Activity Based Costing, GAAP and External
Reports:
Since
activity based costing (ABC) system generally
provides more accurate product costs than
traditional costing methods, why isn't it used for
external reports?
Some
companies do use activity based costing in their
external reports, but most do not. There are a
number of reasons for this. First, external reports
are less detailed than internal reports prepared for
decision making. On the external reports, Individual
product costs are not reported. Cost of goods sold
and inventory valuations are disclosed, but their is
no breakdown of these accounts by product. If some
products are under-costed and some are over-costed,
the errors tend to cancel each other when the
product costs are added together.
Second, it is often very difficult to make changes
in a company's accounting system. The official cost
accounting system in most large companies are
usually embedded in complex computer programs that
have been modified in-house over the course of many
years. It is extremely difficult to make changes in
such computer programs without causing numerous
bugs.
Third,
an ABC costing system does not conform to generally
accepted accounting principles (GAAP). Product cost
computed for external reports purposes must include
all of the manufacturing costs and only
manufacturing costs; but in ABC system products
costs exclude some manufacturing costs and include
some non-manufacturing costs. It is possible to
adjust the ABC data at the end of the period to
conform to GAAP but it requires more work.
Fourth, the auditors are likely to be uncomfortable
with allocation that are based on interviews with
the company's personnel. Such objective data can be
easily manipulated by management to make earnings
and other key variables look more favorable.
For
all of these reasons, most companies confine their
ABC efforts to special studies for management, and
they do not attempt to integrate activity based
costing into their formal cost accounting system.
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