3. As vice president, you probably are pleased with the new ABC system. The cost drivers that are used to allocate activity costs appear to be plausible and reliable and thus probably represent a sound cause-effect model of operations. This will improve both the accuracy of product costing and operating managers’ control over costs. Operating managers will be pleased with the ABC system because it helps them understand how their day-to-day work impacts costs and profits. From a behavioral perspective, this should be highly motivational.
This problem emphasizes the importance of the cost-accounting system to managers. Different systems can result in significantly different management decisions. In this case, the product-line managers’ support for the controller’s idea changes when an ABC system is used to evaluate the idea. Although the company-level gross margins do not change, it is possible that the president would strongly support the idea based on ABC data. Why? Neither of the product-line managers is against the idea, and one strongly supports it. In addition, the president may have more
confidence in the accuracy of the ABC analysis. The substantial losses of the current quarter have been completely eliminated and the serious profitability problem of the cell-phone casing product line has been reversed.
4-1 A cost management system is a collection of tools and techniques that identifies how
management’s decisions affect costs. The three purposes of a CMS are to provide
1. cost information for operational control, 2. cost information for strategic decisions, and
3. measures of inventory value and cost of goods manufactured (or purchased) for
external reporting to investors, creditors, and other external stakeholders.
4-2 a. The production manager needs operational control information. b. Setting the product mix is a strategic decision. c. The cost of inventory that appears on the balance sheet is information that is used by external investors, creditors, and other stakeholders. 4-3 Cost objects are any items for which decision makers desire a separate measurement of costs. They include departments, products, services, territories, and customers. 4-4 No. Products are one of the main cost objects for most companies, but departments are also important cost objects because they represent a logical grouping of activities for which managers desire a separate determination of costs. 4-5 The major purpose of a detailed cost-accounting system is to measure costs for decision making and financial reporting. Cost accounting systems become more detailed as management seeks more accurate data for decision making.
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4-6 The two major processes performed by a cost accounting system are cost accumulation and cost assignment. Cost accumulation is collecting costs by some “natural” classification, such as materials or labor, or by activities performed such as order processing or machine processing. Cost assignment is attaching costs to one or more cost objects, such as activities, processes, departments, customers, or products. 4-7 Managers make important decisions on a daily basis. They base these decisions in large part on financial data provided by the cost accounting system. So it is critically important that the cost accounting system provide accurate and reliable financial information. 4-8 Managers can specifically and exclusively identify direct costs with a given cost object (that is, directly trace them) in an economically feasible way. Indirect costs cannot be so
identified. However, managers can usually identify a plausible and reliable cost driver to use to allocate resource costs to cost objects that consume the resources. When direct tracing is not economically feasible and a plausible and reliable cost driver cannot be found, costs should remain unallocated. 4-9 Yes, the same cost (for example, the department supervisor's salary) can be direct with respect to a department but indirect with respect to the variety of products flowing through a department (e.g., tables, chairs, and cabinets).
4-10 Some costs can be physically linked with a department (or a product), but not in an economically feasible way. An example is the use of departmental meters for measuring power usage. Such devices could measure power costs as direct costs of a department. The alternative is to regard factory power costs as indirect costs of individual departments. Managers often decide whether the resulting increased accuracy provided by individual power meters is worth their additional cost; thus, the test of economic feasibility will decide whether a particular cost is regarded as direct or indirect.
4-11 The four purposes of cost allocation are (1) to predict the economic effects of strategic and operational control decisions, (2) to obtain desired motivation, (3) to compute income and asset valuations, and (4) to justify costs or obtain reimbursement.
4-12 Generally Accepted Accounting Principles (GAAP) require publically-held companies to allocate all production-related costs and only production-related costs to its products for financial reporting to the public.
4-13 No. The costs in a cost pool are not physically traced to cost objects. Only direct costs are traced to cost objects. A cost pool contains indirect costs that are allocated to cost objects using a single cost-allocation base.
4-14 Some possible terms are reallocate, assign, distribute, redistribute, load, apportion, reapportion, and burden.
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4-15 For financial statement purposes, the typical accounting system does not allocate costs associated with value-chain functions other than production to the physical units produced. However, for guiding decisions regarding product-pricing and product-mix decisions, many companies allocate all costs, including R&D, design, marketing, distribution, and customer service costs. However, the allocations of these costs may not be embedded in the system that generates financial statements.
4-16 Yes. The two criteria that should be met before using any measure as a cost-allocation base are economic plausibility and reliability. A measure should be plausible – make common sense. If managers cannot easily understand the logical relationship between a cost allocation-base and the costs of an activity or resource, managers will perceive the resulting allocations as arbitrary.
4-17 Production maintenance costs are normally indirect. Sales commissions normally can be directly traced to specific products. The costs associated with process design are normally unallocated because it is too difficult to identify plausible and reliable cost-allocation bases, although some companies elect to allocate them.
