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    Accounting 202 Chapter 4 Notes

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    nitin
    This document discusses activity-based costing (ABC) and activity-based management (ABM). It explains how traditional costing systems using a single plantwide overhead rate can distort costs. ABC refines the system by assigning overhead costs to activities and then tracing costs to products based on cost drivers like labor hours or machine setups. The document provides an example of how ABC is implemented at a company that manufactures chrome wheels. It calculates activity rates and uses them to assign overhead costs to two jobs. Finally, it discusses how ABM uses ABC data to make decisions to improve profitability, such as changing prices or product mix.

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    Accounting 202 Chapter 4 Notes

    Uploaded by

    nitin
    43 views7 pages
    This document discusses activity-based costing (ABC) and activity-based management (ABM). It explains how traditional costing systems using a single plantwide overhead rate can distort costs. ABC refines the system by assigning overhead costs to activities and then tracing costs to products based on cost drivers like labor hours or machine setups. The document provides an example of how ABC is implemented at a company that manufactures chrome wheels. It calculates activity rates and uses them to assign overhead costs to two jobs. Finally, it discusses how ABM uses ABC data to make decisions to improve profitability, such as changing prices or product mix.

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    This document discusses activity-based costing (ABC) and activity-based management (ABM). It explains how traditional costing systems using a single plantwide overhead rate can distort costs. ABC refines the system by assigning overhead costs to activities and then tracing costs to products based on cost drivers like labor hours or machine setups. The document provides an example of how ABC is implemented at a company that manufactures chrome wheels. It calculates activity rates and uses them to assign overhead costs to two jobs. Finally, it discusses how ABM uses ABC data to make decisions to improve profitability, such as changing prices or product mix.

    Copyright:

    © All Rights Reserved
    Download as DOCX, PDF, TXT or read online from Scribd
    Download as docx, pdf, or txt
    43 views7 pages

    Accounting 202 Chapter 4 Notes

    Uploaded by

    nitin
    This document discusses activity-based costing (ABC) and activity-based management (ABM). It explains how traditional costing systems using a single plantwide overhead rate can distort costs. ABC refines the system by assigning overhead costs to activities and then tracing costs to products based on cost drivers like labor hours or machine setups. The document provides an example of how ABC is implemented at a company that manufactures chrome wheels. It calculates activity rates and uses them to assign overhead costs to two jobs. Finally, it discusses how ABM uses ABC data to make decisions to improve profitability, such as changing prices or product mix.

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    You are on page 1of 7

    Chapter 4 - Activity-Based Costing

    (through page 196 only)


    Traditional Plantwide Overhead Rate
     In Chapter 3 we learned how to use a Predetermined Overhead Rate (POHR)
    o Based on estimates made at the beginning of
    the year
    POHR = Total Estimated Overhead
    Total Estimated Allocation Base
    o One rate used to allocate manufacturing
    overhead to jobs and products produced during the year
    o Use of POHR developed in early 1900’s manufacturing was labor intensive

    Refining Cost Systems


     As companies diversify their product lines and manufacturing processes, a single
    plantwide overhead rate may not be useful
     Cost Distortion results when some products are overcosted and some are undercosted
    by the cost allocation system

    DEPARTMENTAL OVERHEAD RATES


     Separate predetermined manufacturing overhead rates for each department
     Useful when
    o Departments incur different amounts and types of MOH
    o Different jobs or products use the department resources to a different extent
     Each department has a separate overhead pool and may have a different allocation
    base

    Brewing Bottling Packaging

     4 Steps are similar to the steps used in Chapter 3, but are done for each department
    1) Estimate total overhead
    2) Estimate total allocation base
    3) Calculate POHR
    4) Allocate overhead costs to cost object:
    POHR x ACTUAL amount of allocation base
    Donovan’s Fine Furnishings manufactures upscale custom furniture and currently uses a
    plantwide overhead rate based on direct labor hours.
    Plantwide Information:
    Total Estimated Overhead $1,150,000
    Total Estimated Direct Labor Hours 25,000 DLH
    The owner and CEO is considering refining the company’s costing system by using
    departmental overhead rates and has determined the following:
    Departmental Information:
    Department Estimated Overhead Estimate Allocation Base
    Machining $825,000 13,750 machine hours
    Finishing $325,000 13,000 direct labor hours

    Information pertaining to two jobs completed on May 15 follows:


    Machining Dept. Finishing Dept.
    Job 450 2 MH 1 DLH 4 DLH
    Job 455 5 MH 2 DLH 3 DLH

    Req. 1

    Plant-wide = $1,150,000
    allocation rate = 25,000 DLH

    =$46 per DLH


    Req. 2
    Machining Dept. $825,000
    =
    overhead rate 13,750 MH

    = $60 per MH

    Finishing Dept. = $325,000


    overhead rate 13,000 DLH

    = $25 per DLH

    Req. 3
    Overhead allocation based on single, plant-wide rate:
    Job 450 Job 455
    Total direct labor hours 5 5
    × Plant-wide allocation rate  $46 per DLH  $46 per DLH
    Overhead allocation $230 $230
    Req. 4
    Overhead allocation based on departmental rates:
    Job 450 Job 455
    Machining Department:
    Departmental allocation rate $60 per MH $60 per MH
    × Machine hours used by Job  2  5
    Overhead allocation $120 $300

