Question

Companies can choose from different costing methods: process/product costing and activity-based costing. Think about a company you know and answer the following:

What are the differences between the two costing methods, and how do these apply to your company?

What are some ABC cost drivers the company might use?

How could the costs differ if one method is chosen over the other?

Which method would you recommend for your company, and why?

Answer 1

• Process costing is suited to situations where goods are produced in a continuous process, such as refining of petrochemicals.
• Process costing begins with the concept of equivalent units, which is the amount of in-process production expressed in terms of finished units. Cost per equivalent unit is measured and becomes the basis for final cost allocation between work in process and finished goods
• A cost of production report provides a composite view of the entire process costing method, and gives rise to a series of journal entries.
• Activity-based costing is an alternative technique that looks at organizational activities and identifies the related costs. Those costs are then assigned based on how a particular activity is consumed in production. The chapter outlines a series of steps that can be followed to implement ABC. A case study is used to demonstrate ABC and its impact on the decision process.
• imagine the activities involved in making a complex product such as an automobile or computer.
• In Step 2, we identify the cost drivers. Most cost drivers are related to either the volume of production or to the complexity of the production or marketing process.

  Cost driver	Cost of assigned cost driver
  Miles driven	Automobile costs
  Machine-hours	Electricity to run machines
  Customers served	Overhead in a bank
  Flight hours	Airplane maintenance costs
  Number of customers	Selling costs

  Activity-based costing (ABC) uses several cost pools, organized by activity, to allocate overhead costs. The idea is that activities are required to produce products—activities such as purchasing materials, setting up machinery, assembling products, and inspecting finished products. These activities can be costly. Thus the cost of activities should be allocated to The primary reason that using activity-based costing shifted overhead costs is that producing each unit requires more resources than the batch. based on the products’ use of the activities.

  Advantages

  More accurate cost information leads to better decisions.

  Increased knowledge of production activities leads to process improvements and reduced costs.

• Thus, ABC costing would be recommended.