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0. 26. Cost Allocation and Activity-Based Costing. 0. 26-1. Objective 1. Identify three methods used for allocating factory overhead costs to products. 0. Product Costing. 26-1.

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Cost Allocation and Activity-Based Costing

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0

26

Cost Allocation and Activity-Based Costing


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0

26-1

Objective 1

Identify three methods used for allocating factory overhead costs to products.


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Product Costing

26-1

Most companies have accounting systems that trace revenues to individual product lines. In addition, they need to subtract the cost of manufacturing their product from revenues in order to determine the profit from sales. Determining the cost of the product is termed product costing.


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Single Rate

Department

Department

Activity

Activity

0

Factory Overhead Allocation Methods

26-1

P

R

O

D

U

C

T

S

Plantwide Overhead Rate

Multiple Department Rates

Activity-Based Costing

4


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26-2

Objective 2

Use a single plantwide factory overhead rate for product costing.


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Single Factory Overhead Rate Method

26-2

Under the single plantwide factory overhead rate method, all of the factory overhead is allocated to all products, using only one rate.


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Ruiz Company Illustration

26-2

Ruiz Company manufactures two products, snowmobiles and lawnmowers. Both products are manufactured in a single factory. There is $1,600,000 of factory overhead budgeted for the period.


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26-2

Ruiz Company plans to manufacture 1,000 units of each product. Assume snowmobiles and lawnmowers both require 10 direct labor hours per unit to manufacture.


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$1,600,000

20,000 direct labor hours

$80 per direct labor hour

=

(1,000 x 10 dlh) + (1,000 x 10 dlh)

0

Computing Single Plantwide Factory Overhead

26-2

Total budgeted factory overhead costs

Total budgeted plantwide allocation base

9


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$1,600,000

20,000 direct labor hours

$80 per hour overhead rate

=

0

26-2

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

10


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Single Plantwide Factory Overhead Rate Method—Ruiz Company

26-2

11


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26-2

The greatest advantage of the single plantwide overhead rate method is that it is simple and inexpensive to apply in practice.


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26-3

Objective 3

Use multiple production department factory overhead rates for product costing.


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26-3

Multiple Production Department Factory Overhead Rate Method

The multiple production department factory overhead rate method uses different rates for each production department to allocate factory overhead to products.


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26-3

Comparison of Single Plantwide Rate and Multiple Production Department Rate Methods

15


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$1,030,000

10,000 direct labor hours

= $103 per dlh

Assembly Department Overhead Rate:

$570,000

10,000 direct labor hours

= $57 per dlh

0

26-3

Production Department Factory Overhead Rates and Allocation

Fabrication Department Overhead Rate:

16


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26-3

Allocating Factory Overhead to Products—Ruiz Company

17


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4

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26-3

Multiple Production Department Rate Method—Ruiz Company

18


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26-3

Distortion in Product Costs—Single Plantwide versus Multiple Production Department Factory Overhead Rates

Factory Overhead Cost per Unit

Multiple Production Department Rates

Single Plantwide Rate

Snowmobile$800$938

Lawnmower800662

19


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and

(Continued)

0

26-3

In general, the following conditions may indicate that a single plantwide factory overhead rate will lead to distorted product costs.

Condition 1: Differences in production department factory overhead rates. There are significant differences in the factory overhead rates across different production departments. That is, some departments have high rates, while others have low rates


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0

26-3

Condition 2: Differences in the ratios of allocation-base usage. The products require different ratios of allocation base-usage across the departments.

(Concluded)


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26-3

Conditions for Product Cost Distortion—Ruiz Company

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26-4

Objective 4

Use activity-based costing for product costing.


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26-4

Activity-Based Costing (ABC) Method

The activity-based costing (ABC) methodallocates factory overhead more accurately than does the multiple production department rate method.


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26-4

Activity Cost Pools

The activity-based costingmethoduses cost of activities to determine product costs. Under this method, factory overhead costs are initially accounted for in activity cost pools.


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26-4

Multiple-Production Department Factory Overhead Rate Method vs. Activity-Based Costing

26

(Continued)


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26-4

Multiple-Production Department Factory Overhead Rate Method vs. Activity-Based Costing

27

(Concluded)


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26-4

Ruiz Company Example

Activity Cost PoolAmount

Fabrication$ 530,000

Assembly70,000

Setup480,000

Quality control inspection312,000

Engineering changes 208,000

Total budgeted factory overhead$1,600,000

28


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26-4

Activity Rates

The activity cost pools are assigned to products, using factory overhead rates for each activity. These rates are often called activity rates.


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26-4

Activity Base

Activity rates are determined by dividing the cost budgeted for each activity pool by the estimate activity base. This base is related to an activity pool.


