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### 27 Cards in this Set

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 How do ABC systems help managers? They help cost management decisions by improving product designs, processes, and efficiency. What is the problem with averaging? Averaging can provide inaccurate and misleading cost data. Product undercosting a product consumes a high level of resources but is reported to have a low cost per unit. product overcosting a product consumes a low level of resources but is reported to have a high level of costs. Dinner example spent 27 for a 15 dollar dinner. What are the strategic consequences of product overcosting and undercosting? The company uses this info to set pricing decisions. Undercosted products will be underpriced, increasing demand for these products but lowering profits. Product cost cross subsidization Means that if a co undercosts one of its products it will over cost another. In the restaurant example, the amount of cross subsidaztion of each dinner can be readily computed because all cost items can be traced as direct costs to each dinner. If all diners pay \$27 emma is paying \$12 more than her actual cost of \$15. She is subsidizing James who is paying \$15 less than his actual cost of \$42. Simple costing system using a single indirect cost pool 1. Identify the products that are chosen cost objects. 2. Identify direct costs of the products. 3. Select the cost allocation bases to use for allocating indirect or overhead costs to the products. 4. Identify indirect cost associated with each cost allocation base. 5. Calculate rate per unit of each cost allocation base. 6. Compute the indirect costs allocated to the product 7. Compute the total cost by adding direct and indirect costs. Refined costing system Reduces the use of broad averages for assigning the cost of resources to cost objects (such as jobs, products, and services) and provides better measurement of the costs of indirect resources used by different cost objects. There are three principal reasons for a refined cost system: 1. Increase in product diversity. Co no longer produce only one product so they have to have a way to trace costs accurately. 2. Increase in indirect costs. because direct mfg labor is not a cost driver for all costs allocating all costs on the basis of this often doesn't measure accuratly how resources are used for each product. 3. Compettion in product markets. Need to obtain more accurate cost info to make imp strategic decisions. Three guidelines for refining a costing system 1. Direct cost tracing. Identify as many direct costs as economically feasible. The goal is to reduce he amount of costs classified as indirect thereby minimizing the extent to which costs have to be allocated. 2. Indirect cost pools. Expand the number until each pool is homogeneous. In a homogeneous cost pool, all of the costs have the same or a similar cause and effect relationship with a single cost driver which is used as an allocation base. 3. Cost allocation bases-whenever possible use teh cost driver (the cause of the indirect costs) as the cost allocation base for each homogeneous indirect cost pool (the effect). Activity based costing systems Refines a costing system by identifying activities as fundamental cost objects. An activity is an event, task, or unit of work. Activities are verbs; they are the things a firm does. ABC costing systems do what? First calculate the costs of individual activities and then assign costs to cost objects such as products and services on the basis of a mix of activities needed to produce each product or service. Potential problems with ABC costing systems An ABC with many activities becomes overly detailed and hard to operate. however, an ABC system with too few activities may not be refined enough to measure cause and effect relationships between cost drivers and various indirect costs. Cost heiarchy cetegorizes various activity cost pools on the basis of the different types of cost drivers, or cost allocation bases, or different degrees of difficulty in determining cause and effect relationships. ABC systems commonly use a cost heiarchy having four levels: outout unit level costs, batch level costs, product sustaining costs, and facitlity sustaining costs to identify cost allocation bases that are, whenever possible drivers of costs in activity cost pools. Output level costs The costs of activities performed on each individual unit of a product or service. They are output costs because over time, the cost of this activity increases with additional units of output produced. Batch level costs Costs of activities related to a group of units of products or services rather than to each individual unit of product or service. In plastim example, setup costs are batch level costs because, over time, the cost of this setup activity increases with setup hours needed to produce batches of lenses. Product sustaining costs (service sustaingin costs) Costs of activities undertaken to support individual products or services despite the number of units or batches in which the units are produced. Example design of new molds for plastim.Other examples are R&D costs, costs of making engineering changes, and marketing costs to launch a new product. Facility sustaining costs Costs of activities that cannot be traced to individual products or services but that support the organization as a whole. 2 features of ABC systems that are emphasized First, these systems identify all costs used by products, whether the costs are variable or fixed in the short run. That's because the focus of ABC costing systems is on long run decisions where more costs can be managed and fewer costs are regareded as fixed. Second, reorganizing the hierarchy of costs is critical when allocating costs to products. It is easiest to use the cost hierarchy to first calculate the total costs of each product. The per unit costs can then be derived by dividing total costs by the number of units produced. Activity based management Method of management decision making that uses activity based costing info to improve customer satisfaction and profitability. cost reduction and process improvement decisions Managers set cost reduction targets in terms of reducing the cost per unit of the cost allocation base in different activity areas. The goal is to reduce these costs without compromising customer service or the actual or perceived value (usefulness) customers obtain from the product or service. That is, plastim will attempt to take out only those costs that are nonvalue added. Example decrease distribution costs by packing leneses in a way that reduces bulkiness of packages delivered. Costs incurred equation Costs incurred = resources used + cost of unused capacity Unused capacity arises from? Arises from efficiency improvements Advantage of ABC in regards to unused capacity They do not allocate the costs of unused capacity to products, instead, these systems highlight the amount of unused capacity as a separate line item. Highlighting unused capacity signals to managers an opportunity for reducing these costs. Activity based costing and department costing Companies often use costing systems that have features of ABC systems such as multiple cost pools and multiple cost allocation bases--but do not emphasize individual activities. Do not assume that because department costing systems use multiple cost pools That they properly recognize the cost drivers as well as how resources are used by products. Department costing systems can be refined using ABC The signs when an ABC system may be useful significant amounts of indirect costs are allocated using only one or two cost pools. 2. ALl or most indirect costs are identified as output unit level costs 3. Products make diverse demands on resources because of differences in volume, process steps, batch size, or complexity. 4. Products that a co is well suited to make and sell show small profits, whereas products that a company is less suited to produce and sell show large profits. 5. Operations staff have substantial disagreement with the reported costs of manufacturing and matketing products and services.