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Activity-Based Costing and AnalysisChapter 17

Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Wild, Shaw, and ChiappettaFinancial & Managerial Accounting6th Edition

Wild, Shaw, and ChiappettaFinancial & Managerial Accounting6th Edition

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17-C1: Distinguish between the plantwide

overhead rate method, the departmentaloverhead rate method, and the activity-

based costing method.

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Assigning Overhead Costs

Goods in Process

Cost of GoodsSold

Labor

Materials

Ind

irec

tIn

dir

ect

FinishedGoods

FactoryOverhead

Direct

Direct

Allocate

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C 1

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Assigning Overhead Costs

Overhead can be assigned to production in one of three ways:

Single plant-wide overhead

rate

Departmental overhead

rates

Activity-based costing

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C 1

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Allocate overhead costs to productsusing the plantwide overhead rate

method.

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Plantwide Overhead Rate Method (Exhibit 17.2)

Overhead CostIndirect Costs

Cost Allocation

Base

Single Plantwide Overhead Rate

Cost Objects Product 1 Product 2 Product 3

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Plantwide Overhead Rate Method Illustration (exhibits 17.3 & 17.4)

Exhibit 17.3 KartCo's Budgeted Direct Labor HoursDirect Total

Number Labor Direct Laborof units Hours Hours

Standard go-kart 5,000 X 15 =Custom go-kart 1,000 X 25 =Total

Exhibit 17.4 Kartco's Budgeted Overhead Costs

75,00025,000

$4,800,000

Indirect labor costs………………………………………………………………………………………………………………………………..Factory utilities………………………………………………………………………………………………………………………………………..Total budgeted overhead costs……………………………………………………………………………………………………………………………

$4,000,000800,000

100,000

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Plantwide Overhead Rate Method Illustration

Plantwide overhead

rate=

Total budgeted overhead costs

Total budgeted DLH

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Plantwide Overhead Rate Method Illustration

Plantwide overhead

rate=

$4,800,000

100,000 DLH

= $48/DLH

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Overhead allocated to each unit produced =

$48 x DLH per unitP 1

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Plantwide Overhead Rate Method Illustration

Allocation of overhead cost to products

Overhead AllocatedRate Per Per

DLH DLH UnitStandard go-kart $48 X 15 = 720$ Custom go-kart $48 X 25 = 1,200$

Total product cost per unitTotal

Direct Direct Factory CostMaterials Labor Overhead per Unit

Standard go-kart 400$ 350$ 720$ 1,470$ Custom go-kart 600 500 1,200 2,300

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P 1

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Allocate overhead costs to products usingthe departmental overhead rate method.

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Departmental Overhead Rate Method (exhibit 17.5)

Overhead Cost

Department A

Indirect Costs

Cost Pools

Cost Allocation

Base

Cost Objects

Department A Overhead Rate

Department B

Department BOverhead Rate

Product 1 Product 2 Product 3

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P 2

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Departmental Overhead Rate Method: First Step

Overhead Cost$4,800,000

Machining Dept.$4,200,000

Assembly Dept.$600,000

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P 2

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Departmental Overhead Rate Method: Second Step

Product 1 Product 2 Product 3

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Machining Dept. Overhead Rate based

on machine hours (MH)

Assembly Dept.Overhead Rate based

on direct labor hours (DLH)

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Departmental Overhead Rate Method: Second Step

Number of

UnitsHours per

UnitTotal Hours

Hours per Unit Total Hours

Standard go-kart 5,000 10 MH 50,000 MH 5 DLH 25,000 DLHCustom go-kart 1,000 20 MH 20,000 MH 5 DLH 5,000 DLHTotals 70,000 MH 30,000 DLH

Exhibit 17.6 Allocation Information for Machining and Assembly DepartmentsMachining Department Assembly Department

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Departmental Overhead Rate Method: Third Step

(Exhibit 17.6)

Departmental Overhead

Rate=

Total budgeted departmental overhead costs

Total amount of departmental allocation base

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Departmental Overhead Rate Method: Third Step

