1 Click to edit Master title style Cost Allocation and Activity-Based Costing 26

2 Click to edit Master title style 2 2 Identify three methods used for allocating factory overhead costs to products. Objective

3 Click to edit Master title style 3 3 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. Product Costing 26-1

4 Click to edit Master title style 4 4 4PRODUCTS Multiple Department Rates Activity-Based Costing Plantwide Overhead Rate Single Rate Department Activity Activity Factory Overhead Allocation Methods

5 Click to edit Master title style 5 5 Use a single plantwide factory overhead rate for product costing. Objective

6 Click to edit Master title style 6 6 Single Factory Overhead Rate Method Under the single plantwide factory overhead rate method, all of the factory overhead is allocated to all products, using only one rate. 26-2

7 Click to edit Master title style 7 7 Ruiz Company Illustration 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. 26-2

8 Click to edit Master title style 8 8 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. 26-2

9 Click to edit Master title style Total budgeted factory overhead costs Total budgeted plantwide allocation base Computing Single Plantwide Factory Overhead $80 per direct labor hour = $1,600,000 20,000 direct labor hours (1,000 x 10 dlh) + (1,000 x 10 dlh)

10 Click to edit Master title style 10 $80 per hour overhead rate $1,600,000 20,000 direct labor hours = 10 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 26-2

11 Click to edit Master title style Single Plantwide Factory Overhead Rate Method— Ruiz Company

12 Click to edit Master title style 12 The greatest advantage of the single plantwide overhead rate method is that it is simple and inexpensive to apply in practice. 26-2

13 Click to edit Master title style 13 Use multiple production department factory overhead rates for product costing. Objective

14 Click to edit Master title style 14 The multiple production department factory overhead rate method uses different rates for each production department to allocate factory overhead to products. Multiple Production Department Factory Overhead Rate Method 26-3

15 Click to edit Master title style Comparison of Single Plantwide Rate and Multiple Production Department Rate Methods

16 Click to edit Master title style 16 Production Department Factory Overhead Rates and Allocation Fabrication Department Overhead Rate: $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

17 Click to edit Master title style Allocating Factory Overhead to Products—Ruiz Company

18 Click to edit Master title style Multiple Production Department Rate Method— Ruiz Company 4

19 Click to edit Master title style 19 Distortion in Product Costs—Single Plantwide versus Multiple Production Department Factory Overhead Rates Factory Overhead Cost per Unit Single Plantwide Rate Multiple Production Department Rates Snowmobile$800$938 Lawnmower

20 Click to edit Master title style 20 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 26-3 (Continued) and

21 Click to edit Master title style 21 Condition 2: Differences in the ratios of allocation-base usage. The products require different ratios of allocation base-usage across the departments. (Concluded) 26-3

22 Click to edit Master title style Conditions for Product Cost Distortion—Ruiz Company

23 Click to edit Master title style 23 Use activity-based costing for product costing. Objective

24 Click to edit Master title style The activity-based costing (ABC) method allocates factory overhead more accurately than does the multiple production department rate method. Activity-Based Costing (ABC) Method

25 Click to edit Master title style The activity-based costing method uses cost of activities to determine product costs. Under this method, factory overhead costs are initially accounted for in activity cost pools. Activity Cost Pools

26 Click to edit Master title style Multiple-Production Department Factory Overhead Rate Method vs. Activity-Based Costing (Continued)

27 Click to edit Master title style Multiple-Production Department Factory Overhead Rate Method vs. Activity-Based Costing (Concluded)

28 Click to edit Master title style 28 Fabrication$ 530,000 Assembly70,000 Setup480,000 Quality control inspection312,000 Engineering changes 208,000 Total budgeted factory overhead$1,600,000 Activity Cost PoolAmount Ruiz Company Example

29 Click to edit Master title style 29 Activity Rates 26-4 The activity cost pools are assigned to products, using factory overhead rates for each activity. These rates are often called activity rates.

30 Click to edit Master title style 30 Activity Base 26-4 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.

31 Click to edit Master title style Estimated Activity-Base Usage Quantities—Ruiz Company

32 Click to edit Master title style 32 Cost Drivers 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, Ruiz Company Budgeted Estimated

33 Click to edit Master title style 33 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, Snowmobile 8,000$53$424,000 Lawnmower 2, ,000 Total10,000$530,000 Fabrication:DL HoursRateTotal 33 Activity AmountActivityRate BudgetedEstimated

34 Click to edit Master title style 34 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, Activity AmountActivityRate BudgetedEstimated Snowmobile2,000$7$14,000 Lawnmower 8, ,000 Total10,000$70,000 Assembly:DL HoursRateTotal

35 Click to edit Master title style 35 Snowmobile100$4,000$400,000 Lawnmower 204,000 80,000 Total120$480,000 Setup:SetupsRateTotal Fabrication$ 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 Activity AmountActivityRate BudgetedEstimated

36 Click to edit Master title style 36 Snowmobile100$3,000$300,000 Lawnmower 43,000 12,000 Total104$312,000 Quality Control:Inspts.RateTotal Fabrication$ 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 Activity AmountActivityRate BudgetedEstimated

37 Click to edit Master title style 37 Snowmobile12$13,000$156,000 Lawnmower 413,000 52,000 Total16$208,000 Engineering:ChangesRateTotal Activity AmountActivityRate BudgetedEstimated Fabrication$ 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

38 Click to edit Master title style 38 Activity SnowmobileMowerTotal Cost Allocation Summary: 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 Total$1,294,000$306,000$1,600,000 Budgeted units1,000 1,000 Cost per unit$1,294 $

39 Click to edit Master title style Activity-Based Costing Method—Ruiz Company

40 Click to edit Master title style 40 Snowmobile$ 800$ 938$1,294 Lawnmower Single Plantwide Multiple Production Rate Department Rates ABC Factory Overhead Cost per Unit— Three Cost Allocation Methods Distortion in Product Costs—Multiple Production Department Factory Overhead Rate Method versus Activity-Based Costing

41 Click to edit Master title style 41 Use activity-based costing to allocate selling and administrative expenses to products Objective

42 Click to edit Master title style 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. Abacus Company Example

43 Click to edit Master title style Cost per Warranty Claim = Field Service Activity Cost Number of Claims Cost per Warranty Claim = $150, Cost per Warranty Claim = $1,500

44 Click to edit Master title style 44 Ipso: 10 warranty claims x $1,500 per warranty claim = $15,000 Facto:90 warranty claims x $1,500 per warranty claim = $135,000 Ipso had 10 warranty claims and Facto had 90 warranty claims. The field service activity would be allocated as follows: 26-5

45 Click to edit Master title style 45 Use activity-based costing in a service business. Objective

46 Click to edit Master title style Hopewell Hospital Example 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.