| What is a cost system and what is its purposes? | The building block of costing systems is how to trace direct costs to the cost object and how to allocate indirect costs to the cost object. There are two basic methods of allocating costs to the cost object, the job-costing system and process-costing system.
Purpose of cost allocation
1. Provide information for economic decisions (Should a new product line be introduced? Do we have to produce or outsource ourselves?)
2. Motivate managers and other employees (E.g., simplify processes, selling high-profit products)
3. Justify costs or compute reimbursement (E.g., consulting fees in relation to the expected cost reductions)
4. Measure income and assets for reporting to external parties (E.g., to determine the cost of stock, etc. |
| What is a job costing system? | A job is a singular product being individually produced each time. Such as a garage, specific windows for houses etc.
A job costing system allocates costs to individual costs. |
| What are the 6 steps in a job costing system? | 1. Identify the chosen cost object
2. Identify the direct costs of the job
3. Identify the indirect costs associated with each cost-allocation base
4. Select the costs-allocation base
5. Compute the rate per unit of each cost-allocation base used to allocate indirect costs to the job (Actual costing vs normal costing)
6. Compute the cost of the job adding all direct and indirect costs assigned to it |
| What is actual costing vs normal costing, and how does it relate to step 5 in the job costing system? | Normal costing uses budgeted indirect-cost rates where’s actual costing method uses an indirect-cost rate calculated at the end of the year.
The formula is Budgeted total costs in indirect cost pool / budgeted total quantity of cost allocation base.
It is used in step 5 of the job costing system because we must compute the indirect cost rate, hence we must decide if we use normal or actual costing. |
| What does under and over allocated indirect costs mean, and why is it relevant for normal costing? | Normal costing uses a budgeted indirect cost rate to allocate indirect costs. Hence, as it is a forecast, they may allocate too much or too little depending on the actual result.
If there is allocated too little compared to actual result, there is an under allocation.
If there is allocated too much compared to actual result, there is an over allocation. |
| What are the two reasons for under/overallocation of indirect costs? | 1. Numerator reason: Actual manufacturing overhead costs are more than budgeted.
2. Denominator reason: Actual machine hours are more than budgeted. |
| How do you dispose of under- or over allocated overhead? | 1. Adjusted allocation rate approach
Here, the indirect cost rate is adjusted to the actual indirect cost rate. Then, all jobs with the allocated indirect cost rate are recomputed. Hence, we go from normal costing --> actual costing.
2. Proration approach
Here, the under- or overallocation is spread onto WIP, finished goods or COGS. There are 3 methods of doing so, see lecture 3 slide 30-33.
3. Immediate write-off to COGS approach
Method 1 is the most accurate, while method 3 is by far the simplest and will often be the one to use. |
| What is process costing? | Process costing is a way of allocating costs when mass producing a product. The unit cost is found by allocating the same amount of direct and indirect manufacturing costs to each unit cost.
Each unit is assumed to receive the same of the above costs. |
| What are the 5 steps of process costing? | Step 1: Summaries the flow of physical units of output
Step 2: Compute output in terms of equivalent units
Step 3: Compute equivalent unit costs
Step 4: Summaries total costs to account for
Step 5: Assign total costs to units completed and to units in ending WIP stock |
| What are equivalent units? | Two semi-finished goods are equivalent to one finished good. Hence, 10.000 units of 70% finished work equals 7.000 equivalent units.
It is the idea that units in their production phase can be converted to equivalent units (I.e. finished products) to get a more true picture of how the costs are used if many units are not completely finished. |
| What are the two methods of process costing? | 1. WA-method:
2. FIFO-method: |
| What is the difference between single rate method and dual rate method of costing systems? | The single rate method uses one cost pool for fixed and variable costs.
The dual rate method uses two cost pools, one for fixed costs and one for variable costs. |
| How do we allocate support department costs, and what are they called/defined as? | 1. The direct method.
The direct method allocates support department costs to operating departments only.
2. Step-down method.
Allocates support department costs to other support departments and to operating departments. This is the simplest method.
