braun3e ch04 st

Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall.

Activity-Based Costing, Lean Operations, and the Costs of

QualityChapter 4

1


Objective 1Develop and use

departmental overhead rates to allocate indirect costs

2


Why and How do Companies Refine Their Cost Allocation Systems?• Why refine?

– Mismatching resources– Cost distortion

• Who can refine?– Manufacturing operations– Service companies and governmental agencies

3


Plantwide Overhead Rate – example in textbook

• Using one predetermined manufacturing overhead rate for all operations

Predetermined MOH rate =

Total estimated manufacturing overhead costsTotal estimated amount of the allocation base

Predetermined MOH rate =

$1,000,00062,500 DL hours

= $16 per DL hour

4


Plantwide Overhead Rate• Using one predetermined manufacturing overhead rate to allocate MOH to units

5

Plantwide Overhead Rate

Actual Use of Allocation Base

MOH Allocated to

One Unit

Elliptical ×$16 per DL hour 10 DL hours = $160

Treadmill ×$16 per DL hour 10 DL hours = $160


Departmental Overhead Rates

• Separate predetermined manufacturing overhead rates for each departmentManufacturing Plant with $1,000,000 of total

estimated MOH and 2 departmentsMachining Department

($400,000 of MOH)Assembly Department($600,000 of MOH)

$400,000 ÷ departmental allocation base

yields a MOH rate for this department ONLY

$600,000 ÷ departmental allocation base

yields a MOH rate for this department ONLY

6


Departmental Overhead Rates

• When to use– Departments incur different amounts and types of MOH

– Different jobs or products use the department resources to a different extent

7


Departmental Overhead Rates – Example on pages 182 - 187

Department

Total Departmental Manufacturing

Overhead Costs

Total Departmental Labor Hours

Departmental

Overhead Rate

Machining $400,000 12,500

hrs

Assembly $600,000 50,000 hrs

TOTAL $1,000,000


Departmental Overhead Rates – Example on pages 182 - 187

Department

Total Departmental Manufacturing

Overhead Costs

Total Departmental Labor Hours

Departmental

Overhead Rate

Machining $400,000 12,500

hrs$400,000/12,500 = $32/DLH

Assembly $600,000 50,000 hrs

$600,000/50,000 = $12/DLH

TOTAL $1,000,000


Departmental Overhead Rates Example -

Exhibit 4-8 (p.186) – Ellipticals

Department Departmental Overhead Rate

Actual Use of Departmental

Allocation Base

MOH Allocated to One

Elliptical

Machini

ng

$32 per DL

hour

× 1 DL

hours

=

Assembl

y

$12 per DL

hour

× 9 DL

hours

=

Total


Departmental Overhead Rates Example -

Exhibit 4-8 (p.186) – Ellipticals

Department Departmental Overhead Rate


Allocation Base

MOH Allocated to One

Elliptical

Machini

ng

$32 per DL

hour

× 1 DL

hours

= $32

Assembl

y

$12 per DL

hour

× 9 DL

hours

= 108

Total $140


Departmental Overhead Rates Example - Exhibit 4-9 (p.186)

- TreadmillsDepartment Departmental

Overhead Rate


Allocation Base

MOH Allocated to OneTreadmill

Machini

ng

$32 per DL

hour

× 4DL hours =

Assembl

y

$12 per DL

hour

× 6DL hours =

Total



- TreadmillsDepartment Departmental

Overhead Rate


Allocation Base

MOH Allocated to OneTreadmill

Machini

ng

$32 per DL

hour

× 4DL hours = $128

Assembl

y

$12 per DL

hour

× 6DL hours = 72

Total $200



PlantwideOverhead RateMOH Allocation(from Exhibit

4-2)

Departmental Overhead Rates MOH Allocation(from Exhibit 4-

10)

Amount of Cost Distortion

Ellipti

cal$ 160 $ 140

$20

overcosted

Treadmi

ll$ 160 $ 200

$40

undercosted


Now turn to S4-3


S4-3 - Compute Departmental Overhead Rates

1.What is Gerbig’s plantwide overhead rate?

