Question

In chapter six, the authors showed how the ABC application was used in the construction industry, comparing three types of rebar used for specific construction projects. It was shown that the company had undercosted two of the types of rebar, while the third type of rebar was overcosted. With this example in mind, consider the following issues. Why is the ABC described in the reading this week, unacceptable for external financial reports? In what fundamental ways does ABC differ from traditional costing methods, such as those described in Chapter 4? Why are top management support and cross-functional involvement crucial when attempting to implement an ABC system?

Answer 1

Q.1 Why is the ABC described in the reading this week, unacceptable for external financial reports?

Activity-based costing is unacceptable for external financial reports for a few different reasons.

• The external reports are less detailed than internal reports that are prepared for decision making.
• It is also often very difficult to make changes ina company’s accounting system, as most large companies usually embedcomplex computer programs that have been modified in-house over the courseof many years.
• ABC costing is also unacceptable because it does not conform to generally accepted accounting principles (GAAP).
• Finally, auditors are likely to be uncomfortable with allocations that are based on interviews with the company’s personnel, as such subjective data can be easily manipulated by management to make earnings and other key variables look more favorable.

Q.2 In what fundamental ways does ABC differ from traditional costing methods, such as those described in Chapter 4?

Activity based costing differs from traditional costing system in number of ways.

• In activity based costing, nonmanufacturing as well as manufacturing costs may be assigned to products. And, some manufacturing costs may be excluded from product costs.
• An activity-based costing system typically include a number of activity cost pools, each of which has its unique measure of activity. These measures of activity often differ from the allocation bases used in traditional costing system.
• Final, the activity rate differs from typical predetermined overhead rates in that they should be based on activity at capacity rather than on the budgeted level of activity.

Q.3 Why are top management support and cross-functional involvement crucial when attempting to implement an ABC system?

a cross-functional team should be created to design and implement the ABC system.The team should include representatives from each area that will use ABC data such as marketing,production, engineering, and accounting departments. These cross-functional employees possess detailed knowledge of many parts of an organization's operations that is crucial for designing an effective ABC system. Moreover, utilizing the knowledge of cross-functional managers reduces their resistance to change because they feel involved in theABC implementation process. Time after time, when accountants have attempted to implement an ABC system on their own without top-management support and cross-functional involvement, the results have been ignored.

The new ABCsystem would supplement, rather than replace, the existing cost accounting system, which would continue to be used for external financial reports. The new ABC system would beused to prepare special reports for management decisions such as bidding on new business.