Cost Management Systems

1. Cost Management Systems • The Problem with Traditional, Volume-Based Product-Costing Systems: They assign costs to products based on a single activity driver related to volume. • The costs are spread across products like peanut butter based on the volume of products. • Tend to over-cost the high volume products and under-cost the complex, low volume products.

2. Activity-Based Costing • ABC systems assign overhead costs to products or services using a two-stage process that focuses on activities. • Stage One: Assign overhead costs to activity cost pools. • Stage Two: Identify appropriate cost drivers for each cost pool and allocate overhead costs based on proportion of cost driver consumed by each product line.

3. Stage One: ABC system • There should be approximately 8 to 10 cost pools for the ABC system to be effective. • A general rule of fingers (not just thumb): One cost pool for each of your ten fingers.

4. Stage Two: ABC system • Stage Two: Identification of cost drivers and allocation of overhead cost. • Identification of Cost Drivers: A cost driver is a characteristic of an event or activity that results in the incurrence of costs. • Degree of correlation between the consumption of the activity and consumption of the cost driver. • Cost of measurement (implementation and maintenance) must not exceed the cost benefit of the ABC system. Limit the number of drivers to approximately ten. • Behavioral effects that the ABC system has on the decision making of managers must be considered before implementing a cost driver. • Allocation of overhead costs: • The pool rate is the cost per unit of the cost driver for a particular activity cost pool. • A transaction-based costing system identifies multiple cost drivers and assigns costs to products on the basis of the number of transactions they generate for the cost drivers.