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Learning Objectives

Power Notes

1. Product Costing Allocation Methods2. Single Plantwide Factory Overhead Rate Method3. Multiple Production Department Factory

Overhead Rate Method4. Activity-Based Costing Method5. Activity-Based Costing for Selling and

Administrative Expenses6. Activity-Based Costing in Service Businesses

Chapter M10

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Cost Allocation and Activity-Based Costing Cost Allocation and Activity-Based Costing

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Chapter M10

Product Costing Allocation Methods Activity-Based Costing Activity-Based Costing in Service

Businesses

Slide # Power Note Topics

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Power Notes

31020

Cost Allocation and Activity-Based Costing Cost Allocation and Activity-Based Costing

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Product Costing Allocation MethodsProduct Costing Allocation Methods

PPRROODDUUCCTTSS

Plantwide Overhead RatePlantwide Overhead Rate

Multiple Department RatesMultiple Department Rates

Activity-Based CostingActivity-Based Costing

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Product Costing Allocation MethodsProduct Costing Allocation Methods

PPRROODDUUCCTTSS

Plantwide Overhead RatePlantwide Overhead Rate

Multiple Department RatesMultiple Department Rates

Activity-Based CostingActivity-Based Costing

Single Rate

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Product Costing Allocation MethodsProduct Costing Allocation Methods

PPRROODDUUCCTTSS

Plantwide Overhead RatePlantwide Overhead Rate

Multiple Department RatesMultiple Department Rates

Activity-Based CostingActivity-Based Costing

DepartmentDepartment

Single Rate

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Product Costing Allocation MethodsProduct Costing Allocation Methods

PPRROODDUUCCTTSS

Plantwide Overhead RatePlantwide Overhead Rate

Multiple Department RatesMultiple Department Rates

Activity-Based CostingActivity-Based Costing

Activity

Department

Activity

Department

Single Rate

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Single Plantwide Factory Overhead RateSingle Plantwide Factory Overhead Rate

Total budgeted factory overhead costsTotal budgeted plantwide allocation base

= $80 per hour$1,600,00020,000 direct labor hours

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

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

What are the advantages of the single plantwide overhead rate method?

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Multiple Department Factory Overhead RateMultiple Department Factory Overhead Rate

Fabrication Department Overhead Rate:

= $103 per hour$1,030,00010,000 direct labor hours

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

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

Assembly Department Overhead Rate:

= $57 per hour$570,00010,000 direct labor hours

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Conditions for Product Cost DistortionConditions for Product Cost Distortion

Fabrication Fabrication DepartmentDepartment

$103 per directlabor hour

Assembly Assembly DepartmentDepartment

Condition 1:Different department overhead rates

$57 per directlabor hour

Condition 2:Different ratios of allocation-base usage

Snowmobile8 direct 2 direct

labor hours labor hours

Lawnmower2 direct 8 direct

labor hours labor hours

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Activity-Based Costing (ABC)Activity-Based Costing (ABC)

1. Activity-based costing changes the way overhead costs are allocated.

2. When identifying specific activities, inefficiencies may be discovered and eliminated, reducing the product’s cost.

3. Traditional cost accounting undercosts complex products and overstates their profit margins.

4. ABC may be used for decision making but not necessarily for inventory valuation.

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Activity-Based CostingActivity-Based CostingActivity Amount Activity RateFabrication $ 530,000 / 10,000 dlh = $53Assembly 70,000 / 10,000 dlh = $7Setup 480,000 / 120 setups = $4,000Quality control 312,000 / 104 insps. = $3,000Engineering 208,000 / 16 changes = $13,000 Total $1,600,000

How are the activity costs allocated to specific products?

