chapter 25 cost allocation and activity-based costing financial and managerial accounting 8th...

Chapter Chapter 2525Cost Allocation and Cost Allocation and

Activity-Based CostingActivity-Based CostingFinancial and Managerial Accounting

8th Edition

Warren Reeve Fess

PowerPoint Presentation by Douglas CloudProfessor Emeritus of AccountingPepperdine University

© Copyright 2004 South-Western, a division of Thomson Learning. All rights reserved.

Task Force Image Gallery clip art included in this electronic presentation is used with the permission of NVTech Inc.

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1. Identify three methods used for allocating factory overhead costs to products.

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.

ObjectivesObjectivesObjectivesObjectives

After studying this After studying this chapter, you should chapter, you should

be able to:be able to:

After studying this After studying this chapter, you should chapter, you should

be able to:be able to:

5. Use activity-based costing to allocate selling and administrative expenses to products.

6. Use activity-based costing in a service business.

ObjectivesObjectivesObjectivesObjectives

Product Costing Allocation MethodsProduct Costing Allocation MethodsProduct Costing Allocation MethodsProduct Costing Allocation Methods

PPRROODDUUCCTTSS

Plantwide Overhead RatePlantwide Overhead Rate

Multiple Department RatesMultiple Department Rates

Activity-Based CostingActivity-Based Costing

Single RateSingle Rate

Department

Department

ActivityActivity

ActivityActivity

Single Plantwide Factory Single Plantwide Factory Overhead RateOverhead Rate

Single Plantwide Factory Single Plantwide Factory Overhead RateOverhead Rate

Total budgeted factory overhead costs

Total budgeted plantwide allocation base

Computing Single Plantwide Computing Single Plantwide Factory OverheadFactory Overhead

Computing Single Plantwide Computing Single Plantwide Factory OverheadFactory Overhead

$80 per hour overhead rate

$1,600,000

20,000 direct labor hours=

Snowmobile:$80 per dlh x 10 direct labor hours = $800

Computing Single Plantwide Computing Single Plantwide Factory OverheadFactory Overhead

Computing Single Plantwide Computing Single Plantwide Factory OverheadFactory Overhead

Lawnmower:$80 per dlh x 10 direct labor hours = $800

Factory Overhead

cost per unit

Factory Overhead

cost per unit

Plantwide factoryPlantwide factoryoverheadoverhead

$1,600,000$1,600,000

Plantwide factoryPlantwide factoryoverheadoverhead

$1,600,000$1,600,000

$80 per direct labor hour

Snowmobile$800 per unit

Snowmobile$800 per unit

x 10 direct labor hours

Lawnmower$800 per unit

Lawnmower$800 per unit

x 10 direct labor hours

The greatest advantage of the single plantwide overhead rate

is that it is simple and inexpensive to apply.

The greatest advantage of the single plantwide overhead rate

is that it is simple and inexpensive to apply.

Multiple Production Multiple Production Department Factory Department Factory

Overhead Rate MethodOverhead Rate Method

Multiple Production Multiple Production Department Factory Department Factory

Overhead Rate MethodOverhead Rate Method

Products

Plantwide factory Plantwide factory overheadoverhead

Plantwide factory Plantwide factory overheadoverhead

Plantwide rate

Single Plantwide RateSingle Plantwide Rate

Products

Fabrication Fabrication Department Department

factory overheadfactory overhead

Fabrication Fabrication Department Department

factory overheadfactory overhead

Fabrication Department factory overhead rate

Assembly Department factory overhead rate

Assembly Assembly Department Department

factory overheadfactory overhead

Assembly Assembly Department Department

factory overheadfactory overhead

Multiple Production Department RateMultiple Production Department Rate

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 Production Department Factory Overhead Rates and AllocationOverhead Rates and AllocationProduction Department Factory Production Department Factory Overhead Rates and AllocationOverhead Rates and Allocation

Snowmobile:Fabrication: $103 x 8 dlh = $824Assembly: $57 x 2 dlh = 114 $938

Production Department Factory Production Department Factory Overhead Rates and AllocationOverhead Rates and AllocationProduction Department Factory Production Department Factory Overhead Rates and AllocationOverhead Rates and Allocation

