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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