• Activity An event that causes the consumption of overhead resources in an organization. (p. 230)
• Activity-based costing (ABC) A costing method based on activities that is designed to provide managers with cost information for strategic and other decisions that potentially affect capacity and therefore fixed as well as variable costs. (p. 227)
• Activity-based management (ABM) A management approach that focuses on managing activities as a way of eliminating waste and reducing delays and defects. (p. 249)
• Activity cost pool A bucket in which costs are accumulated that relate to a single activity measure in an activity-based costing system. (p. 230)
• Activity measure An allocation base in an activity-based costing system; ideally, a measure of the amount of activity that drives the costs in an activity cost pool. (p. 230)
• Batch-level activities Activities that are performed each time a batch of goods is handled or processed, regardless of how many units are in the batch. The amount of resource consumed depends on the number of batches run rather than on the number of units in the batch. (p. 230)
• Benchmarking A systematic approach to identifying the activities with the greatest potential for improvement. (p. 249)
• Customer-level activities Activities that are carried out to support customers, but that are not related to any specific product. (p. 230)
• Duration driver A measure of the amount of time required to perform an activity. (p. 230)
• First-stage allocation The process by which overhead costs are assigned to activity cost pools in an activity-based costing system. (p. 235)
• Organization-sustaining activities Activities that are carried out regardless of which customers are served, which products are produced, how many batches are run, or how many units are made. (p. 230)
• Product-level activities Activities that relate to specific products that must be carried out regardless of how many units are produced and sold or batches run. (p. 230)
• Second-stage allocation The process by which activity rates are used to apply costs to products and customers in activity-based costing. (p. 239)
• Transaction driver A simple count of the number of times an activity occurs. (p. 230)
• Unit-level activities Activities that are performed each time a unit is produced. (p. 230)

Questions:

51 In what fundamental ways does activity-based costing differ from traditional costing methods such as job-order costing as described in Chapter 3?

52 Why is direct labor a poor base for allocating overhead in many companies?

53 Why are top management support and cross-functional involvement crucial when attempting to implement an activity-based costing system?

54 What are unit-level, batch-level, product-level, customer-level, and organization-sustaining activities?

55 What types of costs should not be assigned to products in an activity-based costing system?

56 What are the two stages of allocation in activity-based costing?

57 Why is the first stage of the allocation process in activity-based costing often based on interviews?

58 When activity-based costing is used, why do manufacturing overhead costs often shift from high-volume products to low-volume products?

59 How can the activity rates (i.e., cost per activity) for the various activities be used to target process improvements?

510 Why is the form of activity-based costing described in this chapter unacceptable for external financial reports?

Chapter 6: Differential Analysis: The Key to Decision Making

Glossary:

• Avoidable cost A cost that can be eliminated by choosing one alternative over another in a decision. This term is synonymous with differential cost and relevant cost. (p. 280)
• Bottleneck A machine or some other part of a process that limits the total output of the entire system. (p. 296)
• Constraint A limitation under which a company must operate, such as limited available machine time or raw materials, that restricts the companys ability to satisfy demand. (p. 295)
• Differential cost A future cost that differs between any two alternatives. (p. 280)
• Differential revenue Future revenue that differs between any two alternatives. (p.280)
• Incremental cost An increase in cost between two alternatives. (p. 280)
• Joint costs Costs that are incurred up to the split-off point in a process that produces joint products. (p. 301)
• Joint products Two or more products that are produced from a common input. (p. 300)
• Make or buy decision A decision concerning whether an item should be produced internally or purchased from an outside supplier. (p. 291)
• Opportunity cost The potential benefit that is given up when one alternative is selected over another. (p. 281)
• Relaxing (or elevating) the constraint An action that increases the amount of a constrained resource. Equivalently, an action that increases the capacity of the bottleneck. (p. 299)
• Relevant benefit A benefit that should be considered when making decisions. (p. 280)
• Relevant cost A cost that should be considered when making decisions. (p. 280)
• Sell or process further decision A decision as to whether a joint product should be sold at the split-off point or sold after further processing. (p. 301)
• Special order A one-time order that is not considered part of the companys normal ongoing business. (p. 294)
• Split-off point That point in the manufacturing process where some or all of the joint products can be recognized as individual products. (p. 300)
• Sunk cost A cost that has already been incurred and that cannot be changed by any decision made now or in the future. (p. 281)
• Vertical integration The involvement by a company in more than one of the activities in the entire value chain from development through production, distribution, sales, and after-sales service. (p. 291)