4-18 Generally not. They are direct as far as the physical product is concerned, but in accounting for their cost it would usually be impractical (too costly) to keep records of the amount of glue or tacks used in each unit of product. A more feasible method would be to consider these as supplies (indirect materials).
4-19 Depreciation related to production activities is a product cost, not a period cost. Hence, it will become an expense as a part of manufacturing cost of goods sold. Thus, depreciation is not always an immediate expense.
4-20 \\inventory) and an expense (the cost of goods sold).
4-21 Manufacturing is the transformation of materials into other goods through the use of labor and factory facilities. In contrast, merchandising companies (retailers or wholesalers) sell goods without changing their basic forms. Manufacturing companies differ from merchandising companies in the way they accumulate and report the cost of inventories. Merchandising companies show inventories at the cost they pay to acquire them. In contrast, manufacturing companies classify production costs as either (1) direct material, (2) direct labor, or (3) indirect production costs, and they use the accounting system to determine how much cost of each type should be assigned to product inventories.
4-22 Direct-labor costs are incurred at the same time the direct labor is used in production. Unlike direct materials, it is not purchased and stored for future use. Therefore, there is no direct-labor inventory account.
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4-23 The accuracy of any cost system depends on the complexity of the operating system, the amount of indirect costs, and the reliability of the cost drivers used to allocate indirect costs. A simple operating system coupled with a well-designed traditional costing system with relatively little indirect costs and reliable cost drivers as cost-allocation bases can be just as accurate in providing product or customer costs as a sophisticated ABC system. However, such business environments rarely exist. Further, traditional costing systems do little to aid the operational control purpose of cost-management because they do not accumulate or report operational information about key business activities.
4-24 Activity-based management is using activity-based cost information to improve the operations of an organization. Managers use ABC information for decision making, planning, and controlling purposes. Cost information is vital for each of these purposes. The accuracy level of the cost information is a critical factor in determining the effectiveness of decision making, planning, and controlling.
4-25 One of the most significant non-value-added activities in any manufacturing company is moving inventory, materials, and parts from one point to another during the production process. The time it takes for material-handling labor to move material can be reduced by changing the layout of machines. For example, one company changed its layout so several machines that were used to produce about 50% of its products were placed next to one another. This layout change reduced the distance and time required to move partially completed products from one machine to another. The cost savings were significant.
4-26 Managers seek to eliminate, or at least reduce as much as possible, non-value-added activities. Separating these from value-added activities helps focus attention on the costs to be examined for potential reductions.
4-27 Benchmarking is the continuous process of comparing products, services, and activities against the best industry standards. Companies use benchmarking as a tool to help measure their competitive posture. Benchmarks can come from within the organization, from competing organizations, or from other organizations having similar processes.
4-28 No two businesses operate in the same manner, and often their competitive
environments are significantly different. As a result, comparing either financial or operational measures to benchmarks under the assumption that “all things are equal” should be done with caution. Another important difference between businesses is the degree of accuracy of their cost accounting system. A financial measure such as “cost to serve a commercial customer” in a bank that allocates almost all of its operating costs should not be compared to a benchmark measure from another bank that allocates only a small portion of its operating costs.
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4-29 Six factors that explain why more and more organizations are adopting activity-based costing systems are: 1. Fierce competitive pressure has resulted in shrinking margins, making accurate cost
determinations essential. While companies may know that their overall margin is shrinking, they often do not have faith in the accuracy of the margins for individual products or services. Some are winners and some are losers -- but which ones? 2.
Business complexity has increased, resulting in greater diversity in the types of products and services as well as customer classes. This means that the consumption of a
company’s shared resources also varies substantially across products and customers. New production techniques have increased the indirect proportion of total costs -- that is, indirect costs are far more important in today’s world-class manufacturing environment. In many industries direct labor is being replaced by automated equipment. It is not unusual for indirect cost to be more than 50% of total cost.
The rapid pace of technology change has shortened product life cycles. This means that companies do not have time to make price or cost adjustments once costing errors are discovered.
The costs associated with bad decisions that result from inaccurate cost determinations are substantial (bids lost due to overcosted products, hidden losses from undercosted products, failure to detect activities that are not cost effective, etc.).
Computer technology has reduced the costs of developing and operating ABC systems that track many activities.
3.
4.
5.
6.
4-30 The four steps are:
Step 1. Determine the key components of the ABC system (cost objects, key activities,
resources, and related cost drivers).
Step 2. Determine the relationships among cost object, activities, and resources.
Step 3. Collect relevant data concerning costs and physical flow of cost-driver units among
resources and activities.
Step 4. Calculate and interpret the new activity-based cost information.
4-31 Whenever a resource is constraining the capacity to meet demand, a company can take one or more of the following actions:
a. Reduce demand for the resource. In this case, this means either saying “no” to the
increased business or deferring business (this may not be feasible).
b. Increase capacity. The company can hire additional staff, outsource part of its
order processing function, or permit overtime.
c. Institute process improvements that reduce the consumption of the capacity-constraining resource. The company can investigate ways to reduce the resource consumption rates.
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