Test bank managerial accounting by kieso weygandt 5e ch004

CHAPTER Activity-Based Costing ASSIGNMENT CLASSIFICATION TABLE Study Objectives Questions Brief Exercises 1, Exercises *1 Recognize the difference 1, 2, 3, between traditional costing 4, and activity-based costing 1, 2, 3, 4, 5, 6, 12, 13 *2 Identify the steps in the development of an activitybased costing system *3 Know how companies identify the activity cost pools used in activity-based costing *4 Know how companies identify and use cost drivers in activity-based costing 6, 10, 11, 12 *5 Understand the benefits and limitations of activity-based costing 13, 14, 15 *6 Differentiate between value-added and nonvalue-added activities 8, 16, 17 8, 12, 13, 14, 15, 16 *7 Understand the value of using activity levels in activity-based costing 19 10, 11, 12 17, 18 *8 Apply activity-based costing to service industries 18 9, 10 16 *9 Explain just-in-time (JIT) processing 20 A Problems B Problems 1A, 3A, 4A, 5A 1B, 3B, 4B, 5B 1A, 2A, 3A, 4A, 5A 1B, 2B, 3B, 4B, 5B 1A, 5A 1B, 5B 5A 5B 7, 3, 4, 5, 6, 7, 12 1, 3, 4, 5, 6, 8, 9, 10, 11, 12, 13 11 *Note: All asterisked Questions, Exercises, and Problems relate to material contained in the appendix to the chapter 4-1 ASSIGNMENT CHARACTERISTICS TABLE Problem Number Description Difficulty Level Time Allotted (min.) 1A Assign overhead using traditional costing and ABC; compute unit costs; classify activities as value- or non-value-added Moderate 35–45 2A Assign overhead to products using ABC and evaluate decision Moderate 25–35 3A Assign overhead costs using traditional costing and ABC; compare results Moderate 35–45 4A Assign overhead costs using traditional costing and ABC; compare results Moderate 40–50 5A Assign overhead costs to services using traditional costing and ABC; compute overhead rates and unit costs; compare results Moderate 35–45 1B Assign overhead using traditional costing and ABC; compute unit costs; classify activities as value- or non-value-added Moderate 35–45 2B Assign overhead to products using ABC and evaluate decision Moderate 25–35 3B Assign overhead costs using traditional costing and ABC; compare results Moderate 35–45 4B Assign overhead costs using traditional costing and ABC; compare results Moderate 40–50 5B Assign overhead costs to services using traditional costing and ABC; compute overhead rates and unit costs; compare results Moderate 35–45 4-2 4-3 E4-11 Q4-13 Q4-14 Q4-15 Q4-8 Q4-16 Q4-17 Q4-19 Q4-18 Q4-20 *5 Understand the benefits and limitations of activity-based costing *6 Differentiate between valueadded and non-value-added activities *7 Understand the value of using activity levels in activity-based costing *8 Apply activity-based costing to service industries *9 Explain just-in-time (JIT) processing Broadening Your Perspective BE4-3 BE4-4 BE4-5 BE4-6 BE4-7 BE4-12 E4-1 *4 Know how companies identify Q4-6 and use cost drivers in Q4-10 Q4-11 activity-based costing Q4-12 E4-13 P4-1A P4-2A P4-3A P4-4A P4-5A P4-1B P4-5A P4-1B P4-4B P4-5B E4-13 E4-16 E4-14 P4-1A E4-15 P4-1B E4-4 E4-5 E4-8 E4-9 E4-10 E4-11 E4-12 E4-5 E4-6 E4-12 E4-13 P4-1A P4-4A Application Exploring the Web Managerial Analysis BE4-9 P4-5A BE4-10 P4-5B BE4-10 BE4-11 BE4-12 BE4-8 BE4-9 E4-12 E4-7 E4-8 Q4-7 *2 Identify the steps in the development of an activitybased costing system BE4-1 BE4-2 E4-1 E4-2 E4-3 E4-4 *3 Know how companies identify Q4-9 the activity cost pools used in activity-based costing Q4-1 Q4-2 Q4-3 Q4-4 Q4-5 Knowledge Comprehension *1 Recognize the difference between traditional costing and activity-based costing Study Objective P4-2B P4-3B P4-4B P4-5B E4-15 P4-5A P4-5B E4-10 E4-11 E4-12 E4-13 P4-3A P4-3B P4-3A P4-4A P4-5A P4-3B P4-4B P4-5B P4-5A P4-5B E4-11 P4-1A P4-2A P4-3A P4-4A P4-1B P4-2B P4-3B P4-4B Synthesis P4-5A P4-5B P4-2A P4-3A P4-4A P4-2B P4-3B P4-4B Evaluation Decision Making Decision Making Managerial Anal Real-World Focus Across the Across the Organization Ethics Case Organization Real-World Focus Communication Communication E4-16 P4-5B P4-5A BE4-10 E4-17 E4-18 BE4-8 BE4-9 E4-14 E4-1 E4-3 E4-4 E4-5 E4-6 E4-8 E4-9 E4-1 E4-2 E4-3 E4-4 E4-5 E4-6 Analysis Correlation Chart between Bloom’s Taxonomy, Study Objectives and End-of-Chapter Exercises and Problems BLOOM’S TAXONOMY TABLE STUDY OBJECTIVES RECOGNIZE THE DIFFERENCE BETWEEN TRADITIONAL COSTING AND ACTIVITY-BASED COSTING IDENTIFY THE STEPS IN THE DEVELOPMENT OF AN ACTIVITY-BASED COSTING SYSTEM KNOW HOW COMPANIES IDENTIFY THE ACTIVITY COST POOLS USED IN ACTIVITY-BASED COSTING KNOW HOW COMPANIES IDENTIFY AND USE COST DRIVERS IN ACTIVITY-BASED COSTING UNDERSTAND THE BENEFITS AND LIMITATIONS OF ACTIVITY-BASED