    Finishing Department:
    Departmental allocation rate $25 per DLH $25 per DLH
    × DL hours used by Job  4  3
    Overhead allocation $100 $75

    Total overhead allocation (from $220 $375


    both departments
    Req. 5 Does the plantwide overhead rate over or undercost either job?
    Job 455 was overcosted by $10, however, job 455 was undercosted by $145

    ACTIVITY-BASED COSTING (ABC)


     Focuses on ACTIVITIES instead of just departments
     Not limited to inventoriable product costing – often used for full costs along all value
    chain elements (total cost definition from Chapter 2)
     Further refines the costing system

    Manufacturing
    Activities

    Machine Materials Fabricating Supervising Inspecting Packaging


    Setup Handling Parts Assembly Products Products

     Four Steps:
    1) Identify activities and estimate the overhead costs of each for the year
    2) Select activity allocation base for each activity and estimate total amount for the
    year
    3) Calculate activity cost rate
    4) Allocate costs: Activity cost rate x Actual amount of activity allocation base
     Allocation base should be the COST DRIVER:
    Activities: Possible Cost Drivers:
    Material purchasing # of purchase orders
    Material handling # of parts
    Production scheduling # of batches
    Quality inspections # of inspections
    Photocopying # of pages copied
    Warranty service # of service calls

    West Horizon uses ABC to account for its chrome wheel manufacturing process. Company managers have
    identified the following activity cost pools and the expected amounts of the allocation base for each:

    Activity Estimated Cost Allocation Base


    Materials handling $13,200 Number of Parts
    Machine setup $5,200 Number of Setups
    Insertion of parts $49,500 Number of Parts
    Finishing $86,100 Finishing Direct Labor Hours
    Total $154,000
    The company expects to produce 1,000 chrome wheels during the year. The wheels are expected to use
    3,300 parts, require 20 setups, and 2,100 hours of finishing time.
    The following is the actual results of two Jobs completed during the coming year:

    Number of Parts Number of Setups Finishing DLH


    Job 420 100 3 140
    Job 510 425 6 350

    Req. 1 Compute the allocation rate for each activity

    West Horizon
    Computation of Indirect Cost Allocation Rates
    Estimated
    Quantity of
    Total Cost Activity
    Estimated Allocation Cost Allocation
    Activity Cost Base Rate
    Materials handling $13,200/ 3300 parts = $4 per part
    Machine setups $5,200/ 20 setups = $260 per setup
    Insertion of parts $49,500/ 3300 parts = $15 per part
    Finishing $86,100/ 2100 DLH = $41 per DLH
    Req. 2 Compute the manufacturing overhead for Job 420

    Activity MOH Cost


    Materials handling. 100 parts * $4 $400
    Machine setup. 3 setups * $260 $780
    Insertion of parts. 100 parts * $15 $1,500
    Finishing. 140 DLH * $41 $5,740
    Total 8,420

    Req. 3 Compute the manufacturing overhead for Job 510

    Activity MOH Cost


    Materials handling
    Machine setup COST HIERARCHY –
    Insertion of parts  System used by
    Finishing companies to
    Total $23,985 assist in
    establishing
    activity cost pools
     Allows managers to combine many different activities that behave the same way into
    manageable costs pools
    o Company may identify 100 activities, but can group them together into 10 or 15
    cost pools

    Classifies costs into 4 different levels:


    Unit-level activities
     activities and costs incurred for every unit
     Examples: inspecting and packaging each unit

    Batch-level activities
     activities and costs incurred for every batch, regardless of the number of units in the
    batch
     Example: machine set-ups, ordering materials for a specific batch of product

    Product-level activities
     activities and costs incurred for a product, regardless of the number of units or
    batches of the product produced
     Examples: cost to research, develop, and market new products

    Facility-level activities
     activities and costs incurred regardless of volume of production
     Example: depreciation, insurance, property tax, and maintenance on the production
    plant, CEO salary

    ACTITY-BASED MANAGEMENT (ABM)


     Using ABC to make decisions to improve profitability

    Pricing and Product Mix


    • 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

    Cutting Costs
     Value-Added Activities - customers are willing to pay for because
    these activates add value
     Non-Value-Added Activities- or waste activities; do not enhance the
    product
     Value-Engineering-
     Improve value-added activities
     Eliminate or Reduce non-value-activities
    Which of the following would be considered a value-added activity?
    A) storage of raw materials
    B) movement of parts to production floor
    C) sanding and finishing wood rockers
    D) janitorial services

    Planning and Control


     Uses the costs of activities to create budgets
     Compare with actual activities to see if goals are being met

    Service and Merchandising Companies


     Benefit from implementing ABC systems as well
    o Used ABC to allocate operating costs among its product or service lines

    COST / BENEFIT TEST


    Cost of implementing ABC
     May be significant
     Generally lower with
     accounting and information system expertise to develop the system
     information technology exists to compile cost driver data

    Do the benefits of adopting ABC/ABM exceed the costs?


    • Benefits are higher when:
     Companies are in competitive markets
     Accurate cost information exists
     Cutting costs leads to profits

     Risk of cost distortion is high


     Many different products using many different resources
     High indirect costs (high MOH costs that must be allocated)
     High volumes of some products, low volumes of others

    Warning signs that cost system is outdated


    o Managers don’t understand costs
     Companies lose bids they expected to win
     Competitors price similar products much higher or lower
    o Company has reengineered or diversified products and still using old
    system

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