Why are traditional volume based cost allocation systems likely to systematically distort product cost?
|
Show
EA 5-1 CHAPTER 5 ACTIVITY-BASED COSTING AND ACTIVITY-BASED MANAGEMENT 5-1 What is broad averaging, and what consequences can it have on costs? Broad averaging (or ―peanut-butter costing‖)describes a costing approach that uses broad averages for assigning (or spreading, as in spreading peanut butter) the cost of resources uniformly to cost objects when the individual products or services, in fact, use those resources in non-uniform ways. Broad averaging, by ignoring the variation in the consumption of resources by different cost objects, can lead to inaccurate and misleading cost data, which in turn can negatively impact the marketing and operating decisions made based on that information. 5-2 Inaccurate costing can result in two deviations. Name the two deviations and explain how they can impact a business. These two deviations are overcosting and undercosting. Undercosting will cause underpricing which can lead to sales that actually result in losses, because the sales may bring in less revenue than the cost of resources, though the company is under the assumption that it is making a profit. Overcosting will lead to overpricing, causing a loss in market share to competitors producing similar products. 5-3 What is costing system refinement? Describe three guidelines for refinement. Costing system refinementmeans making changes to a simple costing system that reduces the use of broad averages for assigning the cost of resources to cost objects and provides better measurement of the costs of overhead resources used by different cost objects. Three guidelines for refinement are 1. Classify as many of the total costs as direct costs as is economically feasible. 2. Expand the number of indirect cost pools until each of these pools is more homogenous. 3. Use the cause-and-effect criterion, when possible, to identify the cost-allocation base for each indirect-cost pool. 5-4 What are the fundamental cost objects in activity-based costing? How does activity-based costing work? Individual activities are the fundamental cost objects in activity-based costing. Activity-based costing first uses resource drivers to assign the costs of resources to individual activities and then it uses activity drivers to assign the cost of these activities to products or services (as final cost objects). 5-5 How can a cost hierarchy lead to a more accurate costing system? A cost hierarchy can lead to a more accurate costing system by focusing on the levels of cause- and-effect relationships between various activity cost pools on the one hand and final cost objects on the other hand. It categorizes various activity cost pools into four individual levels on the basis of the different types of cost drivers, cost-allocation bases, or the different degrees of difficulty in determining cause-and-effect relationships. These four levels of a cost hierarchy Under what two conditions are volume based traditional product costing systems most likely to distort product costs?There are two main causes of product cost distortions in traditional costing, i.e., where a single production volume based overhead rate is used by each product department. These include product volume differences (or product volume diversity) and product differences (or product diversity).
What are the problems of traditional costing?The trouble with traditional costing is that factory overhead may be much higher than the basis of allocation, so that a small change in the volume of resources consumed triggers a massive change in the amount of overhead applied.
Why can't traditional product costing systems account for costs of volume diversity?The costing system does not provide information that assists managers in determining the costs of changes in product diversity. These changes may relate to variations in product mix, decisions to drop a product line or the introduction of new products.
Which costing system is most likely to produce the least cost distortion?The correct answer is (a) activity-based costing. Activity-based costing helps the cost to be allocated properly to the cost objects. That's why it is the cost system that will reduce the distortion in costs since it considers the different cost drivers and cost pools.
|