COSTING DIFFERENTIATE BETWEEN VALUE-ADDED AND NONVALUE-ADDED ACTIVITIES UNDERSTAND THE VALUE OF USING ACTIVITY LEVELS IN ACTIVITY-BASED COSTING APPLY ACTIVITY-BASED COSTING TO SERVICE INDUSTRIES *9 EXPLAIN JUST-IN-TIME (JIT) PROCESSING 4-4 CHAPTER REVIEW Traditional Costing And Activity-Based Costing (S.O 1) Often the most difficult part of computing accurate unit costs is determining the proper amount of overhead cost to assign each product, service or job For job order costing we assumed the direct labor cost was the relevant activity base for assigning overhead costs to a job and for process costing we assumed that machine hours was the relevant activity base Activity-based costing (ABC) allocates overhead to multiple activity cost pools and assigns the activity cost pools to products and services by means of cost drivers In ABC, an activity is any event, action, transaction, or work sequence that causes the incurrence of cost in producing a product or providing a service A cost driver is any factor or activity that has a direct cause-effect relationship with the resources consumed ABC allocates overhead in a two-stage process: In the first stage, overhead costs are allocated to activity cost pools, rather than to departments Each is a distinct type of activity In the second stage, the overhead allocated to the activity cost pools is assigned to products using cost drivers which represent and measure the number of individual activities undertaken or performed to produce products or provide services (S.O 2) Activity-based costing involves the following four steps: a Identify and classify the major activities involved in the manufacture of specific products and allocate manufacturing overhead costs to the appropriate cost pools b Identify the cost driver that has a strong correlation to the costs accumulated in the cost pool c For each cost pool, compute the activity-based overhead rate per cost driver d Assign manufacturing overhead costs for each cost pool to products, using the overhead rates (cost per driver) Unit Costs Under ABC (S.O 3) A well designed activity-based costing system starts with an analysis of the activities performed to manufacture a product or provide a service This analysis should identify all resource-consuming activities It requires a detailed, step-by-step walk through of each operation, documenting every activity undertaken to accomplish a task (S.O 4) After costs are allocated to the activity cost pools, the cost drivers for each cost pool must be identified The cost driver must accurately measure the actual consumption of the activity by the various products To achieve accurate costing, a high degree of correlation must exist between the cost driver and the actual consumption of the overhead costs in the cost pool An activity-based overhead rate per cost driver is computed by dividing the total estimated overhead per activity by the number of cost drivers expected to be used per activity The formula for this computation is as follows: Estimated Overhead Per Activity Expected Use of Cost Driver Per Activity 4-5 = Activity Based Overhead Rate In assigning overhead costs, it is necessary to know the expected use of cost drivers for each product To assign overhead costs to each product, the activity-based overhead rates are multiplied by the number of cost drivers expected to be used per product Benefits of ABC (S.O 5) The primary benefit of ABC is more accurate product costing because: a ABC leads to more cost pools b ABC leads to enhanced control over overhead costs c ABC leads to better management decisions Limits of ABC 10 Although ABC systems often provide better product cost data than traditional volume-based systems, there are the following limitations: a ABC can be expensive b Some arbitrary allocations continue When to Use ABC 11 The presence of one or more of the following factors would point to possibly using ABC: a Product lines differ greatly in volume and manufacturing complexity b Product lines are numerous, diverse, and require differing degrees of support services c Overhead costs constitute a significant portion of total costs d The manufacturing process or the number of products has changed significantly e Production or marketing managers are ignoring data provided by the existing system and are instead using “bootleg” costing data or other alternative data when pricing or making other product decisions Value-Added Versus Non-Value-Added Activities 12 (S.O 6) Activity-based management (ABM) is an extension of ABC from a product costing system to a management function that focuses on reducing costs and improving processes and decision