CHAPTER 5 PowerPoint Author: LuAnn Bean, Ph.D., CPA, CIA, CFE Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

5-2 Labor Intensive Process Overhead costs are relatively small. Overhead costs are relatively small. Overhead allocations may be inaccurate, but the amounts are relatively insignificant. Overhead allocations may be inaccurate, but the amounts are relatively insignificant. Automated Process Overhead costs are relatively large. Overhead costs are relatively large. Inaccurate overhead allocation can lead to questionable product cost information. Inaccurate overhead allocation can lead to questionable product cost information. The Development of a Single Companywide Cost Driver

5-3 Overhead is allocated to jobs using direct labor hours. If overhead is $120, how much overhead is allocated to each job? The Development of a Single Companywide Cost Driver (Labor- Intensive) $120 / (2 + 6) = $15/ hour Job 1: $15 x 2 = $30 Job 2: $15 x 6 = $90

5-4 Overhead Rate = $420 ÷ 3 direct labor hours Overhead Rate = $140 per direct labor hour Job 1 = 2 hours × $140 per hour = $280 Job 2 = 1 hour × $140 per hour = $140 The Effects of Automation on the Selection of a Cost Driver

5-5 Level of Complexity Overhead Allocation Companywide Overhead Rate Activity Based Costing Many companies are using activity- based cost drivers to improve product costing. Activity-Based Cost Drivers

5-6 Activity-Based Cost Drivers Allocating setup costs using a volume-based allocation rate (number of cans) Overhead per can = $95,040 ÷ 1,188,000 cans Overhead per can = $0.08 per can Vegetable = 954,000 cans × $0.08 per can = $76,320 Tomato = 234,000 cans × $0.08 per can = $18,720

5-7 Activity-Based Cost Drivers Allocating setup costs using an activity-based allocation rate (number of setups). Overhead per setup = $264 Vegetable = 180 setups × $264 per setup = $47,520 Tomato = 180 setups × $264 per setup = $47,520

5-8 Activity-Based Costing Activity-based costing (ABC) is a two-stage allocation process that employs a variety of cost drivers. Stage 1 Assign costs to pools according to activities that cause costs to be incurred. Stage 2 Allocate costs in the activity pools to products. The first step is to identify essential activities and costs required to perform the activities.

5-9 Types of Production Activities Batch-Level Activity Product-Level Activity Unit-Level Activity Facility-Level Activity Overhead costs associated with each category are pooled together and allocated to products according to how those products benefit from the activities.

5-10 Types of Production Activities Unterman decides to implement ABC and categorizes activities into four activity cost centers. Unit-level Activities Batch-level Activities Product-level Activities Facility-level Activities Incurred each time a shirt is made. Incurred each time a batch of shirts (casual or dress) is made. Supports either dress or casual shirts. Benefits the entire process, not a line of specific shirts.

5-11 Unit-level Activity Center Unterman identifies the following unit-level overhead costs ($1,296,000 of the total $5,730,000):

5-12 Using the Information

5-13 Using the Information Traditional costing resulted in undercosting the casual shirt line and overcosting the dress shirt line.

5-14 Costs that companies incur to assure quality conformance may be classified as:  Prevention costs  Appraisal costs  Internal failure costs  External failure costs Total Quality Management

5-15 Minimizing Total Quality Costs Total Quality cost Percent of Products without Defects Cost per Unit ($) Voluntary costs (Prevention and Appraisal) Failure cost (internal and external) 0100

5-16 Quality Cost Reports Should Unterman spend more on prevention and appraisal in an effort to reduce failure costs? How do the costs differ from 2009 to 2010?

5-17 End of Chapter 5