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Chapter 7

Chapter 7 - Activity Based Costing and Management

6 Pages

Course Code
ACC 406
Vincent Cappelli

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thWednesday February 15 2012 Chapter 7 Activity Based Costing and Management Limitations of Functional Based Cost Accounting Systems Plantwide and departmental rates based on direct labour hours machine hours or other volume based measures have been used for decades to assign overhead costs to products and continue to be used successfully by many organizations however this approach to costing is equivalent to an averaging approach and may produce distorted or inaccurate costsTwo individuals go out for dinner one orders steak and lobster 40 and other orders salad 10 thus the total cost of food is 50 if the bill were to split evenly between the two each individual will pay 25 25 would be the average cost of the meals NOT actual cost of each meal Therefore one meal is overstated by 15 and other is understated by 15 same way plantwide and departmental rates can produce average costs that are either under or overstated product costs in order for accurate cost information to be produced it is important that the firms cost system accurately reflects the firms underlying business or economic reality unfortunately due to the time commitment and costs required to change cost systems some firms do not change their systems when their business environment changes cost distortions result due to the poor matching between the firms business reality and the cost systems representation of that reality need for a more accurate cost has forced many companies to take a serious look at their costing procedures at least 2 major factors can impair the ability of unit based plantwide and departmental rates to assign overhead costs accuratelyProportion of nonunit related overhead costs to total overhead costs is largeDegree of product diversity is greatNonUnit Related Overhead Costs use of either plantwide rates or departmental rates assumes that a product consumption of overhead resources is related strictly to the units produced For Unit Level Activities activities are performed each time a unit is produced volume based cost systems label the costs associated with these activities as variable in nature because they increase or decrease in direct proportions to increase or decrease in the levels of these unit level activities all other costs that are not unit based are considered fixed by volume based cost systems non unit level activities are activities that are not performed each time a unit of product is produced costs associated with non unit level activities are unlikely to vary increase or decrease with units products sometimes these costs vary with some other factors besides units and identifying factors such as is very helpful in predicating and managing these costs activity based costing ABC refers to the ABC cost hierarchy that categorizes costs either as unit level batch level product sustaining or facility sustainingUnit Level varies with output volume ex units traditional variable costs EX Cost of indirect materials for labeling each bottle of Victorias Secret perfumeBatch Level varies with the number of batches producedEX Cost of setting up laser engraving equipment for each batch of Epiolog key chainsProduct Sustaining varies with the number of product lines
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