exam 2 (chapters 5 & 6)

Question 1

traditional approach to overhead allocation

Answer 1

• direct materials are traceable
• direct labor is traceable
• manufacturing overhead is NOT traceable (depreciation, rent, utilities, labor for repairs, labor for cleaning)
  - MOH needs to be allocated based on one
  cost driver!

Question 2

the key assumption is that _____ cost driver can be used to allocate overhead (labor hours, machine hours, etc.)

Answer 2

one (think of how much ONE unit cost to make)

Question 3

why is there a growing need for refinement in practice?

Answer 3

• larger variety of products
• higher indirect costs (larger overheads) through use of automation
• strong competition

Question 4

larger variety of products means…

Answer 4

more opportunities for misallocation (over/under costing leads to bad strategic decisions)

Question 5

higher indirect costs (larger overheads) through use of automation means…

Answer 5

• fewer costs are directly traceable
• larger share of total costs needs to be allocated
• realization that as magnitude and diversity of overhead costs grow, a single cost driver is over simplified

Question 6

strong competition means…

Answer 6

managers need more precise information for pricing decisions (mark up over cost?) and product portfolio decisions (need to know costs to know which products make the most $)

Question 7

ABC system

Answer 7

activity based costing system (follows a two stage procedure to assign overhead costs to products)

Question 8

stage one of ABC systems

Answer 8

• identify significant activities and assign overhead costs to each activity in proportion to resources used
• activity types: unit-level, batch-level, product-level, facility-level

Question 9

stage two of ABC systems

Answer 9

• identify cost drivers appropriate to each activity and allocate overhead to the products based on those drivers
• instead of a single cost driver to allocate OH, you identify a cost driver for EACH activity and allocate those costs based on that driver
• activities drive costs!!!

Question 10

things to remember about ABC systems

Answer 10

• it’s all about being able to more accurately allocate overhead costs (direct labor/material costs are NOT affected)
• total overhead cost for the company does NOT change only the allocation to different departments/divisions/products changes (this affects profitability within the company but not FOR the company; internal analysis over)
• ABC is only good as the drivers selected and their actual relationship to costs (time consuming and requires top level buy in)

Question 11

when is ABC system not useful?

Answer 11

• when there is only 1 product (no allocation needed/not feasible)
• all products’ overhead costs are driven by one cost driver (increasingly rare but possible)
• overhead costs are only a small % of overall costs (most costs are direct materials, labor, etc.)

Question 12

activity based management

Answer 12

focuses on managing activities to reduce costs while using ABC costing information to help management make decisions

ex:
- reduce non-value-added costs
- customer profitability

Question 13

non-value-added activities

Answer 13

operations that are either unnecessary and dispensable OR necessary but inefficient and improvable

Question 14

non-value-added costs

Answer 14

costs that result from activities that can be eliminated without deterioration of product quality, performance, or perceived value

Question 15

where to look for non-value-added activities and costs

Answer 15

• process time
• inspection time
• storage time
• waiting time
• move time

Question 16

activity based management steps to eliminate non value added activities/costs

Answer 16

1. identify activities
2. identify non value added activities (consider opportunity costs of time/resources)
3. understand activity linkages, roots causes, and triggers
4. establish performance measures
5. report non value added costs

Question 17

customer profitability analysis

Answer 17

uses activity-based costing to determine the activities, costs, and profit associated with serving particular customers

• if managers have a good understanding of which customers are generating the greatest profit, they can make more informed decisions about customer service

Question 18

4 types of customers (loyalty/profitability)

Answer 18

1. true friends (high loyalty/high profitability)
   
   • ex: apple customers
2. butterflies (low loyalty/high profitability)
   
   • ex: buys different phones based on the best deal
3. barnacles (high loyalty/low profitability)
   
   • uses local coffee shop for workplace and buys
     one cup of coffee per day working
4. strangers (low loyalty/low profitability)
   
   • walks in the business to look for a deal

Question 19

how can profitability be influenced by cost

Answer 19

• requires special packaging
• orders small quantities
• often changes orders
• orders frequently
• demands fast service

