Cost Control-Ch5

Flashcards covering key concepts from the lecture on Activity-Based Costing and Activity-Based Management, including definitions, comparisons, reasons for implementation, and behavioral considerations.

Trade-off in Applying Manufacturing Overhead

The trade-off involves balancing simplicity (ease of use) with realism (accuracy of cost reflection). Simple methods are easy but less accurate; realistic methods are complex but provide better cost data.

Simple vs. Complex Costing Methods (Accuracy & Realism)

Compared to complex methods, simple costing methods are less accurate, using broad averages. Complex costing methods (like Activity-Based Costing) offer greater accuracy and a more realistic view by tracing costs to specific activities.

Plantwide Overhead Rate

A plantwide overhead rate is a single, aggregated indirect cost rate for the entire plant, used to allocate all manufacturing overhead uniformly using one allocation base.

Department Overhead Rate

A department overhead rate refines allocation by using separate overhead cost pools and allocation bases for each individual department, allowing for more tailored cost allocation.

Peanut-Butter Costing (Broad Averaging)

Peanut-butter costing, or broad averaging, allocates overhead uniformly across all products, regardless of actual resource consumption. This leads to overcosting low-resource products and undercosting high-resource products.

Overcosting (Product Costs)

Overcosting occurs when a product is allocated disproportionately high costs despite consuming few resources. This can make products seem less competitive or shift sales to undercosted alternatives.

Undercosting (Product Costs)

Undercosting occurs when a product is allocated disproportionately low costs despite consuming many resources. This can lead to pricing below true cost, reducing profitability.

Product Cost Cross-Subsidization

Product cost cross-subsidization is when misallocation causes one product's costs to be understated while another's are overstated. Undercosting one product inevitably overcosts another, distorting profitability perception and management decisions.

Drivers for Costing System Refinements

Three drivers for refined costing systems:1. Increase in product diversity: More varied products require different resource consumption patterns. 2. Increase in indirect costs: A larger proportion of total costs are indirect, needing accurate allocation. 3. Increase in competition: Intense competition demands precise product cost information.

Guidelines for Refining a Costing System

Three guidelines to refine a costing system for accuracy:1. Trace more costs as direct costs: Reclassify indirect costs as direct where feasible. 2. Increase the number of indirect-cost pools: Create more granular pools for homogeneous costs. 3. Identify cost drivers: Find cause-and-effect allocation bases for each indirect-cost pool.

Activity-Based Costing (ABC)

Activity-Based Costing (ABC) refines costing by identifying key activities as fundamental cost objects, then assigning activity costs to products/services based on actual consumption, providing more accurate costs.

Activity (in ABC)

In ABC, an activity is an event, task, or unit of work with a specified purpose, represented by verbs like 'setting up machines' or 'processing orders.'

Cost Hierarchy (in ABC)

A cost hierarchy in ABC categorizes activity cost pools based on cost drivers or difficulty in determining cause-and-effect relationships, classifying costs by how they relate to units, batches, products, or the facility.

Levels of Cost Hierarchies (in ABC)

The four common levels of cost hierarchies in ABC are:1. Output unit-level costs2. Batch-level costs3. Product (or service)-sustaining costs4. Facility-sustaining costs

Output Unit-Level Costs

Output unit-level costs are activities performed on each individual unit, varying proportionally with units produced (e.g., direct materials, direct labor).

Batch-Level Costs

Batch-level costs are activities related to a group of units (a batch), incurred per batch regardless of unit count (e.g., machine setup, procurement costs for a batch).

Product (or Service)-Sustaining Costs

Product (or service)-sustaining costs support a specific product or service line, regardless of units/batches (e.g., product design, advertising for a specific product).

Facility-Sustaining Costs

Facility-sustaining costs support the entire organization's operations and infrastructure, not directly traceable to products, batches, or lines (e.g., administrative salaries, rent, property taxes).

Comparison: ABC vs. Simple Costing

While Activity-Based Costing (ABC) offers superior accuracy by tracing costs to activities, it is more costly and complex than simple costing. ABC's accuracy depends on well-designed activities and cost drivers.

Operational Signals for ABC Implementation

Signals suggesting ABC implementation: 1. Significant indirect costs broadly allocated. 2. Diverse resource demands by products/services. 3. Discrepancies in profitability of products. 4. Disagreements over costs among staff. 5. Complex production processes not captured by simple allocation.

Cost Object

A cost object is anything for which a separate measurement of costs is desired (e.g., products, services, departments).

Cost Pool

A cost pool is a grouping of logically related indirect cost items with similar cost drivers, accumulated before allocation to cost objects.

Cost-Allocation Base (Cost Driver)

A cost-allocation base (or cost driver) is a systematic measure used to link indirect costs to cost objects, chosen for its cause-and-effect relationship with cost incurrence (e.g., machine-hours, number of setups).

Behavioral Factors in ABC Implementation

Critical behavioral factors for successful ABC implementation: 1. Top Management Support: Provides resources and legitimacy. 2. Guiding Coalition: Cross-functional team for buy-in. 3. Employee Education & Training: Ensures understanding. 4. Short-Run Successes: Maintains momentum. 5. Realistic Expectations: ABC is a tool, not a perfect solution.

Activity-Based Management (ABM)

Activity-Based Management (ABM) is management decision-making that uses ABC information to improve customer satisfaction and profitability by analyzing activities. It influences pricing, product mix, cost reduction, and process improvement.

Widespread ABC Implementations (Non-Manufacturing)

ABC is widely beneficial in diverse service industries: 1. **Health Care: ** For costing treatments. 2. Banking: To analyze product/customer profitability. 3. **Telecommunications: ** For costing network services. 4. Retailing: To evaluate channel/product profitability. 5. Transportation: For determining route/freight costs.