Using only unit-based activity drivers to assign nonunit-related overhead costs can cause

Activity-Based Costing

Both plantwide and departmental rates rely on unit-level drivers to assign overhead to products. However, not all overhead is caused by or related to units produced. Setup costs, for example, are incurred each time a batch is produced and a batch may consist of 1,000 units or 10,000 units. Setup costs tend to increase as batches increase—not as units produced increase. There are other factors, called non-unit drivers, which better measure the demand that products place on non-unit overhead activities. If non-unit overhead resources are a significant portion of total overhead, then using only unit-based drivers to assign overhead may create distorted product costs. Distorted product costs will not occur provided that products consume the non-unit overhead activities in (THE SAME PROPORTION/ DIFFERENT PROPORTIONS) as the unit-level activities. Product cost distortion requires that product diversity, which means simply that products consume overhead activities in (THE SAME PROPORTION/ DIFFERENT PROPORTIONS). Product diversity is caused by such things as differences in (select all that apply): (PRODUCT COMPLEXITY, PRODUCT SIZE, SETUP TIME, AND SIZE OF BATCHES/ PRODUCT NAME AND PLANT SIZE).

A direct method of overcoming the distortions caused by unit-level rates when product diversity exists (assuming non-unit level overhead is significant) is to expand the number of rates used so that the rates reflect the actual consumption of overhead costs by the various products. Instead of pooling the overhead costs in a plant or departmental pools, rates are calculated for each individual overhead activity. The activity rates are based on causal factors that measure consumption. Costs are assigned to each product by multiplying the activity rates by the amount consumed of each activity, as measured by the activity driver.

Activity costs can also be assigned using consumption ratios. Consumption ratios reflect the proportion of an activity consumed by the individual products. If the activity consumption ratios are approximately equal to the direct labor consumption ratio, then this would indicate that there is (SIGNIFICANT PRODUCT DIVERSITY/ LITTLE PRODUCT DIVERSITY).

A direct method of overcoming the distortions caused by unit-level rates when product diversity exists (assuming non-unit level overhead is significant) is to expand the number of rates used so that the rates reflect the actual consumption of overhead costs by the various products. Instead of pooling the overhead costs in a plant or departmental pools, rates are calculated for each individual overhead activity. The activity rates are based on causal factors that measure consumption. Costs are assigned to each product by multiplying the activity rates by the amount consumed of each activity, as measured by the activity driver.

Activity costs can also be assigned using consumption ratios. Consumption ratios reflect the proportion of an activity consumed by the individual products. If the activity consumption ratios are approximately equal to the direct labor consumption ratio, then this would indicate that there is (SIGNIFICANT PRODUCT DIVERSITY/ LITTLE PRODUCT DIVERSITY). This (WELL/ POORLY) and that there is (NO NEED/ A STRONG NEED) for activity rates. The total of all assigned activity costs is the amount of overhead consumed by-products. Because the assignment uses causal factors, it tends to be ( RELATIVELY MORE/ RELATIVELY LESS) 

accurate than assignments using only unit-level drivers.

Apply the Concepts

Scenario IV: Goodmark Company produces two types of birthday cards: scented and regular. Expected product data for the coming year are given below. Overhead costs are identified by activity.

Overhead costs: