CHAPTER 5: ACTIVITY-BASED COSTING AND ACTIVITY-BASED MANAGEMENT
Document Type : Book Summary
Source : Cost Accounting: A Managerial Emphasis 15th Edition by Charles T.
Horngren, Srikant M. Datar, and Madhav V. Rajan
Learning Objective 1 : Explain How Broad Averaging Undercosts and Overcosts
Products or Services
As product diversity and indirect costs increased, broad averaging led to inaccurate
product costs. That’s because simple peanut-butter costing broadly averages or spreads
the cost of resources uniformly to cost objects when, in fact, the individual products or
services use those resources in nonuniform ways.
Broad averaging often leads to undercosting or overcosting of products or services. This
can lead to certain strategic consequences, as follows. Suppose a manager uses cost
information about products to guide pricing decisions. Undercosted products will be
underpriced and may even lead to sales that actually result in losses because the sales
may bring in less revenue than the cost of resources they use. Overcosted products will
lead to overpricing, causing those products to lose market share to competitors
producing similar products. But what if prices are determined by the market based on
consumer demand and competition among companies? In this case, product
undercosting and overcosting cause managers to focus on the wrong products. Managers
give greater attention to overcosted products that show low profits when in fact costs and
profits from these products are perfectly reasonable. They give less attention to
undercosted products thinking they are highly profitable, when in fact these products
consume large amounts of resources and are far less profitable than they appear.
Learning Objective 2 : Present Three Guidelines for Refining a Costing System
There are three main guidelines for refining a costing system:
Direct-cost tracing - Identify as many direct costs as is economically feasible;
Indirect-cost pools - Expand the number of indirect-cost pools until each pool is more
homogeneous;
Cost-allocation bases - Whenever possible, managers should use the cost driver as
the cost-allocation base for each homogeneous indirect-cost pool.
Document Type : Book Summary
Source : Cost Accounting: A Managerial Emphasis 15th Edition by Charles T.
Horngren, Srikant M. Datar, and Madhav V. Rajan
Learning Objective 1 : Explain How Broad Averaging Undercosts and Overcosts
Products or Services
As product diversity and indirect costs increased, broad averaging led to inaccurate
product costs. That’s because simple peanut-butter costing broadly averages or spreads
the cost of resources uniformly to cost objects when, in fact, the individual products or
services use those resources in nonuniform ways.
Broad averaging often leads to undercosting or overcosting of products or services. This
can lead to certain strategic consequences, as follows. Suppose a manager uses cost
information about products to guide pricing decisions. Undercosted products will be
underpriced and may even lead to sales that actually result in losses because the sales
may bring in less revenue than the cost of resources they use. Overcosted products will
lead to overpricing, causing those products to lose market share to competitors
producing similar products. But what if prices are determined by the market based on
consumer demand and competition among companies? In this case, product
undercosting and overcosting cause managers to focus on the wrong products. Managers
give greater attention to overcosted products that show low profits when in fact costs and
profits from these products are perfectly reasonable. They give less attention to
undercosted products thinking they are highly profitable, when in fact these products
consume large amounts of resources and are far less profitable than they appear.
Learning Objective 2 : Present Three Guidelines for Refining a Costing System
There are three main guidelines for refining a costing system:
Direct-cost tracing - Identify as many direct costs as is economically feasible;
Indirect-cost pools - Expand the number of indirect-cost pools until each pool is more
homogeneous;
Cost-allocation bases - Whenever possible, managers should use the cost driver as
the cost-allocation base for each homogeneous indirect-cost pool.
