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DQ 2
Cost Drivers
What are cost drivers? How do cost drivers relate to cost pools? What are some cost pools?
Name two or three different cost drivers for each of these cost pools.
"A cost driver is any factor or activity that has a direct cause-effect relationship with the
resources consumed" (Weygandt, Kieso, & Kimmel, 2010, pp 153).
"An activity cost pool is the overhead cost attributed to a distinct type of activity (e.g., ordering
materials or setting up machines)" (Weygandt, et al, 2010, pp 153).
The cost drivers are used to allocate the activity cost pools to the products. The cost drivers
measure the number of individual activities undertaken or preformed to product a product or
service.
Material Management (Functional areas)
Issue of purchase orders (Activity)
Number of Purchases orders (Cost Driver)
Inspection of materials (Activity)
Number of Purchase orders (Cost Driver)
Personnel pool (Functional area)
Recruitment of employees (Activity)
Number of employees recruited (Cost Driver)
Maintenance of leave records & attendance (Activity)
Number of employees (Cost Driver)
Reference
Weygandt, J. J., Kimmel, P. D., & Kieso, D. E. (2010). Managerial Accounting Tools for
Business Decision Making (5th ed.). Hoboken, NJ: John Wiley & Sons, Inc..
DQ 3
Overhead Allocation
In tracking overhead costs, cost drivers can help allocate overhead costs to cost pools, activities, end
products, and services. How might this computation and allocation process differ between allocating costs
to an end product for a manufacturing concern and a cost activity for a service provider? Provide specific
examples.
Value Add
What are value-added processes? How do you determine if a process adds value? How does
identifying value-added processes help a company run more efficiently and effectively?
Benefits of ABC
The primary benefit of ABC is more accurate product costing. Here's why:
1. ABC leads to more cost pools being used to assign overhead costs to products
2. ABC leads to enhanced control over overhead costs
3. ABC leads to better management decisions
Activity-based costing does not change the amount of overhead costs. What it does do is allocate
those overhead costs in a more accurate manner. Furthermore, if the scorekeeping is more
realistic and more accurate, managers should be able to better understand cost behavior and
overall profitability.
Limitations of ABC
Although ABC systems often provide better product cost data than traditional volume-based
systems, there are limitations:
1. ABC can be expensive to use.
2. Some arbitrary allocations continue Even though more overhead costs can be assigned directly
to products through ABC's multiple activity cost pools, certain overhead costs remain to be
allocated by means of some arbitrary volume-based cost driver such as labor or machine hours
Reference
Weygandt, J. J., Kimmel, P. D., & Kieso, D. E. (2010). Managerial Accounting Tools for
Business Decision Making (5th ed.). Hoboken, NJ: John Wiley & Sons, Inc
BENEFITS OF ABC
The primary benefit of ABC is more accurate product costing. Here's why:
1. ABC leads to more cost pools being used to assign overhead costs to products.
Instead of one plant wide pool (or even departmental pools) and a single cost
driver, companies use numerous activity cost pools with more relevant cost
drivers. Costs are assigned more directly on the basis of the cost drivers used
to produce each product.
2. ABC leads to enhanced control over overhead costs. Under ABC, companies
can trace many overhead costs directly to activitiesallowing some indirect
costs to be identified as direct costs. Thus, managers have become more
aware of their responsibility to control the activities that generate those costs.
3. ABC leads to better management decisions. More accurate product costing
should contribute to setting selling prices that can help achieve desired
product profitability levels. In addition, more accurate cost data could be
helpful in deciding whether to make or buy a product part or component, and
sometimes even whether to eliminate a product.
Activity-based costing does not change the amount of overhead costs. What it does
do is allocate those overhead costs in a more accurate manner. Furthermore, if the
scorekeeping is more realistic and more accurate, managers should be able to
better understand cost behavior and overall profitability.
LIMITATIONS OF ABC
Although ABC systems often provide better product cost data than traditional
volume-based systems, there are limitations:
1. ABC can be expensive to use. The increased cost of identifying multiple
activities and applying numerous cost drivers discourages many companies
from using ABC. Activity-based costing systems are more complex than