Lawnmower:Fabrication: $103 x 2 dlh = $206Assembly: $57 x 8 dlh = 456 $662

Multiple Production Department Multiple Production Department Rate MethodRate Method—Ruiz Company—Ruiz Company

Multiple Production Department Multiple Production Department Rate MethodRate Method—Ruiz Company—Ruiz Company

Fabrication Department $1,030,000

Fabrication Department $1,030,000

Assembly Department$570,000

Assembly Department$570,000

$103 x 8 dlh$57 x 2 dlh

$938 per unit

Multiple Production Department Multiple Production Department Rate MethodRate Method—Ruiz Company—Ruiz Company

Multiple Production Department Multiple Production Department Rate MethodRate Method—Ruiz Company—Ruiz Company

Fabrication Department $1,030,000

Fabrication Department $1,030,000

Assembly Department$570,000

Assembly Department$570,000

$57 x 8 dlh

$662 per unit

$103 x 2 dlh

Distortion in Product CostsDistortion in Product Costs—Single —Single Plantwide versus Multiple Production Plantwide versus Multiple Production

Department Overhead RatesDepartment Overhead Rates

Distortion in Product CostsDistortion in Product Costs—Single —Single Plantwide versus Multiple Production Plantwide versus Multiple Production

Department Overhead RatesDepartment Overhead Rates

Factory Overhead Cost per Unit

Single Plantwide Rate

Multiple Production Department Rates

Snowmobile $800 $938Lawnmower 800 662

Distortion in Product CostsDistortion in Product Costs—Single —Single Plantwide versus Multiple Production Plantwide versus Multiple Production

Department Overhead RatesDepartment Overhead Rates

Distortion in Product CostsDistortion in Product Costs—Single —Single Plantwide versus Multiple Production Plantwide versus Multiple Production

Department Overhead RatesDepartment Overhead Rates

The single plantwide factory overhead rate distorts product

cost by averaging high and low factory overhead costs.

The single plantwide factory overhead rate distorts product

cost by averaging high and low factory overhead costs.

Conditions for Product Cost Conditions for Product Cost DistortionDistortion—Ruiz Company—Ruiz Company

Conditions for Product Cost Conditions for Product Cost DistortionDistortion—Ruiz Company—Ruiz Company

Fabrication Department

Fabrication Department

Assembly Department

Assembly Department

$103 per direct

labor hour

$103 per direct

labor hour

$57 per direct

labor hour

$57 per direct

labor hour

Condition 1:Differences in production department factory overhead rates

ContinuedContinuedContinuedContinued

Condition 2:Differences in the ratios of allocation-base usage

8 direct labor hours

2 direct labor hours

2 direct labor hours

8 direct labor hours

Conditions for Product Cost Conditions for Product Cost DistortionDistortion—Ruiz Company—Ruiz Company

Conditions for Product Cost Conditions for Product Cost DistortionDistortion—Ruiz Company—Ruiz Company

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.

Activity-Based Costing MethodActivity-Based Costing MethodActivity-Based Costing MethodActivity-Based Costing Method

Products

Production Department Rates

Multiple Production Department Multiple Production Department Factory Overhead versus ABCFactory Overhead versus ABC

Multiple Production Department Multiple Production Department Factory Overhead versus ABCFactory Overhead versus ABC

Production Department Factory Overhead

Production Department Factory Overhead

ContinuedContinuedContinuedContinued

ActivityActivity ActivityActivity ActivityActivity ActivityActivity

Products

Activity Rates

Multiple Production Department Multiple Production Department Factory Overhead versus ABCFactory Overhead versus ABC

Multiple Production Department Multiple Production Department Factory Overhead versus ABCFactory Overhead versus ABC

Fabrication $ 530,000Assembly 70,000Setup 480,000Quality control 312,000Engineering 208,000 Total $1,600,000

Activity Amount Activity Rate

Activity-Based Costing MethodActivity-Based Costing MethodActivity-Based Costing MethodActivity-Based Costing Method

