Chapter 5

uses broad averages for assigning the cost of resources uniformly to cost objects when the individual product might not use resources in the same way.

*historically companies used a simple costing system because they did not have such a variety of products so indirect cost could be allocated evenly amongst products. Now that has changed

Product undercosting: a product consumes a high level of resources but is reported to have a low cost per unit

Product overcosting: product consumes a low level of resources but is reported to have a high cost per unit.

*splitting a dinner 4 ways evenly when cost of individual dinner is not evened out.

if a company overcosts one of its units, it will undercost another and vis versa.

*if meal is divided evenly amongst parties some parties are paying more for their meal while other parties are paying less for what their direct meal costs.

allocates indirect cost using a single indirect cost rate:

• Step 1: Identify the Products that are the chosen cost objects
• Step 2: Identify the Direct cost of the products (direct materials and direct manufacturing labor)
• Step 3: Select the Cost-Allocation Bases to use for allocating Indirect Cost (overhead) (direct manufacturing labor hours)
• Step 4: Identify the indirect cost that correlate to the allocation bases (step 3)
• Step 5: Compute the rate/unit of each cost allocation base: total indirect costs/ total cost-allocation base = indirect cost rate
• Step 6: Compute the Indirect Cost allocated to the Products (Step 5 x Step 1)
• Step 7: Add all indirect cost (step 6) to direct costs.

• 1.) Identify the problem
• 2.) Obtain information
• 3.) Make predictions about the future
• 4.) Make decisions by choosing among alternatives
• 5.) Implement decision evaluate the performance and learn

reduce the use of broad averages for assigning the cost of resources to cost objects and provides a better measurement of the costs of indirect resources used by different cost objects.

* example is activity based costing abc

• Increase in product diversity
• Increase in indirect costs
• Competition in product markets

• Direct-cost tracing
• Indirect-cost pools
• Cost allocation bases

Activity Based Costing:

refines a cost system by identifying individual activities as the fundamental cost object.

In ABC an activity is an even task or unit of work with a specified purpose. Must be a verb

Ex: designing products, setting up machines distribution and operating machines

*activities must be defined and account for a good amount of indirect costs and combines activities that have the same cost drivers

Identify all indirect costs possible to reduce the amount of cost classified as indirect.

A guideline when refining a costing system

expand the number of indirect cost pools until each pool is similar (ie single cost driver for each pool and narrow focused cost)

A guideline when refining a costing system

use the cost driver as an allocation bases for each similar indirect cost pool

categorizes various activity cost pools on the basis of different types of cost drivers/cost allocation bases.

• Four Levels
• 1. Output unit-level costs
• 2. Batch-level costs
• 3. Product sustaining costs
• 4. Facility sustaining costs

the costs of activities performed on each individual unit of a product or service

cost of activities related to a group of units of a product or service rather than each individual unit of product or service.

the costs of activities under taken to support the individual product or services regardless of the number of units or batches in which the units are produced.

cost of activities that cannot be traced to individual product or services but that support the organization as a whole.

the seven-step approach to costing and the three guidelines for refining costing systems.

-large amounts of indirect costs are allocated using only one or two cost pools

-the majority of indirect costs are identified as output unit-level

-products make a diverse demand on resources b/c of differences in volume steps, batch size or complexity

-products that a company is well suited to make and sell show small profits and vis versa

-operations staff has substantial disagreement w/ the reported costs of manufacturing and marketing products and services

uses ABC information to improve customer satisfaction and profitability

• -pricing and product mix decisions
• -cost reduction and process improvement decisions
• -design decisions
• -planning and managing activities

the detailed data from ABC with a value-added analysis by adding customer-perceived value of each activity. ABM identifies value-added and non-value-added activities, and gives managers opportunities to enhance value-added activities and to reduce non-value-added activities.

are important to the customer. From the customer’s perspective they add actual or perceived value, e.g. quality materials,excellent product design.

are not perceived by the customer to add value to the product or service, e.g. defective units, manufacturing equipment breakdowns, completing a firm’s corporate income taxes or weekly staff meetings.