Refining a Costing System

Learning Objective 2 Present three guidelines for refining a costing system

• classify more costs as direct costs, expand the number of indirect-cost pools, and identify cost drivers

In a refined costing system, the use of broad averages for assigning the cost of resources to cost objects (such as jobs, products, and services) is replaced by better measurement of the costs of indirect resources used by different cost objects, even if the various cost objects use the indirect resources to highly varying degrees. Refining a costing system helps managers make better decisions, such as how to price products and which products to produce.

Developments That Have Increased the Demand for Refining Costing Systems

Three key developments have accelerated the demand for refinements to costing systems.

1. INCREASE IN PRODUCT DIVERSITY. The growing demand for customized products has led managers to increase the variety of products and services their companies offer. Kanthal, a Swedish manufacturer of heating elements, for example, produces more than 10,000 different types of electrical heating wires and thermostats. Banks, such as Barclays Bank in the United Kingdom, offer many different types of accounts and services: special passbook accounts, ATMs, credit cards, and electronic banking products. Producing these products places different demands on resources because of differences in volume, process, technology, and complexity. For example, the computer and network resources needed to support electronic banking products are much greater than the computer and network resources needed to support a passbook savings account. The use of broad averages fails to capture these differences in demand and leads to distorted and inaccurate cost information.
2. INCREASE IN INDIRECT COSTS WITH DIFFERENT COST DRIVERS. The use of product and process technology such as computer-integrated manufacturing (CIM) and flexible manufacturing systems (FMS) has led to an increase in indirect costs and a decrease in direct costs, particularly direct manufacturing labor costs. In CIM and FMS, computers on the manufacturing floor instruct equipment to set up and run quickly and automatically. The computers accurately measure hundreds of production parameters and directly control the manufacturing processes to achieve high-quality output. Managing complex technology and producing diverse products also require additional support function resources for activities such as production scheduling, product and process design, and engineering. Because direct manufacturing labor is not a cost driver of these costs, allocating indirect costs on the basis of direct manufacturing labor (as in Plastim’s simple costing system) does not accurately measure how resources are being used by different products.
3. INCREASE IN PRODUCT MARKET COMPETITION. As markets have become more competitive, managers have felt the need to obtain more accurate cost information to help them make important strategic decisions, such as how to price products and which products to sell. Making correct decisions about pricing and product mix is critical in competitive markets because competitors quickly capitalize on a manager’s mistakes. For example, if Plastim overcosts the S3 lens and charges a higher price, a competitor aware of the true costs of making the lens could charge a lower price and gain the S3 business as Bandix is attempting to do.

The preceding developments explain why managers have an increasing need to refine cost systems. Refining costing systems requires gathering, validating, analyzing, and storing vast quantities of data. Advances in information technology have drastically reduced the costs of performing these activities.