Machining Department Overhead

Rate

=$4,200,000

70,000 MH= $60/MH

Assembly Department Overhead

Rate

=$600,000

30,000 DLH= $20/DLH

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P 2

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Departmental Overhead Rate Method: Fourth Step

Departmental Overhead Rate

Hours per Unit

Overhead Allocated

Hours per Unit

Overhead Allocated

Machining Dept. $60 per MH 10 MH per unit $600 20 MH per Unit 1,200.00$ Assembly Dept. $20 per DLH 5 DLH per unit 100 5 DLH per unit 100.00$ Totals $700 1,300.00$

Exhibit 17.8 Comparison of Plant wide OH Rate and Departmental OH Rate Methods:Overhead per unit using:

Standard go Kart Custom go-KartPlantwide OH Rate Method $720 1,200$ Departmental OH Rate Method $700 1,300

Exhibit 17.7 Overhead Allocation Using Departmental Overhead RatesStandard go-kart Custom go-kart

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P 2

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1. What is the company’s single plantwide overhead rate based on direct labor hours?

$900,000 $36 per DLH25,000 DLH

2. What are the company’s departmental overhead rates if the machining department assigns overheadbased on machine hours and the assembly department assigns overhead based on direct labor hours?

$600,000 $30 per MH20,000 MH

$300,000 $60 per DLH5,000 DLH

3. Using the departmental overhead rates from part 2, how much overhead should be assigned to a jobthat uses 16 machine hours in the machining department and 5 direct labor hours in the assemblydepartment?

Overhead Costs - Machining Dept. 16 MHs x $30 per MH = $480Overhead Costs - Assembly Dept. 5 DLHs x $60 per DLH = 300Total Overhead Cost assigned to Job $780

Direct Labor Hours - Assembly Dept.

Total Plant Overhead CostsTotal Direct Labor Hours

Overhead Costs - Machining Dept.Machine Hours - Machining Dept.

Overhead Costs - Assembly Dept.

A manufacturer reports the following budgeted data for its two production departments.

Machining AssemblyManufacturing overhead costs $600,000 $300,000Machine hours to be used (MH) 20,000 0Direct labor hours to be used (DLH) 20,000 5,000

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Identify and assess advantages anddisadvantages of the plantwide overhead

and departmental overhead rate methods.

17-A1:

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Plantwide Overhead Rate Method Advantages and Disadvantages

Advantages• Information is

readily available• Easy to implement• Consistent with

GAAP and can be used for external reporting needs

Disadvantages• Overhead costs may

not bear any relationship with direct labor hours

• All products may not use overhead costs in the same proportion

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Departmental Overhead Rate MethodAdvantages and Disadvantages

Advantages

•More accurate overhead allocations

•More refined than the plantwide overhead rate method

Disadvantages

•Can distort product costs

•Assumes that products are similar in volume, complexity, batch size

•Assumes that departmental overhead costs are proportional to the allocation base

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A 1

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17-C2: Explain cost flows for activity-based

costing.

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Cost Flows Under Activity-Based Costing Method (Exhibit 17.9)

Overhead Cost

Activity Cost

Pool X

Activity Cost

Pool Y

Activity Cost

Pool Z

Activity Overhead rate

Activity Overhead

rateActivity Overhead

rate

Product 1 Product 2 Product 3

Indirect Costs

Cost Pools

Cost Objects

Cost Allocation

Base

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Allocate overhead costs to products usingactivity-based costing.

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Applying Activity-Based Costing

4 STEPS:1. Identify activities and the costs they cause.2. Trace overhead costs to cost pools.3. Determine activity rates.4. Assign overhead costs to cost objects

(products).

