Book cover for Cost Accounting A Managerial Emphasis

Cost Accounting A Managerial Emphasis

Charles T. Horngren, Srikant M. Datar, Madhav V. Rajan

ISBN #9780132109178

14th Edition

910 Questions

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44,957 Students Helped

Homework Questions

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Summary
Learning Objectives
Key Concepts
Example Problems
Explanations
Common Mistakes

Summary

This chapter section highlights the pitfalls of broad averaging in cost allocation, such as undercosting, overcosting, and product-cost cross-subsidization, which can severely impact pricing decisions and managerial focus. By implementing activity-based costing, which involves direct cost tracing, organizing homogeneous cost pools, and using specific cost drivers, managers can achieve a more accurate reflection of product costs. This, in turn, supports more informed strategic decisions related to pricing, product mix, and process improvements.

Learning Objectives

1

Explain how broad averaging in cost allocation can lead to undercosting and overcosting of products.

2

Describe the concept of product-cost cross-subsidization and its impact on pricing decisions.

3

Analyze the benefits of activity-based costing (ABC) in providing more accurate product cost information.

4

Evaluate methods to refine costing systems through direct cost tracing, homogeneous indirect cost pools, and appropriate cost drivers.

5

Discuss how accurate cost information improves strategic decisions in pricing, product mix, and process improvement.

Key Concepts

CONCEPT

DEFINITION

Broad Averaging

A cost allocation method that applies a general average rate across products, often leading to inaccurate cost allocation.

Undercosting

The allocation of costs that is less than the actual cost incurred, potentially resulting in underpricing of a product.

Overcosting

The allocation of costs that is greater than the actual cost incurred, which can lead to overpriced products.

Product-Cost Cross-Subsidization

A misallocation phenomenon where some products are subsidized by others due to generalized cost allocation methods.

Activity-Based Costing (ABC)

A costing methodology that assigns indirect costs to products based on the activities and cost drivers that truly contribute to resource consumption.

Direct Cost Tracing

A method of assigning costs directly to a product, improving the accuracy of cost information.

Homogeneous Indirect Cost Pools

Grouping indirect costs based on similar activities or cost drivers to facilitate more precise allocation.

Cost Hierarchies

A structure that organizes costs based on the level of activity drivers, used to identify appropriate cost drivers for allocation.

Example Problems

Example 1

What is broad averaging and what consequences can it have on costs?

Example 2

Why should managers worry about product overcosting or undercosting?

Example 3

What is costing system refinement? Describe three guidelines for refinement.

Example 4

What is an activity-based approach to designing a costing system?

Example 5

Describe four levels of a cost hierarchy.
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Step-by-Step Explanations

QUESTION

How does broad averaging lead to product-cost cross-subsidization?

STEP-BY-STEP ANSWER:

Step 1: Identify the broad averaging method used for cost allocation.
Step 2: Recognize that this method computes an average cost for all products without accounting for product-specific resource usage.
Step 3: Understand that products with lower actual resource consumption may be overcosted while products with higher consumption are undercosted.
Step 4: See that the imbalances cause some products to effectively subsidize the costs of others, hence cross-subsidization occurs.
Final Answer: Broad averaging fails to reflect the true cost of each product, resulting in some products being undercosted and others overcosted, which leads to product-cost cross-subsidization.

Product-Cost Cross-Subsidization

QUESTION

How does activity-based costing improve product costing accuracy compared to broad averaging?

STEP-BY-STEP ANSWER:

Step 1: Begin by identifying all activities that incur indirect costs in the production process.
Step 2: Group indirect costs into homogeneous pools based on similar activities.
Step 3: Select appropriate cost drivers that cause costs in each activity pool.
Step 4: Trace costs to products based on their actual consumption of each activity.
Step 5: Compare the allocated costs with actual resource usage, revealing more accurate product cost information.
Final Answer: By linking costs directly to activities and using specific cost drivers, ABC allocates costs more precisely, thereby enhancing the accuracy of product costing.

Activity-Based Costing (ABC)

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Common Mistakes

  • Assuming that a simple average method accurately reflects the real costs of all products.
  • Confusing activity-based costing with traditional costing methods that rely on broad averaging.
  • Ignoring the importance of selecting appropriate cost drivers within cost hierarchies.
  • Overlooking the impact of miscosting on pricing and strategic decision making.