Module 8 ABC -overhead allocation Notes and Quiz answers

Traditional overhead allocation

1 big bucket of costs spread across all products, but what about cost pools?

Cost pools

Partition overhead costs into SEVERAL buckets based on activities that drive overhead costs

spread costs over product as appropriate

The Steps in Implementing an ABC System

Identify overhead cost activities.

Analyze individual overhead costs in terms of those cost activities.

Identify measurable cost drivers.

Assign overhead.

Use the ABC data to make decisions.

Summary of cost pools

The collection of overhead costs associated with a specific overhead cost activity is called a cost pool.

Identifying the costs associated with a particular cost pool requires a careful analysis of how support and supervisory people spend their time; which activities use electricity and cause depreciation; and which overhead cost activities cause other overhead costs such as travel, supplies, training, and so forth.

In an ice cream production setting, how does the management accountant determine how much of the factory machine cleaners' total wages should be assigned to the "changing ice cream batches" cost pool?

Analyze what fraction of the machine cleaners' time is typically taken up in activities associated with changing ice cream batches

Identifying how much of the factory machine cleaners' total wages should be assigned to the "changing ice cream batches" cost pool requires a careful analysis of the fraction of the machine cleaners' time typically taken up in the activities required to change the factory from making a batch of one ice cream flavor to making a batch of a different flavor.

What is the first step for a company in implementing an ABC overhead allocation system?

Determine what activities are causing the miscellaneous costs associated with production

The first step for a company implementing an ABC overhead system is to determine which activities are causing the overhead costs.

What is an important point for companies to remember when deciding whether to implement an ABC overhead allocation system?

Companies that understand their costs have an advantage over their competitors that do not understand their costs.

Companies that understand their costs have an advantage over their competitors that do not understand their costs. For example, companies that understand their costs are able to strategically price their products to a greater extent than companies who do not understand their own costs and thus price their products blindly without such available knowledge.

What does identifying the overhead costs associated with a particular production cost pool require?

Analyzing how indirect production personnel involved in a production process spend their time during the workday

Identifying how indirect production personnel involved in a production process spend their time during the workday helps a company identify the overhead costs associated with a particular production cost pool.

What is the collection of overhead costs associated with a specific overhead cost activity called?

A cost pool is a collection of overhead costs associated with a specific overhead activity.

ABC only relates to...

overhead, not direct materials or labor

Overhead cost activities

1. operating the production

2. producing a specific product

3. servicing the special needs of each product

4. keeping the production open

s.k.o.p

Creating large batches of two flavors at a time

doesn't generate a lot of overhead costs.

vanilla for 2 hours

choco for 2 hours

Creating small batches of two flavors

generates a lot of overhead costs

vcvcvcvcvcvcvcvcvcvcvcvc

takes time and money to clean and fill in different flavors each time.

Routine overhead examples

1. wear/tear of machines

2. electricity

3. cleanup

4. maintaenance

5. regular accounting

anything that's doing "more" or "different" like creating/switching to different ice cream flavors(lesson 22) will increase overhead costs, even when the production of total ice cream remains the same.

Four general categories of ABC activities have been identified for use in any business setting:

Unit—Activities that take place each time a unit of product is produced

--machine maintenance/depreciation/electricity

Batch—Activities that take place to support a batch or production run, regardless of the size of the batch

---inspection

---machine setups

Product line—Activities that take place to support a product line, regardless of the number of batches or individual units actually produced

---engineering design

---storage

Facility support—Activities necessary to have a production facility in place. However, these activities are not related to any particular line of products or services

---tax

-security/landscaping

-accounting

Summary

The first step in implementing an ABC overhead system is to perform a detailed study of the production process to determine exactly what activities cause overhead costs.

The four general categories of ABC activities are: unit, batch, product line, and facility support.

Once the activities associated with the creation of overhead costs are identified, implementation of an ABC system continues with an analysis of each of the specific overhead costs to determine which of the overhead activities causes that particular cost. The total overhead cost identified as being generated by a specific overhead cost activity is called a cost pool.

The cost of preparing documents to order ingredients from various suppliers is an example of which type of ABC support activity?

Product line activity

The cost of special machine maintenance, which is necessary because of the frequent starting and stopping of the machines, is an example of which type of ABC support activity?

Batch activity

The depreciation of the factory building is an example of which type of ABC support activity?

Facility support activity

The cost of electricity to operate the machines in a factory is an example of which type of ABC support activity?

Unit activity

The security safeguards implemented to protect the manufacturing facility are an example of which type of ABC support activity?

Facility support activity

5 steps of ABC

1. Identify overhead cost activities in each process (Unit, Batch, Product Line, & Facility Support) for an example electricity,

2. Analyze individual overhead costs in terms of cost activities (cost pools: how much OC is created by Unit, Batch, Product Line, & Facility = the end results,

3. Identify measurable cost drivers (we need cost drivers which is a numerical measure that reflects the amount of an overhead cost caused by a particular activity). Each overhead cost activities need a cost driver.

