Product Costing
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Module 5 Case Analysis: Product Costing
INTRODUCTION
How much does a product cost? How can a company determine the cost of a product? These are questions every manager needs to be able to answer. Most companies allocate overheads to products using a two-stage procedure. In the first stage overheads are assigned to cost centers, while the second stage allocates the costs accumulated in the cost center to products. Activity Based Costing (ABC) basically seeks to remove some of the variable costs incorrectly applied to the fixed costs. In this paper I will differentiate between traditional costing and ABC as it applies to the case study about Steinway Piano. First I will define the terms: traditional cost allocation and ABC. Then I will determine why Steinway Piano is a good candidate for ABC. Finally, I will identify several dysfunctional decisions that could be made using the traditional cost allocation method; after all, accurate decisions are vital to success.
Traditional Cost Allocation
The traditional costing systems focus on the product in the costing process (King, 2000). Costs are traced to the product because each product item is assumed to consume the resources; therefore, traditional allocation bases measure only attributes of the individual product item. For example, these would be the number of direct labor hours or machine hours or value of materials consumed. However, in many modern-manufacturing operations, overheads are not homogeneous in terms of being primarily influenced by volume. Indeed it could be argued that the majority of overheads in a modern manufacturing operation are largely unaffected by changes in production volume.
The logical conclusion is that if products are to be costed in a manner that reflects their actual consumption of resources then they must absorb their share of overheads on the basis of the activities; nevertheless, traditional cost systems focus on the product. Costs are traced to the product...
INTRODUCTION
How much does a product cost? How can a company determine the cost of a product? These are questions every manager needs to be able to answer. Most companies allocate overheads to products using a two-stage procedure. In the first stage overheads are assigned to cost centers, while the second stage allocates the costs accumulated in the cost center to products. Activity Based Costing (ABC) basically seeks to remove some of the variable costs incorrectly applied to the fixed costs. In this paper I will differentiate between traditional costing and ABC as it applies to the case study about Steinway Piano. First I will define the terms: traditional cost allocation and ABC. Then I will determine why Steinway Piano is a good candidate for ABC. Finally, I will identify several dysfunctional decisions that could be made using the traditional cost allocation method; after all, accurate decisions are vital to success.
Traditional Cost Allocation
The traditional costing systems focus on the product in the costing process (King, 2000). Costs are traced to the product because each product item is assumed to consume the resources; therefore, traditional allocation bases measure only attributes of the individual product item. For example, these would be the number of direct labor hours or machine hours or value of materials consumed. However, in many modern-manufacturing operations, overheads are not homogeneous in terms of being primarily influenced by volume. Indeed it could be argued that the majority of overheads in a modern manufacturing operation are largely unaffected by changes in production volume.
The logical conclusion is that if products are to be costed in a manner that reflects their actual consumption of resources then they must absorb their share of overheads on the basis of the activities; nevertheless, traditional cost systems focus on the product. Costs are traced to the product...