Theory of Constraints Handbook - James Cox Iii [242]
Because TA follows the same basic format as direct or variable costing accounting for periodic reporting, however, this discussion is important.
Advantages of Direct Costing
Advocates for direct costing base their interest on internal flows (Dopuch and Birnberg, 1969, Chapter 15)7 and providing information for internal decisions. They claim that direct costing:
Focuses attention on those costs that most closely approximate the marginal (incremental) costs of production;
Relates profit to sales, rather than to sales and production, as does traditional accounting;
Treats fixed costs as a period expense since these amounts must be expended in order to be in position to produce and must be incurred each period without regard to production quantity (that is, certain costs must be incurred even when production is at or near zero).
The advantages and disadvantages of direct costing are discussed in every cost or management accounting textbook when the methodology is introduced. While supporters and distracters at one time were passionate in their support or opposition, most authors now just list the advantages and disadvantages.
Disadvantages of Direct Costing
Opponents of direct costing do not accept the benefits claimed for direct costing and point out its theoretical weaknesses. They claim, as support for their stance, that direct costing:
Violates the matching concept of accounting where the total unit cost of production (variable and fixed) must be recognized in the period when units are sold and not match the period in which they were incurred;
Does not account for the total costs of producing a product on a recurring basis and that full (totally absorbed) costing, as in traditional accounting, is a better measure of the incremental cost of production;
Is only applicable over a specified output range and variable costs may change outside the originally assumed range. (Of course, fixed costs are subject to the same claim.)
While it is difficult to know what proportion of companies regularly record variable and fixed costs in separate journal accounts (companies are not required to disclose this information), the author’s experience is that most companies do not. Since the separation of costs into fixed and variable components is required for virtually all internal decisions, this information must be accumulated in special studies. Unfortunately, most accounting/finance departments have little time to devote to special projects when relevant information is not readily available.
Activity-Based Cost Accounting
Activity-based cost (ABC) accounting might be considered accounting’s attempt to “return to the basics” with several new twists. First, overhead is assigned to many pools, not to departments. Second, since all overhead costs can be changed over time, they are assumed to be variable. Third, the selection of allocation bases (drivers) used to allocate pool costs depends on whether costs are incurred at the unit, batch, product line, or facility level. (Facility-level costs include general manufacturing costs common to all production.)
In practice, companies implementing ABC accounting allocate manufacturing costs as originally proposed by Church (1908, 1917), but rather than assigning overhead costs to departments, they are allocated to activity pools. Activity pools are holding accounts where costs for a particular activity, such as material movement, can be accumulated prior to being charged to users of the activity. Thus, if one product or product line requires