Cost Allocation and Activity-Based Costing

11e

Principles of Managerial Accounting

Chapter 11

Prepared by: C. Douglas Cloud

Professor Emeritus of Accounting
Pepperdine University

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Reeve Warren Duchac
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 Learning Objectives
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.

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 Learning Objectives
5. Use activity-based costing to allocate selling and
administrative expenses to products.

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 Learning Objectives
5. Use activity-based costing to allocate selling and
administrative expenses to products.
6. Use activity-based costing in a service business.

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 Learning Objective 1

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

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 LO 1

Product Costing Allocation Methods

Most companies have accounting systems that

trace revenues to individual product lines. In
addition, they need to subtract the cost of
manufacturing their products from revenues in
order to determine the profit from sales.
Determining the cost of a product is termed
product costing.

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 LO 1

Product Costing Allocation Methods

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 LO 1

Product Costing Allocation Methods

 Three methods of allocating factory overhead
costs are:
1. Single plantwide factory overhead rate method

2. Multiple production department factory

overhead rate method
3. Activity-based costing method

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 Learning Objective 2

Use a single
plantwide factory
overhead rate for
product costing.

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 LO 2

Single Plantwide Factory Overhead Rate Method

 Under the single plantwide factory overhead

rate method, all of the factory overhead is
allocated to all products using only one rate.

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 LO 2
Ruiz
Ruiz Company Illustration Ruiz
Company
Company

Ruiz Company Illustration

Ruiz Company manufactures two products,
snowmobiles and riding mowers. Both products
are manufactured in a single factory. There is
$1,600,000 of factory overhead budgeted for the
period.

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 LO 2
Ruiz
Ruiz Company Illustration Ruiz
Company
Company

Each product is budgeted 10,000 direct labor

hours as shown below:

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 LO 2
Ruiz
Ruiz Company Illustration Ruiz
Company
Company

The plantwide rate is calculated as follows:

Total Budgeted Factory Overhead Costs
Total Budgeted Plantwide Allocation Base
$1,600,000 $80 per direct
=
20,000 direct labor hours labor hour

(1,000 × 10 dlh) + (1,000 × 10 dlh)

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 LO 2
Ruiz
Ruiz Company Illustration Ruiz
Company
Company

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

Riding Mower:
$80 per dlh × 10 direct labor hours = $800

Factory
Factory
Overhead
Overhead
Cost
Costper
perUnit
Unit

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 LO 2

Ruiz Company Illustration

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 LO 2

Single Plantwide Factory Overhead Rate Method

 The primary advantage of the single plantwide

overhead rate method is that it is simple and
inexpensive to apply in practice.

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 EE 11-1

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 Learning Objective 3

Use multiple
production
department factory
overhead rates for
product costing.

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 Multiple Production Department FactoryLO 3
Overhead Rate Method
 The multiple production department factory
overhead rate method uses different rates for
each production department to allocate factory
overhead costs to products.

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 Multiple Production Department FactoryLO 3
Overhead Rate Method

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 Department Overhead Rates and LO 3
Ruiz
Allocation Ruiz
Company
Company

Fabrication Department Factory Overhead Rate:

$1,030,000
= $103 per dlh
10,000 direct labor hours

Assembly Department Factory Overhead Rate:

$570,000
= $57 per dlh
10,000 direct labor hours

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 Department Overhead Rates and LO 3
Ruiz
Allocation Ruiz
Company
Company

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 Department Overhead Rates and LO 3
Ruiz
Allocation Ruiz
Company
Company

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 LO 3
Ruiz
Distortion of Product Costs Ruiz
Company
Company

The differences in factory overhead for each

product using the two methods are shown below:

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 LO 3

Distortion of Product Costs

 The following conditions indicate that a single
plantwide factory overhead rate may cause
product cost distortions:
Condition 1: Differences in production department
factory overhead rates
Condition 2: Differences among products in
the ratios of allocation base usage within a
department and across departments

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 LO 3
Ruiz
Distortion of Product Costs Ruiz
Company
Company

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 EE 11-2

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 EE 11-2

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 Learning Objective 4

Use activity-
based costing
for product
costing.

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 LO 4

Activity-Based Costing Method

 The activity-based costing method provides an
alternative approach for allocating factory
overhead that uses multiple factory overhead
rates based on different activities.
 Activities are the types of work, or actions,
involved in a manufacturing or service process.

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 LO 4

Activity-Based Costing Method

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 LO 4
Ruiz
Activity-Based Costing Method Ruiz
Company
Company

Budgeted
Cutting metal
Activity Activity Cost
to shape the
Manually
Fabrication product
assembling
Changing tooling in $ 530,000
Assembly machined
machines in 70,000
piecesfor
preparation Inspecting the
Setup 480,000
product for
making a new
Quality-control inspections
product
An engineering 312,000
conformity to
change order (ECO)
specifications
Engineering changes 208,000
initiates changing a
Total budgeted activity costs product or process. $1,600,000

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 LO 4

Activity Rates and Allocation

 The budgeted activity costs are assigned to
products using factory overhead rates for each
activity. These rates are called activity rates
because they are related to activities.

