LIMITATIONS OF FUNCTIONAL BASED COST

ACCOUNTING SYSTEMS
How does a company know
if its functional-based costing is producing distorted cost?

Overhead costs have increased in significance over time and

in many firms represent a much higher percentage of product
costs than direct labor.
Assigning overhead using only unit-based drivers can distort
product costs. This can be a serious matter if the non-unit-based
overhead costs are a significant proportion of total overhead
costs.

Non-Unit-Related Overhead Costs

Definition

Factors that measure consumption of non-unitlevel activities by product & can distort product
costs.

Product Diversity
Definition

Products consume overhead activities in

systematically different proportions.

Symptoms of an Outdated Functional Costing System are:

1. The outcome of bids is difficult to explain.
2. Competitors prices appear unrealistically low.
3. Products that are difficult to produce show high profits.
4. Profit margins are difficult to explain.
5. The company has a highly profitable niche all to itself.
6. Customers do not complain about price increases.

Creating Distortions
When a unit-level approach is used to assign non-unit-level
costs (overhead), cost information can be distorted.

Cost Distortions: Plantwide Cost

Assignment
Proportional
application
assigns 9
times as much
overhead to
Regular
phones.
Should
we
assume that
regular phones
will use 9 times
more overhead
cost than
cordless
phones?