activity based costing - mheducation.ca · explain the major differences between activity-based...
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© McGraw-Hill Ryerson Limited., 2001
LEARNING OBJECTIVES
1. Explain the major differences between activity-based costing and a traditional costingsystem.
2. Distinguish between unit-level, product-level,customer-level and organization-sustainingactivities.
3. Assign costs to cost pools using a first-stageallocation.
4. Compute activity rates for cost pools andexplain how they can be used to targetprocess improvements.
After studying this chapter, you should be able to:
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LEARNING OBJECTIVES
5. Assign costs to a cost object using a second-stage allocation.
6. Prepare a report showing activity-basedcosting product margins from an activity view.
7. Prepare an action analysis report usingactivity-based costing data and interpret thereport.
8. Use the simplified approach to computeactivity-based costs and margins.
9. (Appendix 8A) Record the flow of costs in anactivity-based costing system.
After studying this chapter, you should be able to:
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Activity Based Costing (ABC)
The objective ofactivity-basedcosting is tounderstand
overhead and theprofitability ofproducts andcustomers.
ABC is agood supplementto our traditional
cost systemI agree!
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Overhead rates maybe based on activity
at capacity.
Overhead rates maybe based on activity
at capacity.
Activity Based Costing (ABC)
Activity-Based CostingActivity-Based Costing
Both manufacturingand nonmanufacturing
costs may be assigned toproducts.
Both manufacturingand nonmanufacturing
costs may be assigned toproducts.
Some manufacturingcosts may be excluded
from productcosts.
Some manufacturingcosts may be excluded
from productcosts.
There are a numberof cost pools each of
which is allocatedusing a unique
measure of activity.
There are a numberof cost pools each of
which is allocatedusing a unique
measure of activity.
Allocation bases oftendiffer from
traditional costingsystems.
Allocation bases oftendiffer from
traditional costingsystems.
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How Costs are Treated UnderActivity-Based Costing
Level o
f Com
plexit
y
Level o
f Com
plexit
y
O verhead Allocation
Plantwide Overhead
Rate
Plantwide Overhead
Rate
DepartmentalOverhead
Rates
DepartmentalOverhead
Rates
Activity BasedCosting
Activity BasedCosting
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Plantwide Overhead Rate
Companies tend to use direct labourdirect labour as the overhead allocation base.
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A two stage process isnecessary because costs
are allocated to departmentsand then to products.
A two stage process isnecessary because costs
are allocated to departmentsand then to products.
Finishing Department
Shipping Department
Painting Department
Departmental Overhead Rates
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Department1
Department2
Department3Cost poolsCost pools
IndirectLabourIndirectLabour
IndirectMaterialsIndirect
MaterialsOther
OverheadOther
OverheadStage One:Stage One:Costs assignedCosts assignedto poolsto pools
Departmental Overhead Rates
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Department1
Department2
Department3Cost poolsCost pools
Stage One:Stage One:Costs assignedCosts assignedto poolsto pools
Products Products
Stage Two:Stage Two:Costs appliedCosts appliedto productsto products
Departmental Overhead Rates
IndirectLabourIndirectLabour
IndirectMaterialsIndirect
MaterialsOther
OverheadOther
Overhead
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Department1
Department2
Department3Cost poolsCost pools
Stage One:Stage One:Costs assignedCosts assignedto poolsto pools
Products Products
Stage Two:Stage Two:Costs appliedCosts appliedto productsto products
Direct Labour Hours
MachineHours
RawMaterials
Cost
Departmental Allocation Bases
Departmental Overhead Rates
IndirectLabourIndirectLabour
IndirectMaterialsIndirect
MaterialsOther
OverheadOther
Overhead
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Designing an ABC System
Cost Objects(e.g., productsand customers)
Cost Objects(e.g., productsand customers)
ActivitiesActivities Consumptionof Resources
Consumptionof Resources
CostCost
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Designing an ABC System
Steps for Implementing ABCSteps for Implementing ABC! Identify and define activities and activity pools.
"Where possible, trace costs to activities and costobjects.
#Assign costs to activity cost pools.
$Calculate activity rates.
%Assign costs to cost objects.
&Prepare management reports.
