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Unformatted text preview: CHAPTER 5 ACTIVITY-BASED COSTING AND ACTIVITY-BASED MANAGEMENT 5-1 Broad averaging (or peanut-butter costing) describes a costing approach that uses broad averages for assigning (or spreading, as in spreading peanut butter) the cost of resources uniformly to cost objects when the individual products or services, in fact, use those resources in non-uniform ways. Broad averaging, by ignoring the variation in the consumption of resources by different cost objects, can lead to inaccurate and misleading cost data, which in turn can negatively impact the marketing and operating decisions made based on that information. 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 a simple 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 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: 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: costs of activities that cannot be traced to individual products or services but support the organization as a whole. 5-6 It is important to classify costs into a cost hierarchy because costs in different cost pools relate to different cost-allocation bases and not all cost-allocation bases are unit-level. For example, an allocation base like setup hours is a batch-level allocation base, and design hours is a product-sustaining base, both insensitive to the number of units in a batch or the number of units of product produced. If costs were not classified into a cost hierarchy, the alternative would be to consider all costs as unit-level costs, leading to misallocation of those costs that are not unit-level costs. unit-level costs....
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- Spring '11