Chapter 7

Question 1

Activity based costing

Answer 1

is a costing system based on a number of activities (cost drivers) that affect the product rather than the use of plantwide or department overhead rates.

Question 2

Traditional costing systems (normal absorption costing) are

Answer 2

primarily for external users (e.g., the financial statements and tax returns).

Question 3

For external reporting,

Answer 3

ALL manufacturing costs must be assigned to a product and non-manufacturing costs (S&A exp.) are not assigned to products even if caused by a product.

Question 4

There are five major differences between a traditional and an activity-based costing system.

Answer 4

Non-manufacturing costs may be assigned to products. Ex.: sales commissions are not included in product costs in a traditional environment whereas they could be in an ABC system.

2. Some manufacturing costs may be excluded from products [such as organization sustaining level costs (president’s salary, etc.) and idle capacity]. In Ch 6 we called them common fixed costs.
3. In ABC there are a number of cost pools and cost drivers as opposed to 1 or 2 in traditional costing.
4. The cost drivers often differ from those used in a traditional system, which are based on volume or number of units produced. (DLH or MH).
5. The OH rates may be based on the level of activity at capacity rather than on the budgeted.

Question 5

Overhead costs are assigned in a 2 step process.

Answer 5

1. Activities are identified and overhead costs are traced to each activity.
2. Cost drivers are determined for each activity and the costs are assigned to the product.

Question 6

An ABC system will typically shift costs away from

Answer 6

from high volume products that are produced in large batches to low volume products that are produced in small batches.

Question 7

Benefits of ABC systems

Answer 7

are that they provide more accurate cost information. It helps to focus the managers on the costs that they can control.

Question 8

Limitations

Answer 8

include the high cost of measurement. Companies that do not have diverse products may not benefit as much from ABC. (Diverse products consume resources differently). It requires a long-term commitment by all areas of the business.

Question 9

ABC does not conform to GAAP

Answer 9

. As a result, companies will need 2 cost systems. It may be used for internal decision making and pricing purposes.