There are three main guidelines for refining a costing system:
TRACE MORE COSTS AS DIRECT COSTS. Identify as many direct costs as is economically feasible. This guideline aims to reduce the amount of costs classified as indirect, thereby minimizing the extent to which costs have to be allocated rather than traced.
INCREASE THE NUMBER OF INDIRECT-COST POOLS. Expand the number of indirect-cost pools until each pool is fairly homogeneous. All costs in a homogeneous cost pool have the same or similar cause-and-effect or benefits-received relationship with a single cost driver or metric that is used as the cost-allocation base. Consider, for example, a single indirect-cost pool, containing both indirect machining costs and indirect distribution costs, that is allocated to products using machine-hours. This pool is not homogeneous because machine-hours are a cost driver of machining costs but not of distribution costs, which have a different cost driver: cubic feet of product delivered. If, instead, machining costs and distribution costs are separated into two indirect-cost pools, with machine-hours as the cost-allocation base for the machining-cost pool and cubic feet of product delivered as the cost-allocation base for the distribution-cost pool, each indirect-cost pool would become homogeneous.
IDENTIFY COST DRIVERS. As we describe later in the chapter, whenever possible, managers should use the cost driver (the cause of indirect costs) as the cost-allocation base for each homogeneous indirect-cost pool (the effect).