Costing Concerns in Society

In todays competitive economy, the monetary value structure is more more complex than that of the past, and there is a lot less(prenominal) elbow room for error than that anyowed in the more laid back economy of the past. Todays be concerns arise from the growing disparity between direct and indirect fruit be. Ameri chamberpot manufacturers convey been pursuing a steady stream of manufacturing manners and technologies. The finis was simple and uniform to reduce or eliminate direct cost. nevertheless as manufacturing has evolved, so has the structure of a crossings cost. Direct costs, such as get, be no longer the dominant cost of a crossway. The cost of indirect activities such as automation, marketing, sales, design, and order processing move over dramatically increased. Overhead has grown to become the most expensive element of product cost structure.This might not be so bad if unoriginal product costing carcasss could handle the shift in cost structure. Unfortun ately, they fagt. Most conventional systems allocate bang based on approximately burdened rate (direct labor hours is a good example). This was acceptable when strike was small and direct costs were high. only in todays automated factory, this can lead to disaster. established systems report inaccurate product costsoft clock grossly inaccurate. Management, in turn, makes strategic decisions based on these inaccurate product costs.Traditional cost systems assume all hit activities are consumed equally by all products relative to volume produced. Further, all costs are allocated to products because the system assumes that current output drives current command processing overhead costs. Overhead costs are allocated to products on the basis of the products demand for approximately volume variable direct cost, usually labor hours, machine hours, or materials cost. But none of these bases individually represents the actual overhead incurred to make the product. Conventional thinkin g holds that the inaccuracy is not relevant because in total all costs are accounted for, and on average the relative distortion in valuation account reporting can not be significant.Activity based costing, by contrast, identifies what activities are performed by the overhead organization and calculates the cost incurred to perform severally use. Costs are traced to products on the basis of the individual products demand for these activities throughout the process of converting raw materials, energy and human enterprise into the finished article. The assignation bases used in first rudiment, so, are the quantifications of activities performed. These might include hours of labor or number of measure handled.As already mentioned, conventional costing often leads to gross inaccuracies. This is because direct costsespecially direct laborhave been minimized by automation. At the same time, indirect costs have increased dramatically. And its the indirect costs that get averaged acr oss product lines by conventional methods.To see how bad the errors can be, look at the following chart. Conventional costing says that product B has a practically lower overhead cost per unit ($4.80 vs. $7.20 for intersection A). But this cant be so. overlap B consumes five times as much engineering shift activity as Product A. Product B should cost more to produce.What has happened here is that the conventional system has averaged overhead costs across both products. The total cost of engineering changes is carve up by the total direct labor hours. The result, $2.40 per direct labor hour, is then applied to each product. This overhead averaging causes Product A to campaign an partialand inaccurateportion of the overhead costs.Now guess what happens when these cost figures are used in pricing. Product A will probably be overpriced for the market, and Product B will be sold for less than its true production cost.Conventional costing says that product B has a much lower overhea d cost per unit ($4.80 vs. $7.20 for Product A). But this cant be so. Product B consumes five times as much engineering change activity as Product A. Product B should cost more to produce.What has happened here is that the conventional system has averaged overhead costs across both products. The total cost of engineering changes is divided by the total direct labor hours. The result, $2.40 per direct labor hour, is then applied to each product. This overhead averaging causes Product A to carry an unfairand inaccurateportion of the overhead costs.Now, using the ABC concept, the costs are apportioned according to a driver, the number of engineering change orders. (ECOs) The next graph shows the reallocation of overhead costs by the ABC method. Product B is now carrying its fair share of ECO processing costs. As would be expected, Product B actually costs five times more than Product A in terms of indirect activity consumption.As you have seen, activity based costing can say much clea rer insight into the operations of a business than the conventional method .of the past. When ABC is used as a management system, it is a almighty tool for rethinking and improving products, services, processes and a companys market strategies.