making a Value-added activities increase the worth of a product or service to customers Examples include engineering design, machining, assembly, painting, and packaging b Non-value-added activities are product- or service-related activities that simply add cost to, or increase the time spent on, a product or service without increasing its market value Examples include repair of machines, the storage of inventory, the moving of raw materials, assemblies, and finished product; building maintenance; inspections; and inventory control Examples for service enterprises might include taking appointments, reception, bookkeeping, billing, traveling, ordering supplies, advertising, cleaning, and computer repair 13 The purpose of ABM is to reduce or eliminate the time and cost devoted to non-value-added activities 4-6 Classification of Activity Levels 14 (S.O 7) The recognition that some activity costs are not driven by output units has led to the development of a classification of ABC activities, consisting of four levels The four levels are classified and defined as follows: a Unit-level activities Activities performed for each unit of production b Batch-level activities Activities performed for each batch of products rather than each unit c Product-level activities Activities performed in support of an entire product line, but are not always performed every time a new unit or batch of products is produced d Facility-level activities Activities required to support or sustain an entire production process Activity-Based Costing in Service Industries 15 (S.O 8) The general approach to identifying activities, activity cost pools, and cost drivers is the same for service companies and for manufacturers Also, the labeling of activities as value-added and non-value-added, and the attempt to reduce or eliminate non-value-added activities as much as possible is just as valid in service industries as in manufacturing operations 16 Implementation of activity-based costing in service industries is sometimes more difficult because there is a larger proportion of overhead costs which are company-wide costs that cannot be directly traced to specific services provided by the company Just-In-Time Processing *17 (S.O 9) Just-in-time (JIT) manufacturing is dedicated to having the right amount of materials, products, or parts at the time they are needed Under JIT processing, raw materials are received just in time for use in production, subassembly parts are completed just in time for use in finished goods, and finished goods are completed just in time to be sold *18 A primary objective of JIT is to eliminate all manufacturing inventories Inventories are considered to have an adverse effect on net income because they tie up funds and storage space that could be made available for more productive purposes *19 There are three important elements in JIT processing: a A company must have dependable suppliers who are willing to deliver on short notice exact quantities of raw materials according to precise quality specifications This may even include multiple deliveries within the same day b A multiskilled work force must be developed c A total quality control system must be established throughout the manufacturing operations *20 The major benefits of implementing JIT processing are: a Manufacturing inventories are significantly reduced or eliminated b Product quality is enhanced c Rework costs and inventory storage costs are reduced or eliminated d Production cost savings are realized from the improved flow of goods through the processes 4-7 LECTURE OUTLINE A Traditional Costing Systems A traditional costing system allocates overhead to products on the basis of predetermined plantwide or departmentwide volume of unit-based output rates such as direct labor or machine hours Direct labor is sometimes the appropriate basis for assigning overhead cost to products when B a It constitutes a significant part of total product cost, and b A high correlation exists between direct labor and changes in the amount of overhead costs Activity-Based Costing Activity-based costing (ABC) allocates overhead to multiple activity cost pools, and it then assigns the activity cost pools to products and services by means of cost drivers In ABC, an activity is any event, action, transaction, or work sequence that incurs cost when producing a product or providing a service ABC allocates overhead in a two-stage process The first stage allocates overhead costs to activity cost pools The second stage assigns the overhead allocated to the activity cost pools to products, using cost drivers Cost drivers measure the number of individual