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Unformatted text preview: CHAPTER 5 ACTIVITY-BASED COSTING AND ACTIVITY-BASED MANAGEMENT 5-1 Cost smoothing or peanut-butter costing describes a costing approach that uses broad averages for assigning the cost of resources uniformly to cost objects when the individual products or services, in fact, use those resources in a nonuniform way. One way of determining if peanut-butter costing is occurring is to separately examine how individual products (services, customers, etc.) use the resources of the organization and to compare the results with the way the accounting system represents that usage. 5-2 Overcosting may result in competitors entering a market and taking market share for products that a company erroneously believes are low-margin or even unprofitable. Undercosting may result in companies selling products on which they are in fact losing money, when they erroneously believe them to be profitable. 5-3 Costing system refinement means making changes to an existing costing system that reduces the use of broad averages for assigning the cost of resources to cost objects and provides better measurement of the costs of overhead resources used by different cost objects. Three guidelines for refinement are: 1. Classify as many of the total costs as direct costs as is economically feasible. 2. Expand the number of indirect cost pools until each of these pools is more homogenous. 3. Use the cause-and-effect criterion, when possible, to identify the cost-allocation base for each indirect-cost pool. 5-4 An activity-based approach refines a costing system by focusing on individual activities as the fundamental cost objects. It uses the cost of these activities as the basis for assigning costs to other cost objects such as products or services. 5-5 Four levels of a manufacturing cost hierarchy are: (i) Output unit-level costs, costs of activities performed on each individual unit of a product or service. (ii) Batch-level costs, costs of activities related to a group of units of products or services rather than to each individual unit of product or service. (iii) Product-sustaining costs, or service-sustaining costs are the costs of activities undertaken, to support individual products or services regardless of the number of units or batches in which the units are produced. (iv) Facility-sustaining costs are the cost of activities that cannot be traced to individual products or services but support the organization as a whole. 5-6 The purpose for computing a product cost will determine whether unit costs should be based on total manufacturing costs in all or only some levels of the cost hierarchy. Inventory valuation for financial reporting requires total manufacturing costs (all levels of the hierarchy) to be expressed on a per output-unit basis. In contrast, for cost management purposes, the cost hierarchy need not be unitized, as the units of output is not the cost driver at each level in the hierarchy....
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This note was uploaded on 11/09/2010 for the course ACC 3313 taught by Professor Ann during the Spring '10 term at Nanyang Technological University.
- Spring '10
- Cost Accounting