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Question:

How manufacturing overhead costs of a company increased as a proportion of the total costs and diversity of product-line increased? Explain.

 

Answer:

According to Cooper and Kaplan (1988), as the manufacturing overhead costs of a company increased as a proportion of the total costs and diversity of product-line increased, the assumptions of traditional cost system gets violated. They indicated that although, support department costs have been considered fixed but they actually varied and were driven by product-line diversity and complexities of activities (operating) like inspection, handling, set-up etc. This complexity can be handled by the support departments when they are larger and sophisticated. Since, low-volume products associates more with such transactions per unit than the high-volume products, it can result in cross-subsidization that is the high-volume products can be allocated more overhead by subsidizing the low-volume ones. Outputs of support depaartments can increase as most of it involves human activities and eventually, the maximum output of department is reached and further personnel are requested. As this request rises with an increase in output, the support department grows intermittently.

The cost of complexity concept is not used in the traditional concept of cost systems because both are different methods for allocating overhead costs to products. The traditional cost accounting model or system puzzles the underlying relationship between the ranges of different products produced and the size or magnitude of support departments. Cooper and Kaplan argued that the traditional cost systems used volume related bases in order to allocate manufacturing overhead and hence led to material misreporting of the product costs. Also, as the cost of support departments is treated as fixed, this concept makes it problematic to realize that these costs are varying systematically (Cooper & Kaplan, 1988). 

As the traditional cost accounting systems were not considered accurate because they may result in over-costing or under-costing, Cooper and Kaplan decided to aware people of a comprehensive cost system so that it can incorporate even the long-term variable costs of marketing and manufacturing of every products or product-line, thereby resulting in a much efficient basis for managerial decision-making on discontinuing, pricing, reengineering and introducing product lines. The cost system can also facilitate in the smooth running of a business, hence generating sustainable advantages for the business. Previously, managers in companies made significant decisions on pricing and product mix etc on the basis of distorted information on cost and alternative methods rarely existed to alert the managers about the flaw in cost information (Maher, 2005). Another reason behind this article was that previously management accounting mainly concentrated on cost information for making short-run decisions and the most relevant aspect of decision on products got avoided (Don & Maryanne, 2006). The thinking of people regarding the cost behavior needed to be changed as it was ineffective and hence, two relevant changes needed to be made through this article. Firstly, the cost allocation from the pool of costs to products was required to be achieved as overhead costs were driven by production complexities and not volume of production and secondly, the overhead costs varied with variations in production complexities but these variations were actually intermittent in nature. Hence, to sum up, Cooper and Kaplan wrote this article so that the flaws of the traditional accounting system could be neglected and the benefits of a comprehensive cost system could be informed to the people in order to facilitate better decision making in their processes. 

is very important in every business whether it be related to pricing, product-mix etc. Accounting managers were making a mistake in their decisions as they relied on the distorted cost information and this paper successfully fulfills its objective in informing people about the relevance of a comprehensive cost system. People must read the paper because it not only comprises of information on the benefits of a comprehensive cost accounting system but also comprises of the flaws that are present in the traditional system of cost accounting (Drury, 2011).

 

Readers can learn that in the present scenario, marketing channels and product lines have become proliferated. Direct labor represents only a small portion of corporate costs whereas marketing expenses, distribution expenses etc have risen but still many of the companies allocate these increasing overhead by their decreasing base of direct labor. These simple approaches are no longer required and can prove dangerous especially in this era of global competition and innovative production technologies (Lanen et. al, 2008). As a matter of fact, people were aware that decision-making was a key factor of the success of a business and many managers were even aware that their systems of accounting distorted product costs but they were unaware of the impact of the decisions they would be making (Horngren, 2011). Hence, an effective system was urgently needed so that the product costs could be measured and could also be assigned to product the costs of complexities.

 

References     

Cooper, Robin & Kaplan, Robert S. “How Cost Accounting Distorts Product Costs” Management Accounting 69(1988): 10. Print 

Don R. H & Maryanne, M. M. Cost Management Accounting & Control. : Thomas South-Western, 2006. Print

Drury, C. Cost and management accounting. Andover, Hampshire, UK: South-Western Cengage Learning, 2011. Print

Horngren, C. Cost accounting. Frenchs Forest, N.S.W: Pearson Australia, 2011. Print

Lanen, W. N., Anderson, S & Maher, M. W. Fundamentals of cost accounting. NY: Hang Loose press, 2008. Print

Maher, L.  Fundamentals of Cost Accounting. McGraw-Hill, 2005. Print 

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