activities undertaken or performed to produce products or provide services 4-8 TEACHING TIP ILLUSTRATION 4-1 provides examples of activities and related cost drivers that measure each activity’s contribution to the finished product C Unit Costs Under ABC Activity-based costing involves the following steps: a Identify and classify the major activities involved in the manufacture of specific products, and allocate manufacturing overhead costs to the appropriate cost pools b Identify the cost driver that has a strong correlation to the costs accumulated in the cost pool c Compute the overhead rate for each cost driver d Assign manufacturing overhead costs for each cost pool to products, using the overhead rates (cost per driver) TEACHING TIP ILLUSTRATION 4-2 presents the steps involved in an activity-based costing system Also available as teaching transparency A well designed activity-based costing system starts with an analysis of the activities performed to manufacture a product or provide a service It requires a detailed, step-by-step review of each operation, documenting every activity undertaken to accomplish a task Next, the system assigns overhead costs directly to the appropriate activity cost pool 4-9 D Identify Cost Drivers, Compute Overhead Rates, and Assign Overhead Costs to Products After costs are allocated to the activity cost pools, the company must identify the cost drivers for each cost pool A high degree of correlation must exist between the cost driver and the actual consumption of the overhead costs in the cost pool to achieve accurate costing The company computes an activity-based overhead rate per cost driver by dividing the estimated overhead per activity by the number of cost drivers expected to be used per activity TEACHING TIP ILLUSTRATION 4-3 provides formulas for the activity-based overhead rate, the overhead costs assigned to products, and the overhead cost per unit Also available as teaching transparency In assigning overhead costs, it is necessary to know the expected use of cost drivers for each product The company multiplies activity-based overhead rates per cost driver by the number of cost drivers expected to be used per product to assign overhead costs to each product Under ABC, overhead costs are usually shifted from a high-volume product to a low-volume product This shift results in more accurate costing because: a Low-volume products often require more special handling, (i.e.more machine setups and inspections), than high-volume products b Assigning overhead using ABC will usually increase the cost per unit for low-volume products (and decrease the cost per unit for high-volume products) 4-10 F d The manufacturing process or the number of products has changed significantly e Production or marketing managers are ignoring data provided by the existing system and are instead using other alternative data when making pricing decisions Value-Added Versus Non-Value-Added Activities A refinement of activity-based costing used in activity-based management (ABM) is the classification of activities as either value-added or nonvalue-added Value-added activities increase the worth of a product or service, for which the customer is willing to pay Value-added activities are the activities of actually manufacturing a product or performing a service (i.e., engineering design, assembly, packaging) Non-value-added activities are production- or service-related activities that simply add cost to, or increase the time spent on, a product or service without increasing its market value (i.e machine repair, building maintenance, inventory control) TEACHING TIP ILLUSTRATION 4-5 provides examples of activities that are classified as valueadded and non-value-added Point out that not all non-value-added activities are totally wasteful or easily eliminated Also available as teaching transparency Companies often use activity flowcharts to help identify the ABC activities 4-12 Not all non-value-added activities are totally wasteful, nor can they be totally eliminated, but managers are motivated to minimize them as much as possible G Classification of Activity Levels A classification of ABC activities consisting of four levels are defined as a Unit-level activities: activities performed for each unit of production b Batch-level activities: activities performed for each batch of products rather than each unit c Product-level activities: activities performed in support of an entire product line d Facility-level activities: activities required to support an entire production process TEACHING TIP ILLUSTRATION 4-7 provides the types of activities and examples of cost drivers