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18/06/2018 07:44:43 PM

Reasons for Refining a Costing System

A refined costing system reduces the use of broad averages for assigning the cost of resources to cost objects (such as jobs, products, and services) and provides better measurement of the costs of indirect resources used by different cost objects—no matter how differently various cost objects use indirect resources.

There are three principal reasons that have accelerated the demand for such refinements.

First, increase in product diversity. The growing demand for customized products has led companies to increase the variety of products and services they offer. Kanthal, the Swedish manufacturer of heating elements, for example, produces more than 10,000 different types of electrical heating wires and thermostats. Banks, such as the Cooperative Bank in the United Kingdom, offer many different types of accounts and services: special passbook accounts, ATMs, credit cards, and electronic banking. These products differ in the demands they place on the resources needed to produce them, because of differences in volume, process, and complexity. The use of broad averages is likely to lead to distorted and inaccurate cost information.

Second, increase in indirect costs. The use of product and process technology such ascomputer-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 give instructions to set up and run equipment quickly and automatically.

The computers accurately measure hundreds of production parameters and directly control the manufacturing processes to achieve high-quality output. Managing more complex technology and producing very diverse products also requires committing an increasing amount of resources for various support functions, 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 (which was the common practice) does not accurately measure how resources are being used by different products.

Third, competition in product markets. 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 pricing and product mix decisions is critical in competitive markets because competitors quickly capitalize on a company’s mistakes.

Whereas the preceding factors point to reasons for the increase in demandfor refined cost systems, advances in information technologyhave enabled companies to implement these refinements. Costing system refinements require more data gathering and more analysis, and improvements in information technology have drastically reduced the costs to gather, validate, store, and analyze vast quantities of data.


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