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Identifying Activity to Include
A part of the productionA part of the productionprocess for which managementprocess for which management
wants a separate reporting of thewants a separate reporting of thecosts of the activity involved.costs of the activity involved.
Unit-LevelActivity
Batch-Level Activity
Product-LevelActivity
Customer-LevelActivityOrganization-
sustainingActivity
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Identifying Activity to Include
Activity Cost PoolActivity Cost Poolis a “bucket” inwhich costs are
accumulated thatrelate to a single
activity in the ABCsystem.
$
$
$ $
$$
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The Mechanics of ABC
At Classic Brass, the ultimate cost objects are:!Products,
"Customer orders, and
#Customers.
One overhead cost - shipping - can be traceddirectly to customer orders.
The company’s overhead costs are shown onthe next slide.
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Production DepartmentIndirect factory wages 500,000$ Factory equipment amortization 300,000 Factory utilities 120,000 Factory building lease 80,000 1,000,000$
Shipping costs traced to customer orders 40,000 General Administrative Department
Administrative wages and salaries 400,000 Office equipment amortization 50,000 Administrative building lease 60,000 510,000
Marketing DepartmentMarketing wages and salaries 250,000 Selling expenses 50,000 300,000
Total overhead costs 1,850,000$
Overhead Costs at Classic Brass
(Manufacturing and NonManufacturing)
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Activity-Based Costing at Classic Brass
DirectMaterials
DirectMaterials
DirectLabourDirectLabour
ShippingCosts
ShippingCosts Overhead CostsOverhead Costs
TracedTraced $/DLH$/DLH TracedTraced
Cost Objects:Products, Customer Orders, Customers
Cost Objects:Products, Customer Orders, Customers
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Activity-Based Costing at Classic Brass
DirectMaterials
DirectMaterials
DirectLabourDirectLabour
ShippingCosts
ShippingCosts
OrderSize
OrderSize
CustomerOrders
CustomerOrders
ProductDesignProductDesign
CustomerRelationsCustomerRelations OtherOther
Overhead CostsOverhead Costs
Cost Objects:Products, Customer Orders, Customers
Cost Objects:Products, Customer Orders, Customers
First-Stage Allocation
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Activity-Based Costing at Classic Brass
DirectMaterials
DirectMaterials
DirectLabourDirectLabour
ShippingCosts
ShippingCosts
Cost Objects:Products, Customer Orders, Customers
Cost Objects:Products, Customer Orders, Customers
OrderSize
OrderSize
CustomerOrders
CustomerOrders
ProductDesignProductDesign
CustomerRelationsCustomerRelations OtherOther
Overhead CostsOverhead Costs
First-Stage Allocation
Second-Stage Allocations
$/MH$/MH $/Order$/Order $/Design$/Design $/Customer$/Customer
UnallocatedUnallocated
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Assigning Costs to Activity Cost Pools
Customer Orders
Product Design
Order Size
Customer Relations Other Total
Production DepartmentIndirect factory wages 25% 40% 20% 10% 5% 100%Factory equipment amortization 20% 0% 60% 0% 20% 100%Factory utilities 0% 10% 50% 0% 40% 100%Factory building lease 0% 0% 0% 0% 100% 100%
Shipping costs traced to customer order N/AGeneral Administrative Department
Administrative wages and salaries 15% 5% 10% 30% 40% 100%Office equipment amortization 30% 0% 0% 25% 45% 100%Administrative building lease 0% 0% 0% 0% 100% 100%
Marketing DepartmentMarketing wages and salaries 20% 10% 0% 60% 10% 100%Selling expenses 10% 0% 0% 70% 20% 100%
Activity Cost Pools
Management at Classic Brass believes overhead should bedistributed as follows:
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Customer Orders
Product Design
Order Size
Customer Relations Other Total
Production DepartmentIndirect factory wages 125,000$ Factory equipment amortizationFactory utilitiesFactory building lease
General Administrative DepartmentAdministrative wages and salariesOffice equipment amortizationAdministrative building lease
Marketing DepartmentMarketing wages and salariesSelling expenses
Total
First-Stage Allocation to Activity Cost Pools
Assigning Costs to Activity Cost Pools
Indirect factory wages $500,000Percent consumed by customer orders 25%
$125,000
Indirect factory wages $500,000Percent consumed by customer orders 25%
$125,000
Using the total costs and percentage consumption ofoverhead, costs are assigned to activity pools.
