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5-1 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 to uniformly assign the cost of resources to cost objects when the individual products, services, or customers 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 results in a better measure of the way that jobs, products, customers, and so on differentially use the resources of the organization. Three guidelines for refinement are: a. Classify as many of the total costs as direct costs as is economically feasible. b. Select the number of indirect cost pools on the basis of homogeneity. c. Use cost drivers as the chosen allocation bases. 5-4 An activity-based approach focuses on 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, services, or customers. 5-5 Four levels of a manufacturing cost hierarchy are: (i) Output unit-level costs (ii) Batch-level costs (iii) Product-sustaining costs (iv) Facility-sustaining costs 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 or only some 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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5-2 5-7 An ABC approach focuses on activities as the fundamental cost objects. The costs of these activities are built up to compute the costs of products, services and customers, and so on. The traditional approach seeks to have one or a few indirect cost pools, irrespective of the heterogeneity in the facility. An ABC approach attempts to use cost drivers as the allocation base, whereas the traditional approach is less clear on this issue. 5-8 Four decisions for which ABC information is useful are: (1) pricing and product mix decisions, (2) cost reduction and process improvement decisions, (3) design decisions, and (4) planning and managing activities 5-9 No. Department indirect-cost rates are similar to activity-cost rates if (1) a single activity
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