Questions:

61 What is a relevant cost? 62 Define the following terms: incremental cost, opportunity cost, and sunk cost.

63 Are variable costs always relevant costs? Explain.

64 Sunk costs are easy to spottheyre the fixed costs associated with a decision. Do you agree? Explain.

65 Variable costs and differential costs mean the same thing. Do you agree? Explain.

66 All future costs are relevant in decision making. Do you agree? Why?

67 Prentice Company is considering dropping one of its product lines. What costs of the product line would be relevant to this decision? What costs would be irrelevant?

68 If a product is generating a loss, then it should be discontinued. Do you agree? Explain.

69 What is the danger in allocating common fixed costs among products or other segments of an organization?

610 How does opportunity cost enter into a make or buy decision?

611 Give at least four examples of possible constraints.

612 How will relating product contribution margins to the amount of the constrained resource they consume help a company maximize its profits?

613 Define the following terms: joint products, joint costs, and split-off point.

614 From a decision-making point of view, should joint costs be allocated among joint products?

615 What guideline should be used in determining whether a joint product should be sold at the split-off point or processed further?

616 Airlines sometimes offer reduced rates during certain times of the week to members of a businesspersons family if they accompany him or her on trips. How does the concept of relevant costs enter into the decision by the airline to offer reduced rates of this type?

Chapter 7: Capital Budgeting Decisions

Glossary:

• Capital budgeting The process of planning significant investments in projects that have longterm implications such as the purchase of new equipment or the introduction of a new product. (p. 354)
• Cost of capital The average rate of return a company must pay to its long-term creditors and shareholders for the use of their funds. (p. 362)
• Internal rate of return The discount rate at which the net present value of an investment project is zero; the rate of return of a project over its useful life. (p. 364)
• Net present value The difference between the present value of an investment projects cash inflows and the present value of its cash outflows. (p. 359)
• Out-of-pocket costs Actual cash outlays for salaries, advertising, repairs, and similar costs. (p. 364)
• Payback period The length of time that it takes for a project to fully recover its initial cost out of the net cash inflows that it generates. (p. 356)
• Postaudit The follow-up after a project has been approved and implemented to determine whether expected results were actually realized. (p. 374)
• Preference decision A decision in which the acceptable alternatives must be ranked. (p. 354)
• Project profitability index The ratio of the net present value of a projects cash flows to the investment required. (p. 371)
• Screening decision A decision as to whether a proposed investment project is acceptable. (p. 354)
• Simple rate of return The rate of return computed by dividing a projects annual incremental net operating income by the initial investment required. (p. 372)
• Time value of money The concept that a dollar today is worth more than a dollar a year from now. (p. 355)
• Working capital Current assets less current liabilities. (p. 355)

Questions:

71 What is the difference between capital budgeting screening decisions and capital budgeting preference decisions?

72 What is meant by the term time value of money?

73 What is meant by the term discounting?

74 Why isnt accounting net income used in the net present value and internal rate of return methods of making capital budgeting decisions?

75 Why are discounted cash flow methods of making capital budgeting decisions superior to other methods?

76 What is net present value? Can it ever be negative? Explain.

77 Identify two simplifying assumptions associated with discounted cash flow methods of making capital budgeting decisions.

78 If a company has to pay interest of 14% on long-term debt, then its cost of capital is 14%. Do you agree? Explain.

79 What is meant by an investment projects internal rate of return? How is the internal rate of return computed?

710 Explain how the cost of capital serves as a screening tool when using (a) the net present value method and (b) the internal rate of return method.

711 As the discount rate increases, the present value of a given future cash flow also increases. Do you agree? Explain.

712 Refer to Exhibit 78. Is the return on this investment proposal exactly 14%, more than 14%, or less than 14%? Explain.

713 How is the project profitability index computed, and what does it measure?

714 What is meant by the term payback period? How is the payback period determined? How can the payback method be useful?

715 What is the major criticism of the payback and simple rate of return methods of making capital budgeting decisions?