|Activity-Based Cost Systems |[pic] |
Traditional volume-based cost allocation systems that use only drivers that vary directly with the volume of products produced—such as direct labor dollars, direct labor hours, or machine hours—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 costs to the individual products. Costs may vary not only with respect to volume of production, but also, for example, with batch-related activities (e.g., changeovers, setups, and inspection of the first item of production run) and the number of products (e.g., scheduling materials receipts and improving products). 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 volume-related measures do not accurately reflect these differences.
Volume-based traditional product costing systems that use only drivers that vary directly with the volume of products produced—such as direct labor dollars, direct labor hours, or machine hours—are most likely to distort product costs under the following two conditions: (1) Indirect and support expenses are high, especially when they exceed the cost of the allocation base itself (such as direct labor cost); and (2) Product diversity is high: the plant produces both high-volume and low-volume products, standard and custom products, and complex and simple products. The combination of these two conditions will magnify the distortions that arise because volume-based product costing systems do not accurately reflect differences in non-volume-related resource usage across products or other cost objects.
Activity-based costing systems provide more accurate costs when these two conditions hold by creating more accurate links between the causes of indirect and support costs and the bases for assignment of the costs to cost objects. For example, costs may vary not only with respect to volume of production, but also activities such as changeovers, setups, and inspection of the first item of production run, which are not done in proportion to the number of units produced. Moreover, some costs vary with the number of different products (e.g., scheduling materials receipts and improving products).
Yes, traditional costing systems are more likely to overcost high-volume products because all indirect and support costs are assigned to products in proportion to the number of production units (through volume-based cost drivers), and the low-volume products are likely to require higher indirect and support costs per unit. The high-volume products essentially cross-subsidize the low-volume products in the sense that indirect and support costs are assigned uniformly in proportion to volume.
Companies producing a varied and complex mix of products require many more resources to support their highly varied mix, and therefore have higher costs. Examples of the greater resources required include a much larger production support staff to schedule machine and production runs; perform changeovers and setups between production runs; inspect items at the beginning of each production run; move materials; ship and expedite orders; develop new and improve existing products; negotiate with vendors; schedule materials receipts; order, receive, and inspect incoming materials and parts; and update and maintain the much larger computer-based information system.
A significant change in resource costs triggers an update of the capacity cost rates. A significant and permanent change in operations, such as the efficiency with which an activity is performed, triggers an update of the unit time estimate. If new activities become part of operations, the time to perform...
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