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Activity-Based Costing (cost pools and allocation) - Activity Based Costing, Cost Management Video Lecture | Cost Management - B Com
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FAQs on Activity-Based Costing (cost pools and allocation) - Activity Based Costing, Cost Management Video Lecture - Cost Management - B Com
| 1. What is activity-based costing and how does it differ from traditional costing methods? |  |
Ans. Activity-based costing (ABC) is a costing method that assigns costs to products or services based on the activities that drive costs. It differs from traditional costing methods, such as direct costing or absorption costing, as it focuses on the activities themselves rather than the volume of output. ABC recognizes that not all activities consume costs equally and provides a more accurate understanding of cost drivers and their relationship to products or services.
| 2. What are cost pools in activity-based costing? | |
Ans. Cost pools in activity-based costing are categories or groups of costs that are accumulated for allocation to products or services. These cost pools represent various activities that consume costs, such as setup costs, inspection costs, or machine maintenance costs. By grouping costs into cost pools, ABC allows for a more detailed analysis of how activities contribute to overall costs.
| 3. How are costs allocated in activity-based costing? | |
Ans. Costs are allocated in activity-based costing by first identifying the activities that consume costs and then assigning those costs to specific cost objects, such as products or services. This allocation process involves tracing costs to cost pools based on the activities performed and then allocating the costs from the cost pools to the cost objects using appropriate cost drivers. Cost drivers are factors that measure the consumption or demand for an activity, such as the number of setups or the machine hours required.
| 4. What are the benefits of using activity-based costing? | |
Ans. Activity-based costing provides several benefits, including:
1. Improved cost accuracy: ABC provides a more accurate understanding of the costs associated with individual activities and their impact on products or services, leading to more accurate product pricing and cost control.
2. Enhanced decision-making: By identifying cost drivers, ABC enables managers to make informed decisions about resource allocation, process improvement, and product mix.
3. Cost transparency: ABC reveals the true costs of activities, allowing for better cost management and identification of areas for cost reduction or optimization.
4. Better understanding of profitability: ABC helps identify the profitability of different products or customer segments by providing insights into the costs incurred at each activity level.
5. Continuous improvement: ABC facilitates the identification of non-value-added activities, encouraging businesses to streamline processes and improve efficiency.
| 5. What are some limitations of activity-based costing? | |
Ans. Activity-based costing also has some limitations, including:
1. Implementation complexity: ABC requires significant effort and resources to implement, as it involves identifying activities, cost drivers, and cost pools, as well as collecting and analyzing data. This complexity can be challenging for small businesses with limited resources.
2. Subjectivity in cost driver selection: Selecting appropriate cost drivers can be subjective and may vary across organizations or individuals. This subjectivity can impact the accuracy of cost allocations and the overall effectiveness of ABC.
3. Potential for excessive detail: ABC can result in a high level of detail, which may not always be necessary or useful. Excessive detail can complicate the cost allocation process and make it difficult to interpret the results.
4. Time-consuming data collection: Collecting the necessary data for activity-based costing can be time-consuming and may require additional systems or processes to capture activity-related information accurately.
5. Resistance to change: Implementing ABC may face resistance from employees who are accustomed to traditional costing methods, which can hinder its successful adoption and utilization.
Text Transcript from Video
Now that we have explained the difference between direct costs and indirect costs
how do we allocate indirect costs to our two products?
What we have to do is to group costs into costs pools
find out how each performance object consumes resources from that cost pool
and how much of is consumed
Here we face a tension between complexity and accuracy:
more cost pools may increase the accuracy of the allocation of indirect costs
but might lead to a lot of complexity in the cost system
For Malea Fashion District it was important to have a small number of cost pools
and Malea decided to have only one cost pool for indirect manufacturing costs
She chose the cost of direct materials as the allocation base
The idea is to divide your indirect costs by the total allocation base (here the cost of direct materials)
to get an indirect cost per direct material used (called allocation rate)
and then you just have to multiply this number by the quantity of direct materials used by each of your products
It was a challenge for Malea to implement this cost system
First of all she had to decide on the number of cost pools and find the right allocation base
Choosing an irrelevant one can lead to distortion of cost estimates and bad decisions
Secondly, at the time, MFD was a real soap opera
I mean it
Francesca was having a bad break up
while Malea, herself, was really only thinking about one of her investors
who happened to be a really good looking man
You might ask yourself how is this relevant to managerial accounting?
Well it may not be directly but it’s very relevant to real life.
You see, a company is not only financials and logic
it’s also people and this kind of story can have a real impact on the business
how do we allocate indirect costs to our two products?
What we have to do is to group costs into costs pools
find out how each performance object consumes resources from that cost pool
and how much of is consumed
Here we face a tension between complexity and accuracy:
more cost pools may increase the accuracy of the allocation of indirect costs
but might lead to a lot of complexity in the cost system
For Malea Fashion District it was important to have a small number of cost pools
and Malea decided to have only one cost pool for indirect manufacturing costs
She chose the cost of direct materials as the allocation base
The idea is to divide your indirect costs by the total allocation base (here the cost of direct materials)
to get an indirect cost per direct material used (called allocation rate)
and then you just have to multiply this number by the quantity of direct materials used by each of your products
It was a challenge for Malea to implement this cost system
First of all she had to decide on the number of cost pools and find the right allocation base
Choosing an irrelevant one can lead to distortion of cost estimates and bad decisions
Secondly, at the time, MFD was a real soap opera
I mean it
Francesca was having a bad break up
while Malea, herself, was really only thinking about one of her investors
who happened to be a really good looking man
You might ask yourself how is this relevant to managerial accounting?
Well it may not be directly but it’s very relevant to real life.
You see, a company is not only financials and logic
it’s also people and this kind of story can have a real impact on the business
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Dec 23, 2024 Last updated |
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