ABCnotes_08 - 1 CMA1 Supplementary Notes Activity Base...

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1 CMA1 - Supplementary Notes - Activity Base Costing LO1 : Problems With Traditional Cost Systems 1. Manufacturing costs that do not actually arise because of a particular product are still assigned to that product as part of the plant-wide overhead rate. Example, depreciation on equipment not used to make a particular product 2. Non-mfg costs that are caused by a particular product are not assigned as a cost of that product. Example, sales commissions on the sale of the product. 3. Since all manufacturing costs must be assigned to products via the overhead rate, the costs of idle capacity must be assigned to all products. This is because the overhead rate will be higher if fewer units than plant capacity are expected to be produced and this higher rate will therefore include a component strictly due to idle capacity. Therefore, products will be charged for the costs of idle resources (rather than only the costs of resources actually used in making the product). 4. Overhead costs are usually allocated to products using a single measure of activity such as direct labour hours even though some manufacturing costs may not be affected by the number of DLH’s. These problems may cause product costs to be distorted or to be incomplete under the traditional costing approach. LO2: Explain How ABC Overcomes the Limitation Described in LO1 1. A cost is assigned to a product only if that cost arose because of the use of that activity by the product. Costs not caused by the product are not assigned to a product. 2. Non-mfg. costs that are involved in the design, development, selling, distributing, or servicing of a product, are assigned as a cost of the product. 3. In traditional cost systems, the master budget volume is the most common denominator level used for determining the overhead rate. This is usually less than plant capacity. Therefore, the mfg. overhead rate is typically higher and includes a component for idle capacity. These idle capacity costs are charged to the product even though they in no way enhance the value of the product. However, under ABC, some measure of capacity is usually used as the denominator measure for calculating activity rates. Therefore, the activity rates are lower and include no component for idle capacity. Any cost for unused capacity will be written off as an adjustment to Cost of Goods Sold and will not be assigned to the product itself. 4. By assigning cost to products on the basis of activities (using multiple activity cost pools with different activity bases), there can be a more accurate assignment of costs to products that reflect cause and effect rather than under the traditional system (where either a single plant-wide rate of multiple departmental overhead rates are used). This is a particular problem for traditional cost systems when batch sizes differ or the degree of complexity varies widely from one product to another. LO3:
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This note was uploaded on 03/03/2012 for the course ACCT 2460 taught by Professor Farrar during the Winter '12 term at Conestoga.

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ABCnotes_08 - 1 CMA1 Supplementary Notes Activity Base...

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