, machinery- Machinery
Machine maintenance wages- Maintenance
Identify activity cost drivers.
Machine setup, indirect materials- Number of setups
Inspections- Number of tests
Tests – Number of tests
Insurance, factory- Machine hours or Square feet
Engineering design- Engineering hours
Depreciation, machinery – Machine hours
Machine setup, indirect labor- Number of setups
Property taxes on factory- Machine hours
Factory heating – Machine hours or Square feet
Electricity, factory lighting – Machine hours or Square feet
Engineering prototypes – Engineering hours
Depreciation, factory – Machine hours or Square feet
Electricity, machinery- Machine hours
Machine maintenance wages- Number of machine or hours
E4.9 (LO 2, 3), AP An icon reads, Writing. Air United, Inc. manufactures two products: missile range instruments and space pressure gauges. During April, 50 range instruments and 300 pressure gauges were produced,and overhead costs of $94,500 were estimated. An analysis of estimated overhead costs reveals the following activities.
Activities Cost Drivers Total Cost
1. Materials handling Number of requisitions $40,000
2. Machine setups Number of setups 21,500
3. Quality inspections Number of inspections 33,000
$94,500
The cost driver volume for each product was as follows.
Cost Drivers Instruments Gauges Total
Number of requisitions 400 600 1,000
Number of setups 200 300 500
Number of inspections 200 400 600
Instructions
Determine the overhead rate for each activity.
The overhead cost for material handling. Machine setups, and quality inspections is $40,000, $43,000 and $55,000 correspondingly.
Assign the manufacturing overhead costs for April to the two products using activity-based costing.
The total manufacturing overhead costs for instrument and gauges is $35600 and $58900 respectively.
Write a memorandum to the president of Air United explaining the benefits of activity-based costing.
Internal Memo
To: The president of Air United
From:
CC
Date: 7/22/2022
SUBJECT: THE IMPORTANCE OF ACTIVITY-BASED COSTING
Activity-based costing is important because it produces more accurate results when it comes to estimating the cost of goods and services. Consequently, it enhances the understanding of cost drivers, and overheads. It is important to note activity-based costing makes non-value and expensive activities visible in the organization. In the long-ruin managers get the knowledge and capacity to reduce cost and eliminate unnecessary expenses.
Assign overhead using traditional costing and ABC.
The overhead cost per unit for instruments and gauges is $712 and $196 respectively.
E4.13 (LO 3), AN William Mendel & Sons, Inc. is a small manufacturing company in La Jolla that uses activity-based costing. Mendel & Sons accumulates overhead in the following activity cost pools.
Hiring personnel.
Managing parts inventory.
Purchasing.
Testing prototypes.
Designing products.
Setting up equipment.
Training employees.
Inspecting machined parts after each setup.
Machining.
Assembling.
Instructions
For each activity cost pool, indicate whether the activity cost pool would be unit-level, batch-level, product-level, or facility-level.
Hiring personnel- Facility-level activity
Managing parts inventory- product-level activity
Purchasing- Batch-level activity
Testing prototypes- product-level activity
Designing products- product-level activity
Setting up equipment- Batch-level activity
Training employees- Facility-level activity
Inspecting machined parts after each setup- Unit-level activity
Machining- Unit-level activity
Assembling-Unit-level activity
Assign overhead using traditional costing and ABC.
Hiring personnel- ABC
Managing parts inventory- Traditional costing
Purchasing- ABC
Testing prototypes- Traditional costing
Designing products- ABC
Setting up equipment - ABC
Training employees- Traditional costing
Inspecting machined parts after each setup- Traditional costing
Machining- ABC
Assembling- Traditional costing
P4.5 (LO 1, 2, 3, 4), AN An icon reads, Service. Lewis and Stark is a public accounting firm that offers two primary services, auditing and tax-return preparation. A controversy has developed between the partners of the two service lines as to who is contributing the greater amount to the bottom line. The area of contention is the assignment of overhead. The tax partners argue for assigning overhead on the basis of 40% of direct labor dollars, while the audit partners argue for implementing activity-based costing. The partners agree to use next year's budgeted data for purposes of analysis and comparison. The following overhead data are collected to develop the comparison.
Activity Cost Pools Cost Drivers Estimated Overhead Estimated Use of Cost Drivers Use of Cost Drivers per Service
Audit Tax
Employee training Direct labor dollars $216,000 $1,800,000 $1,100,000 $700,000
Typing and secretarial Number of reports/ forms 76,200 2,500 800 1,700
Computing Number of minutes 204,000 60,000 27,000 33,000
Facility rental Number of employees 142,500 40 22 18
Travel Per expense reports 81,300 Trace directly 56,000 25,300
$720,000
Instructions
Using traditional product costing as proposed by the tax partners, compute the total overhead cost assigned to both services (audit and tax) of Lewis and Stark.
Using activity-based costing, prepare a schedule showing the computations of the activity-based overhead rates (per cost driver). (Hint: As a result of breaking out travel costs as a separate cost pool, travel costs can now be traced directly to services provided. Thus, an overhead rate is not needed.)
Prepare a schedule assigning each activity's overhead cost pool to each accounting service based on the use of the cost drivers.
Cost assigned—Tax $337,441
Comment on the comparative overhead cost for the two services under both traditional costing and ABC.
Difference—Audit $57,441
Requirement a

Audit

Tax


Direct labor cost

1100000

700000


Multiply: OH rate as % of DLC (40%)

40%



Overheads applied

440000

280000






Requirement b




Activity rate




Activity

Total OH

Total Drivers

Activity rate

Employee training

216000

1800000

0.12 per $ of DLC

Typing and secretarial

76200

2500

Per form

Computing

204000

60000

3.5 per minute

Facility rental

142500

40

3562.5 per worker





Activity cost allocated




Activity

Rate

Audit

Tax



Driver OH Cost

Driver

Employee training

0.12 1100000

132000 700000

84000

Typing and secretarial

30.48 800

24384 1700

51816

Computing

3.4 27000

91800 33000

112200

Facility rent

3562.5 22

78375 18

64125

Travel

Direct

56000

25300

TOTAL OVERHEADS


382559

337441





Requirement c





Audit

Tax


OH allocated per traditional costing

440000

280000


OH allocated per ABC

382559

337441