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Customer Orders
Product Design
Order Size
Customer Relations Other Total
Production DepartmentIndirect factory wages 125,000$ Factory equipment amortization 60,000 Factory utilitiesFactory building lease
General Administrative DepartmentAdministrative wages and salariesOffice equipment amortizationAdministrative building lease
Marketing DepartmentMarketing wages and salariesSelling expenses
Total
First-Stage Allocation to Activity Cost Pools
Assigning Costs to Activity Cost Pools
Factory equipment amortization $300,000Percent consumed by customer orders 20%
$ 60,000
Factory equipment amortization $300,000Percent consumed by customer orders 20%
$ 60,000
Using the total costs and percentage consumption ofoverhead, costs are assigned to activity pools.
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Customer Orders
Product Design
Order Size
Customer Relations Other Total
Production DepartmentIndirect factory wages 125,000$ 200,000$ 100,000$ 50,000$ 25,000$ 500,000$ Factory equipment amortization 60,000 - 180,000 - 60,000 300,000 Factory utilities - 12,000 60,000 - 48,000 120,000 Factory building lease - - - - 80,000 80,000
General Administrative DepartmentAdministrative wages and salaries 60,000 20,000 40,000 120,000 160,000 400,000 Office equipment amortization 15,000 - - 12,500 22,500 50,000 Administrative building lease - - - - 60,000 60,000
Marketing DepartmentMarketing wages and salaries 50,000 25,000 - 150,000 25,000 250,000 Selling expenses 5,000 - - 35,000 10,000 50,000
Total 315,000$ 257,000$ 380,000$ 367,500$ 490,500$ 1,810,000$
First-Stage Allocation to Activity Cost Pools
Assigning Costs to Activity Cost PoolsUsing the total costs and percentage consumption of
overhead, costs are assigned to activity pools.
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Customer Orders
Product Design
Order Size
Customer Relations Other Total
Production DepartmentIndirect factory wages 125,000$ 200,000$ 100,000$ 50,000$ 25,000$ 500,000$ Factory equipment amortization 60,000 - 180,000 - 60,000 300,000 Factory utilities - 12,000 60,000 - 48,000 120,000 Factory building lease - - - - 80,000 80,000
General Administrative DepartmentAdministrative wages and salaries 60,000 20,000 40,000 120,000 160,000 400,000 Office equipment amortization 15,000 - - 12,500 22,500 50,000 Administrative building lease - - - - 60,000 60,000
Marketing DepartmentMarketing wages and salaries 50,000 25,000 - 150,000 25,000 250,000 Selling expenses 5,000 - - 35,000 10,000 50,000
Total 315,000$ 257,000$ 380,000$ 367,500$ 490,500$ 1,810,000$
First-Stage Allocation to Activity Cost Pools
Assigning Costs to Activity Cost PoolsUsing the total costs and percentage consumption of
overhead, costs are assigned to activity pools.
These costs shouldbe cross-added to get
the total
This number should thenequal the total of the
individual overhead itemto be allocated
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Computation of Activity Rates
The ABC team has determined that ClassicBrass has the following total activities for each
activity cost pool . . .'1,000 customer orders,
'200 new designs,
'20,000 machine-hours
'100 customers.
Now the team can compute the individualNow the team can compute the individualactivity rates.activity rates.
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1,000 Orders
200 Designs
20,000
machine-hours
100 Customers Other
Production Department
Indirect factory wages 125$ Factory equipment amortizationFactory utilitiesFactory building lease
General Administrative DepartmentAdministrative w ages and salariesOffice equipment amortizationAdministrative building lease
Marketing DepartmentMarketing wages and salariesSelling expenses
Total
Activity Rates for each Activity Cost Pools
Computation of Activity Rates
Customer Orders
Indirect factory wages 125,000$ Number of orders ÷ 1,000 Indirect factory wages/order 125$
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Computation of Activity Rates
1,000 Orders
200 Designs
20,000
machine-hours
100 Customers Other
Production Department
Indirect factory wages 125$ 1,000$ 5$ 500$ N/AFactory equipment amortization 60 - 9 - Factory utilities - 60 3 - Factory building lease - - - -
General Administrative DepartmentAdministrative w ages and salarie 60 100 2 1,200 Office equipment amortization 15 - - 125 Administrative building lease - - - -
Marketing DepartmentMarketing wages and salaries 50 125 - 1,500 Selling expenses 5 - - 350
Total 315$ 1,285$ 19$ 3,675$
Activity Rates for each Activity Cost Pools
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Assigning Costs to Cost Objects
Let’s take a look at how our system works for just onecustomer - Windward Yachts.