for each of the four different levels of ABC activities Also available as teaching transparency Companies may achieve greater accuracy in overhead cost allocation by recognizing the different levels of activities and developing specific activity cost pools and their related cost drivers Nonrecognition of this classification of activities is one of the reasons that volume-based cost allocation causes distortions in product costing The resources consumed by batch-, product-, and facility-level supporting activities not vary at the unit level, nor can managers control them at the unit level 4-13 Companies can control batch-, product-, and facility-level costs only by modifying batch-, product-, and facility-level activities, respectively H Activity-Based Costing in Service Industries The overall objective of ABC in service firms is no different than it is for a manufacturing company: The objective is to identify the key activities that generate costs and to keep track of how many activities are performed for each service provided The general approach to identifying activities, activity cost pools, and cost drivers is the same for service companies and for manufacturers A larger proportion of overhead costs are company-wide costs that cannot be directly traced to specific services rendered by the company, which sometimes makes implementation of ABC difficult in service industries *I Just-in-Time Processing Traditionally, continuous process manufacturing has been based on a just-in-case philosophy: inventories of raw materials are maintained just in case some items are of poor quality or a key supplier is shut down by a strike This philosophy results in a “push approach”, in which raw materials are pushed through each process and often results in the buildup of extensive manufacturing inventories Many U.S firms have switched to just-in-time (JIT) processing Under JIT processing, companies receive raw materials just in time for use in production, they complete subassembly parts just in time for use in finished goods, and they complete finished goods just in time to be sold JIT strives to eliminate inventories by using a pull approach in manufacturing This approach begins with the customer placing an order with the company which starts the process of pulling the product through the manufacturing process 4-14 JIT processing consists of three important elements: a Suppliers must be dependable and willing to deliver on short notice exact quantities of materials, and to specified work stations Online computer linkage between the company and its suppliers facilitates this arrangement b Workers must be multiskilled in order to operate and maintain several different types of machines c The company must establish total quality control throughout the manufacturing operations, which tolerates no defects Continuous monitoring by both employees and supervisors at each work station is required TEACHING TIP ILLUSTRATION 4-6 presents the elements in JIT processing Point out that JIT’s primary objective is to eliminate all manufacturing inventories The major benefits of JIT processing include: a Significant reduction or elimination of manufacturing inventories b Enhanced product quality c Reduction or elimination of rework costs and inventory storage costs d Production cost savings from the improved flow of goods through the processes One of the major accounting benefits of JIT is the elimination of separate raw materials and work-in-process inventory accounts 4-15 20 MINUTE QUIZ Circle the correct answer True/False In today’s automated environment, direct labor is sometimes the appropriate basis for assigning overhead cost to products True False In the first stage of activity-based costing, overhead is assigned to products using cost drivers True False The first step in activity-based costing is to identify and classify the major activities involved in the manufacture of specific products, and allocate manufacturing overhead to the appropriate cost pools True False Before costs are allocated to the cost pools, the cost drivers for each cost pool must be identified True False Under ABC, overhead costs are shifted from the high-volume product to the low-volume product True False Activity-based costing does not change the amount of overhead costs, but it does allocate those costs in a more accurate manner True False Overhead costs are not allocated by means of arbitrary volume-based cost drivers under ABC True False Value-added activities increase the worth of a product or service to customers and involve resource usage that customers are willing to pay for True False Product-level activities in ABC