Question 20

most companies do not use ABC for external reporting because…

Answer 20

• external reports are less detailed than internal reports
• it may be difficult to make changes to the company’s accounting system
• ABC does not conform to GAAP
• auditors may be suspicious of the subjective allocation process based on interviews with employees

Question 21

five limitations of ABC

Answer 21

1. substantial resources required to implement and maintain
2. desire to fully allocate all costs to products
3. resistance to unfamiliar numbers and reports
4. potential misinterpretation of unfamiliar numbers
5. does not conform to GAAP and 2 costing systems may be needed

Question 22

the 7 key concepts in decision-making are…

Answer 22

1. define the alternatives being considered
2. identify the criteria for choosing among them
   
   • relevant costs and benefits should be considered
   • irrelevant costs and benefits should be ignored
3. differential analysis
   
   • focusing on future costs and benefits that differ
     between alternatives; differential costs,
     incremental costs, and avoidable costs
4. sunk costs are ALWAYS irrelevant
   
   • sunk cost is a cost that has already been
     incurred and cannot be changed regardless of
     what the manager decides to do
5. future costs and benefits that do not differ between alternatives are irrelevant
6. opportunity costs need to be considered
   
   • opportunity cost is the potential benefit given up
     when the other alternative is selected
7. once you have calculated the quantitative answer to the decision problem at hand, also consider the role of qualitative factors before making your final decision

Question 23

differential costs (revenue) is a…

Answer 23

future cost (revenue) that differs between any 2 alternatives

Question 24

an incremental cost is…

Answer 24

increase in cost between two alternatives

Question 25

an avoidable cost is…

Answer 25

cost that can be eliminated by choosing one alternative over another

Question 26

when a company is involved in more than one activity in the entire value chain it is…

Answer 26

vertically integrated

Question 27

a decision to carry out one of the activities in the value chain internally rather than to buy externally from a supplier is called…

Answer 27

make or buy decision

Question 28

quantitative decision rule

Answer 28

is it cheaper to make the part/produce it ourselves OR to have someone else produce it?

Question 29

qualitative decision rule

Answer 29

what other factors should be considered like quality, reputation, supply chain control, security, etc.?

Question 30

a special order is..

Answer 30

a one-time order that is not considered part of the company’s normal ongoing business

• when analyzing a special order, only incremental costs and benefits are relevant

Question 31

companies are forced to make volume trade-off decisions when..

Answer 31

they do not have enough capacity to produce all products and sales volume demanded by customers

• in this situation, the company must trade off or sacrifice production of some products in favor of others in an effort to maximize profits

Question 32

a constraint is…

Answer 32

when a limited resource of some type restricts the company’s ability to satisfy demand

Question 33

the bottleneck is…

Answer 33

the machine or process that is limiting overall output (it is the constraint)

Question 34

utilization of a contrained resource

Answer 34

• fixed costs are usually unaffected
• find the product mix that maximized the total contribution margin; however, a company should not necessarily promote those products that have the highest contribution margin per unit
• instead, total contribution margin will be maximized by promoting those products or accepting orders that provide highest contribution margin per the constraining resource

Question 35

managing constraints in short-term and long-term

Answer 35

• it is possible for a manager to increase the capacity of a bottleneck (this is called relaxing/elevating the constraint) by:

1. working overtime on the bottleneck
2. subcontracting some processing that would be done at the bottleneck
3. investing in additional machines at the bottleneck
4. shifting workers from non-bottleneck processes to the bottleneck
5. focus business process improvement efforts on the bottleneck
6. reduce defective units processed through the bottleneck

Question 36

using the differential approach is desirable for 2 reasons…

Answer 36

1. only rarely will enough info be available to prepare detailed income statements for both alternatives
2. mingling irrelevant costs with relevant costs may cause confusion and distract attention away from the info that is really critical

Question 37

a relevant cost is…

Answer 37

a cost that differs in total between the alternatives in a decision

Question 38

not all fixed costs are sunk

Answer 38

only those for which the cost has already been irrevocably incurred

Question 39

variable costs are relevant costs on if…

Answer 39

they differ in total between the alternatives under consideration

Question 40

only future costs that differ between alternatives are…

Answer 40

relevant