' Windward ordered two products - Stanchions andCustomer Compass Housings.
' The details are outlined on the following slide.
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Assigning Costs to Cost Objects
Custom Compass Housing (requires new design)1. One order during the year.2. Each housing required 4 machine-hours .3. Selling price is $650 each.4. Direct materials total $13.5. Direct labour totals $50.6. Shipping costs total $25.
Custom Compass Housing (requires new design)1. One order during the year.1. One order during the year.2. Each housing required 4 machine-hours .2. Each housing required 4 machine-hours .3. Selling price is $650 each.3. Selling price is $650 each.4. Direct materials total $13.4. Direct materials total $13.5. Direct labour totals $50.5. Direct labour totals $50.6. Shipping costs total $25.6. Shipping costs total $25.
Standard Stanchions (no design required)1. 400 units ordered with 2 separate orders.2. Each stanchion required 0.5 machine-hours .3. Selling price is $34 each.4. Direct materials total $2,110.5. Direct labour totals $1,850.6. Shipping costs total $180.
Standard Stanchions (no design required)1. 400 units ordered with 2 separate orders.1. 400 units ordered with 2 separate orders.2. Each stanchion required 0.5 machine-hours .2. Each stanchion required 0.5 machine-hours .3. Selling price is $34 each.3. Selling price is $34 each.4. Direct materials total $2,110.4. Direct materials total $2,110.5. Direct labour totals $1,850.5. Direct labour totals $1,850.6. Shipping costs total $180.6. Shipping costs total $180.
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2 Orders No new design
200
machine hours N/A Total
Production Department
Indirect factory wages 250$ Factory equipment amortizationFactory utilitiesFactory building lease
General Administrative DepartmentAdministrative wages and salariesOffice equipment amortizationAdministrative building lease
Marketing DepartmentMarketing wages and salariesSelling expenses
Total
Activity Cost Pools - Two Standard Stanchions
Assigning Costs to Cost Objects
$125 per order × 2 orders = $250$125 per order × 2 orders = $250
Overhead cost of two orders for standard stanchions.Overhead cost of two orders for standard stanchions.
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Assigning Costs to Cost Objects
2 Orders No new design
200
machine hours N/A Total
Production Department
Indirect factory wages 250$ -$ 1,000$ -$ 1,250$ Factory equipment amortization 120 - 1,800 - 1,920 Factory utilities - - 600 - 600 Factory building lease - - - -
General Administrative DepartmentAdministrative wages and salaries 120 - 400 - 520 Office equipment amortization 30 - - - 30 Administrative building lease - - - -
Marketing DepartmentMarketing wages and salaries 100 - - - 100 Selling expenses 10 - - - 10
Total 630$ -$ 3,800$ -$ 4,430$
Activity Cost Pools - Two Standard Stanchions
Overhead cost of two orders for standard stanchions.Overhead cost of two orders for standard stanchions.
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1 Order 1 new design
4 machine
hours N/A Total
Production DepartmentIndirect factory wages 125$ Factory equipment amortizationFactory utilitiesFactory building lease
General Administrative DepartmentAdministrative w ages and salariesOffice equipment amortizationAdministrative building lease
Marketing DepartmentMarketing wages and salariesSelling expenses
Total
Activity Cost Pools - One Custom Compass Housing
Assigning Costs to Cost ObjectsOverhead cost of one order for custom compass housing.Overhead cost of one order for custom compass housing.