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Step One: Identify Activities and the Costs They Cause

Machine setup

Machine repair

Factory maintenance

Engineer salaries

Assembly line power

Heating and lighting

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Step One: Identify Activities and the Costs They Cause

ActivityIndirect

LaborFactory Utilities

Total Overhead

Machine setup 700,000$ $700,000Machine repair 1,300,000$ 1,300,000Factory maintenance 800,000$ 800,000Engineer salaries 1,200,000$ 1,200,000Assembly line power $600,000 600,000Heating and lighting 200,000 200,000Totals $4,000,000 $800,000 $4,800,000

Exhibit 17.10 KartCo Overhead Cost Details

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Step Two: Trace Overhead Costs to Cost Pools

Overhead Cost

Activity Cost Pool

(Craftsmanship)

Activity Cost Pool

(Setup)

Activity Cost Pool (Design

Modification)

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Activity Cost Pool

(Plant Services)

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Step Two: Trace Overhead Cost to Cost Pools

Activity Pools Activity Cost Pooled Cost Activity DriverCraftsmanship 30,000 DL hours

Assembly line power $600,000 $600,000Set-up 200 batches

Machine setup 700,000 Machine repair 1,300,000 2,000,000Design modification 10 designs

Engineer salaries 1,200,000 1,200,000Plant services 20,000 square feet

Factory maintenance 800,000 Heating and lighting 200,000 1,000,000Total overhead cost $4,800,000

Exhibit 17.11 Assigning Overhead to Activity Cost Pools

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Step Three: Determine Activity Rates

Step 3 is to compute the activity rates used to assign overhead costs to final cost objects such as products.

Activity Overhead rate ?

Activity Overhead

Rate ?Activity Overhead

rate ?

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Activity Cost Pool

(Craftsmanship)

Activity Cost Pool

(Setup)

Activity Cost Pool (Design

Modification)

Activity Cost Pool

(Plant Services)

Activity Overhead rate ?

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Step Three: Determine Activity Rate

Proper identification of the factor that drives

the cost

Proper measures of

activities

Proper determination of activity rates depends on:

and

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Step Three: Determine Activity Rate

For example:Craftsmanship cost pool activity rate= $600,000 / 30,000 DLH = $20 per DLH

Cost Pool Activity Rate

=Overhead costs assigned to pool

Expected activity level

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Step Three: Determine Activity Rate

Activity CostPools

Activity DriverChosen

Overhead Costs

Assigned to Pool

Expected Activity Level

Activity Rate

Craftsmanship DLH $600,000 30,000 DLH $20 per DLHSet-up Batches 2,000,000 200 batches $10,000 per batch Design

modificationNumber of designs

1,200,000 10 designs $120,000 per design

Plant services Square feet 1,000,000 20,000 sq. ft. $50 per sq. ft.

Exhibit 17.12 Activity Rates for KartCo.

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=

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Step Four: Assign Overhead Costs to Cost Objects

Step 4 is to assign overhead costs in each activity cost pool to final cost objects using activity rates.

Activity Overhead rate

Activity Overhead

rateActivity Overhead

rate

Product 1 Product 2 Product 3

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Step Four: Assign Overhead Costs to Cost Objects

• To illustrate, the overhead costs in the craftsmanship pool are allocated to standard go-karts as follows:

Overhead allocated from craftsmanship pool to standard go-kart =

Activities consumed X Activity rate

25,000 DLH x $20 per DLH = $500,000

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Step Four: Assign Overhead Costs to Cost Objects

Standard Go-karts Custom Go-kartsActivities

ConsumedActivity

RateActivity Cost

AllocatedActivities

ConsumedActivity

RateActivity Cost

AllocatedCraftsmanship 25,000 DLH $20 per DLH $500,000 5,000 DLH $20 per DLH $100,000

Set-up 40 batches$10,000 per

batch 400,000 160 batches $10,000 per batch 1,600,000$ Design

modification 0 designs$120,000 per

design 0 10 designs $120,000 per design 1,200,000 Plant services 12,000 sq. ft. $50 per sq. ft. $600,000 8,000 sq. ft. $50 per sq. ft 400,000

Total cost $1,500,000 $3,300,000

Exhibit 17.13 Overhead Allocated to Go-Karts for KartCo.