are required to support or sustain an entire production process True False *10 Just-in-time processing strives to eliminate inventories by using a “pull approach” in manufacturing True False 4-16 Multiple Choice The last step in activity-based costing is to a identify the major activities involved in the manufacture of specific products b compute the overhead rate per cost driver c identify the cost driver that has a strong correlation to the costs accumulated in the cost pool d assign manufacturing overhead costs for each cost pool to products Machine hours would be an accurate cost driver for a assembly costs b inspecting costs c machining costs d machine setup costs All of the following are benefits of ABC except it leads to a less cost pools used to assign overhead b more accurate cost data c enhanced control over overhead costs d better management decisions The level of ABC activities performed in support of an entire product line are classified as a batch-level activities b facility-level activities c product-level activities d unit-level activities *5 Just-in-time processing strives to eliminate inventories by using a a just in case approach b pull approach c push approach d process approach 4-17 ANSWERS TO QUIZ True/False True False True False True *10 True False True False True Multiple Choice *5 d c a c b 4-18 ILLUSTRATION 4-1 ACTIVITIES AND COST DRIVERS Activities Assembling Inspecting Machining Ordering Setting up machines Storing Supervising Cost Drivers Number of parts Number of inspections Machine hours Number of purchase orders Number of setups Amount of square footage Number of employees 4-19 ILLUSTRATION 4-2 STEPS IN ACTIVITY-BASED COSTING SYSTEM Step Identify and classify the major activities involved in the manufacture of specific products, and allocate manufacturing overhead costs to the appropriate cost pools Step Identify the cost driver that has a strong correlation to the costs accumulated in the cost pool Step Compute the overhead rate for each cost driver Step Assign manufacturing overhead costs for each cost pool to products, using the overhead rates (cost per driver) 4-20 = = = Activity-Based Overhead Rate Overhead Cost Assigned Overhead Cost Per Unit 4-21 Total Overhead Cost Assigned Activity-Based Overhead Rate × Total Units Produced Number of Cost Drivers Expected to Be Used Estimated Overhead Per Activity Expected Use of Cost Drivers Per Activity ILLUSTRATION 4-3 COMPUTING ACTIVITY-BASED OVERHEAD RATE ILLUSTRATION 4-4 BENEFITS OF ABC Benefits: ABC leads to more cost pools being used to assign overhead costs ABC leads to enhanced control over overhead costs ABC leads to better management decisions 4-22 ILLUSTRATION 4-5 VALUE-ADDED AND NON-VALUE-ADDED ACTIVITIES ACTIVITIES Value-added Assembly Engineering design Machining Packaging Painting Non-value-added Building maintenance Inspections Moving of materials Repair of machines Storage of inventory 4-23 ILLUSTRATION 4-6 CLASSIFICATION OF ACTIVITY LEVELS Four Levels Unit-Level Activities Batch-Level Activities Types of Activities Examples of Cost Drivers Machine-related: Drilling, cutting, milling, trimming, pressing Machine hours Labor-related: Assembling, painting, sanding, sewing Direct labor hours or cost Equipment setups Purchase ordering Inspection Number of setups/setup time Number of purchase orders Number of inspections/ inspection time Number of material moves Material handling Product-Level Activities Product design Engineering changes Number of product designs Number of changes Facility-Level Activities Number of employees managed Square footage Square footage Square footage Plant management salaries Plant depreciation Property taxes Utilities 4-24 ILLUSTRATION 4-7 ELEMENTS OF JIT PROCESSING Elements: Suppliers must be willing to deliver on short notice exact quantities of materials according to precise quality specifications A multiskilled work force to operate and maintain different types of machines The company must establish total quality control throughout the manufacturing process 4-25 ... cost pool An activity-based overhead rate per cost driver is computed by dividing the total estimated overhead per activity by the number of cost drivers expected to be used per activity The formula... costing The company computes an activity-based overhead rate per cost driver by dividing the estimated overhead per activity by the number of cost drivers expected to be used per activity TEACHING... overhead to multiple activity cost pools and assigns the activity cost pools to products and services by means of cost drivers In ABC, an activity is any event, action, transaction, or work sequence