97 Chapter 4 Activity Based Cost Systems QUESTIONS 4 1Conventional cost systems are likely to systematically distort product costs because they break the link between the cause for the costs and the basis for assignment of the cost to the individual products Two factors that contribute to such cost distortions are 1 the use of unit related measures to allocate indirect costs and 2 differences in relative consumption ratios of indirect resources between cost objects Unit related measures are used to allocate support costs to products but the demand for activities might be driven by batch related and product sustaining cost drivers Also cost distortions tend to be greater with greater differences between relative proportions of indirect resources used by cost objects because traditional cost assignments based on unit related measures do not accurately reflect these differences 4 2Conventional costing systems allocate batch related and product sustaining costs in proportion to a unit related measure In a highly automated plant costs of batch related and product sustaining activities are greater Allocating these costs based on a unit related measure distorts costs Activity based costing systems correct the distortion by employing appropriate cost drivers for different activities to assign costs to products 4 3Yes conventional costing systems are more likely to overcost high volume products because batch related and product sustaining costs are assigned to products in proportion to the number of production units Atkinson Solutions Manual t a Management Accounting 5E 98 4 4Activity cost driver is the unit of measurement for the quantity of the activity used to produce individual products or services Activity cost drivers identify the linkage between activities and cost objects such as products services and customers An activity cost driver rate is the ratio of the cost of the resources required to provide an activity to the total quantity of the cost driver that is the practical capacity quantity made available by those resources 4 5The major steps to determine activity cost driver rates in a traditional activity based cost system are Step 1 Identify the activities performed by the organization prepare an activity dictionary Step 2 Determine the cost of performing each activity Step 3 Identify a cost driver for each activity Step 4 Determine the number of units of the cost driver practical capacity made available by the resources committed to each activity Step 5 Divide each activity cost by the relevant activity cost driver units to obtain each activity cost driver rate 4 6Under the framework of a conventional cost system costs are allocated to products based on unit related measures such as machine hours and direct labor hours Distortion caused by the use of unit related measures to allocate costs is corrected in activity based costing systems because batch related activity costs are assigned to jobs on the basis of batch related cost drivers 4 7No this statement is not correct Activity based costing systems use different cost drivers to better link the activities performed to the products manufactured The reason they provide more accurate product costs is that they take into account the demand placed on a hierarchy of activities for example unit level batch level and product level by different products not because they use more cost drivers A system that uses many cost drivers that do not reflect the activity costs such as a system that relies only on unit related cost drivers is also likely to distort product costs 4 8Activity based costing systems use cost drivers that link the activities performed to the cost objects that use the activities For example the cost objects might be products services or customers Chapter 4 Activity Based Cost Systems 99 4 9Using the number of setups instead of setup hours is appropriate when all products require approximately the same number of setup hours per batch 4 10 Managers use the information on activity costs to identify opportunities for operational improvements and reductions in operations costs decisions about product mix and pricing and targeted customer segments An example of an operational change is requiring minimum order sizes to eliminate short unprofitable production runs Another example is changing the facility layout to reduce moves of work in progress Product designs can be changed in order to manufacture products with fewer parts or common parts to reduce material handling support costs Finally if activity based cost analysis shows that full pallet shipments are less costly per unit than partial pallet shipments customers can be encouraged to receive full pallet shipments Of course customers who insist on very small order sizes or partial pallet shipments can be charged a price high enough to cover the extra costs associated with such activities 4 11 The activity cost driver rate should reflect the underlying efficiency of the process the cost of resources