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Step Four: Assign Overhead Costs to Cost Objects

(A)Total Overheadcost allocated

(B) Units of

production

(A/B)Overhead cost

per UnitStandard go-kart 1,500,000$ 5,000 units $300 per unitCustom go-kart 3,300,000$ 1,000 units $3,300 per unit

Exhibit 17.14 Overhead Cost per Unit for Go-Karts Using ABC

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Comparison of Overhead Allocations by Method (Exhibit 17.15)

Exhibit 17.15 Comparison of Overhead Allocations by Method

Overhead CostAllocation method Standard CustomPlantwide method……. 720$ 1,200$ Departmental method…… 700 1,300 Activity-based costing…… 300 3,300

Overhead Cost per Go-Kart

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17-A2: Identify and assess advantages and

disadvantages of activity-basedcosting.

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Activity-Based CostingAdvantages and Disadvantages

Advantages:

• More accurate overhead cost allocation

• More effective overhead cost control

• Focus on relevant factors

• Better management of activities

Disadvantages:

• Costs to implement and maintain

• Uncertainty with decisions remains

• Advantages (Continued)

• Costs of Quality

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Not

acceptable

under

GAAP

A 2

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A manufacturer makes two types of snowmobiles, Basic and Deluxe, and reports the following data to be used in applying activity-based costing. The company budgets production of 6,000 Basic snowmobiles and 2,000 Deluxe snowmobiles.

Activity Cost Pool Activity Cost Driver Cost Assigned to Pool Basic DeluxeMachine setup Number of setups $150,000 200 setups 300 setupsMaterials handling Number of parts 250,000 10 parts per unit 20 parts per unitMachine depreciation Machine hours (MH) 720,000 1 MH per unit 1.5 MH per unit

$1,120,000

1. Compute overhead activity rates for each cost pool using ABC.

$150,000 $300.00 per setup500 setups

$250,000 $2.50 per part100,000 parts

$720,000 $80.00 per MH9,000 MHs

Depreciation costNumber of MHs (6,000 x 1) + (2,000 x 1.5)

Machine setup costsNumber of setups (200 + 300)

Materials handling costsNumber of parts (6,000 x 10) + (2,000 x 20)

2. Compute the total amount of overhead cost to be allocated to each of the company’s product lines using ABC.

Activity Cost Pool Activity Pool RateMachine setup $300 per setup 200 setups x $300 $60,000 300 setups x $300 $90,000Materials handling $2.50 per part 60,000 parts x $2.50 150,000 40,000 parts x $2.50 100,000Machine depreciation $80 per MH 6,000 MHs x $80 480,000 3,000 MHs x $80 240,000Totals $690,000 $430,000

Basic Deluxe

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A manufacturer makes two types of snowmobiles, Basic and Deluxe, and reports the following data to be used in applying activity-based costing. The company budgets production of 6,000 Basic snowmobiles and 2,000 Deluxe snowmobiles.

Activity Cost Pool Activity Pool RateMachine setup $300 per setup 200 setups x $300 $60,000 300 setups x $300 $90,000Materials handling $2.50 per part 60,000 parts x $2.50 150,000 40,000 parts x $2.50 100,000Machine depreciation $80 per MH 6,000 MHs x $80 480,000 3,000 MHs x $80 240,000Totals $690,000 $430,000

Units produced 6,000 2,000

Cost per unit $115/unit $215/unit

Basic Deluxe

3. Compute the overhead cost per unit for each product line using ABC.

A 2

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17-C3: Describe the four types of activities that

cause overhead costs.

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Four types of activities that cause overhead costs

Unit-level

Batch-level

Product-level

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C 3

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Unit-level activities are performed on each product unit; for example, providing electricity to power machinery in the machining

department is needed to produce each unit of product.

Unit-level

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Levels of Activities

C 3

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Batch-level activities are performed only on each batch or group of units.

Batch-level

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Levels of Activities

C 3

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Levels of Activities

Product-level activities are performed on each product line and are not

affected by either numbers of units or batches.

Product-level

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C 3

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Facility-level activities are performed to sustain facility capacity as a whole

and are not caused by any specific product.

Facility-level

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Levels of Activities

C 3

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End of Chapter 17

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