University:
California State University, Northridge
Course:
ACCT 220 | Introduction to Financial Accounting
Academic year:

2024
Views:

401

Pages:

21
Author:

Zara Fuller

Chapter 3 System Design: Activity Based Costing Part 2 3-23 Learning Objective 2 Compute activity rates for an activity-based costing system. 3-24 Computing Activity Rates The ABC project team at Comtek has developed the following basic information. Activity and Activity Measures Estimated Overhead Cost Labor related (DLH) $ 800,000 Machine related (MH) 2,100,000 Machine setups (setups) 1,600,000 Production orders (orders) 3,150,000 Parts administration (part types) 350,000 General factory (MH) 2,000,000 $ 10,000,000 Expected Activity Total DVD CD 500,000 100,000 400,000 1,000,000 300,000 700,000 4,000 3,000 1,000 1,200 800 400 700 400 300 1,000,000 300,000 700,000 3-25 Computing Activity Rates We can calculate the following activity rates: Estimated Overhead Cost Activity and Activity Measures Labor related (DLHs) $ 800,000 Machine related (MHs) 2,100,000 Machine setups (setups) 1,600,000 Production orders (orders) 3,150,000 Parts administration (part types) 350,000 General factory (MHs) 2,000,000 $ 10,000,000 ÷ ÷ ÷ ÷ ÷ ÷ Total Expected Activity 500,000 1,000,000 4,000 1,200 700 1,000,000 = = = = = = Activity Rate $ 1.60 per DLH 2.10 per MH 400.00 per setup 2,625.00 per order 500.00 per part type 2.00 per MH Using the new activity rates, let’s assign overhead to the two products based upon expected activity. 3-26 Learning Objective 3 Compute product costs using activity-based costing. 3-27 Computing Overhead Cost per Unit DVD Units Expected Activity and Activity Measures Activity Labor related (DLHs) 100,000 Machine related (MHs) 300,000 Machine setups (setups) 3,000 Production orders (orders) 800 Parts administration (part types) 400 General factory (MHs) 300,000 Total overhead cost assigned Number of units produced Overhead cost per unit × × × × × × Activity Rate $ 1.60 2.10 400.00 2,625.00 500.00 2.00 = = = = = = Amount $ 160,000 630,000 1,200,000 2,100,000 200,000 600,000 $ 4,890,000 50,000 $ 97.80 3-28 Computing Overhead Cost per Unit CD Units Expected Activity Activity and Activity Measures Labor related (DLHs) 400,000 Machine related (MHs) 700,000 Machine setups (setups) 1,000 Production orders (orders) 400 Parts administration (part types) 300 General factory (MHs) 700,000 Total overhead cost assigned Number of units produced Overhead cost per unit × × × × × × Activity Rate $ 1.60 2.10 400.00 2,625.00 500.00 2.00 = = = = = = Amount $ 640,000 1,470,000 400,000 1,050,000 150,000 1,400,000 $ 5,110,000 200,000 $ 25.55 3-29 Comparing the Two Approaches Activity-Based Costing DVD Unit CD Unit Direct material $ 90.00 $ 50.00 Direct labor 20.00 20.00 Manufacturing overhead 97.80 25.55 Unit product cost $ 207.80 $ 95.55 Direct-Labor Costing DVD Unit CD Unit $ 90.00 $ 50.00 20.00 20.00 40.00 40.00 $ 150.00 $ 110.00 Note that the unit product cost of a CD unit decreased from $110 to $95.55 . . . . . . . . while the unit cost of a DVD unit increased from $150 to $207.80. 3-30 Learning Objective 4 Contrast the product costs computed under activitybased costing and conventional costing methods. 3-31 Comparing the Two Approaches Activity-Based Costing DVD Unit CD Unit Direct material $ 90.00 $ 50.00 Direct labor 20.00 20.00 Manufacturing overhead 97.80 25.55 Unit product cost $ 207.80 $ 95.55 The ABC system assigns $14.45 less overhead than the traditional system to each CD player. Direct-Labor Costing DVD Unit CD Unit $ 90.00 $ 50.00 20.00 20.00 40.00 40.00 $ 150.00 $ 110.00 3-32 Comparing the Two Approaches Activity-Based Costing DVD Unit CD Unit Direct material $ 90.00 $ 50.00 Direct labor 20.00 20.00 Manufacturing overhead 97.80 25.55 Unit product cost $ 207.80 $ 95.55 The ABC system assigns $57.80 more overhead than the traditional system to each DVD player. Direct-Labor Costing DVD Unit CD Unit $ 90.00 $ 50.00 20.00 20.00 40.00 40.00 $ 150.00 $ 110.00 3-33 Shifting of Overhead Cost Activity-Based Costing DVD Unit CD Unit Direct material $ 90.00 $ 50.00 Direct labor 20.00 20.00 Manufacturing overhead 97.80 25.55 Unit product cost $ 207.80 $ 95.55 Direct-Labor Costing DVD Unit CD Unit $ 90.00 $ 50.00 20.00 20.00 40.00 40.00 $ 150.00 $ 110.00 Low-volume product When a company implements activity-based costing, overhead cost often shifts from high-volume to lowvolume products with a higher unit product cost resulting for the low-volume products. 