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ACTG 2020 (19)

Textbook Chapters Summary Summaries of the chapters in the textbook, starting from 5 and going until 13. Chapters 8 and 11 are not included as they weren't covered in the course.

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ACTG 2020
Sylvia Hsingwen Hsu

Chapter 5: Activity-based Costing (ABC) Systems: o Follow a two-stage procedure to assign overhead costs to products First stage identifies significant activities in the production of the three products and assigns overhead costs to each activity in accordance with the cost of the organizations resources used by the activity The overhead costs assigned to each activity make up an activity-cost pool Stage two identifies cost drivers appropriate for each cost pool Using pool rates, the overhead costs are allocated from each activity cost pool to each product line in proportion to the amount of the cost driver consumed by the product line o Cost levels: Unit level: this type of activity must be done for each unit of production I.e. machine-related activity cost pool Batch level: these activities must be performed for each batch of products, rather than each unit I.e. setup, purchasing, material handling, quality assurance, packing/shipping activity cost pools Product-sustaining level: these are activities needed to support an entire product line but are not performed every time a new unit or batch of products is produced I.e. engineering design costs Facility (or general operations) level: these activities are required in order for the entire production process to occur I.e. plan management, salaries, plant depreciation, property taxes, etc. The classification of cost levels is called a cost hierarchy Traditional volume-based costing systems distort costs by overcosting the high-volume product lines and undercosting complex but relatively low-volume product lines Consumption ratio: the proportion of an activity consumed by a particular product The following characteristics will undermine the ability of a volume-based product-costing system to assign overhead costs accurately: o A large proportion of non-unit-level activities o Product diversity Indicators that management should consider incurring the significant cost of updating their costing system and implementing ABC: o Complex products that are difficult to manufacture are reported to be very profitable, although they are not priced at a premium o Product-line profit margins are difficult to explain o Sales are increasing but profits are declining o Line managers suggest that apparently profitable products be dropped o See exhaustive list on pg. 160-161 Cost drivers: Three important factors in selecting appropriate cost drivers: o Degree of correlation (between consumption of the activity and consumption of the cost driver) o Cost of measurement: the higher the correlation between a cost driver and the actual consumption of the associated activity, the greater the accuracy of the cost assignments o Behavioural effects Collecting data o Interviews and paper trails o Storyboarding A procedure used to develop a detailed process flowchart, which visually represents activities and the relationships among the activities o Multidisciplinary ABC Project Teams ABC should be seen as a company-wide initiative, not simply an accounting project Activity dictionary: a complete listing of the activities identified and used in the ABC analysis Bill of activities: a complete listing of the activities required for the product or service to be produced Non-value-added activities: operations that are either unnecessary and dispensable, or necessary but inefficient and improvable Non-value-added costs: result from non-value-added activities and are the costs of activities that can be eliminated without deterioration of product quality, performance or perceived value 5 steps to eliminate non-value-added costs: o Identifying activities Identifies all of the organizations significant activities broken down to the most fundamental level practical o Identifying non-value-added activities: Is the activity necessary? Is the activity efficiently performed? Is an activity sometimes value-added and sometimes non-value-added? o Understanding activity linkages, root causes and triggers o Establishing performance measures o Reporting non-value-added costs Customer profitability analysis: uses activity-based costing to determine the activities, costs and profits associated with serving particular customers Chapter 6: The learning curve: production efficiency increases with experience o As cumulative production output increases, the average labour time required per unit declines o As the labour time declines, labour cost declines as well Cost behaviour: the relationship between cost and activity o In order to plan operations and prepare a budget, managers need to predict costs Cost prediction: a forecast of cost at a particular level of activity o Knowledge of cost behaviour helps to make the desired cost prediction Cost estimation cost behaviour cost prediction Variable costs: costs that increase in direct proportion to the change in activity level Step-variable costs: costs that are nearly variable but increase in small steps instead of continuously Fixed costs: remains unchanged in total as the activity level or cost driver varies o The costs of creating production capacity, e.g. depreciation, property taxes, etc. Step-fixed costs: costs that remain fixed over a wide range of activity but jump to a different amount for activity levels outside o E.g. supervisory salaries Mixed cost: has both a fixed and variable component (i.e. for a car: fixed costs are rent and insurance, variable costs are gasoline and maintenance) o The horizontal line is fixed costs, the diagonal is total costs, the space between the two is variable costs and the space underneath the horizontal line is fixed costs o E.g. utilities and equipment maintenance Curvilinear costs: can be approximated in certain ranges with a mixed-cost behaviour pattern, but it is important to limit this approximation to the range of activity in which its accuracy is acceptable o E.g. utilities and equipment maintenance Relevant range: the range of activity within which management expects the company to operate Using cost behaviour patterns to predict costs: o A sales forecast is made for each month of the budgeted year o A cost prediction is made for each of the firms cost items Fixed costs are becoming more prevalent in many industries as machinery replaces labour and labour unions succeed in negotiating agreements that result in a relatively stable workforce o This makes management less flexible in adjusting a firms workforce to the desired level of production Cost estimation: the process of determining how a particular cost behaves Account-classification method: o Classifies each cost item in the ledger as a variable, fixed or mixed cost o After costs have been classified, cost amounts are estimated by examining job-cost records, paid bills, labour time cards or other historical source documents o This examination of historical source documents is combined with other knowledge that may affect costs in the future Visual-fit method: o Plots recent observations of the cost at various activity levels in a scatter diagram which helps to visualize the relationship between cost and the level of activity (or cost driver) o Helpful to use this method when a cost has been classified as mixed or when the analyst has no clear idea about the behaviour of a cost item o It allows an experienced cost analyst to spot outliers in the data o The primary drawback is its lack of objectivity High-low method: o In the high-low method, the mixed-cost approximation is computed using exactly two data points o Variable cost per item = difference between the costs corresponding to the highest and lowest activity levels/difference between the highest and lowest activity levels o This method is more objective than the visual-fit method, but it uses only two data points to estimate the cost behaviour pattern and ignores the rest Least-squares regression method Engineered cost: bears a definitive physical relationship to the activity measure (i.e. direct material costs for a donut shop because it is impossible to produce more donuts without incurring greater material cost for food ingredients) Committed cost: results from an organizations ownership or use of facilities and its basic organization structure )e.g. depreciation, rent, property taxes)
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