AFTER STUDYING THIS CHAPTER, YOU SHOULD BE ABLE TO:
Discuss the limitations of using only unit-based drivers to assign costs. 2.
Provide a detailed description of activity-based product costing. 3.
Describe how homogeneous cost pools can be used to reduce the number of activity rates. 4.
Describe activity-based system concepts including an ABC relational database and ABC software.
THIS CHAPTER EXPLAINS HOW ACTIVITY-BASED COSTING SYSTEMS PRODUCE MORE ACCURATE PRODUCT COST INFORMATION THAN TRADITIONAL COSTING SYSTEMS THAT USE UNIT-BASED DRIVERS. POTENTIAL USERS OF ABC SYSTEMS ARE THOSE COMPANIES THAT PRODUCE MULTIPLE PRODUCTS, HAVE HIGH DEGREE OF PRODUCT DIVERSITY, AND HAVE A SIGNIFICANT PERCENTAGE OF NONUNIT-LEVEL OVERHEAD COSTS. THIS CHAPTER ALSO OUTLINES THE ESSENTIAL STEPS IN DESIGNING AN ABC SYSTEM IN ORDER FOR IT TO BE IMPLEMENTED SUCCESSFULLY. THE CHAPTER CONCLUDES BY DESCRIBING AN ABC RELATIONAL DATABASE AND ABC SOFTWARE.
UNIT-BASED PRODUCT COSTING
Functional-based costing uses only unit-based drivers to assign overhead costs to products. a.
Functional-based costing first assigns overhead costs to a functional unit, creating plant or departmental cost pools. Next, these pooled costs are assigned to products using only unit-based drivers. b.
Unit-based drivers are factors that cause changes in cost as the units produced change. ■ Functional-based costing uses only unit-based drivers because it assumes that overhead consumed by products is highly correlated with the units produced.
Review textbook Exhibit 12-1, which provides a model
of the functional-based product costing system.
Plantwide and Departmental Rates
Both plantwide rates and departmental rates are used to assign overhead costs to products using unit-based cost drivers. 2.
A plantwide rate uses a single cost pool for the entire plant. 3.
Departmental rates use separate cost pools for the different departments.
Review textbook Exhibits 12-3 and 12-4, which show product unit cost computations using plantwide rates and departmental rates, respectively.
The Failure of Plantwide and Departmental Rates
Using plantwide or departmental rates to assign overhead costs will produce inaccurate product costs when: 1.
The proportion of nonunit-related overhead costs to total overhead costs is large (e.g., reaching more than 40 or 50 percent of the total). a.
Using only unit-based activity drivers to assign nonunit-based costs can create cost distortions. b. Nonunit-related overhead costs refer to those costs that are unrelated to the number of units produced but more logically relate to nonunit-based drivers. ■ Nonunit-based drivers are factors, other than the number of units produced, that measure the demands that cost objects place on activities. c.
Setup costs relate to the number of batches of products produced. (2)
Product engineering costs depend on the number of different engineering work orders. (3)
Material-moving costs relate to the number of moves required, not to the number of units produced. 2.
The degree of product diversity is great.
Product diversity means that products consume overhead activities in different proportions because of their differences in product size, product complexity, setup time, and size of batches. b. The consumption ratio measures the proportion of each activity consumed by a product. D.
Potential users of ABC systems can be identified when these companies:
Produce multiple products,
Have a high degree of product diversity, and
3. Have a significant percentage of nonunit-level overhead in production costs.
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