Chapter 5: Activity-Based Costing (ABC) & Management (ABM)

What does a traditional volume-based costing system use?

A single cost driver (e.g., direct labor hours, machine hours).

How is overhead handled in traditional costing?

All overhead is combined into one plantwide cost pool with one predetermined overhead rate.

What is a weakness of traditional costing?

It can distort product costs when products are diverse.

What is Activity-Based Costing (ABC)?

A costing system that assigns overhead based on activities and their cost drivers.

What happens in Stage One of ABC?

Identify significant activities and assign overhead costs to activity cost pools.

What happens in Stage Two of ABC?

Identify cost drivers and allocate activity costs to products.

Why is ABC more accurate than traditional costing?

It assigns costs based on multiple activity drivers instead of one volume-based driver.

What are unit-level activities?

Activities performed for each unit produced.

What are batch-level activities?

Activities performed for each batch (e.g., machine setups).

What are product-sustaining activities?

Activities that support an entire product line (e.g., engineering design).

What are facility-level activities?

Activities required for overall production (e.g., rent, factory management).

When does cost distortion occur?

When non-unit-level costs are allocated using only unit-level drivers.

Why won’t a single cost driver work for diverse products?

Because products consume activities in different proportions.

Why might managers prefer traditional costing despite distortion?

It’s simpler, cheaper, and easier to explain.

What is a good rule for implementing ABC?

If overhead is a large portion of total cost, ABC is more beneficial.

What are the three criteria for selecting cost drivers?

Degree of correlation, cost of measurement, behavioral effects.

What does degree of correlation mean?

How closely the driver tracks the actual cost.

What does cost of measurement mean?

Whether the benefit of accuracy is worth the cost of collecting the data.

What are behavioral effects?

How the cost driver influences decision-maker behavior.

Why must managers balance accuracy and practicality?

Because more precision may cost more than it saves.

How is ABC data initially collected?

Interviews with employees and review of department records.

What is storyboarding?

Creating detailed process flowcharts to map activities.

Why use multidisciplinary ABC teams?

To gather insights from accounting, finance, operations, engineering, and marketing.

What is Activity-Based Management (ABM)?

Using ABC information to improve operations and decision-making.

What is the main goal of ABM?

Eliminate non-value-added activities.

What is the vertical view in ABC?

Cost assignment (resources → activities → cost objects).

What is the horizontal view in ABC?

Process improvement (root causes and performance evaluation).

What is a non-value-added activity?

An activity that can be eliminated without reducing product value.

Example of a non-value-added activity?

Rework of defective units.

What triggers rework?

Detection of defects during inspection.

What could be root causes of rework?

Incorrect specs, unreliable vendors, wrong parts, poor production.

What types of time are analyzed in process value analysis?

Inspection time, process time, move time, storage time, waiting time.

What is customer profitability analysis?

Using ABC to determine costs and profits associated with serving specific customers.

Why are some customers less profitable?

Frequent small orders, special packaging, fast delivery demands, frequent changes.

Are all sales equally profitable?

No — profitability often follows a logarithmic pattern.

Does ABC apply to service organizations?

Yes, using the same steps as manufacturing.

Examples of service industries using ABC?

Hospitals, banks, colleges.

Example cost drivers in hospitals?

Number of ER visits, surgeries, KPIs.

Exam window?

Monday 8:00am – Tuesday 6:15pm.

Exam format?

25 questions, 70 minutes.

Difference between ABC and ABM?

ABC = Better cost assignment; ABM = Uses ABC data to improve operations.