Chapter 25 Cost Allocation and ActivityBased Costing Financial

Chapter 25 Cost Allocation and Activity-Based Costing Financial and Managerial Accounting 8 th Edition Warren Reeve Fess Power. Point 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 electroni 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 Activity-Based Costing 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 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 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 Rates Products Continued

Multiple Production Department Factory Overhead versus ABC Activity Rates Products Activity

Activity-Based Costing Method Activity Fabrication Assembly Setup Quality control Engineering Total Amount Activity $ 530, 000 70, 000 480, 000 312, 000 208, 000 $1, 600, 000 Rate

Activity-Based Costing Method Activity Fabrication $53 Assembly $7 Setup $4, 000 Quality control Fabrication: $3, 000 Engineering Snowmobile $13, 000 Lawnmower Total Amount Activity Rate $ 530, 000 ÷ 10, 000 dlh = 70, 000 ÷ 10, 000 dlh = 480, 000 ÷ 120 setups = 312, 000 ÷ 104 inspts. DL Hours Rate Total Cost Drivers 208, 000 $53 ÷ 16 changes 8, 000 $424, 000 2, 000 53 106, 000 $1, 600, 000 10, 000 $530, 000 = =

Activity-Based Costing Method Activity Fabrication $53 Assembly $7 Setup $4, 000 Quality control Assembly: $3, 000 Engineering Snowmobile $13, 000 Lawnmower Total Amount Activity Rate $ 530, 000 ÷ 10, 000 dlh = 70, 000 ÷ 10, 000 dlh = 480, 000 ÷ 120 setups = 312, 000 ÷ 104 inspts. DL Hours Rate Total 208, 000 changes 2, 000 $7 ÷ 16$14, 000 8, 000 7 56, 000 $1, 600, 000 10, 000 $70, 000 = =

Activity-Based Costing Method Activity Fabrication $53 Assembly $7 Setup $4, 000 Quality control Setup: $3, 000 Engineering Snowmobile $13, 000 Lawnmower Total Amount Activity Rate $ 530, 000 ÷ 10, 000 dlh = 70, 000 ÷ 10, 000 dlh 480, 000 ÷ 120 setups = = 312, 000 ÷ 104 inspts. = Setups Rate Total 208, 000 100 $4, 000 ÷ 16 changes $400, 000 = 20 4, 000 80, 000 120$1, 600, 000 $480, 000

Activity-Based Costing Method Activity Amount Activity Rate Fabrication $ 530, 000 ÷ 10, 000 dlh = $53 Assembly 70, 000 ÷ 10, 000 dlh = $7 Setup 480, 000 ÷ 120 setups = $4, 000 Quality control 312, 000 ÷ 104 inspts. = Quality Control: Inspts. Rate Total $3, 000 Engineering 208, 000 changes = Snowmobile 100 $3, 000 ÷ 16 $300, 000 $13, 000 Lawnmower 4 3, 000 12, 000 Total 104$1, 600, 000 $312, 000

Activity-Based Costing Method Activity Fabrication $53 Assembly $7 Setup $4, 000 Quality control Engineering: $3, 000 Engineering Snowmobile $13, 000 Lawnmower Total $208, 000 Amount Activity Rate $ 530, 000 ÷ 10, 000 dlh = 70, 000 ÷ 10, 000 dlh = 480, 000 ÷ 120 setups = 312, 000 ÷ 104 inspts. Changes Rate Total ÷ 16 changes 12208, 000 $13, 000$156, 000 4 13, 000 52, 000 16 $1, 600, 000 = =

Activity-Based Costing Method Cost Allocation Summary: Activity Snowmobile Fabrication Assembly Setup Quality control Engineering Total Budgeted units Cost per unit $ 424, 000 14, 000 400, 000 300, 000 156, 000 $1, 294, 000 1, 000 $1, 294 Mower $106, 000 56, 000 80, 000 12, 000 52, 000 $306, 000 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 Inspection 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 $ 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. Rate: I Operating Radiological Testing Activity 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 Name: Mary Wilson Activity Admitting Radiology testing Operating room Pathological testing Dietary and laundry Total $2, 790 Activity-Base Usage 1 admission 2 images 4 hours 1 specimen 7 days x x x Activity Rate Cost $180 = $ 180 320 = 640 200 = 800 120 = 120 150 = 1, 050 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 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