4. Assign overhead

5. Use the ABC data to make decisions

In an ABC system, facility support overhead costs are treated as...

common costs that are not assigned to any specific product, division, or product line.

property tax/security guards/routine reports overhead costs do not increase with more gallons/batches/ingredients.

The activity rate is computed as

the cost pool total divided by the number of cost driver events.

This activity rate is used to assign overhead to different divisions, product lines, projects, and orders.

A company has a warehouse supervisor whose annual costs to the company are $40,000. The warehouse is used to receive and store packaged goods in boxes. Once a customer's order is received, the boxes are removed and shipped. The company is trying to determine what the best way is to allocate the warehouse supervisor's annual costs to each customer order that is shipped during the year.

What is the appropriate cost driver to allocate the warehouse supervisor's annual costs to each customer order?

The number of boxes shipped to customers throughout the year

The number of boxes shipped to customers throughout the year is the appropriate cost driver in this situation as the company's objective is to determine the best way to allocate the warehouse person's annual costs to each customer order shipped during the year.

The cost accountant has gathered the overhead costs associated with the following activities during the past year:

Purchasing materials: $2,000,000

Setting up the machines: $4,000,000

Running the machines: $3,000,000

Inspecting final production: $10,000,000

The cost accountant has also identified the cost driver and the number of cost driver activities for each of the above overhead costs over the past year as follows:

Number of materials requisitions: 10,000

Setting up the machines: 2,000 setups

Running the machines: 10,000 hours

Inspecting final production: 20,000 hours

The cost accountant has decided to apply the activity pool concept to allocate overhead costs to each product being produced by the company during the past year.

Which would be the correct amount for the per hour inspection cost for allocating the final production cost activity pool to a company product?

The correct answer is calculated as follows: Total inspecting final production overhead cost of $10,000,000/Total inspecting final production hours of 20,000 hours = $500 per inspecting final production hour.

Which of the following would be the correct amount for the per requisition overhead allocation of the purchasing materials overhead cost activity pool to a company product?

The correct answer is caluclated as follows: Purchasing materials total overhead cost pool of $2,000,000/Number of materials requisitions of 10,000 = $200 per material requisition.

Which of the following would be the correct amount for the per set up cost of the setting up the machines' overhead cost activity pool to a company product?

The correct answer is calculated as follows: Total overhead costs for setting up the machines of $4,000,000/2,000 machine set ups = $2,000 per set up.

The first three steps in implementing an ABC system are

Identify the key cost activities.

Analyze each overhead cost in terms of these activities to compute the cost pools.

Specify numerical cost drivers that can be used to assign the overhead costs to production.

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To then assign overhead costs to production, the necessary steps are

Gather the overhead cost and numerical cost driver data.

Compute the amount of overhead cost per cost driver event.

Use these data to assign overhead to production.

Which is an advantage of using ABC overhead costing over traditional overhead costing?

ABC allocates manufacturing overhead more accurately to products and processes that use the various activities.

Which is the definition of activity-based costing (ABC)?

A costing method that assigns overhead and indirect costs to related products and services in a less arbitrarily way than traditional costing systems

ABC is a product costing method that assigns manufacturing overhead costs to products and services based on the relationships that exist between specific overhead costs and activity drivers that determine how much of each overhead item is used.

Which category of overhead includes factory building depreciation, factory insurance, and factory security costs?

Facility support

Factory building depreciation, factory insurance, and factory security are overhead costs that remain the same no matter how much production goes on inside the factory. These overhead costs are classified as the cost of keeping the factory open and are given the general label of "facility support costs."

What production-related cost driver is typically used for facility support costs?

Production-related cost drivers are not used for facility support costs.

There is no production-related cost driver that matches up with changes in the amount of overhead cost associated with facility support costs.

Which statement is correct with respect to an activity-based costing (ABC) system?

Implementing an ABC system requires a more careful analysis of the factors that create overhead costs.

What describes when an activity-based costing (ABC) overhead allocation system is appropriate?

The production process for each different product, project, or process uses infrastructure support services in very different ways.

What is a cost pool in an ABC system?

The collection of overhead costs associated with a specific overhead cost activity

Which category of overhead activities are costs such as inspections, machine setups, and movement of and accounting for materials?

Batch-level activities are those overhead activities that are performed each time a new production batch is started or ended. Examples of batch-level activities are inspections, machine setups, and movement of and accounting for materials.

Implementation of an ABC system requires that each individual overhead cost be analyzed to determine which fraction of that cost is caused by each identified overhead cost activity.

The cost of this step can be high.

The hard part of implementing an ABC system is analyzing individual overhead costs in terms of what fraction is associated with each overhead cost activity. This analysis requires a detailed understanding of the production process and the underlying causes of all the individual overhead costs. This step is where some companies decide to avoid the cost of implementing an ABC system and instead stay with their traditional overhead allocation approach.

What is the proper treatment of facility support overhead costs in an activity-based costing (ABC) system?

In an activity-based costing (ABC) system, facility support costs are treated as common costs that are not assigned to any specific product, division, or product line.