Slide 20 Cost management systems can be broadly classified as traditional or

Slide 20 cost management systems can be broadly

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is the manufacturing cost of all goods that were sold during the period. (Slide 20)Cost management systems can be broadly classified as traditionalor activity-based. Both traditional andactivity-based costing systems are widely used in practice. As both can be used in the same company, the text integrates the treatment of the two types of costing systems.A traditional cost accountingsystemassumes that all costs can be classified as fixed or variable with respect to changes in production volume. Unit-based or volume-based drivers such as direct labor hours 9
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or machine hours are used to assign production costs to products. Assignment of costs using unit-based drivers does not consider all of the causalfactors of cost incurrence and is therefore classified as allocation. A traditional operation controlsystemassigns costs to organizational units and then holds the organizational unit manager responsible for controlling the assigned costs. Performance is measured by comparing actualoutcomes with standardor budgetedoutcomes. The emphasis here is on financial measures of performance, and managers are rewarded for controlling costs.(Slide 21)An activity-based cost accounting systememphasizes tracing drivers ofcosts instead of allocating them. Driver tracing includes the use of non-unit-based activity drivers. Driver tracing should increase the accuracy of cost assignments and the overall relevance of cost information. The emphasis of the operationcontrol system is the management of activitiesrather than costs. The emphasis of performance evaluationis on the organization as a whole rather than subunits. Both financial and nonfinancial measures are used for evaluation purposes. (Slide 22)Exhibit 2.7 (page 49) displays an activity-based management model, while Exhibit 2.8 (page 50) compares the characteristics of the traditional and activity-based cost management systems.(Slide 23)In deciding to choose a cost management system, a manager must assess the trade-off between the cost of measurement and the cost of errors. An activity-basedcost management system offers significant benefits, but is more complexand costly. Measurement costsare the costs associated with the measurements required by the cost management system. Error costsare the costs associated with making poor decisions based on bad cost information. Although the two costs conflict, an optimal cost management system would minimize the sum of both. (Slide 24)The trade-off between error and measurement costs is illustrated in Exhibit 2.9 (page 51). (Slide 25) Exhibit 2.10 (page 52) illustrates how changing error and measurement costs can make an existing cost management system obsolete. As the exhibit illustrates, a more accurate cost management system is mandated because of changes in error and measurement costs. Firms then should consider implementing an activity-based management (ABM) system if they have experienced a decrease in measurement costs and an increase in error costs. 10
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