Ch. 7 - Activity Based Costing (ABC)

Question 1

Plant-wide Overhead Rate

Answer 1

A single overhead rate used throughout an entire factory

Question 2

Why was direct labour used as the allocation base for overhead in the past?

Answer 2

• Direct labour information was already being recorded
• Direct labour was a large component of product costs
• Managers believed direct labour and overhead costs were highly correlated

Question 3

Departmental Overhead Rates

Answer 3

Each department has its own overhead rate that uses its own allocation base

Question 4

What is the disadvantage of using departmental overhead rates?

Answer 4

Departmental rates will not correctly assign overhead in situations where a company has a range of products and complex overhead costs. It relies exclusively on volume-related allocation bases (some overhead costs may be caused by non volume-related factors)

Question 5

How does ABC differ from traditional costing?

Answer 5

• ABC assigns both manufacturing and non-manufacturing costs to products
• ABC does not assign all manufacturing costs to products
• ABC uses more cost pools
• ABC bases level of activity on capacity

Question 6

What are the 5 classes of costs?

Answer 6

• Unit-level costs
• Batch-level costs
• Product-level costs
• Customer-level costs
• Organization-sustaining costs

Question 7

Unit-level Costs

Answer 7

Costs that vary proportionally with the number of units produced

Question 8

Batch-level Costs

Answer 8

Costs that are incurred each time a batch of goods is processed

Question 9

Product-level Costs

Answer 9

Costs incurred to enable individual products to be produced or sold

Question 10

Customer-level Costs

Answer 10

Costs related to specific customers

Question 11

Organization-sustaining Costs

Answer 11

Costs incurred to create productive capacity for all products

Question 12

In what situations is it appropriate to implement ABC?

Answer 12

When an organization:
- uses large amounts of indirect resources in its production processes
- has diversity in products, production processes, and customers
- faces significant competition

Question 13

Benefits of ABC

Answer 13

• Improved decisions
• Continuously improve activities to reduce overhead costs
• Ease of determining relevant costs

Question 14

Limitations of ABC

Answer 14

• Substantial resources required to implement and maintain
• Data can be misinterpreted (need to accurately identify relevant costs)
• Does not conform to GAAP (cannot use for external reporting)