Bridgeton Case Summary

The Bridgeton case introduced a relatively simple costing system: DM, DL, and one pool of indirect, support, or overhead costs. The one and only "cost pool" containing all overhead (OH) costs was allocated on the basis of DL$. In this case, the direct costs seem to be largely variable (i.e., they vary proportionally with production volume), whereas some of the indirect costs are relatively variable and others are largely fixed. Case in point: Not all INDIRECT costs are necessarily FIXED. To figure out which indirect costs are fixed or variable, one may want to use a combination of common sense and some analytical procedure applied to a time series of data across the various indirect cost accounts. There is no GAAP-rule spelling out which method
to use; this is MANAGEMENT accounting! One approach is to compute the burden rate (OH/DL$) for each OH-account line item. If the ratio is relatively constant over time, the corresponding OH cost is largely variable. Alternatively, one could do a regression analysis, ideally on a large(r) time series of data. Interviewing plant managers about how costs behave usually provides good insights too.
In this case, the "burden rate," "OH rate" or "allocation rate" is easy to compute: Total OH$ divided by total DL$. However, the burden rate may vary slightly from year to year because slight variations in production volume can be carried out with basically the same level of OH costs. Hence, the denominator of the burden rate tends to vary slightly (i.e., 5% growth in sales) whereas the numerator is largely constant under "normal" conditions.
However, when we deviate from the "normal" operating conditions, i.e., when a "discontinuity" in the production process occurs (e.g., because of discontinuing a product or product line), we may want to think of "fixed" vs. "variable" costs in terms of "avoidable" vs. "unavoidable" costs. Variable costs are avoidable, but some fixed costs are more unavoidable than others. Again, when presented with real-life costing data from a firm of reasonable complexity, it may not be possible to easily figure out which costs are (un)avoidable by just "looking at the data." Hence, it may be necessary to again come up with some analytical procedure to apply to the data. We discussed one such procedure (but there are other ways of doing it too) in terms of computing ratios of burden rates in a time-series fashion. There is again no GAAP-rule that tells you what to do ... use your ingenuity ...
When the firm is stuck with "unavoidable" costs despite a reduction in production volume, the firm is in danger of getting trapped in a "death spiral" when using reported costs to compute burden rates. Arithmetically, the decrease in the numerator of the burden rate is less than proportional to the decrease in the denominator. Hence, unavoidable costs are subsequently allocated to the remaining products, which causes the reported product costs of the remaining products to go up, which makes them "non-competitive" ...
IN SUM ... the Bridgeton case was about ...
- The primary calculations that cost systems use to determine burden rates;
- The concept of the "death spiral" -- When production volume decreases, the burden rate increases (because some fixed costs are unavoidable), and hence, the reported product costs of the remaining products increase;
- The concept of direct and indirect costs, fixed and variable costs, and avoidable and unavoidable costs;
- Ways to deal with, or avoid, the death spiral (e.g., think about redeployability of resources).