ABC and Product Cost Distortion (14-5 to 14-10)

To implement ABC, activity cost pools usually are calculated by estimating what
portion of the efforts of each cost center, team, or employee is devoted to each

significant activity.
Using these estimates, the costs of each center or other overhead cost category are

divided into portions assigned to each activity.

Many activity cost pools can result and for each one an appropriate activity driver is

selected.
Two cost pools with the same activity driver can be combined.
If a single activity driver cannot be identified for practically all cost in a cost pool,
then the pool is divided into two or smaller, more homogeneous cost pools, each with

its own activity driver.

In dual company, departments already exist and overhead cost are routinely

accumulated for each department.

For convenience, Dual company formed activity cost by reallocating each

departments overhead to activities.

Dual company used estimates of employees time spent on each activity as the

resource driver for allocating each departments total overhead to activity cost pools.
In contrast, Duals existing traditional costing system identified only the total of all

overhead and allocated it based on direct labor hours.

Even if the traditional costing system had been departmentalized, it would not be an
approximation of ABC, because departments generally do not correspond to activities.
One department can perform many activities, and a single activity can involve many

department.
Overhead rates for ABC can be actual or predetermined.
The exhibits use actual overhead cost of the past year = the calculated ABC rates are

actual overhead rates.

To use ABC for routine product costing during the year, the rates generally are
calculated from estimated amounts of overhead costs and estimated measures of

drivers = predetermined rate are used.

The first important point about the differences between two systems reported product
cost is that the direction of the difference is predictable: compare to ABC, the
traditional system inevitably reports a higher unit cost for the high-volume product

and a lower unit cost for the low-volume product.

Second, the amount of cost different between two systems can be explained
systematically.

The final point concerning the differences of the two system is that the precise
circumstance that cause a traditional systems cost distortion can be identified by

linking the data to the reconciliation.

One circumstance necessary for product cost distortion is a complex cost structure,

one that entails significant amounts of non-volume-related costs.

If non-volume-related costs are insignificant, the traditional systems distortions

inevitably are insignificant, because they are percentages of insignificant amounts.

The other circumstance necessary for product cost distortion is a diverse product line.
A diverse product line is one in which different products consume different mixes of
volume-related and non-volume-related costs.