$3,762,000 manufacturing overhead 17,100 machine hours

= $220 per machine hour

Total estimated manufacturing overhead costsTotal estimated amount of the allocation base

16


S4-3 (cont.)2.Calculate the departmental

overhead rates for Gerbig’s three production lines. Round all answers to the nearest cent.Departmen

tOverhead Cost

Machine Hours

Overhead Rate

Potato chips $2,147,000 11,300 MH

Corn chips $959,000 2,600 MH

Cheese puffs $ 656,000 3,200 MH 17

$190.00

$368.85

$205.00


S4-3 (cont.)3.Which products had been overcosted by the plantwide rate? Which products had been undercosted by the plantwide rate?

Plantwide Rate = $220.00 per machine hour

Departmental Rate:

18

PotatoChips= $190.00 OvercostedCorn Chips= 368.85 UndercostedCheesePuffs= 205.00 Overcosted


Objective 2Develop and use activity-based costing (ABC) to allocate indirect costs

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Activity-Based Costing • Allocates indirect costs to production

• Focuses on activities and costs of activities

• Separate allocation rate for each activity

Manufacturing Activities

Machine Setup

Materials

Handling

Fabricating

Parts

Supervising

Assembly

Inspecting

Products

Packaging

Products

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Activity MOH Costs for the Activity Total Activity Cost Pool

Machine Setup Indirect labor to set up machines $80,000

Materials Handling

Forklifts, gas, operators’ wages 200,000

Fabricating Parts

Machine lease payments, electricity, repairs 300,000

Supervising Assembly

Production engineers’ labor 150,000

Inspecting Testing equipment, inspection labor 170,000

Packaging Packaging equipment 100,000$1,000,000

Activity-Based Costing StepsStep 1: Identify and estimate

indirect costs

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Activity-Based Costing StepsStep 2: Select an allocation base for

each activity

22

Activity Allocation base Total Cost Pool

Total Estimated Amount of

Allocation BaseMachine Setup Number of setups $80,000 8,000 setupsMaterials Handling

Number of parts moved 200,000 400,000 parts

Fabricating Parts Machine hours 300,000 12,500 machine

hours (MH)Supervising Assembly

Direct labor hours 150,000 DL hours

Inspecting Number of inspections 170,000 Inspections

Packaging Cubic feet packaged 100,000 Cubic feet

$1,000,000


Activity-Based Costing Steps

Step 3: Compute cost allocation rate for each activity

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Activity Allocation baseTotal Cost Pool

Cost Allocation Rate

Machine Set-up

Number of set-ups $80,000 $80,000 / 8000 = $10

per setupMaterials Handling

Number of parts moved 200,000 200,000/ 400,000 =

$0.50 per partFabricating Parts Machine hours 300,000 300,000/ 12,500 = $24

per MHSupervising Assembly

Direct labor hours 150,000 150,000 / 50,000 = $3

per DLH

Inspecting Number of inspections 170,000 170,000 / 34,000 = $5

per inspection

Packaging Cubic feet packaged 100,000

100,000 / 400,000 =$0.25 per cubic foot

1,000,00

0


Step 4: Allocate some manufacturing overhead for each

activity to the individual jobs that use the activities.


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Info for 1 Elliptical

Activity Activity Cost Allocation Rate

Actual Use of Activity Allocation Base (collected

on job)

MOH Allocated to One object

Machine Setup $10 per setup × 2 setups = $20Materials Handling $0.50 per part × 20 parts = 10

Fabricating $24 per machine hour × 1 machine hour = 24Supervising Assembly $3 per DL hour × 9 DL hours = 27

Inspecting $5 per inspection× 3 inspections = 15

Packaging $0.25 per cubic foot × 52 cubic feet = 13

Total $109


Step 4: Allocate some manufacturing overhead for each



25

Info for 1 Treadmi

ll

Activity Activity Cost Allocation Rate

Actual Use of Activity Allocation Base (collected

on job)

MOH Allocated to One object

Machine Setup $10 per setup × 4 setups = $40Materials Handling $0.50 per part × 26 parts = 13

Fabricating $24 per machine hour × 4 machine hour = 96Supervising Assembly $3 per DL hour × 6 DL hours = 18

