Notes_Chapter_08 - CHAPTER 8 ACTIVITY-BASED COSTING I...

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CHAPTER 8: ACTIVITY-BASED COSTING I. Traditional vs. Activity-Based Costing Systems A. Traditional Costing Systems A traditional costing system allocates overhead to products on the basis of predetermined plant-wide or department-wide predetermined overhead rate. Direct labor may be the appropriate basis for assigning overhead cost to products if it constitutes a significant part of total product cost, and a high correlation exists between direct labor and changes in the amount of overhead costs. Machine hours may be the appropriate basis for assigning overhead costs to products in a highly automated manufacturing environment. B. Activity-Based Costing (ABC) ABC is a costing method that is designed to provide managers with cost information for management decisions. ABC is usually a SUPPLEMENT to, rather than a replacement for, the company’s traditional costing system. ABC allocates overhead in a two-stage process. 1 st : ABC allocates overhead costs to activity cost pools. 2 nd : the overhead allocated to the activity cost pools is assigned to products using cost drivers (i.e., the activity that causes costs to be incurred). In ABC, an activity is any event, action, transaction, or work sequence that incurs cost when producing a product or providing a service. Three key differences between traditional costing and ABC 1) Nonmanufacturing as well as manufacturing costs may be assigned to products (if a definite cause-and-effect exists) 2) Some manufacturing costs may be excluded from product costs —i.e., those that are not caused by producing a product or providing a service 1
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3) ABC uses numerous overhead activity rates to assign overhead costs to products and services. 2
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II. Classifications in ABC A. 5 Levels of Activity 1) Unit-level activities : activities performed for each unit of production. 2) Batch-level activities : activities performed for each batch of products processes, regardless of how many units are in the batch. 3) Product-level activities : activities performed in support of an entire product line regardless of how many units are produced or how many batches are run. 4) Customer-level activities: relate to specific customers and are not tied to any particular product. 5) Organization-sustaining activities : activities required to support the organization regardless of what products are produced or how many units are made recognizing these 5 different levels of activities facilitates the allocation of overhead cost to the appropriate activity cost pools.
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