Question

Discuss how an emphasis on financial performance of cost centers, as measured by traditional cost accounting information, may lead to inefficient and ineffective production output.

Answer 1

The traditional costing system in accounting is the allocation of factory overhead to products which is based on the volume of consumed production resources. Companies using this method will apply overhead to either the number of machine hours used or the direct labor hours which were consumed.

Under traditional costing, one would add an average overhead rate to the direct costs of manufacturing goods or providing services. It is applied on the basis of cost driving, reflecting what is required to produce finished products.

Traditional cost accounting techniques emphasize financial performance rather than manufacturing performance and the traditional techniques do not support the objectives of lean manufacturing firms. Inaccurate cost allocations can result from traditional cost accounting systems since they do not accurately allocate costs to the products and processes.

This can lead to product cost distortions in a lean environment which can cause products to appear to cost more than other to appear to cost less than they really do. This may result in poor decisions regarding pricing, valuation, and profitability.

Standard costing motivates non-lean behavior in operations through the performance measurements of personal efficiency or production workers, effective utilization of manufacturing facilities, and the degree of overhead absorbed by production. Standard costing conceals waste within the overhead allocation that is difficult to detect. This can lead to the production of large batches of products and building inventory.