3-34 Shifting of Overhead Cost Activity-Based Costing DVD Unit CD Unit Direct material $ 90.00 $ 50.00 Direct labor 20.00 20.00 Manufacturing overhead 97.80 25.55 Unit product cost $ 207.80 $ 95.55 Direct-Labor Costing DVD Unit CD Unit $ 90.00 $ 50.00 20.00 20.00 40.00 40.00 $ 150.00 $ 110.00 High-volume product The traditional system assigns the same amount of all overhead costs to each CD or DVD player ($40 per unit). 3-35 Shifting of Overhead Cost Production Orders Activity Cost Pool (a batch-level cost pool) The ABC system assigns different amounts of Production Order-related overhead costs to each product. This fact can be illustrated in a two-step process. 1. Compute the number of units processed per production order for each product. Number of units produced per year Number of production orders issued per year Number of units processed per production order DVD Units 50,000 800 62.5 CD Units 200,000 400 500 3-36 Shifting of Overhead Cost 2. Compute production order cost per unit for each product. Cost to issue a production order Average number of units processed per production order Production order cost per unit DVD Units CD Units $ 2,625 $ 2,625 $ 62.5 42.00 $ 500 5.25 Notice, the costs are being shifted from the high volume CD players to the low volume DVD players. 3-37 Targeting Process Improvements An ABC system can help identify areas where the company can benefit from improving its current processes. Activity-Based Management Focuses on managing activities to eliminate waste and reduce delays and defects. 3-38 Targeting Process Improvements The first step in any improvement program is deciding what to improve. The Theory of Constraints approach targets the highest impact improvement opportunities. Activity rates can be used to target areas where costs seem excessively high. Benchmarking can be used to compare activity cost information with world-class standards of performance achieved by other organizations. 3-39 Benefits of Activity-Based Costing ABC improves the accuracy of product costing by: • • • Increasing the number of cost pools used to accumulate overhead costs. Using activity cost pools that are more homogeneous than departmental cost pools. Assigning overhead costs using activity measures that cause those costs, rather than relying solely on direct labor hours. Activity-based costing also highlights activities that could benefit most from process improvement efforts, such as Six Sigma. 3-40 Limitations of Activity-Based Costing Costs of implementing an ABC system may outweigh the benefits. However, the benefits are more likely to be worth the costs when: 1. Products differ substantially in volume, batch size, and in activities required. 2. Conditions have changed substantially since the existing cost system was established. 3. Overhead costs are high and increasing and no one seems to understand why. 4. Management does not trust the existing cost system and it ignores data from it when making decisions. 3-41 Activity-Based Costing Critical Assumption The cost in each activity pool is strictly proportional to its activity measure. When this assumption is violated, the accuracy of ABC data can be called into question. For example, managers should be particularly alert to product costs that contain allocated facility-level costs. 3-42 Modifying the ABC Model The illustrations in the chapter assume that ABC is being used for external reporting purposes. If the system is used for internal decision-making purposes, two important modifications should be made: 1. Selling and administrative costs should be assigned to products, where appropriate. 2. Facility-level costs should be removed from product costs.