$125 per order × 1 order = $125$125 per order × 1 order = $125
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Assigning Costs to Cost Objects
1 Order 1 new design
4 machine
hours N/A Total
Production DepartmentIndirect factory wages 125$ 1,000$ 20$ -$ 1,145$ Factory equipment amortization 60 - 36 - 96 Factory utilities - 60 12 - 72 Factory building lease - - - -
General Administrative DepartmentAdministrative wages and salaries 60 100 8 - 168 Office equipment amortization 15 - - - 15 Administrative building lease - - - -
Marketing DepartmentMarketing wages and salaries 50 125 - - 175 Selling expenses 5 - - - 5
Total 315$ 1,285$ 76$ -$ 1,676$
Activity Cost Pools - One Custom Compass Housing
Overhead cost of one order for custom compass housing.Overhead cost of one order for custom compass housing.
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Product MarginsStandard Stanchions
Sales 13,600$ Cost: Direct materials 2,110$ Direct labour 1,850 Shipping costs 180 Customer orders 630 Product design - Order size 3,800 8,570
Product margin 5,030$
Standard StanchionsSales 13,600$ Cost: Direct materials 2,110$ Direct labour 1,850 Shipping costs 180 Customer orders 630 Product design - Order size 3,800 8,570
Product margin 5,030$
Custom Compass HousingSales 650$ Cost: Direct materials 13$ Direct labour 50 Shipping costs 25 Customer orders 315 Product design 1,285 Order size 76 1,764
Product margin (1,114)$
Custom Compass HousingSales 650$ Cost: Direct materials 13$ Direct labour 50 Shipping costs 25 Customer orders 315 Product design 1,285 Order size 76 1,764
Product margin (1,114)$
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Custom Compass HousingSales 650$ Cost: Direct materials 13$ Direct labour 50 Shipping costs 25 Customer orders 315 Product design 1,285 Order size 76 1,764
Product margin (1,114)$
Custom Compass HousingSales 650$ Cost: Direct materials 13$ Direct labour 50 Shipping costs 25 Customer orders 315 Product design 1,285 Order size 76 1,764
Product margin (1,114)$
Product MarginsStandard Stanchions
Sales 13,600$ Cost: Direct materials 2,110$ Direct labour 1,850 Shipping costs 180 Customer orders 630 Product design - Order size 3,800 8,570
Product margin 5,030$
Standard StanchionsSales 13,600$ Cost: Direct materials 2,110$ Direct labour 1,850 Shipping costs 180 Customer orders 630 Product design - Order size 3,800 8,570
Product margin 5,030$
Windward YachtsProduct margins: Standard stanchion 5,030$ Custom compass housing (1,114) Total product margin 3,916 Less: Customer relations 3,675 Customer margin 241$
Windward YachtsProduct margins: Standard stanchion 5,030$ Custom compass housing (1,114) Total product margin 3,916 Less: Customer relations 3,675 Customer margin 241$
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Product Margins
Standard Stanchions
Compass Housing
Sales 13,600$ 650$ Costs
Direct materials (2,110) (13) Direct labour (1,850) (50) Manufacturing overhead (10,000) (200)
Product margin (360)$ 387$
Traditional Cost Accounting System
Predetermined manufacturingoverhead rate
$1,000,000 20,000 MH
= $50/MH=
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Product Margins
Standard Stanchions
Compass Housing
Sales 13,600$ 650$ Costs
Direct materials (2,110) (13) Direct labour (1,850) (50) Manufacturing overhead (10,000) (200)
Product margin (360)$ 387$
Traditional Cost Accounting System
400 units x 0.5 MH/unit x $50/MH = $10,000400 units x 0.5 MH/unit x $50/MH = $10,000
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Product Margins
Standard Stanchions
Compass Housing
Sales 13,600$ 650$ Costs
Direct materials (2,110) (13) Direct labour (1,850) (50) Manufacturing overhead (10,000) (200)
Product margin (360)$ 387$
Traditional Cost Accounting System
1 units x 4.0 MH/unit x $50/MH = $2001 units x 4.0 MH/unit x $50/MH = $200
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Difference Between ABC andTraditional Product Costs
ABC will ordinarily shiftbatch-level andproduct-level
overhead costs fromhigh-volume
products produced inlarge batches to low-
volume productsproduced in small
batches.
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Difference Between ABC andTraditional Product Costs
Under ABC bothmanufacturing andnonmanufacturing
costs may beassigned to products.
