Management accounting (chap 3)

chapter 3

Why are indirect costs not directly traced to cost objects in the same way as direct costs?

• Cannot be traced to a specific item

• Indirect costs is usually common for several cost items

• Indirect objects are sometimes intangible making it harder to specify cost for one cost item

Define direct cost tracing, cost allocation, allocation base and cost driver.

• Direct cost tracing - process use for finding cost of direct cost items. (eg.direct labor)

• Cost allocation - process use for deducing cost for indirect cost items (the cost of overhead activity)

• Allocation base - the basis or estimate measure used to assign costs to cost items (eg. the floor area occupied by each department in a factory is used to calculate their par of electricity/tax/rent)

• Cost driver - synonym for allocation base and majorly used with ABC costing systems

Distinguish between arbitrary and cause-and-effect allocations.

Arbitrary allocations use not a very significant determinant of the cost leading to less accurate for calculating indirect cost.

eg. allocating material costs on number of material receipts

Cause-and cause and effect allocations use a significant determinant reducing errors.

eg. allocating material costs on labor hours

Explain how cost information differs for profit measurement/inventory valuation requirements compared with decision-making requirements.

Profit measured & inventory valuation (FA)

• When reporting to external stakeholders only manufacturing costs are included in product costs. this follows absorption costing

Decision making (MA)

• Managers need all relevant costs for decision including manufacturing and non manufacturing(marketing/distribution). sunk costs are not used. the goal is to find true product profitability

Explain why cost systems should differ in terms of their level of sophistication.

Cost system differ on the level of sophistication making it making appropriate for the firm’s operations.

• many product - high proportion of indirect costs - wide range of different products consumed at different proportions = highly sophisticated systems (ABC) to ensure high accuracy and low error in cost calculations

otherwise, use Traditional Systems 

Describe the process of assigning direct labour and direct materials to cost objects.

Direct labor and direct materials are traced directly to each product as their usage can be easily measured. Costs are recorded based on receipts and time sheets ensuring each product get the exact cost of resources it consumed.

Why are separate departmental or cost center overhead rates preferred to a plant-wide (blanket) overhead rate?

Different departments have consume resources differently thereby having separate departmental rates increase the accuracy making sure products are charged based on the specific consumption.

*plan-wide OH rate assume EQUAL consumption

Describe the two-stage overhead allocation procedure.

Stage 1:

• Allocate all OH rates to departments

• Reallocate service department costs to production departments

Stage 2:

• Apply production department OH to product using appropriate bases(eg. labour hrs/machine hrs)

Define the term ‘activities’.

Refers to the tasks performed by a business that consumer resources.

Describe two important features that distinguish activity–based costing from traditional costing systems.

ABC

• uses multiple specific activity cost pools rather than broad OH pools ensuring better cost tracking

• applies OH using cause-and-effect cost drivers (eg. number of setups) instead of totally replying on labor or machine hrs

Why are some overhead costs sometimes not relevant for decision-making purposes?

Costs that will not be affected by a decision (depreciation) should be excluded when taking managerial reviews such as discontinuing the use of that machinery because depreciation is considered a sunk cost.

Why are budgeted overhead rates preferred to actual overhead rates?

Budgeted OH rates are preferred over actual OH rates because, they do not fluctuate as they are typically based on the annual estimated overhead expenditure and activity

Give two reasons for the under- or over-recovery of overheads at the end of the accounting period.

• when the actual activity differ from the estimates activity level  (aka volume variance)

• when actual overhead expenditure differs from the estimated OH expenditure (aka fixed OH expenditure variance)