University:
California State University, Northridge
Course:
ACCT 230 | Introduction to Managerial Accounting
Academic year:

2024
Views:

106

Pages:

23
Author:

Pienazzaab2

Chapter 3 Systems Design: ActivityBased Costing Part 1 Learning Objective LO1 To understand the basic approach in activitybased costing and how it differs from conventional costing. 3-2 Assigning Overhead Costs to Products When cost systems were developed in the 1800s, the emphasis was on simplicity because: 1. Cost and activity data had to be collected by hand and all calculations were done with paper and pencil. 2. Most companies produced a limited variety of similar products, so there was little difference in the overhead costs consumed by each product. 3-3 Assigning Overhead Costs to Products Plantwide Overhead Rate A single overhead rate used throughout an entire factory. Direct labor has often been used as the allocation base for overhead because: 1. Direct labor information was already being recorded. 2. Direct labor was a large component of product costs. 3. Managers believed direct labor and overhead costs were highly correlated. 3-4 Plantwide Overhead Rate Today, direct labor may no longer be a satisfactory base for allocation of overhead. 1. Most companies sell a large variety of products that consume differing amounts of overhead. 2. As a percentage of total costs, direct labor has been shrinking and overhead has been increasing. Many of the new overhead costs may not be correlated with direct labor. 3. Technology advancements have reduced the cost and complexity of gathering diverse sources of data. A plantwide overhead allocation system may not be optimal for many companies in today’s business environment. 3-5 Departmental Overhead Rates Many companies have a system in which each department has its own overhead rate. Finishing Department Painting Department Shipping Department The allocation bases depend on the nature of the work performed in each department. In the machining department, overhead may be based on machine-hours, but in the assembly department, overhead may be based on labor-hours. 3-6 Departmental Overhead Rates Unfortunately, even departmental rates will not correctly assign overhead in situations where a company has a range of products and complex overhead costs. The departmental approach relies exclusively on volume-related allocation bases. Some overhead costs may be caused by factors that are not related to the volume of production. A more sophisticated approach, such as activity-based costing, is required to account for these other factors. 3-7 Activity-Based Costing (ABC) A number of allocation bases are used for assigning costs to products. 3-8 Activity-Based Costing (ABC) A number of allocation bases are used for assigning costs to products. Cost Objects (e.g., products and customers) Activities Consumption of Resources Cost 3-9 Activity-Based Costing (ABC) An event that causes the consumption of overhead resources Activity Examples of Activities Setting up machines Admitting hospital patients Billing customers Opening a bank account 3-10 Activity-Based Costing (ABC) Activity An event that causes the consumption of overhead resources Activity Cost Pool A “cost bucket” in which costs related to a particular activity measure are accumulated Activity Measure Expresses how much of the activity is carried out and is used as the allocation base for applying overhead costs 3-11 Activity-Based Costing (ABC) Activity An event that causes the consumption of overhead resources Activity Cost Pool A “cost bucket” in which costs related to a particular activity measure are accumulated Activity Measure Expresses how much of the activity is carried out and is used as the allocation base for applying overhead costs Activity Rate A predetermined overhead rate for each activity cost pool. 3-12 Activity-Based Costing (ABC) For each activity in isolation, this system works exactly like the job-order costing system described in Chapter 2. A predetermined overhead rate is computed for each activity and then applied to jobs and products based on the amount of activity consumed by the job or product. 3-13 Designing an Activity-Based Costing System In most companies, hundreds or even thousands of different activities cause overhead costs. The challenge is to select a reasonably small number of activities that explain the bulk of the variation in overhead costs. Activities are usually chosen by interviewing a broad range of managers to find out what activities they think consume most of the organization’s resources. 3-14 Designing an Activity-Based Costing System Related activities are frequently combined to reduce the amount of detail and record-keeping costs. For example, several activities may be involved in handling and moving raw materials, but these may be combined into a single activity entitled material handling. An activity dictionary defines each of the activities that will be included in the activity-based costing system and how the activities will be measured. 3-15 Hierarchy of Activities Level Activities Activity Measure Unit-level Processing units on machines Processing units by hand Consuming factory supplies Machine-hours Direct labor-hours Units produced Batch-level Processing purchase orders Processing production orders Setting up equipment Handling materials Purchase orders processed Production orders processed Number of setups Pounds of material handled Product-level Testing new products Administering parts inventories Designing products Hours of testing time Number of part types Hours of design time Facility-level General factory administration Plant building and grounds Direct labor-hours Direct labor-hours 3-16 Graphic Example of Activity-Based Costing Various Manufacturing Overhead Costs First-Stage Cost Assignment Labor Related Pool Machine Related Pool Setup Pool Production Order Pool Parts Admin. Pool General Factory Pool 3-17 Graphic Example of Activity-Based Costing Various Manufacturing Overhead Costs First-Stage Cost Assignment Labor Related Pool Machine Related Pool Setup Pool Production Order Pool Parts Admin. Pool General Factory Pool Second-Stage Allocations $/DLH $/MH Unit-Level Activity $/Setup $/Order Products Batch-Level Activity $/Part Type $/MH Product-Level Facility-Level Activity Activity 3-18 Using Activity-Based Costing Comtek Sound, Inc.  Comtek Sound, Inc. makes two products that are sold to automobile manufacturers, a radio with a built-in CD player and a radio with a built-in DVD player.  The company has been losing bids to supply CD players, its main product, to lower price competitors.  The company has been winning all bids to supply DVD players, its secondary product. 3-19 Using Activity-Based Costing Comtek Sound, Inc.  For the current year, Comtek has budgeted sales of 50,000 DVD units and 200,000 CD units.  Comtek’s traditional cost system applies manufacturing overhead to products based on direct labor hours.  Both products require two direct labor-hours to complete, for a total of 500,000 direct labor hours. Hours DVDs: 50,000 units @ 2 hours per unit = 100,000 CDs: 200,00 units @ 2 hours per unit = 400,000 Total direct labor-hours 500,000 3-20 Using Activity-Based Costing Comtek Sound, Inc.  Unit costs for materials and labor are: Direct materials Direct Labor DVD Units $ 90 $ 20 CD Units $ 50 $ 20 3-21 Direct Labor-Hours as a Base Total manufacturing overhead costs for the current year are estimated to be $10,000,000. The company develops the following overhead rate based upon labor-hours: Predetermined $10,000,000 = 500,000 DLHs overhead rate = $20 per DLH 3-22 Direct Labor-Hours as a Base Since each product requires two hours of direct labor, $40 of overhead is assigned to each product. Direct materials Direct labor Manufacturing overhead (2 DLHs x $20 per DLH) Unit product cost DVD Unit $ 90 20 40 CD Unit $ 50 20 40 $ $ 150 110 3-23