Organization-sustaining costs and
the costs of idlecapacity are not
assigned to products.
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Ease of Adjustment Codes(Green, Yellow and Red Costs)
Costs that adjust automatically to changes in activity:' Direct materials.
' Shipping.
Costs that could be adjusted to changes in activity:' Direct labour.
' Factory utilities.
' Administrative wages and salaries.
' Office equipment amortization.
' Marketing wages and salaries.
' Selling expenses.
Costs that are difficult to adjust to changes in activity:' Factory equipment amortization.
' Factory building lease.
' Administrative building lease.
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Custom Compass HousingSales 650$ Green costs:
Direct materials 13$ Shipping costs 25 38 Green margin 612
Yellow costs:Direct labour 50.00 Indirect factory wages 1,145.00 Factory utilities 72.00 Administrative wages 168.00 Office equip. amortization 15.00 Marketing wages 175.00 Selling expenses 5.00 1,630 Yellow margin (1,018)
Red costs:Factory equip. amortization 96 Factory building lease 0Admin. Building lease 0 96 Red margin (1,114)$
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Simplified Approach to ABC
After the first-stage allocation is complete, computationof activity rates for each activity cost pool can be
simplified as follows:
Computation of the Activity Rates Customer
Orders Product Design Order Size
Customer Relations Other
Costs from first- stage allocation 315,000$ 257,000$ 380,000$ 367,500$ 490,500$ Total activity 1,000 200 20,000 100 N/ACost per unit of activity 315$ 1,285$ 19$ 3,675$
Computation of the Activity Rates Customer
Orders Product Design Order Size
Customer Relations Other
Costs from first- stage allocation 315,000$ 257,000$ 380,000$ 367,500$ 490,500$ Total activity 1,000 200 20,000 100 N/ACost per unit of activity 315$ 1,285$ 19$ 3,675$
÷ ÷ ÷ ÷
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Simplified Approach to ABC
Standard Stanchions: Sales 13,600$ Costs: Direct materials 2,110$ Direct labour 1,850 Shipping costs 180 Customer orders (2) 630 Product design - Order size (200) 3,800 8,570 Product margin 5,030$
2 orders @ $315 per order2 orders @ $315 per order
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Simplified Approach to ABC
Custom Compass Housing Sales 650$ Costs: Direct materials 13$ Direct labour 50 Shipping costs 25 Customer orders (1) 315 Product design 1,285 Order size 76 1,764 Product margin (1,114)$
1 design @ $1,285 per design1 design @ $1,285 per design
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Simplified Approach to ABC
Customer margin for Windward Yachts is shown below:
Customer Profitability AnalysisProduct margins: Standard stanchion $ 5,030 Custom compass housing (1,114) Total product margins 3,916 Less: Customer relations (3,675) Customer margin 241
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Predetermined Overhead Rates
(Calculate the predetermined overheadrate for each activity centre based on thefollowing formula:
Predetermined overhead rate =
Estimated overhead cost associatedwith the activity centre
Expected activity level of the cost driver
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JOURNAL ENTRIES
( Record purchase of raw materialsDr Raw Materials
Cr Accounts Payable
( Record transfer of raw material to work inprocess
Dr Work In Process (direct material)
Dr Manufacturing overhead (indirect material)
Cr Raw Materials
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JOURNAL ENTRIES (con’t)
(Record labour costsDr Work In Process (direct labour)
Dr Manufacturing Overhead (indirect labour)
Cr Salaries and Wages Payable
(Record overhead costsDr Manufacturing Overhead
Cr Accumulated Amortization
Cr Property Taxes Payable
Cr Prepaid Insurance
Cr Accounts Payable
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JOURNAL ENTRIES (con’t)
(Record applied overhead
Dr Work In Process
Cr Manufacturing Overhead
Applied overhead for each activity centre iscalculated by multiplying each of the individualpredetermined overhead rates by the actuallevel of cost driver activity incurred. Then, sumall these individual totals to determine the totalapplied overhead for the company.
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JOURNAL ENTRIES (con’t)
(Record transfer to finished goods
Dr Finished Goods
Cr Work In Process
(Record sale of goods
Dr Accounts Receivable
Cr Sales
and
Dr Cost of Goods Sold
Cr Finished Goods