3. Reciprocal method
Allocates costs by including the mutual services provided among all support departments. |
| What is a common cost? | A common cost is a cost that is not attributable to a specific cost object, such as a product or process. When a common cost is associated with the manufacturing process, it is included in factory overhead and allocated to the units produced. |
| How do we allocate common costs? | 1. Stand-alone method: Individual equal assessment – Weighted distribution
2. Incremental: additional cost activity. |
| What are joint costs? | Joint costs are the costs of a single production process that yields multiple products simultaneously. Joint costs are for allocating costs when companies produce two or more products simultaneously out of the same process. |
| What two products are produced in a joint production process? | 1. Joint products: are products with relatively high sales value at the split-off point.
2. By-products: are incidental products resulting from the processing of another product and has a normally relatively low sales value compared to the joint products. |
| What is the split-off point? | Split-off point is the point in a production process where the joint products and by-products become visible. |
| Why is it important to allocate joint costs proporly? | 1. To assign costs to the inventory
2. During cost reimbursement contracts, one might be able to get costs reimbursed during a project. However, one must be able to document their costs to get it reimbursed.
3. Insurance settlements. If the warehouse burns, one must be able to document the value of the product to get insurance pay.
4. To document the value of the goods in a lawsuit. |
| What are the 3 methods of allocating joint costs? | 1. Sales value at split-off method: The value of the product before split-off is allocated to each main and by-product. The most simple method.
2. The physical measurement method: Uses the physical units of production to allocate costs. This method is more applicable to products measured per kg, liters etc. But there is no common unit point for weighting. Hence, it is a problem when products have a much different value.
3. Constant gross-margin percentage NRV method: Allocates joint costs so that the overall gross-margin percentage is identical for each individual product. By far the most difficult method. |
| Why are joint costs irrelevant for decision making? | The costs incurred up to the split-off point are past costs, hence they are sunk costs. Sunk costs mean that these costs were incurred anyways and are therefore irrelevant to the decision to sell a joint (or main) product at the split-off point or to process it further.
Decision making is forward-looking, and we must therefore focus on the future-oriented alternatives. |
| What is stock-costing method, what are the two methods of doing so and how do they impact profits? | 1. Variable costing:
All variable manufacturing costs are assigned to production, and they become part of the unit cost.
This highlights the distinction between variable and fixed costs, hence focusing more on the behavior of costs and the contribution margin.
2. Absorption costing:
Absorption costing enables a manager to increase operating profit in a specific period by increasing the production schedule, even if there is no customer demand for the additional production.
This highlights the distinction between manufacturing and non-manufacturing costs. Hence, the focus is on the gross margin, distinction made by the business function. |
| What is activity based costing? | Activity based costing traces costs to activities. This defers from traditional costing systems, where costs are traced to the product.
Direct costs are traced directly to the cost object.
Indirect costs are allocated based of the activities (Cost driver) and the cost of the activities.
Individual activities = cost objects
ABC-costing is advantageous for:
• Companies with a large product portfolio and diversification
• For companies with many indirect costs, such as maintenance, product development, advanced IT support and other services.
• For companies with an advanced complicated customer portfolio. |
| What does over- and under costing mean? | Undercosting is when a product consumes a relatively high level of resources but is reported to have a relatively low total cost.
Overcosting is when a product consumes a relatively low level of resources but is reported to have a relatively high total cost. |
| What is the 7-step process of ABC costing? | 1. Identify the chosen cost objects.
2. Identify the direct costs of the product.
3. Select the cost-allocation bases to use in allocating indirect costs to the products.
4. Identify the indirect costs associated with each cost-allocation base.
5. Compute the rate per unit of each cost allocation base used to allocate indirect costs to the products.
6. Compute the indirect costs allocated to the products.
7. Compute the costs of the products by adding all direct and indirect costs assigned to them. |
| What is activity based management (ABM) and what is it good for? | ABM describes management decisions that use activity-based costing information to satisfy customers and improve profits.
• Product pricing and mix decisions
- Insight into the cost structures and more accurate product cost information.
• Cost reduction and process improvement decisions
• Design decisions
• Planning and managing activities |
| What are some advantages and disadvantages of implementing and having a ABC costing system? | Advantages:
1. Provides realistic costs of manufacturing for specific products.
2. Allocates manufacturing overhead more accurately if many processes are involved.
3. Is better for optimising processes and the costs associated with them. Is good for Activity based management.
4. Determines product profit margins more precisely.
Disadvantages:
1. Collection and preparation of data is time-consuming and expensive to operate and analyze.
2. Source data can be hard to come by.
3. The data from ABC systems can rarely be used for external reporting as it does not comply with accounting standards. |
