Chapter 7 Managerial Accounting

TERM: What happens when product cost information is distorted?
DEFINITION: It leads to poor decisions and unexpected results, as jobs may appear profitable when they’re not, and vice versa.

TERM: Why do companies use Activity-Based Costing (ABC)?
DEFINITION: Because managers question cost accuracy when profits don’t meet expectations or when bids are lost despite minimal pricing.

TERM: Direct materials and labor vs. Manufacturing Overhead
DEFINITION: Direct materials/labor are traceable and easy to calculate. Manufacturing overhead (MOH) is less traceable and harder to allocate accurately.

TERM: What is a major challenge in product costing today?
DEFINITION: Increased manufacturing overhead (up to 40%) makes errors in overhead allocation more impactful.

TERM: Activity-Based Costing
DEFINITION: A technique that assigns costs to products/customers based on the activities they require.

TERM: What is an Activity in ABC?
DEFINITION: An event that consumes resources (e.g., setting up machines, processing orders).

TERM: ABC Costing Goal
DEFINITION: To allocate costs based on how much of a resource is consumed by each activity required for a product.

TERM: Is overhead allocation a problem for all companies?
DEFINITION: No — it depends on product similarity, complexity, and facility use.

TERM: Signs ABC may help a company
DEFINITION: - Complex product bids accepted more than simple ones

• High volume jobs show losses

• Special processing jobs often accepted

• Some departments are at capacity while others are idle

TERM: Does ABC benefit GAAP financials?
DEFINITION: No — GAAP uses aggregate product costs. ABC includes selling/admin expenses and is for internal decision-making.

TERM: What does ABC costing include that GAAP doesn’t?
DEFINITION: Selling and administrative costs — all costs incurred to deliver a product.

TERM: Downside of ABC
DEFINITION: Time-consuming to analyze activities and allocate costs. Managers must weigh the cost vs. decision-making benefits.

TERM: Five categories of activity costs in ABC
DEFINITION:

1. Unit-level

2. Batch-level

3. Product-level

4. Customer-level

5. Organization-level

TERM: Unit-level activities
DEFINITION: Incurred for each unit produced. Cost increases with the number of units.

TERM: What’s a good way to allocate unit-level costs?
DEFINITION: Use traditional methods like direct labor hours (DLH) or machine hours (MH).

TERM: Batch-level activities
DEFINITION: Incurred for each group or batch of items produced/handled at once.

TERM: Product-level activities
DEFINITION: Support specific products or processes regardless of volume; e.g., product design, testing.

TERM: Customer-level activities
DEFINITION: Incurred to support specific customers; not based on the number of units or products sold.

TERM: Are customer-level costs part of product cost?
DEFINITION: No — they support customers, not products.

TERM: Organization-level activities
DEFINITION: Support the company as a whole (e.g., HR, plant maintenance); not based on production volume.

TERM: Which activity levels are included in product costs under ABC?
DEFINITION: Unit-level, batch-level, and product-level.

TERM: Step 1 in ABC: Identify Activities
DEFINITION: Ask “What do you do?” and measure the time/resources each activity uses.

TERM: Why is activity identification detail important?
DEFINITION: Too much detail increases classification errors; too little reduces accuracy.

TERM: Step 2 in ABC: Develop Activity Cost Pools
DEFINITION: Group costs by shared drivers/resources. This is the first stage allocation.

TERM: First Stage Allocation
DEFINITION: Assigning costs to activity cost pools before assigning to cost objects (like products).

TERM: Step 3 in ABC: Calculate Activity Cost Pool Rates
DEFINITION:
Activity Rate = Total Activity Cost Pool / Total Activity Driver Volume

TERM: What is an Activity Rate used for?
DEFINITION: To allocate costs based on how much of an activity a product/service uses.TERM: Step 4 in ABC: Allocate Costs to Cost Objects
DEFINITION: Multiply the activity rate by the number of cost driver units used by each cost object (product/service).

TERM: What are cost objects in ABC?
DEFINITION: Products, services, or customers that consume activities and incur costs.

TERM: Step 5 in ABC: Calculate Unit Product Costs
DEFINITION: Add the allocated activity costs and divide by the number of units produced.

TERM: Unit Product Cost Formula (ABC)
DEFINITION:
Unit Product Cost =
(Direct Materials + Direct Labor + MOH allocated using ABC)
÷ Number of units produced

TERM: ABC vs. Traditional Costing
DEFINITION:

• ABC: Allocates overhead using multiple cost pools based on activity usage

• Traditional: Uses one or two cost drivers (e.g., DLH or MH) to allocate all overhead

TERM: When is traditional costing okay to use?
DEFINITION: When products are similar in volume and complexity, and overhead is low.

TERM: Benefits of ABC
DEFINITION:

• More accurate cost allocation

• Better product pricing

• Identifies inefficient activities

• Informs management decisions

TERM: Drawbacks of ABC
DEFINITION:

• Time-consuming to implement

• Costly to maintain

• Requires lots of data

• May face resistance from staff

TERM: Activity-Based Management (ABM)
DEFINITION: Uses ABC info to improve operations and profitability by managing activities and reducing costs.

TERM: ABM Strategy Focus
DEFINITION:

• Eliminate non–value-added activities

• Improve value-added activities

• Better allocate resources

TERM: Value-added activity
DEFINITION: Adds worth to the product/service; the customer is willing to pay for it.

TERM: Examples of value-added activities
DEFINITION:

• Assembling a product

• Providing customer support

• Delivering products

TERM: Non–value-added activity
DEFINITION: Does not enhance the product and can often be eliminated without reducing value.

TERM: Examples of non–value-added activities
DEFINITION:

• Rework

• Excess inventory storage

• Unnecessary movement of materials

TERM: Goal of ABM
DEFINITION: Reduce or eliminate non–value-added activities to improve efficiency and lower costs.

TERM: Does ABC help with budgeting?
DEFINITION: Yes — it helps create more accurate, activity-based budgets by predicting resource needs.

TERM: Activity-Based Budgeting (ABB)
DEFINITION: Forecasts future costs by estimating activity levels and resources required.

TERM: How does ABB differ from traditional budgeting?
DEFINITION: ABB focuses on activities and resource drivers, while traditional budgeting focuses on departmental spending.

TERM: Examples of Activity Cost Pools
DEFINITION:

• Machine Setup

• Quality Control

• Purchasing

• Shipping

• Customer Service

TERM: Example of Activity Driver for Machine Setup
DEFINITION: Number of setups

TERM: Example of Activity Driver for Purchasing
DEFINITION: Number of purchase orders

TERM: Example of Activity Driver for Shipping
DEFINITION: Number of shipments or weight of items

TERM: Example of Activity Driver for Quality Control
DEFINITION: Number of inspections or testing hours