Question

Johnson Superior Products Inc. produces hospital equipment and the setup requirements vary from product to product. Johnson produces its products based on customer orders and uses ABC costing. In one of its indirect cost pools, setup costs and distribution costs are pooled together. Costs in this pool are allocated using number of customer orders for the easiness of costing operations. Based on the information provided, which of the following arguments is valid?
Select one:
a. Johnson has clearly failed to identify as many direct costs as is economically feasible.
b. All costs in a homogeneous cost pool have the same or a similar cause-and-effect relationship with the single cost driver that is used as the cost-allocation base for Johnson.
c. Johnson has unnecessarily wasted resources by classifying setup and distribution costs as they could have been considered as direct costs.
d. Johnson has failed to use the correct cost driver as the cost-allocation base for setup costs.

Answer 1

Answer:

D) Johnson has failed to use the correct cost driver as the cost-allocation base for setup costs.

Explanation:

One of the main disadvantages of ABC costing method is that it is very hard and expensive to implement, and sometimes you cannot allocate all overhead costs to specific cost drivers. That is what happened here with Johnson's costing method, they combined two cost drivers and allocated resources using the number customer orders which is not a valid base, e.g. one single large order represents higher costs than 10 small orders.

ABC costing is not accepted by US GAAP due to its limitations or how hard it is to apply correctly, but it is a very useful information source for making decisions. The problem is, if gathering the information is worth the effort and extra cost of ABC?