Cost DriversCost Drivers

Activity Amount Activity Rate

Fabrication $ 530,000 ÷ 10,000 dlh = $53Assembly 70,000 ÷ 10,000 dlh = $7Setup 480,000 ÷ 120 setups = $4,000Quality control 312,000 ÷ 104 inspts. = $3,000Engineering 208,000 ÷ 16 changes = $13,000 Total $1,600,000

Snowmobile 8,000 $53 $424,000Lawnmower 2,000 53 106,000 Total 10,000 $530,000

Fabrication: DL Hours Rate Total

Activity-Based Costing MethodActivity-Based Costing MethodActivity-Based Costing MethodActivity-Based Costing Method

Activity Amount Activity Rate

Fabrication $ 530,000 ÷ 10,000 dlh = $53Assembly 70,000 ÷ 10,000 dlh = $7Setup 480,000 ÷ 120 setups = $4,000Quality control 312,000 ÷ 104 inspts. = $3,000Engineering 208,000 ÷ 16 changes = $13,000 Total $1,600,000

Activity-Based Costing MethodActivity-Based Costing MethodActivity-Based Costing MethodActivity-Based Costing Method

Snowmobile 2,000 $7 $14,000Lawnmower 8,000 7 56,000 Total 10,000 $70,000

Assembly: DL Hours Rate Total

Snowmobile 100 $4,000 $400,000Lawnmower 20 4,000 80,000 Total 120 $480,000

Setup: Setups Rate Total

Activity Amount Activity Rate

Fabrication $ 530,000 ÷ 10,000 dlh = $53Assembly 70,000 ÷ 10,000 dlh = $7Setup 480,000 ÷ 120 setups = $4,000Quality control 312,000 ÷ 104 inspts. = $3,000Engineering 208,000 ÷ 16 changes = $13,000 Total $1,600,000

Activity-Based Costing MethodActivity-Based Costing MethodActivity-Based Costing MethodActivity-Based Costing Method

Snowmobile 100 $3,000 $300,000Lawnmower 4 3,000 12,000 Total 104 $312,000

Quality Control: Inspts. Rate Total

Activity Amount Activity Rate

Fabrication $ 530,000 ÷ 10,000 dlh = $53Assembly 70,000 ÷ 10,000 dlh = $7Setup 480,000 ÷ 120 setups = $4,000Quality control 312,000 ÷ 104 inspts. = $3,000Engineering 208,000 ÷ 16 changes = $13,000 Total $1,600,000

Activity-Based Costing MethodActivity-Based Costing MethodActivity-Based Costing MethodActivity-Based Costing Method

Snowmobile 12 $13,000 $156,000Lawnmower 4 13,000 52,000 Total 16 $208,000

Engineering: Changes Rate Total

Fabrication $ 530,000 ÷ 10,000 dlh = $53Assembly 70,000 ÷ 10,000 dlh = $7Setup 480,000 ÷ 120 setups = $4,000Quality control 312,000 ÷ 104 inspts. = $3,000Engineering 208,000 ÷ 16 changes = $13,000 Total $1,600,000

Activity Amount Activity Rate

Activity-Based Costing MethodActivity-Based Costing MethodActivity-Based Costing MethodActivity-Based Costing Method

Activity Snowmobile Mower Total

Cost Allocation Summary:

Fabrication $ 424,000 $106,000 $ 530,000Assembly 14,000 56,000 70,000Setup 400,000 80,000 480,000Quality control 300,000 12,000 312,000Engineering 156,000 52,000 208,000 Total $1,294,000 $306,000 $1,600,000

Budgeted units 1,000 1,000 Cost per unit $1,294 $306

Activity-Based Costing MethodActivity-Based Costing MethodActivity-Based Costing MethodActivity-Based Costing Method

Activity-Based Costing MethodActivity-Based Costing Method—Ruiz Company—Ruiz CompanyActivity-Based Costing MethodActivity-Based Costing Method—Ruiz Company—Ruiz Company

