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Chapter 7

ACC 406 Chapter Notes - Chapter 7: Resource Consumption

Course Code
ACC 406
Donna Zathy

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ACC406 - Chapter 7
Limitations of Functional-Based Cost Accounting Systems
oPlantwide and Departmental Rates based on direct labor hours,
machine hours, or other volume-based measures
been used for decades to assign overhead costs to products
oThis approach to costing is equivalent to an averaging approach and
may produce inaccurate costs
oNeed for more accurate product costs has forced many companies to
take a serious look at their costing procedures
o2 major factors impair the ability of unit-based plantwide and
departmental rates to assign overhead costs accurately
1) Proportion of nonunit-related overhead costs to total
overhead costs is large
2) Degree of product diversity is great
Nonunit-Related Overhead Costs
oUse of plantwide or departmental rates assumes that a product's
consumption of overhead resources is related strictly to the units
oUnit-level Activities = activities that are performed each time a unit is
oVolume-based cost systems label costs associated with these activities
as variable
All other costs (e.g., ones that aren't unit-level) are considered
fixed by this system
oCosts associated with nonunit-level activities are unlikely to vary with
units produced
oProponents of ABC refer to the ABC cost hierarchy that categorizes
costs as:
unit-level (vary with output volume)
batch-level (vary with the number of groups or batches that run)
product-sustaining (vary with the diversity of the product or
service line)
facility-sustaining (do not vary with any factor but are necessary
in operating the plant)
oABC cost hierarchy used in helping managers realize that certain costs
associated with nonunit-level activities are driven by other factors
oNonunit-level activity drivers are factors that measure the consumption
of nonunit-level activities by products and other cost objects
E.g., batch, product-sustaining, facility-sustaining
oUnit-level activity drivers measure the consumption of unit-level
oActivity drivers are factors that measure the consumption of activities
by products and other cost objects, can be classified as either unit-
level or nonunit-level
Product Diversity
oProducts that consume overhead activities in systematically different

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oPresence of significant nonunit overhead costs is a necessary condition
for plantwide and departmental failures
oConsumption Ratio = proportion of each activity consumed by a
Problems with Costing Accuracy
oFour types of overhead activities, performed by four distinct support
Setting up the equipment for each batch
Moving a batch
oMain problem with either procedure is the assumption that unit-level
drivers such as machine hours or direct labor hours, drive or cause all
overhead costs
oEach products demands for setup and material-moving activities are
more logically related to the setup hours and the number of moves,
Solving Problem with Cost Distribution
oCan be solved by the use of activity rates
oTo assign overhead costs, the amount of activity consumed by each
product is needed along with the activity rates
Comparison of Functional-Based and Activity-Based Product Costs
oPlantwide rate based on direct labor hours is calculated by dividing the
total overhead costs by the total direct labor hours
Plantwide Rate = Total Overhead Costs / Total Direct Labor
Activity-Based Product Costing: Detailed Description
oFunctional-based overhead costing involves 2 major stages
1) Overhead costs are assigned to an organizational unit (plant
or departmental)
2) Overhead costs are then assigned to cost objects
oABC system first traces costs to activities and then to cost objects
Activities consume resources, and cost objects, in turn, consume
ABC is a two-stage process
oABC system emphasizes direct tracing and driver tracing
Volume-based costing system tends to be allocation-intensive
oFocus of ABC is activities
Identifying activities is first step in designing an ABC system
oActivity Dictionary = lists the activities in an organization along with
some critical activity attributes
oActivity Attributes = financial and nonfinancial information items that
describe individual activities
Assigning Costs to Activities
oRequires identification of the resources
oActivities consume resources such as labor, materials, energy, and
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