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Activity Based Costing (ABC)

12 important questions on Activity Based Costing (ABC)

What are the three main reasons why a cost accumulation system is required to generate relevant cost information for decision making?

1. Many indirect costs are relevant for decision making
2. An attention directing information system is required that periodically identifies those potentially unprofitable products that require more detailed special studies.
3. Product decisions are not independent.

What are the three types of costing systems and what is the main difference between this systems?

Direct costing systems, traditional absorption costing systems and activity based costing systems.

Direct costing systems only assign direct costs to cost objects. Both traditional and ABC systems assign indirect costs to cost objects.

Volume Based Cost drivers

Volume based cost drivers assume that a product's consumption of overhead resources is directly related to units produced. They are appropriate when activities are performed each time a unit of the product or service is produced.

Which two conditions are necessary for product cost distortion?

1. Non-volume related overheads are a large proportion of total overheads
2. Product diversity applies

Which four steps are involved in designing ABC systems?

1. Identifying the major activities that take place in an organization
2. Assigning costs to cost polls for each activity.
3. Determining the cost driver for each major activity
4. Assigning the cost of activities to products according to the product's demand for activities.

Resource cost drivers

Case-and-effect cost drivers used at the second stage (assigning costs to cost pools for each activity) to allocate shared resources to individuals activities are called resource cost drivers.

Activity cost drivers

Cost drivers at the third stage (determining the cost driver for each major activity) are called activity cost drivers. They consist of transaction and duration drivers.

Manufacturing activities can be classified along a cost hierarchy dimension consisting of:

1. Unit-level activities (e.g. direct labor and direct materials)
2. Batch-level activities (e.g. set up resources). Traditional costing systems treat batch related expenses as fixed costs, whereas ABC systems assume that batch related expenses vary with the number of batches processed.
3. Product-sustaining activities (e.g. maintaining and updating product specifications).
4. Facility-sustaining activities (e.g. general administrative staff, plant mgmt, property costs)

Formula cost of resources supplied

Cost or resources supplied = cost of resource used + cost of unused capacity.

Left hand side of the equation indicated that the amount of expenditure on an activity depends on the cost of resources supplied rather than the cost of resources used. The cost of unused capacity represent the difference between the cost of resources supplied and the cost of resources used.

When does unused capacity arise?

Unused capacity arises because the supply of some resources has to be acquired in discrete amounts in advance of usage such that the supply cannot be continually adjusted in the short run to match exactly the usage of resources.

What cause support activity costs?

Support activity costs are caused by the level of activity that is made available rather than the budgeted level of actual usage. Therefore, the correct denominator activity level to use for calculating activity cost driver rates is practical capacity (i.e. capacity supplied) and not the anticipated activity usage.

A simplistic traditional costing system should be used when:

1. Low levels of competition
2. Non-volume-related indirect costs are low proportion of total indirect costs
3. Fairly standardize product ranges all consuming organizational resources in similar proportions (i.e. low product diversity)

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Samenvatting FIDM

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Activity Based Costing (ABC)

12 important questions on Activity Based Costing (ABC)

What are the three main reasons why a cost accumulation system is required to generate relevant cost information for decision making?

What are the three types of costing systems and what is the main difference between this systems?

Volume Based Cost drivers

Which two conditions are necessary for product cost distortion?

Which four steps are involved in designing ABC systems?

Resource cost drivers

Activity cost drivers

Manufacturing activities can be classified along a cost hierarchy dimension consisting of:

Formula cost of resources supplied

When does unused capacity arise?

What cause support activity costs?

A simplistic traditional costing system should be used when:

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