Activity-Based Costing: Solutions to Review Questions

9 Activity-Based Costing Solutions to Review Questions 9-1. Give examples of cost drivers commonly used to allocate overhead costs to products and services. Common allocation bases are direct labor-hours, direct labor costs, and machine-hours. Somewhat less common is direct material costs. 9-2. What is the death spiral? How is it related to the cost accounting system? The term “death spiral” refers to a process that begins by attempting to increase prices to meet reported product costs. Higher prices reduce demand, leading to production and still higher reported product costs. Eventually, the firm loses products as the market will not support them and goes out of business. The death spiral is not the result of the cost system directly, but the result of managers making decisions (in this case raising prices) based on the cost system that is (often inaccurately) signaling increased costs. 9-3. The product costs reported using either plantwide or department allocation are the same. The only difference is in the number of cost drivers used. True or false? Explain. False. Department allocation is a two-stage process, so the first-stage assignment of costs and the choice of cost drivers affects the allocation of costs to products. The total product costs are the same under either approach, but the individual product costs differ. This can affect the decisions managers make regarding individual products. 9-4. Why do companies commonly use direct labor-hours or direct labor cost but not the number of units to allocate overhead? Most companies produce multiple products and simply adding them up does not account for differences in complexity of the use of resources. As an extreme example, suppose a company produced airplanes and staplers. Allocating overhead on the basis of units would assign the same overhead cost to a stapler and a plane. 9-5. What are the costs of moving to an activity-based cost system? What are the benefits? The costs include the systems and the software, but the most important cost is managers’ time. Managers need to make many decisions about the activities and the cost drivers and managers need to make many of the first-stage allocations. The benefits come from having better information about the use of resources and better information for decisions. 9-6. What are the basic steps in computing costs using activity-based costing? 1. Identify activities that consume resources. 2. Identify the cost driver associated with each activity. 3. Compute a cost rate per activity unit (e.g., rate per setup, rate per part, rate per machine-hour). 4. Allocate costs to products by multiplying the activity rate times the volume of activity consumed by the product. 9-7. What is the cost hierarchy? The cost hierarchy is a classification of costs into general levels of activity. Costs assigned to the different levels of the hierarchy tend to be related to the volume of the activity volume. 9-8. Cost allocation allocates only a given amount of costs to products. The total allocated is the same; therefore the choice of the system does not matter. True or false? Explain. False. While the total cost allocated is the same, the reported costs for individual products will differ. Because managers make decisions at the product level, it is important that the reported costs reflect, to the extent possible, the use of resources by the products. 9-9. In what ways is implementing an activity-based costing system in a manufacturing firm's personnel department the same as implementing it in the plant? In what ways is it different? A personnel department provides its services by completing a set of activities using resources. In this way, implementing activity-based costing in an administrative function is the same as implementing it in a manufacturing firm. However, the products and activities may be much harder to define, making it less like a manufacturing environment. 9-10. How does complexity lead to higher costs? Why is it important for the cost system design to consider complexity? Complexity adds costs by requiring additional resources for overhead (support) activities for the same volume. It is important to include complexity in cost system designs to avoid spreading the cost of complexity across both simple and complex products. 9-11. What two questions must a manager answer if a company is implementing time-driven activity-based costing? The two questions a manager must answer when implementing time-driven activity-based costing are (1) what is the cost of the resources supplied to a department and (2) how much time it takes to complete the various activities of the department. 9-12. In the context of time-driven ABC, what are time equations? Time equations allow managers to adjust the time required for activities for selected characteristics of products or services.