Chapter 25 Cost Allocation and Activity-Based Costing Financial and Managerial Accounting 8th Edition Warren Reeve Fess PowerPoint Presentation by Douglas Cloud Professor Emeritus of Accounting Pepperdine University © Copyright 2004 South-Western, a division of Thomson Learning. All rights reserved. Task Force Image Gallery clip art included in this electronic presentation is used with the permission of NVTech Inc. Some of the action has been automated, so click the mouse when you see this lightning bolt in the lower right-hand corner of the screen. You can point and click anywhere on the screen. Objectives 1. Identify three methods used for After studying this costs to allocating factory overhead products. chapter, you should be able to: 2. Use a single plantwide factory overhead rate for product costing. 3. Use multiple production department factory overhead rates for product costing. 4. Use activity-based costing for product costing. Objectives 5. Use activity-based costing to allocate selling and administrative expenses to products. 6. Use activity-based costing in a service business. Product Costing Allocation Methods Plantwide Overhead Rate Single Rate Multiple Department Rates Department Department Activity-Based Costing Activity Activity P R O D U C T S Single Plantwide Factory Overhead Rate Computing Single Plantwide Factory Overhead Total budgeted factory overhead costs Total budgeted plantwide allocation base $1,600,000 $80 per hour = overhead rate 20,000 direct labor hours Computing Single Plantwide Factory Overhead Snowmobile: $80 per dlh x 10 direct labor hours = $800 Lawnmower: $80 per dlh x 10 direct labor hours = $800 Factory Overhead cost per unit Plantwide factory overhead $1,600,000 $80 per direct labor hour x 10 direct labor hours Snowmobile $800 per unit x 10 direct labor hours Lawnmower $800 per unit The greatest advantage of the single plantwide overhead rate is that it is simple and inexpensive to apply. Multiple Production Department Factory Overhead Rate Method Single Plantwide Rate Plantwide factory overhead Plantwide rate Products Multiple Production Department Rate Fabrication Department factory overhead Assembly Department factory overhead Fabrication Department factory overhead rate Assembly Department factory overhead rate Products Production Department Factory Overhead Rates and Allocation Fabrication Department Overhead Rate: $1,030,000 10,000 direct labor hours = $103 per hour Assembly Department Overhead Rate: $570,000 10,000 direct labor hours = $57 per hour Production Department Factory Overhead Rates and Allocation Snowmobile: Fabrication: $103 x 8 dlh = $824 Assembly: $57 x 2 dlh = 114 $938 Lawnmower: Fabrication: $103 x 2 dlh = $206 Assembly: $57 x 8 dlh = 456 $662 Multiple Production Department Rate Method—Ruiz Company Fabrication Department $1,030,000 $103 x 8 dlh $938 per unit Assembly Department $570,000 $57 x 2 dlh Multiple Production Department Rate Method—Ruiz Company Fabrication Department $1,030,000 Assembly Department $570,000 $103 x 2 dlh $57 x 8 dlh $662 per unit Distortion in Product Costs—Single Plantwide versus Multiple Production Department Overhead Rates Factory Overhead Cost per Unit Single Plantwide Rate Snowmobile Lawnmower $800 800 Multiple Production Department Rates $938 662 Distortion in Product Costs—Single Plantwide versus Multiple Production Department Overhead Rates The single plantwide factory overhead rate distorts product cost by averaging high and low factory overhead costs. Conditions for Product Cost Distortion—Ruiz Company Fabrication Department Condition 1: Differences in production department factory overhead rates $103 per direct labor hour Continued Assembly Department $57 per direct labor hour Conditions for Product Cost Distortion—Ruiz Company Condition 2: Differences in the ratios of allocation-base usage 8 direct labor hours 2 direct labor hours 2 direct labor hours 8 direct labor hours Activity-Based Costing Method Activity-based costing changes the way overhead costs are allocated. When identifying specific activities, inefficiencies may be discovered and eliminated, reducing the product’s cost. Traditional cost accounting undercosts complex products and overstates their profit margins. ABC may be used for decision making but not necessarily for inventory valuation. Multiple Production Department Factory Overhead versus ABC Production Department Factory Overhead Production Department Factory Overhead Production Department Rates Products Continued Multiple Production Department Factory Overhead versus ABC Activity Activity Activity Activity Rates Products Activity Activity-Based Costing Method Activity Fabrication Assembly Setup Quality control Engineering Total Amount $ 530,000 70,000 480,000 312,000 208,000 $1,600,000 Activity Rate Activity-Based Costing Method Activity Fabrication