Inspecting $5 per inspection× 6 inspections = 30

Packaging $0.25 per cubic foot × 60 cubic feet = 15

Total $212


Examples of Cost Drivers

Activities: Cost Drivers:Material purchasing

# of purchase orders

Material handling # of partsProduction scheduling # of batches

Quality inspections # of inspections

Photocopying # of pages copiedWarranty service # of service calls

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Now turn to E4-36B ABC Example

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E4-36B ABC ExampleStep 1: Identify each activity and estimate the total indirect costs of each activity.– Material handling $6,400– Machine setup $9,000– Insertion of parts $54,400– Finishing $89,700

28


E4-36B Example (cont.)Step 2: Select an allocation base for each activity and estimate the total that will be used during the year.Activity

Total Est.Cost

Est. Quant. of Cost Allocation Base

Mat. handling $6,400 ÷ 3,200 partsMachine

setups $9,000 ÷ 25 setupsInsertion of

parts$54,40

0÷

3,200 parts

Finishing $89,700

÷2,300 hrs


E4-36B Example (cont.)Step 3. Compute cost allocation rate for each. activity

ActivityTotal Est.

Cost

Est. Quant. of Cost

Allocation Base

AllocationRate

Mat. handling

$6,400 ÷ 3,200 parts

Machine setups 9,000 ÷ 25 setups

Insertion of parts

54,400 ÷ 3,200 parts

Finishing 89,700 ÷ 2,300 hrs

$ 2.00/part $360.00/

setup$17.00/part$39.00/hr


E4-36B Example (cont.)Step 4. Allocate some manufacturing overhead from each


Job 420

Material handling 250 parts $ 2.00 $ 500

Machine setup 3 setups 360.00 1,080Insertion of parts 250 parts 17.00 4,250

Finishing 130 finishing hours 39.00 5,070

Total $10,900

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E4-36B Example (cont.)Step 4. Allocate some manufacturing overhead from each


Job 420

Material handling 250 parts $ 2.00 $ 500

Machine setup 3 setups 360.00 1080Insertion of parts 250 parts 17.00 4,250


Total $10,900

32

Job 510

Material handling 425 parts $ 2.00 $850

Machine setup 6 setups 360.00 2,160Insertion of parts 425 parts 17.00 7,225


Total $22,715


Cost Hierarchy

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Now turn to S4-9

34


S4-9 Classifying Costs Within the Cost Hierarchy

1.Each container is cut from the mold once the plastic has cooled and hardened.

2.Patents are obtained for each new type of container mold.

3.Plastic resins are used as the main direct material for the containers.

4.A plant manager oversees the entire manufacturing operation.

5.The sales force incurs travel expenses to attend various trade shows throughout the country to market the containers.

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Unit-level

Unit-level

Product-level

Facility-level

Facility-level


S4-9 (cont.)6. Each container product line

has a product line manager.7. The extrusion machine is

calibrated for each batch of containers made.

8. Each type of container has its own unique molds.

9. Routine maintenance is performed on the extrusion machines

10.Rent is paid for the building that houses the manufacturing processes.

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Facility-level

Facility-level

Product-level

Product-level

Batch-level


Objective 3Understand the benefits and

limitations of ABC/ABM systems

37


Activity-Based Management (ABM)

• Using ABC information to make decisions– Pricing and product mix– Cost cutting– Planning and control

38


Pricing and Product Mix Decisions

• Change the prices for products after identifying the different total cost

• Decide to market the higher profitability product

• Shift the product mix away from less-profitable products

39


Cutting Costs• Analyze costs in value chain

– Value-added activities– Non–value-added activities

• Value-added vs. non–value-added

40


Planning and Control Decisions

• Uses the costs of activities to create budgets

• Compare with actual activities to see if goals are being met

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Using ABC Outside of Manufacturing

• Merchandising and service: find the most profitable product or service

• Manufacturers: allocate operating activities

42


Sustainability and Refined Costing Systems

• Environmental overhead should be allocated to different activities that drive their costs.

• Creates better transparency

43


Cost Benefit Test• Do the benefits of adopting ABC/ABM exceed the costs?