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26-4

Estimated Activity-Base Usage Quantities—Ruiz Company

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26-4

Ruiz Company

Estimated

Budgeted

Activity AmountActivityRate

Fabrication$ 530,000/ 10,000 dlh=$ 53

Assembly70,000/ 10,000 dlh=$ 7

Setup480,000/ 120 setups= $ 4,000

Quality control

inspections312,000/ 104 inspects.=$ 3,000

Engineering

changes 208,000/ 16 changes=$13,000

Total$1,600,000

Cost Drivers

32


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Fabrication:DL HoursRateTotal

Snowmobile 8,000$53$424,000

Lawnmower 2,00053 106,000

Total10,000$530,000

0

26-4

Budgeted

Estimated

Activity AmountActivityRate

Fabrication$ 530,000/ 10,000 dlh=$ 53

Assembly70,000/ 10,000 dlh=$ 7

Setup480,000/ 120 setups=$ 4,000

Quality control312,000/ 104 inspts.=$ 3,000

Engineering 208,000/ 16 changes=$13,000

Total$1,600,000

33


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Assembly:DL HoursRateTotal

Snowmobile2,000$7$14,000

Lawnmower 8,0007 56,000

Total10,000$70,000

0

26-4

Budgeted

Estimated

Activity AmountActivityRate

Fabrication$ 530,000/ 10,000 dlh=$ 53

Assembly70,000/ 10,000 dlh=$ 7

Setup480,000/ 120 setups=$ 4,000

Quality control312,000/ 104 inspts.=$ 3,000

Engineering 208,000/ 16 changes=$13,000

Total$1,600,000

34


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Setup:SetupsRateTotal

Snowmobile100$4,000$400,000

Lawnmower 204,000 80,000

Total120$480,000

0

26-4

Budgeted

Estimated

Activity AmountActivityRate

Fabrication$ 530,000/ 10,000 dlh=$ 53

Assembly70,000/ 10,000 dlh=$ 7

Setup480,000/ 120 setups=$ 4,000

Quality control312,000/ 104 inspts.=$ 3,000

Engineering 208,000/ 16 changes=$13,000

Total$1,600,000

35


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Quality Control:Inspts.RateTotal

Snowmobile100$3,000$300,000

Lawnmower 43,000 12,000

Total104$312,000

0

26-4

Budgeted

Estimated

Activity AmountActivityRate

Fabrication$ 530,000/ 10,000 dlh=$ 53

Assembly70,000/ 10,000 dlh=$ 7

Setup480,000/ 120 setups=$ 4,000

Quality control312,000/ 104 inspts.=$ 3,000

Engineering 208,000/ 16 changes=$13,000

Total$1,600,000

36


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Engineering:ChangesRateTotal

Snowmobile12$13,000$156,000

Lawnmower 413,000 52,000

Total16$208,000

0

26-4

Budgeted

Estimated

Activity AmountActivityRate

Fabrication$ 530,000/ 10,000 dlh=$ 53

Assembly70,000/ 10,000 dlh=$ 7

Setup480,000/ 120 setups=$ 4,000

Quality control312,000/ 104 inspts.=$ 3,000

Engineering 208,000/ 16 changes=$13,000

Total$1,600,000

37


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26-4

Cost Allocation Summary:

Activity SnowmobileMowerTotal

Fabrication$ 424,000$106,000$ 530,000

Assembly14,00056,00070,000

Setup400,00080,000480,000

Quality control300,00012,000312,000

Engineering 156,000 52,000 208,000

Total$1,294,000$306,000$1,600,000

Budgeted units1,000 1,000

Cost per unit$1,294 $306

38


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26-4

Activity-Based Costing Method—Ruiz Company

39


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26-4

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$ 800$ 938$1,294

Lawnmower800662306

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26-5

Objective 5

Use activity-based costing to allocate selling and administrative expenses to products


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26-5

Abacus Company Example

The selling and administrative expenses of Abacus Company are allocated to its two products, Ipso and Facto, on the basis of warranty claims. Abacus Company has a budgeted cost of $150,000. One hundred warranty claims are estimated for the period.


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Field Service Activity Cost

Cost per Warranty Claim

=

Number of Claims

$150,000

100

Cost per Warranty Claim

=

Cost per Warranty Claim

$1,500

=

0

26-5

43


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26-5

Ipso had 10 warranty claims and Facto had 90 warranty claims. The field service activity would be allocated as follows:

Ipso: 10 warranty claims x $1,500 per warranty claim = $15,000

Facto:90 warranty claims x $1,500 per warranty claim = $135,000

44


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26-6

Objective 6

Use activity-based costing in a service business.


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Hopewell Hospital Example

26-6

Service businesses can use an activity-based costing system to determine how overhead is allocated to customers. The activity rate would be determined by dividing the budgeted activity cost pool by the estimated activity-base quantity, just as in a manufacturing firm.


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