LIMITATIONS OF FUNCTIONAL BASED COST ACCOUNTING SYSTEMS

Plantwide and departmental rates have been used for decades and continue to be used
successfully by many organizations. In some settings, however, they do not work well and may
actually cause severe product cost distortions. As firms operating in this competitive
environment adopt new strategies to achieve competitive excellence, their cost accounting
systems often must change to keep pace. Specifically, the need for more accurate product costs
has forced many companies to take a serious look at their costing procedures. Cost accounting
systems that worked reasonably well in the past may no longer be acceptable.
Thus, one symptom of an outdated costing system is the inability to explain the outcome
of bids. On the flip side, if competitors prices seem unrealistically low, it should cause managers
to wonder about the accuracy of their costing systems. Similarly, if somehow an organizations
costing system is systematically understating the cost of low-volume, specialty products
products that require special processes and handlingthen the organization may find that it has a
seemingly profitable niche all to itself.
Symptoms of an Outdated Functional Costing System are:
1. The outcome of bids is difficult to explain.
2. Competitors prices appear unrealistically low.
3. Products that are difficult to produce show high profits.
4. Operational managers want to drop products that appear profitable.
5. Profit margins are difficult to explain.
6. The company has a highly profitable niche all to itself.
7. Customers do not complain about price increases.
8. The accounting department spends a lot of time supplying cost data for special projects.
9. Some departments are using their own cost accounting system.
10. Product costs change because of changes in financial reporting regulations.
Non Unit Related Overhead Costs
The use of either plantwide rates or departmental rates assumes that a products consumption of
overhead resources is related strictly to the units produced. For activities that are performed each
time a unit is produced, this assumption makes sense.
Non-unit-level drivers such as setups and engineering orders are needed for accurate cost
assignment of non-unit-level activities. Non-unit-level activity drivers are factors that measure
the consumption of non-unit-level activities by products and other cost objects. Activity drivers,
then, are factors that measure the consumption of activities by products and other cost objects;
furthermore, activity drivers can be classified as unit-level and non-unit-level.
Product Diversity
The presence of product diversity is necessary. Product diversity simply means that products
consume overhead activities in systematically different proportions. Products might consume
overhead in different proportions for several reasons. For example, differences in product size,
product complexity, setup time, and size of batches all can cause products to consume overhead
at different rates. Regardless of the nature of the product diversity, product cost will be distorted
whenever the quantity of unit-based overhead that a product consumes does not vary in direct
proportion to the quantity consumed of non-unit-based overhead.