Costs

Aerotech’s controller, Chuck Dickens decided to change from a traditional volume-based system to an activity-based costing (ABC) system after reading about the two-stage procedure to assign overhead cots to products. Chuck questioned if the current cost-management system was providing the management with accurate data about product costs. In a traditional, volume-based product-costing system, only a single predetermine overhead rate is used. All manufacturing-overhead costs are combined into one cost pool, a grouping of individual indirect cost items, and they are applied to products on the basis of a single variable that costs over a given time span (cost driver) that is closely related to production volume. The most frequently used cost drivers in traditional product-costing systems are direct-labor hours, direct-labor dollars, machine hours, and units of production. An activity-based system is a two-stage process of assigning costs to products. In stage one, activity-cost pools are established. In stage two a cost driver is identified for each activity-cost pool. Then the costs in each pool are assigned to each product line in proportion to the amount of the cost driver consumed by each product line. When Aerotech moved to an ABC system, the company was in a better position to price its products competitively. Aerotech Corporation’s management was being misled by the traditional product-costing system, because the high-volume (Mode I & II) product lines were being overcosted and the low-volume (Mode III) product line was being undercosted. The high-volume products essentially were subsidizing the low-volume line. The traditional product-costing system failed to show that the low-volume products were driving more than their share of overhead costs. As a result of these misleading costs, the company’s management was mispricing its products.
With the change in to an ABC system, Aerotech Corporation was able to accurately assign costs to