Overcasting
A product consumes a low level of resources but is allocated high costs per unit
Under casting
A product consumes a high level of resources but is allocated low costs per unit
Overcosting One Product and Undercosting Another
-The over casted product absorbs too much cost, making it seem less profitable than it really is
-The under casted product is left with too little cost, making it seem more profitable than it is
Problem: Cross-subsidization
The results of using normal costing with one cost allocation base
Solution: Implementing ABC
-Identifying the activities that drive indirect costs
>Numerous activities may drive indirect costs
>Better indirect cost allocation occurs when these drivers are identified:
+Accountant will need to understand business process
*Observing operations
*Interviewing employees
*Examining data on potential cost drivers and indirect costs
Solution: Implementing ABC (con.)
-Establishing indirect cost pools
>Indirect cost pools should include "homogenous" costs
+Those driven by the same cost driver
+Should have the same cause and effect relationship with a cost driver
Steps to ABC
1) Create budgeted cost pools for each category of indirect cost
2) Create budgeted amounts of each cost allocation base
3) Calculate an allocation rate for each pool/base combo
4) Calculate the OH allocation using the allocation bases for each particular job
Reasons to Select ABC
1) Increase in product diversity (Different kinds of products require different OH/indirect costs
2) Increase in indirect costs (More indirect costs make issues with over/under costing more severe
3) Advances in information technology (Makes the use of multiple allocation bases easier)
4) Increased competition (Makes accurate costing more important when sales prices are set based on a mark-up of production costs)
Unit-Level Costs
Costs that are driven by each individual unit of production
-Machine maintenance costs, utilities, line supervisor salary
Batch-Level Costs
Costs that are driven by groups of units of production, or batches
-Machine set-up costs, materials handling, documentation costs
Product-Sustaining Costs
Costs that are driven by the decision to produce a product category
-Engineering & design, marketing, plant rent
Facility-Sustaining Costs
Costs that are driven by the existence of the organization and not any particular product line
-Management, office rent, accounting systems
Reason 1 ABC is Decision Useful
More accurate costing and product pricing and mix decisions
-Companies can identify the proper pricing for products
-Companies know what to market (higher margin products)
-Companies can identify unprofitable products they may need to be eliminated
Reason 2 ABC is Decision Useful
More accurate costing and cost reduction and process improvement
-Companies can identify wasteful activities and improve the efficiency of resource usage
Reason 3 ABC is Decision Useful
More accurate costing and product design
-Products can be designed with a more precise idea of the indirect costs that their production will consume
Reason 4 ABC is Decision Useful
More accurate costing and planning
-Financial plans and budgets will be more precise as future indirect cost projections will be more accurate
