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Activity Based Costing In todays competitive economy the cost structure is much more complex than that of the past and there is a lot less room for error than that allowed in the more laid back economy of the past Todays costing concerns arise from the growing disparity between direct and indirect product costs American manufacturers have been pursuing a steady stream of manufacturing methods and technologies The goal was simple and uniform to reduce or eliminate direct costs But as manufacturing has evolved so has the structure of a products cost Direct costs such as labor are no longer the dominant cost of a product The cost of indirect activities such as automation marketing sales engineering and order processing have dramatically increased Overhead has grown to become the most expensive element of product cost structure This might not be so bad if conventional product costing systems could handle the shift in cost structure Unfortunately they dont Most conventional systems allocate overhead based on some burdened rate direct labor hours is a good example This was acceptable when overhead was small and direct costs were high But in todays automated factory this can lead to disaster Conventional systems report inaccurate product costs--often grossly inaccurate Management in turn makes strategic decisions based on these inaccurate product costs Traditional cost systems assume all overhead activities are consumed equally by all products relative to volume produced Further all costs are allocated to products because the system assumes that current output drives current overhead costs Overhead costs are allocated to products on the basis of the products demand for some volume variable direct cost usually labor hours machine hours or materials cost But none of these bases individually represents the actual overhead incurred to make the product Conventional thinking holds that the inaccuracy is not relevant because in total all costs are accounted for and on average the relative distortion in margin reporting can not
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