Chapter 5: ABC Costing & Capacity Analysis

What is Activity Based Costing?

Divides costs into several pools and allocates each based on the best driver for that task

When is ABC Costing important?

In organizations that produce different products with different exposures to indirect costs

How is the ABC Cost System different?

There are multiple cost pools for indirect costs

What does it mean to Cross-Subsidize?

Charge higher prices to one type of consumers, while artificially lowering prices for another group

What is an Over-Costed Product?

Absorbs too much cost, making it seem less profitable than reality 

What is an Under-Costed Product?

Is left with too little cost, making it seem more profitable than reality

What do you need if you have at least 1 over-costed or under-costed product?

Must have at least 1 product that balances out the cost

What is an Intermediate-Level Cost?

Cost we’re incurring to get to the main thing we’re trying to do

What is the risk associated with Intermediate-Level Costs?

Can sometimes distort profitability

Why is Volume-Based Costing often inadequate?

Indirect (support) costs do not always occur in proportion to output volume, which may provide inappropriate incentives to managers

What information does ABC yield?

Info that can be used by management to guide strategic decision-making

What is the use of ABC data for decision-making purposes often referred to as?

Activity-Based Management

What is one of the most strategic and difficult problems managers face?

Planning the correct amount of capacity

Can too much AND too little capacity be costly?

Yes

What is Capacity?

What you can produce given resource constraints

What are the types of capacity on the supply side?

• Theoretical Capacity

• Practical Capacity

What is Theoretical Capacity?

Based on producing at full efficiency all the time

What is Practical Capacity?

Reduces theoretical capacity by considering unavoidable operating interruptions (e.g., maintenance, holidays, etc.)

What do we generally use to begin with?

Practical capacity, and then we make adjustments for what we believe will be the demand for the output from the plant

What are the types of capacity on the demand side?

• Normal Capacity

• Budget Capacity

What is Normal Capacity?

Level of capacity that meets average customer demand for a given period

What is Budget Capacity?

Level of capacity that we need to satisfy the demand for this period

What are the two rules to remember about capacity?

1. Do not charge the cost of excess capacity to customers

2. Unless they demanded it

What is Unused (Excess) Capacity?

The amount of productive capacity available over and above the productive capacity employed to meet consumer demand in the current period

How can managers reduce capacity-based fixed costs?

By measuring and managing unused capacity

What is Downsizing (Rightsizing)?

An integrated approach of configuring processes, products, and people to match costs to the activities that need to be performed to operate effectively and efficiently in the present and future

What is the drawback of downsizing?

Often means eliminating jobs, which can adversely affect employee morale and the culture of a company

What is the difference between Practical and Theoretical Capacity?

Theoretical capacity assumes no down time or breaks; practical capacity takes into account that an employee is not productive 100% of the time

Will Practical or Theoretical Capacity lead to a lower cost/unit?

Theoretical Capacity will lead to this

If a company estimated its budgeted manufacturing overhead rate using Theoretical Capacity instead of Practical Capacity, would allocated overhead be more likely to be under- or over-allocated?

Under allocation

What is the advantage of highlighting the amount of unused capacity?

Managers know there is underutilized capacity so they can take on more production or try to lease/sell unused capacity that there is no foreseeable use for