• Benefits are higher for companies in competitive markets:– Accurate product cost information is essential– ABM can pinpoint cost savings opportunities

• Benefits are higher when risk of cost distortion high:– Many different products, many different types/amounts of resources

– High indirect costs– High- and low-volume products

44


Costs of Adopting ABC• Generally lower with

– Accounting and information system expertise to develop the system

– Information technology

• Are companies glad they adopted ABC?– 89% of the companies say that it was worth the cost

– Not a cure-all, helps managers understand costs better

45


Signs the Old System May Be Distorting Costs

• Cost system may need repair when– Managers don’t understand costs and profits

– Bids are lost when expected to win– Win bids expected to lose– Competitors price similar products much higher or much lower

• The cost system may be outdated if there is a diversified product line

46


Objective 4Describe lean operations

47


Traditional Production Systems

• Keep large inventories on hand

• Problems:– Storage cost– Hide quality– Bottlenecks and obsolete products

• Solution: Lean Productions System

48


Lean Thinking• Philosophy and a business strategy

• Primary goal: eliminate waste and cost

• Focus of JIT– Purchase raw materials just in time for production

– Finish goods just in time for delivery49


Lean Production/Just-in-Time

• Common characteristics of Just-in-Time (JIT)– Production occurs in self-contained cells– Broad employee roles– Small batches produced just in time – “demand-pull system”

– Shortened setup times– Shortened manufacturing cycle times– Emphasis on quality– Supply-chain management

50


Drawbacks to Lean Production Systems

• Vulnerable when problems strike suppliers or distributors

• Examples– Delays in delivery – Personnel problems – union strikes– Shortage of parts due to recalled products

– Weather related issues51


Sustainability and Lean Thinking

• Both seek to reduce waste• Lean focus on internal• Green focus on external• Lean and Green

52


Objective 5Describe and use the cost

of quality framework

53


Total Quality Management

• Goal: Provide customers with superior products and services

• Continuous improvement

• More investment up front to generate savings in the back end of the value chain

54


Four Types of Quality Costs

1.Prevention costs – avoid poor quality goods or services – Employee training– Improved materials– Preventive maintenance

2.Appraisal costs – detect poor quality goods or services– Inspection throughout production– Inspection of final product– Product testing

55


Four Types of Quality Costs (cont.)

3.Internal failure costs – avoid poor quality goods or services before delivery to customers– Production loss caused by downtime– Rejected product units

4.External failure costs – incurred after defective product is delivered– Lost profits from lost customers– Warranty costs– Service costs at customer sites– Sales returns due to quality problems

56


Non-Manufacturing Costs of Quality

• Service firms and merchandising companies also incur costs of quality

• Prevention– Professional training to their staff – Develop standardized service checklists

• Appraisal costs – Review work continuously– Inspect before releasing

57


Cost of Quality Report• Identifies, categorizes, and quantifies all of the costs it incurs relating to quality.

• Calculate the percentage of total costs of quality that are incurred in each cost category

• Use as a framework for decisions

58

Prevention Costs

Appraisal Costs

Internal Failure Costs

External Failure Costs


Now turn to E4-34A

60


E4-34APrevention costs

– Training employees in TQM– Training suppliers in TQM– Identifying preferred suppliers who commit to on-time delivery of perfect quality materials

61


E4-34A (cont.)Appraisal costs

– Strength testing one item from each batch of panels

– Avoid inspection of raw materials

Internal failure costs– Avoid rework and spoilage

62


E4-34 (cont.)External failure costs

– Avoid lost profits from lost sales due to disappointed customers

– Avoid warranty costs

63


E4-34A (cont.)Costs of Adopting New Quality Program:

Prevention costs:

Training employees in TQM $ 29,000

Training suppliers in TQM 33,000Identifying preferred suppliers 59,000

Appraisal costs:

Strength testing 64,000

Savings on inspection of raw materials (51,000)


E4-34A (cont.)Quality report (continued from prior slide):

Internal failure costs: Savings on rework and spoilage

(65,000)

External failure costs:Savings on formerly lost profits

(92,000)

Savings on warranty costs

(16,000)

Net (Benefit) ($39,000)


End of Chapter 4

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