Comparing Alternative Costing Systems

Exhibit 5-6 compares the simple costing system using a single indirect-cost pool (Exhibits 5-1 and 5-2) that Plastim had been using and the newly developed ABC system (Exhibits 5-3 and 5-5). Note three points in Exhibit 5-6, consistent with the guidelines for refining a costing system: (1) ABC systems classify more costs as direct costs; (2) ABC systems have more indirect-cost pools that reflect homogenous costs of the different activities; and (3) for each activity-cost pool, ABC systems seek a cost-allocation base that has a cause-and-effect relationship with costs in the cost pool (cost driver).

Exhibit 5-6

Comparing Alternative Costing Systems

A table shows the various cost categories and cost for simple costing system using a single indirect-cost pool, ABC system and the difference between them.

The details of the table are as follows:

  1. Direct-cost categories

    1. Simple costing system using a single indirect-cost pool (1): 2

      1. Direct materials

      2. Direct manufacturing labor

    2. ABC system (2): 3

      1. Direct materials

      2. Direct manufacturing labor

      3. Direct mold cleaning and maintenance labor

    3. Difference (3) equals (2) minus (1): 1

  2. Total direct costs

    1. Simple costing system using a single indirect-cost pool: dollar 2,595,000

    2. ABC system: dollar 2,865,000

    3. Difference: dollar 270,000

  3. Indirect-cost pools

    1. Simple costing system using a single indirect-cost pool: 1

      1. Single indirect-cost pool allocated using direct manufacturing labor-hours

    2. ABC system: 6

      1. Design (parts-square feet), Machine operations (molding machine-hours), Shipment setup (shipment setup-hours), Distribution (cubic feet delivered), and Administration (direct manufacturing labor-hours)

    3. Difference: 5

  4. Total indirect costs

    1. Simple costing system using a single indirect-cost pool: dollar 2,385,000

    2. ABC system: dollar 2,115,000

    3. Difference: (dollar 270,000) in parenthesis

  5. Total costs assigned to simple (S3) lens

    1. Simple costing system using a single indirect-cost pool: dollar 3,525,000

    2. ABC system: dollar 2,998,953

    3. Difference: (dollar 526,047) in parenthesis

  6. Cost per unit of simple (S3) lens

    1. Simple costing system using a single indirect-cost pool: dollar 58.75

    2. ABC system: dollar 49.98

    3. Difference: (dollar 8.77) in parenthesis

  7. Total costs assigned to complex (C5) lens

    1. Simple costing system using a single indirect-cost pool: dollar 1,455,000

    2. ABC system: dollar 1,981,047

    3. Difference: dollar 526,047

  8. Cost per unit of complex (C5) lens

    1. Simple costing system using a single indirect-cost pool: dollar 97.00

    2. ABC system: dollar 132.07

    3. Difference: dollar 35.07

The increased number and homogeneous nature of cost pools and the choice of cost-allocation bases, tied to the cost hierarchy, give Plastim’s managers greater confidence in the activity and product cost numbers from the ABC system.

The bottom part of Exhibit 5-6 shows that allocating costs to lenses using the simple costing system with just a single indirect-cost pool and a single output unit-level allocation base—direct manufacturing labor-hours—overcosts the simple S3 lens by $8.77 per unit and undercosts the complex C5 lens by $35.07 per unit. The C5 lens uses a disproportionately larger amount of indirect costs than is represented by the direct manufacturing labor-hour cost-allocation base. The S3 lens uses a disproportionately smaller amount of these costs.

The benefit of an ABC system is that it provides more accurate information that leads to better decisions. But managers must weigh this benefit against the measurement and implementation costs of an ABC system.