1. 1 Chapter 7- Cost Management Systems-ABC. M11-Chp-08-1-Cost-Mgt-Systems-ABC-2011-0523 Summer, 2011. Edited May 23, 2011. Copyright © 2011, Dr. Howard Godfrey This file contains illustrative problems that will be used in the lecture to illustrate important concepts and procedures. Copyright 2011. Dr. Howard Godfrey - M11-Chp-07-1-Cost-Mgt-Systems-ABC-2011-0523

2. 2 After studying Chapter 7, you should be able to: LO1 Understand activity-based costing and how it differs from a traditional costing system. LO2 Assign costs to cost pools using a first- stage allocation. LO3 Compute activity rates for cost pools. LO4 Assign costs to a cost object using a second-stage allocation. LO5 Use activity-based costing to compute product and customer margins.

3. Caution from Instructor. This chapter has material that is very detailed. The instructor will cover a Job Order Cost problem that sets the stage for ABC. The instructor will work a “less complex” “ABC” problem and you will be expected to solve a similar problem on the next test. 3

4. How can ABC be helpful? A bank trust department analyzed its costs (activities) to prepare necessary paperwork to set up a trust account for a family. The cost for the paperwork was the same (say personnel time and supply costs of $300) for a small trust (assets of $10,000) as for a large trust (assets of $1,000,000 or more). Decision: do not agree to handle trust accounts with balances under say $200,000. 4

5. Overview of this File This file contains an illustration of Job Order Costing procedures and an illustration of Activity Based Costing procedures. 5

6. Overview of this File You may want to print some slides separately – a full page for a slide. That gives you worksheets to use in working the problems. 6

7. Job Order Cost System-1 of 8 With this illustration, we see a cost accounting system in action. When a job (100 widgets) is completed in January, we have an estimate of the cost of that job at completion, even though there are still eleven more months in the year. Our system has actual cost of materials and labor and an estimate of overhead costs (Applied Overhead). 7

8. Job Order Cost System-2 of 8 Big Co. uses a job order cost system. The following transactions were completed in January, 2010, which was its first month of operations: (a) Purchased and received direct materials and supplies costing $18,000. 8

9. Job Order Cost System-3 of 8 (a) Purchased and received direct materials and supplies costing $18,000. (b) Materials and supplies were requisitioned as follows: Job no. 1$3,000 Job no. 2 4,000 Job no. 3 1,000 $8,000 Indirect Materials (Supplies)$1,000 9

10. Job Order Cost System-4 of 8 (c) Factory payroll was distributed as follows: DIRECT LABOR: Job no. 1 (200 hours)$2,000 Job no. 2 (300 hours) 3,000 Job no. 3 (400 hours) 4,000 $9,000 INDIRECT LABOR$2,000 (Janitors - an example of indirect labor- not working on specific jobs.) 10

11. Job Order Cost System-5 of 8 (d) Indirect manufacturing costs are applied on the basis of direct labor hours. The budget for 2010 included 6,000 direct labor hours and a total overhead budget of $42,000. Overhead is applied based on direct labor hours worked. (e) Other manufacturing overhead costs were incurred, but not mentioned in this problem. 11

12. Job Order Cost -Practice 12

13. Job Order Cost System-8 of 8 1. What was the amount of factory overhead applied in January for all jobs? a. $4,800 b. $4,600 c. $6,300 d. $7,200 2. What was the cost of Job No. 3 (which was completed in January)? a. $4,800 b. $4,600 c. $6,600 d. $7,800 3. Activity based costing adds precision when it is used for tracing the following cost to the final product? a. direct materials b. direct labor c. overhead 13

14. Job Order Cost System-7 of 8 14

15. Overhead Application Case Company B had total factory overhead of $80,000 and total direct labor of $60,000. Using the factory overhead rate, how much factory overhead would be allocated to goods in process at the end of the period, which are estimated to contain $12,000 of direct labor? a. $45,000 b. $16,000 c. $11,250 d. $9,000 15

16. Activity-Based Costing System You may want to print the following spreadsheets as one slide per page, so you can see the detail more easily. 16

17. Designing and Implementing an Activity- Based Costing System The following slide contains worksheet for questions 1, 2 and 3. 17

20. Designing and Implementing an Activity- Based Costing System Do you notice that the overhead application rate is $29 per direct labor hour? (See later slide) Is all overhead “driven” by the labor hours? This may have been a repeat job with no engineering, one setup, one inspection. 20

21. Questions. 1. If the company applies overhead items above based on direct labor cost for a job, the overhead cost assigned to Job 1 would be: a. $2,800 b. $5,600 c. $5,800 d. $10,000 2. If the company uses activity-based costing, how much overhead cost should be assigned to Job 1? a. $1,300 b. $1,400 c. $1,500 d. $5,600 3. If the company uses activity-based costing, compute the cost of each unit in Job 2. a. $340 b. $350 c. 440 d. $520 21

22. Your Answers 1. If the company applies overhead items above based on direct labor cost for a job, the overhead cost assigned to Job 1 would be: a. $2,800 b. $5,600 c. $5,800 d. $10,000 (290% of direct labor cost for the job) 2. If the company uses activity-based costing, how much overhead cost should be assigned to Job 1? a. $1,300 b. $1,400 c. $1,500 d. $5,600 ($600 + $100 + 300 + 400) 3. If the company uses activity-based costing, compute the cost of each unit in Job 2. a. $340 b. $350 c. 440 d. $520 (See answer Slide) 22

24. 24

25. The End 25