CHAPTER 7 for exam 1.docx

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Mary Kate Dodgson

CHAPTER 7 Traditional cost systems rely exclusively on allocation bases that are driven by the volume of production. On the other hand, activity-based costing defines five levels of activity—unit-level, batch-level, product-level, customer-level, and organization-sustaining—that largely do not relate to the volume of units produced. The costs and corresponding activity measures for unit-level activities do relate to the volume of units produced; however, the remaining categories do not. These levels are described as follows: 1. Unit-level activities are performed each time a unit is produced. The costs of unit-level activities should be proportional to the number of units produced. For example, providing power to run processing equipment would be a unit-level activity because power tends to be consumed in proportion to the number of units produced. 2. Batch-level activities are performed each time a batch is handled or processed, regardless of how many units are in the batch. For example, tasks such as placing purchase orders, setting up equipment, and arranging for shipments to customers are batch-level activities. They are incurred once for each batch (or customer order). Costs at the batch level depend on the number of batches processed rather than on the number of units produced, the number of units sold, or other measures of volume. For example, the cost of setting up a machine for batch processing is the same regardless of whether the batch contains one or thousands of items. 3. Product-level activities relate to specific products and typically must be carried out regardless of how many batches are run or units of product are produced or sold. For example, activities such as designing a product, advertising a product, and maintaining a product manager and staff are all product-level activities. 4. Customer-level activities relate to specific customers and include activities such as sales calls, catalog mailings, and general technical support that are not tied to any specific product. 5. Organization-sustaining activities - are carried out regardless of which customers are served, which products are produced, how many batches are run, or how many units are made. This category includes activities such as heating the factory, cleaning executive offices, providing a computer network, arranging for loans, preparing annual reports to shareholders, and so on. Activity-Based Costing:An Overview Traditional absorption costing is designed to provide data for external financial reports. In contrast, activity-based costing is designed to be used for internal decision making.As a consequence, activity- based costing differs from traditional cost accounting in three ways. In activity-based costing: 1. Nonmanufacturing as well as manufacturing costs may be assigned to products, but only on a cause- and-effect basis. 2. Some manufacturing costs may be excluded from product costs. 3. Numerous overhead cost pools are used, each of which is allocated to products and other cost objects using its own unique measure of activity. Nonmanufacturing Costs and Activity-Based Costing In activity-based costing, products are assigned all of the overhead costs—nonmanufacturing as well as manufacturing—that they can reasonably be supposed to have caused. In essence, we will be determining the entire cost of a product rather than just its manufacturing cost. Manufacturing Costs and Activity-Based Costing Activity-based costing systems purposely do not assign two types of manufacturing overhead costs to products. Manufacturing overhead includes costs such as the factory security guard's wages, the plant controller's salary, and the cost of supplies used by the plant manager's secretary.Activity-based costing systems do not arbitrarily assign these types of costs, which are called organization-sustainin
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