Question

1. Indicators that an activity-based costing analysis may be appropriate include all the following except

   		bids for complex products are accepted, while bids for simple products are rejected
   		products are similar and consume resources in the same way
   		high-volume jobs show losses or minimal profits, while low-volume jobs show healthy profits
   		bids for jobs that require “special” processing are always accepted

1. In changing from a traditional costing system to an activity-based costing system, overhead costs tend to shift from high-volume standard products to low-volume premium products because

   		all overhead costs are indirect
   		premium products usually consume more activities per unit than standard products
   		standard products use more total activities than premium products
   		all overhead costs are direct

Answer 1

The concepts of ABC were developed in the manufacturing sector of the United States during the 1970s and 1980s.It is a practice in which activities are identified and all related costs of performing them are calculated, providing actual costs chargeable. The focus of activity based costing is activities. Thus identifying activities is a logical first step in designing an activity based costing. An activity is an event, task or unit of work with a specified purpose. For example; designing products, setting up machines, operating machines and distributing products.

The CIMA terminology defines ABC as a cost attribution to cost units on the basis of benefit received from indirect activities. Peter B. B. Turney defines ABC as “a method of measuring the cost and performance of activities and cost objects. Assigns cost to activities based on their use of resources and assigns cost to cost objects based ontheir use of activities.

ABC recognizes the causal relationship of cost drivers to activities.” ABC can be defined by the following equation: C/A = HD + M + E + S Where C/A = Estimated cost per activity H = Number of labor hours required to perform the activity one time D = Wages per labor hour M = Material costs required to perform the activity one time E = Equipment costs to perform the activity one time S = Subcontracting costs to perform the activity one time The total cost for performing the activity will be based on the number of times the activity is performed during a specific time frame. An activity based costing system first traces costs to activities and then to products and other cost objects. The following figure diagrammatically explains the basic flow of Activity-Based Costing.

Important Terms in Activity Based Costing The operation of the ABC system involves the use of the following terms:

Activity: An activity means an aggregate of closely related tasks having some specific functions which are used for completion of goal or objectives. For example, customer order processing is an activity. It includes receiving order from customers, interacting with production department regarding capacity to produce and giving commitment to the customer regarding delivery time. Other activities may be assembling, packaging, advertising etc.

Resource : Resources are elements that are used for performing the activities or factors helping in the activities. For example, order receiver, telephone, computers etc. are resources in customer order processing activity. It may include material, labour, equipment, office supplies etc.

Cost : Cost is amount paid for resource consumed by the activity. For example, salaries, printing stationary, telephone bill etc. are cost of customer order processing activity. It is also known as activity cost pool.

Cost object: It refers to an item for which cost measurement is required. e.g. a product, a service, or a customer.

Cost pool: A cost pool is a term used to indicate grouping of costs incurred on a particular activity which drives them.

Cost driver: Any element that would cause a change in the cost of activity is cost driver. Actually cost drivers are basis of charging cost of activity to cost object. Cost drivers are used to trace cost to product by using a measure of resources consumed by each activity. For example, frequency of order, number of order etc. may be cost driver of customer order processing activity. Cost driver may be involved two parts: 1. Resource cost driver 2. Activity cost driver A resource cost driver is a measure of the quantity of resources consumed by an activity. An activity cost driver is a measure of the frequency and intensity of demand, placed on activities by cost objects.