Question

Explain the difference between committed fixed costs and discretionary fixed costs and give an example of each.

Why are more and more organizations in both manufacturing and nonmanufacturing industries adopting activity-based costing systems?

Answer 1

A committed cost is an investment that a business entity has already made and cannot recover by any means, as well as obligations already made that the business cannot get out of. Examples - Rent, Insurance.

A discretionary cost is a cost or capital expenditure that can be curtailed or even eliminated in the short term without having an immediate impact on the short-term profitability of a business. Examples - Advertising, Equipment maintainance.

Activity-based costing (ABC) is an accounting method that identifies and assigns costs to overhead activities and then assigns those costs to products. An activity-based costing (ABC) system recognizes the relationship between costs, overhead activities, and manufactured products, and, through this relationship, it assigns indirect costs to products less arbitrarily than traditional methods.Activity-based costing (ABC) is mostly used in the manufacturing industry since it enhances the reliability of cost data, hence producing nearly true costs and better classifying the costs incurred by the company during its production process.

Activity-based costing enhances the costing process in three ways. First, it expands the number of cost pools that can be used to assemble overhead costs. Instead of accumulating all costs in one company-wide pool, it pools costs by activity. Second, it creates new bases for assigning overhead costs to items such that costs are allocated based on the activities that generate costs instead of on volume measures, such as machine hours or direct labor costs. Finally, ABC alters the nature of several indirect costs, making costs previously considered indirect - such as depreciation, inspection, or power - traceable to certain activities. Alternatively, ABC transfers overhead costs from high-volume products to low-volume products, raising the unit cost of low-volume products.