Assembly Setup Quality control Engineering Total Fabrication: Snowmobile Lawnmower Total Amount $ 530,000 70,000 480,000 312,000 208,000 $1,600,000 Activity ÷ 10,000 dlh ÷ 10,000 dlh ÷ 120 setups ÷ 104 inspts. ÷ 16 changes = = = = = Rate $53 $7 $4,000 $3,000 $13,000 DL Hours Rate Total Cost Drivers 8,000 $53 $424,000 2,000 53 106,000 10,000 $530,000 Activity-Based Costing Method Activity Fabrication Assembly Setup Quality control Engineering Total Amount $ 530,000 70,000 480,000 312,000 208,000 $1,600,000 Activity ÷ 10,000 dlh ÷ 10,000 dlh ÷ 120 setups ÷ 104 inspts. ÷ 16 changes Assembly: Snowmobile Lawnmower Total DL Hours 2,000 8,000 10,000 Rate $7 7 = = = = = Rate $53 $7 $4,000 $3,000 $13,000 Total $14,000 56,000 $70,000 Activity-Based Costing Method Activity Fabrication Assembly Setup Quality control Engineering Total Amount $ 530,000 70,000 480,000 312,000 208,000 $1,600,000 Setup: Snowmobile Lawnmower Total Setups 100 20 120 Activity ÷ 10,000 dlh ÷ 10,000 dlh ÷ 120 setups ÷ 104 inspts. ÷ 16 changes Rate $4,000 4,000 = = = = = Rate $53 $7 $4,000 $3,000 $13,000 Total $400,000 80,000 $480,000 Activity-Based Costing Method Activity Fabrication Assembly Setup Quality control Engineering Total Amount $ 530,000 70,000 480,000 312,000 208,000 $1,600,000 Quality Control: Snowmobile Lawnmower Total Activity ÷ 10,000 dlh ÷ 10,000 dlh ÷ 120 setups ÷ 104 inspts. ÷ 16 changes Inspts. Rate 100 $3,000 4 3,000 104 = = = = = Rate $53 $7 $4,000 $3,000 $13,000 Total $300,000 12,000 $312,000 Activity-Based Costing Method Activity Fabrication Assembly Setup Quality control Engineering Total Engineering: Snowmobile Lawnmower Total Amount $ 530,000 70,000 480,000 312,000 208,000 $1,600,000 Activity ÷ 10,000 dlh ÷ 10,000 dlh ÷ 120 setups ÷ 104 inspts. ÷ 16 changes Changes Rate 12 $13,000 4 13,000 16 = = = = = Rate $53 $7 $4,000 $3,000 $13,000 Total $156,000 52,000 $208,000 Activity-Based Costing Method Cost Allocation Summary: Activity Snowmobile Mower Fabrication Assembly Setup Quality control Engineering Total $ 424,000 14,000 400,000 300,000 156,000 $1,294,000 $106,000 56,000 80,000 12,000 52,000 $306,000 Budgeted units Cost per unit 1,000 $1,294 1,000 $306 Total $ 530,000 70,000 480,000 312,000 208,000 $1,600,000 Activity-Based Costing Method—Ruiz Company Fabrication Activity $530,000 Assembl y Activity $70,000 Setup Activity $480,000 Quality Control Inspectio n Activity $312,000 $53 per dlh $7 per dlh $4,000 per setup $3,000 per inspection $1,294 per unit $306 per unit Engineering Change Activity $208,000 $13,000 per engineering change Distortion in Product Costs—Multiple Production Department Factory Overhead Rate Method versus Activity-Based Costing Factory Overhead Cost per Unit— Three Cost Allocation Methods Single Plantwide Multiple Production Rate Department Rates ABC Snowmobile Lawnmower $ 800 800 $ 938 662 $1,294 306 Activity-Based Costing for Selling and Administrative Activities Selling and administrative activities may include: 1. Post-sale technical support 2. Order writing 3. Promotional support 4. Order entry 5. Customer return processing 6. Shipping document preparation 7. Shipping and handling 8. Field service Activity-Based Costing in Service Businesses Hopewell Hospital—Activity-Based Costing Admitting $180 per admission Radiological Testing $320 per image Operating Room $200 per operating room hour Pathological Testing $120 per specimen Dietary and Laundry $150 per day P A T I E N T S Activity-Based Costing in Service Businesses Hopewell Hospital—Activity-Based Costing Admitting $180 per admission Radiological Testing $320 per image P A T $200 per operating Operating Radiological Testing Activity Rate: I room $960,000 hour Room Cost Budget E = = $320 N Estimated Activity 3,000 images Pathological T $120 per specimen Testing S Dietary and $150 per day Laundry Activity Costs Allocated to a Patient Patient Name: Mary Wilson Activity Admitting Radiology testing Operating room Pathological testing Dietary and laundry Total Activity-Base Usage 1 admission 2 images 4 hours 1 specimen 7 days x x x x x Activity Activity Rate Cost $180 = $ 180 320 = 640 200 = 800 120 = 120 150 = 1,050 $2,790 The overhead cost associated with services can be related to the customers that use the service. Customer Profitability Report Hopewell Hospital Customer (Patient) Profitability Report For the Period Ending December 31, 2006 Adcock, Birini, Conway, Kim Brian Don Revenues $9,500 $21,400 $5,050 Less: Patient costs Drugs and supplies $ 400 $ 1,000 $ 300 Admitting 180 180 180 Radiological testing 1,280 2,560 1,280 Operating room 2,400 6,400 1,600 Pathological testing 240 600 120 Dietary and laundry 4,200 14,700 1,050 Total patient costs $8,700 $25,440 $4,530 Income from operations $ 800 $ (4,040) $ 520 Wilson, Mary $3,300 $ 200 180 640 800 120 1,050 $2,990 $ 310 Chapter 25 The End