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Activity-Based CostingActivity-Based CostingActivity Amount Activity Rate

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

Fabrication: DL Hours 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 insps. = $3,000Engineering 208,000 / 16 changes = $13,000 Total $1,600,000

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Activity-Based CostingActivity-Based Costing

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

Assembly: DL Hours 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 insps. = $3,000Engineering 208,000 / 16 changes = $13,000 Total $1,600,000

Activity Amount Activity Rate

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Activity-Based CostingActivity-Based Costing

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

Setup: Setups 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 insps. = $3,000Engineering 208,000 / 16 changes = $13,000 Total $1,600,000

Activity Amount Activity Rate

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Activity-Based CostingActivity-Based Costing

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

Quality Control: Insps. 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 insps. = $3,000Engineering 208,000 / 16 changes = $13,000 Total $1,600,000

Activity Amount Activity Rate

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Activity-Based CostingActivity-Based Costing

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 insps. = $3,000Engineering 208,000 / 16 changes = $13,000 Total $1,600,000

Activity Amount Activity Rate

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Activity-Based CostingActivity-Based Costing

Activity Snowmobile Mower TotalCost 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 $1,600,000Budgeted units 1,000 1,000 Cost per unit $1,294 $306

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Distortion in Product CostsDistortion in Product Costs

Single plantwide rate $ 800 $ 800Multiple department rates 938 662Activity-based costing 1,294 306

What caused these differences, and which method is more accurate?

Snowmobile Lawnmower

Factory Overhead Cost per Unit:

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1. Post-sale technical support2. Order writing3. Promotional support4. Order entry5. Customer return processing6. Shipping document preparation7. Shipping and handling8. Field service

Selling and administrative activities may include:

Selling and Administrative ActivitiesSelling and Administrative Activities

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Activity-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

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

PPAATTIIEENNTTSS

Hopewell Hospital—Activity-Based Costing

$180 per admissionAdmittingAdmitting

RadiologicalRadiologicalTestingTesting

Operating Operating RoomRoom

PathologicalPathologicalTestingTesting

Dietary andDietary andLaundryLaundry

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

PPAATTIIEENNTTSS

Hopewell Hospital—Activity-Based Costing

$320 per image

$180 per admissionAdmittingAdmitting

RadiologicalRadiologicalTestingTesting

Operating Operating RoomRoom

PathologicalPathologicalTestingTesting

Dietary andDietary andLaundryLaundry

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

PPAATTIIEENNTTSS

Hopewell Hospital—Activity-Based Costing

$320 per image

$180 per admissionAdmittingAdmitting

RadiologicalRadiologicalTestingTesting

Operating Operating RoomRoom

PathologicalPathologicalTestingTesting

Dietary andDietary andLaundryLaundry

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

Radiological Testing Activity Rate:

= $320

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

PPAATTIIEENNTTSS

$200 per hour

Hopewell Hospital—Activity-Based Costing

$320 per image

$180 per admissionAdmittingAdmitting

RadiologicalRadiologicalTestingTesting

Operating Operating RoomRoom

PathologicalPathologicalTestingTesting

Dietary andDietary andLaundryLaundry

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

PPAATTIIEENNTTSS

$200 per hour

Hopewell Hospital—Activity-Based Costing

$120 per specimen

$320 per image

$180 per admissionAdmittingAdmitting

RadiologicalRadiologicalTestingTesting

Operating Operating RoomRoom

PathologicalPathologicalTestingTesting

Dietary andDietary andLaundryLaundry

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

PPAATTIIEENNTTSS

$200 per hour

Hopewell Hospital—Activity-Based Costing

$120 per specimen

$150 per day

$320 per image

$180 per admissionAdmittingAdmitting

RadiologicalRadiologicalTestingTesting

Operating Operating RoomRoom

PathologicalPathologicalTestingTesting

Dietary andDietary andLaundryLaundry

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Activity Costs Allocated to a PatientActivity Costs Allocated to a Patient

Activity-Base Activity ActivityActivity Usage Rate CostAdmitting 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

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Activity Costs Allocated to a PatientActivity Costs Allocated to a Patient

The overhead cost associated with services can be related to the customers that use the service.

Activity-Base Activity ActivityActivity Usage Rate CostAdmitting 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

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Power NotesChapter M10 Cost Allocation and Activity-Based Costing Cost Allocation and Activity-Based Costing