CHAPTER 5: ACTIVITY-BASED COSTING AND CUSTOMER PROFITABILITY ANALYSIS
CHAPTER 5: ACTIVITY-BASED COSTING AND CUSTOMER PROFITABILITY ANALYSIS
QUESTIONS
5-1Undercosting a product may appear to have increased the reported profit the product earned (assuming the firm did not lower its selling price because of the reported lower product cost). However, the increased profit is, at best, a twist in truth. Costs of the product not charged to the product itself are borne by other products of the firm.
Worse, undercosting a product may result in managers erroneously believing the product to be more profitable than other products and shifting the limited resource the firm has into manufacturing, promotion, and sales of the product when, in fact, other products are more profitable to the firm. Severe cost distortions may lead firms not to drop unprofitable products because the cost data show these products are profitable.
5-2Overcosting does not increase revenues. A firm can increase the selling price of a product, thereby increasing the total revenue from the product only if the market allows. Increases in the selling price of a product without experiencing noticeable decrease in the sales quantity of the product is likely an indication that the product was not priced properly, which might be a result of undercosting of the product.
Furthermore, overcosting a product is likely accompanied by undercosting of the firm’s other products and, as a result, underpricing of one or more of the firm’s other products.
When a firm sets a high selling price that is a result of overcosting, competitors also are likely to enter the market and take away the firm’s market share. A firm also may drop or de-emphasize an erroneously overcosted product when it erroneously believes the product is either unprofitable or having a low-margin.
5-3Product costs are likely distorted when a firm uses a volume-based rate if the plant has more than one activity in its operations and not all activities consume overhead in the same proportion. The more diverse the
QUESTIONS
5-1Undercosting a product may appear to have increased the reported profit the product earned (assuming the firm did not lower its selling price because of the reported lower product cost). However, the increased profit is, at best, a twist in truth. Costs of the product not charged to the product itself are borne by other products of the firm.
Worse, undercosting a product may result in managers erroneously believing the product to be more profitable than other products and shifting the limited resource the firm has into manufacturing, promotion, and sales of the product when, in fact, other products are more profitable to the firm. Severe cost distortions may lead firms not to drop unprofitable products because the cost data show these products are profitable.
5-2Overcosting does not increase revenues. A firm can increase the selling price of a product, thereby increasing the total revenue from the product only if the market allows. Increases in the selling price of a product without experiencing noticeable decrease in the sales quantity of the product is likely an indication that the product was not priced properly, which might be a result of undercosting of the product.
Furthermore, overcosting a product is likely accompanied by undercosting of the firm’s other products and, as a result, underpricing of one or more of the firm’s other products.
When a firm sets a high selling price that is a result of overcosting, competitors also are likely to enter the market and take away the firm’s market share. A firm also may drop or de-emphasize an erroneously overcosted product when it erroneously believes the product is either unprofitable or having a low-margin.
5-3Product costs are likely distorted when a firm uses a volume-based rate if the plant has more than one activity in its operations and not all activities consume overhead in the same proportion. The more diverse the