Two Australian firms, one with three divisions (HC1, HC2 and HC3), and the second with two divisions (FT1 and FT2) were studied. HC1 and FT1 had the simplest costing systems with all of the overheads accumulated into a single cost pool. In other words, a plant-wide overhead rate was used. HC2 and HC3 established separate ‘work centre cost pools’ that reflect manufacturing processes (e.g. HC2 had three cost pools and HC3 two cost pools). Overheads such as power were directly traced to the work centres. The remaining overheads were allocated to the work centres based on their levels of direct labour hours (DLHs) usage.
The work centre overhead was then determined by dividing the work centre cost pool by the number of DLHs and allocating the costs to the product according to the consumption of DLHs in each of the work centres.
FT2 was the only research site that had a highly sophisticated costing system consisting of many different cost pools. The overheads for each cost pool were allocated to products on the basis of two cost drivers, namely direct labour hours and machine hours. The overheads allocated based on DLHs included indirect labour associated with materials handling, packers and factory foremen.
Overheads allocated on the basis of machine hours include costs that vary with machine hours (e.g. power and electricity) as well as fixed costs such as factory management and depreciation.
HC1, HC2 and FT1 all had low product diversity (i.e. products consumed organizational resources in similar proportions) and users were satisfied with the information provided by the costing system.
Both HC3 and FT2 had high levels of product diversity. FT2 had a relatively sophisticated costing system while HC3 maintained a simplistic system. The users of the costing system at FT2 were very satisfied with the system whereas there was much dissatisfaction with HC3’s system.
Costing information at HC3 was particularly important for determining product costs. However, management believed that the costs were highly inaccurate and were inadequate for setting prices. Overheads were large and product diversity was high, creating the need for a relatively sophisticated costing system. However, a simplistic costing system was implemented. This absence of ‘fit’ was a major dissatisfaction with the existing costing system. In contrast, there was a ‘fit’ between the costing systems and the level of product diversity in the four other business units and a general satisfaction with the costing systems.
Questions:
1 Why might increasing the number of cost centres (pools) result in the reporting of more accurate product costs?
2 What other factors, besides product diversity, might enable a simplistic product costing system to report reasonably accurate product costs?