$53 per dlh

$7 per dlh

$4,000 per setup

$3,000 per inspection

$13,000 per engineering

change

$1,294 per unit $306 per unit

Fabrication Activity $530,000

Assembly

Activity $70,000

Setup Activity $480,000

Quality Control

Inspection Activity $312,000

Engineering Change Activity $208,000

Distortion in Product CostsDistortion in Product Costs—Multiple —Multiple Production Department Factory Overhead Production Department Factory Overhead

Rate Method versus Activity-Based CostingRate Method versus Activity-Based Costing

Distortion in Product CostsDistortion in Product Costs—Multiple —Multiple Production Department Factory Overhead Production Department Factory Overhead

Rate Method versus Activity-Based CostingRate Method versus Activity-Based Costing

Snowmobile $ 800 $ 938 $1,294Lawnmower 800 662 306

Single Plantwide Multiple Production Rate Department Rates ABC

Factory Overhead Cost per Unit— Three Cost Allocation Methods

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

Selling and administrative activities may include:

Activity-Based Costing for Selling Activity-Based Costing for Selling and Administrative Activitiesand Administrative Activities

Activity-Based Costing in Service BusinessesActivity-Based Costing in Service BusinessesActivity-Based Costing in Service BusinessesActivity-Based Costing in Service Businesses

PPAATTIIEENNTTSS

Hopewell Hospital—Activity-Based Costing

AdmittingAdmitting

RadiologicalRadiologicalTestingTesting

Operating Operating RoomRoom

PathologicalPathologicalTestingTesting

Dietary andDietary andLaundryLaundry

$180 per admission$180 per admission

$320 per image$320 per image

$200 per operating $200 per operating room hourroom hour

$120 per specimen$120 per specimen

$150 per day$150 per day

PPAATTIIEENNTTSS

Hopewell Hospital—Activity-Based Costing

AdmittingAdmitting

RadiologicalRadiologicalTestingTesting

Operating Operating RoomRoom

PathologicalPathologicalTestingTesting

Dietary andDietary andLaundryLaundry

$180 per admission$180 per admission

$320 per image$320 per image

$200 per operating $200 per operating room hourroom hour

$120 per specimen$120 per specimen

$150 per day$150 per day

Activity-Based Costing in Service BusinessesActivity-Based Costing in Service BusinessesActivity-Based Costing in Service BusinessesActivity-Based Costing in Service Businesses

Cost Budget $960,000Estimated Activity 3,000 images

Radiological Testing Activity Rate:

= $320=

Activity Costs Allocated to a PatientActivity Costs Allocated to a PatientActivity Costs Allocated to a PatientActivity Costs Allocated to a Patient

Activity-Base Activity ActivityActivity Usage Rate Cost

Admitting 1 admission $180 $ 180Radiology testing 2 images 320 640Operating room 4 hours 200 800Pathological testing 1 specimen 120 120Dietary and laundry 7 days 150 1,050 Total $2,790

Patient Name: Mary Wilson

The overhead cost associated with The overhead cost associated with services can be related to the services can be related to the

customers that use the service.customers that use the service.

The overhead cost associated with The overhead cost associated with services can be related to the services can be related to the

customers that use the service.customers that use the service.

xxxxx

=====

Customer Profitability ReportCustomer Profitability ReportCustomer Profitability ReportCustomer Profitability ReportHopewell Hospital

Customer (Patient) Profitability ReportFor the Period Ending December 31, 2006

Adcock, Kim

Revenues $9,500 $21,400 $5,050 $3,300Less: Patient costs

Drugs and supplies $ 400 $ 1,000 $ 300 $ 200Admitting 180 180 180 180Radiological testing 1,280 2,560 1,280 640Operating room 2,400 6,400 1,600 800Pathological testing 240 600 120 120Dietary and laundry 4,200 14,700 1,050 1,050 Total patient costs $8,700 $25,440 $4,530 $2,990

Income from operations $ 800 $ (4,040) $ 520 $ 310

Birini, Brian

Conway, Don

Wilson, Mary

The EndThe End

Chapter 25Chapter 25