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ACC550 Cost Accounting Activity-Based Costing and Cost Management Systems

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Sandra Watson
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ACC550 Cost Accounting

CHAPTER 5 Activity-Based Costing and Cost Management Systems
ANSWERS TO REVIEW QUESTIONS
5-1 In a traditional, volume-based product-costing system, only a single predetermined overhead rate is used. All manufacturing-overhead costs are combined into one cost pool, and they are applied to products on the basis of a single cost driver that is closely related to production volume. The most frequently used cost drivers in traditional product-costing systems are direct-labor hours, direct-labor dollars, machine hours, and units of production.
5-2 Aerotech Corporation’s management was being misled by the traditional productcosting system, because the high-volume product lines were being overcosted and the low-volume product line was being undercosted. The high-volume products essentially were subsidizing the low-volume line. The traditional product-costing system failed to show that the low-volume products were driving more than their share of overhead costs. As a result of these misleading costs, the company’s management was mispricing its products.
5-3 An activity-based costing system is a two-stage process of assigning costs to products. In stage one, activity-cost pools are established. In stage two a cost driver is identified for each activity-cost pool. Then the costs in each pool are assigned to each product line in proportion to the amount of the cost driver consumed by each product line.
5-4 A cost driver is a characteristic of an event or activity that results in the incurrence of costs by that event or activity. In activity-based costing systems, the most significant cost drivers are identified. Then a database is created that shows how these cost drivers are distributed across products. This database is used to assign costs to the various products depending on the extent to which they use each cost driver.
5-5 The four broad categories of activities identified in an activity-based costing system are as follows:
(a) Unit-level activities: Must be done for each unit of production.
(b) Batch-level activities: Must be performed for each batch of products.
(c) Product-sustaining activities: Needed to support an entire product line.
(d) Facility-level (or general-operations-level) activities: Required for the entire production process to occur.
5-6 An activity-based costing system alleviated the problems Aerotech Corporation was having under its traditional, volume-based product-costing system by more accurately assigning costs to products. Products were assigned costs based on the extent to which they used various cost drivers that were determined to be closely related to the incurrence of a variety of overhead costs.
5-7 Product-costing systems based on a single, volume-based cost driver tend to overcost high-volume products, because all overhead costs are combined into one pool and distributed across all products on the basis of only one cost driver. This simple averaging process fails to recognize the fact that a disproportionate amount of costs often is associated with low-volume or complex products. The result is that low-volume products are assigned less than their share of manufacturing costs, and high-volume products are assigned more than their share of the costs.
5-8 In traditional, volume-based costing systems, only direct material and direct labor are considered direct costs. In contrast, under an activity-based costing system, an effort is made to account for as many costs as possible as direct costs of production. Any cost that can possibly be traced to a particular product line is treated as a direct cost of that product.
5-9 A cost management system (CMS) has the following objectives:
(a) To measure the cost of the resources consumed in performing the organization’s significant activities.
(b) To identify and eliminate non-value-added costs. These are costs of activities that can be eliminated with no deterioration of product quality, performance, or perceived value.
(c) To determine the efficiency and effectiveness of all major activities performed in the enterprise.
(d) To identify and evaluate new activities that can improve the future performance of the organization.
5-10 Non-value-added costs are the costs of activities that can be eliminated with no deterioration of product quality, performance, or perceived value. Some examples of potential non-value-added costs are as follows: time spent unnecessarily moving raw materials, work in process, or finished goods between operations; unnecessary time spent by raw materials or work in process waiting for the next operation; storage of unnecessary inventories of raw materials, parts, or partially completed products; costs incurred in repairing defective units when the defects could be eliminated with better quality control systems.
5-11 Time is spent in a manufacturing process in the following five ways: process time, inspection time, move time, waiting time, and storage time. There is the potential for non-value-added costs in any of these five areas. Inefficient or unnecessary steps in the production process may result in non-value-added costs. Other potential nonvalue-added activities include unnecessary inspections, unnecessary movement of materials and goods between operations, unnecessary time spent waiting by materials or partially completed goods, and excessive inventory in storage.
5-12 Two factors that tend to result in product cost distortion under traditional, volumebased product-costing systems are as follows:
(a) Non-unit level overhead costs: Many overhead costs vary with cost drivers that are not unit-level activities. Use of a unit-level cost driver to assign such costs tends to result in cost distortion.
(b) Product diversity: When a manufacturer produces a diverse set of products, which exhibit different consumption ratios for overhead activities, use of a single cost driver to assign costs results in cost distortion.
5-13 Activity-based management means the use of an activity-based costing system to improve the operations of an organization.
5-14 Three important factors in selecting cost drivers for an ABC system are as follows:
(a) Degree of correlation between consumption of an activity and consumption of the cost driver.
(b) Cost of measurement of the cost driver.
(c) Behavioral effects, that is, how the cost driver selected will affect the behavior of the individuals involved in the activity related to the cost driver.
5-15 A homogeneous cost pool is a grouping of overhead costs in which each cost component is consumed in roughly the same proportion by each cost object (e.g., product line).

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ACC550 Cost Accounting Activity-Based Costing and Cost Management Systems

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