Budgeted Activity Cost

Activity Rate =
Total Activity Base Usage

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 LO 4

Activity Rates and Allocation

 The term activity base, rather than allocation
base, is used because the base is related to an
activity.

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 LO 4
Ruiz
Activity-Based Costing Method Ruiz
Company
Company

Snowmobiles are a new product for Ruiz

Company, and engineers are still making
minor design changes. Riding mowers have
been produced by Ruiz Company for many
years.

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 LO 4
Ruiz
Activity-Based Costing Method Ruiz
Company
Company

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 LO 4
Ruiz
Activity-Based Costing Method Ruiz
Company
Company

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 LO 4
Ruiz
Activity-Based Costing Method Ruiz
Company
Company

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 LO 4
Ruiz
Activity-Based Costing Method Ruiz
Company
Company

Fabrication: DL Hours Rate Total

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

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 LO 4
Ruiz
Activity-Based Costing Method Ruiz
Company
Company

Assembly: DL Hours Rate Total

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

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 LO 4
Ruiz
Activity-Based Costing Method Ruiz
Company
Company

Setup: Setups Rate Total

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

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 LO 4
Ruiz
Activity-Based Costing Method Ruiz
Company
Company

Quality Control: Inspts. Rate Total

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

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 LO 4
Ruiz
Activity-Based Costing Method Ruiz
Company
Company

Engineering: Changes Rate Total

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

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 LO 4
Ruiz
Activity-Based Costing Method Ruiz
Company
Company

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 LO 4
Ruiz
Activity-Based Costing Method Ruiz
Company
Company

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 LO 4
Ruiz
Distortion of Product Costs Ruiz
Company
Company

Comparison of the Three

Allocation Methods

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 LO 4
Ruiz
Distortion of Product Costs Ruiz
Company
Company

If Ruiz Company used the $800 factory overhead

cost allocation (single plantwide rate) instead of
activity-based costing, the following would likely
result:
1. The snowmobile would be underpriced because its
factory overhead cost is understated by $494
($1,294 – $800).
2. The riding mower would be overpriced because its
factory overhead cost is overstated by $494 ($800
– $306).

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 EE 11-3

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 EE 11-3

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 Learning Objective 5

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

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 Activity-Based Costing for Selling and LO 5
Administrative Expenses
Abacus
Abacus Company
Company
Abacus Company has two products, Ipso and
Facto. Both products have the same total sales
volume. The selling and administrative expenses of
Abacus Company are allocated to its two products
on the basis of sales volume. However, Ipso and
Facto consume selling and administrative activities
differently, as shown in Exhibit 11 (next slide).

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 Activity-Based Costing for Selling and LO 5
Administrative Expenses

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 Activity-Based Costing for Selling and LO 5
Administrative Expenses
Budgeted Warranty Claim
Warranty Claim Expenses
=
Activity Rate Estimated Warranty
Claims
Warranty Claim $150,000
Activity Rate =
100 claims

Warranty Claim
Activity Rate = $1,500 per claim

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 Activity-Based Costing for Selling and LO 5
Administrative Expenses
Assuming that Ipso had 10 warranty claims and
Facto had 90 warranty claims, the field service
activity expenses would be allocated as follows:
Ipso: $15,000 = 10 warranty claims x $1,500
per warranty claim
Facto: $135,000 = 90 warranty claims x $1,500
per warranty claim

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 EE 11-4

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 Learning Objective 6

Use activity-
based costing
in a service
business.

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 Activity-Based Costing in Service LO 6
Businesses
Hopewell
Hopewell Hospital
Hospital
Hopewell Hospital uses an activity-based costing
system to determine how hospital overhead is
allocated to patients. Each activity rate shown in
Exhibit 12 (next slide) has an estimated patient
activity-base usage.

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 Activity-Based Costing in Service LO 6
Businesses
Hopewell
Hopewell Hospital
Hospital

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 Activity-Based Costing in Service LO 6
Businesses
Hopewell
Hopewell Hospital
Hospital
The budgeted costs for radiological testing are
$96,000, based on total estimated activity-base
usage of 3,000 images.
Budgeted Activity Cost
Activity Rate =
Total Activity Base Usage
Radiological $960,000
Testing Activity = = $320 per image
Rate 3,000 images

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 Activity-Based Costing in Service LO 6
Businesses
Hopewell
Hopewell Hospital
Hospital

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 Activity-Based Costing in Service LO 6
Businesses
Hopewell
Hopewell Hospital
Hospital

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 Activity-Based
6 Costing in Service LO 6
Businesses
Hopewell
Hopewell Hospital
Hospital

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 EE 11-5

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 Cost Allocation and Activity-Based Costing

The
The End
End
Prepared by: C. Douglas Cloud
Professor Emeritus of Accounting
Pepperdine University

© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.