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Chapter 16 Operating Costs and Cost Allocation, Including Activity-Based Costing

Chapter 16 Operating Costs and Cost Allocation, Including Activity-Based Costing. Belverd E. Needles, Jr. Marian Powers Sherry K. Mills Henry R. Anderson - - - - - - - - - - - Multimedia Slides by: Dr. Paul J. Robertson New Mexico State University Steve Leask New Mexico State University.

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Chapter 16 Operating Costs and Cost Allocation, Including Activity-Based Costing

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  1. Chapter 16Operating Costs andCost Allocation, Including Activity-Based Costing Belverd E. Needles, Jr. Marian Powers Sherry K. Mills Henry R. Anderson - - - - - - - - - - - Multimedia Slides by: Dr. Paul J. Robertson New Mexico State University Steve Leask New Mexico State University

  2. The Management Cycle OBJECTIVE 2 Define and give examples of the three elements of product cost and compute a product’s unit cost for a manufacturing organization.

  3. Elements of Product Costs • There are three types of manufacturing costs. 1. Direct materials can be conveniently and economically traced to specific units of product. 2. Direct labor can be conveniently and economically traced to specific units of product. 3. Manufacturing overhead includes all manufacturing costs that are not direct materials or direct labor costs.

  4. Manufacturing Overhead • The following are examples of manufacturing overhead: • Indirect materials. • Indirect labor. • Depreciation associated with manufacturing operations. • Machinery and tool maintenance.

  5. Total Direct Materials + Direct Labor + Manufacturing Overhead for Units Produced Total Units Produced Product Unit Cost • A product’s unit cost equals:

  6. Product Cost Elements Actual Costing Normal Costing Standard Costing Direct materials Actual costs Actual costs Estimated costs Direct labor Actual costs Actual costs Estimated costs Manufacturing overhead Actual costs Estimated costs Estimated costs Summary of the Use of Actual or Estimated Costs inThree Cost-Measurement Methods

  7. Manufacturing Inventory Accounts OBJECTIVE 3 Describe the flow of product-related activities, documents, and costs through the Materials Inventory, Work in Process Inventory, and Finished Goods Inventory accounts.

  8. Product-Related Activities • The flow of product-related activities relates to: 1. Bringing materials into the organization. 2. Converting raw materials into a finished product. 3. Transferring completed products to finished goods storage.

  9. Direct Materials Inventory Account Work in Process Inventory Account Balance 1/1/00: Used during $10,000 2000: Total direct $25,000 materials purchased during 2000: 20,000 Balance 12/31/00: $ 5,000 Balance 1/1/00: Completed $ 2,000 during 2000: $30,000 Direct materials used during 2000: 25,000 Direct labor 2000: 12,000 Manufacturing overhead 2000: 6,000 Balance 12/31/00 $ 15,000 Manufacturing Cost Flow:An Example

  10. Factory Payroll Account Work in Process Inventory Account Direct labor 2000: earned during $12,000 2000: $12,000 Balance 12/31/00: $ 0 Balance 1/1/00: Completed $ 2,000 during 2000: $30,000 Direct materials used during 2000: 25,000 Direct labor 2000: 12,000 Manufacturing overhead 2000: 6,000 Balance 12/31/00 $ 15,000 Manufacturing Cost Flow:An Example

  11. Manufacturing Overhead Control Account Work in Process Inventory Account Total 2000: manufacturing $ 6,000 overhead incurred during 2000: $ 6,000 Balance 12/31/00: $ 0 Balance 1/1/00: Completed $ 2,000 during 2000: $30,000 Direct materials used during 2000: 25,000 Direct labor 2000: 12,000 Manufacturing overhead 2000: 6,000 Balance 12/31/00 $ 15,000 Manufacturing Cost Flow:An Example

  12. Work in Process Inventory Account Finished Goods Inventory Account Balance 1/1/00: Completed $ 2,000 during 2000: $30,000 Direct materials used during 2000: 25,000 Direct labor 2000: 12,000 Manufacturing overhead 2000: 6,000 Balance 12/31/00 $ 15,000 Balance 1/1/00: Sold during 2000: $ 6,000 $24,000 Completed during 2000: 30,000 Balance 12/31/00: $12,000 Manufacturing Cost Flow:An Example

  13. Finished Goods Inventory Account Cost of Good Sold Account Balance 1/1/00: Sold during 2000: $ 6,000 $24,000 Completed during 2000: 30,000 Balance 12/31/00: $12,000 Sold during 2000: $24,000 Manufacturing Cost Flow:An Example

  14. Manufacturing and Reporting OBJECTIVE 4 Prepare a statement of cost of goods manufactured and an income statement for a manufacturing organization.

  15. Statement of Cost of Goods Manufactured: Step 1 Angelo’s Rolling Suitcases, Inc. Statement of Cost of Goods Manufactured For the Year Ended December 31, 20xx Direct Materials Used: Direct Materials Inventory, 1/1/xx $10,000 Direct Materials Purchased 20,000 Cost of Direct Materials Available for Use $30,000 Less Direct Materials Inventory, 12/31/xx 5,000 Cost of Direct Materials Used $25,000

  16. Statement of Cost of Goods Manufactured: Step 2 Angelo’s Rolling Suitcases, Inc. Statement of Cost of Goods Manufactured For the Year Ended December 31, 20xx Cost of Direct Materials Used $25,000 Direct Labor 12,000 Manufacturing Overhead 6,000 Total Manufacturing Costs $43,000

  17. Total Manufacturing Costs $43,000 Add Work in Process Inventory, 1/1/xx 2,000 Total Cost of Work in Process During the Year $45,000 Less Work in Process Inventory, 12/31/xx 15,000 Cost of Goods Manufactured $30,000 Statement of Cost of Goods Manufactured: Step 3 Angelo’s Rolling Suitcases, Inc. Statement of Cost of Goods Manufactured For the Year Ended December 31, 20xx

  18. Sales $50,000 Cost of Goods Sold: Finished Goods Inventory, 1/1/xx $ 6,000 Cost of Goods Manufactured 30,000 Total Cost of Finished Goods Available for Sale $36,000 Less Finished Goods Inventory, 12/31/ xx 12,000 Cost of Goods Sold 24,000 Gross Margin $26,000 Selling & Administrative Expenses 16,000 Net Income $10,000 Income Statement Angelo’s Rolling Suitcases, Inc. Income Statement For the Year Ended December 31, 20xx

  19. Cost Allocation OBJECTIVE 5 Define cost allocation and explain the process of manufacturing overhead allocation using cost objects, cost pools, and cost drivers.

  20. Cost Allocation • A cost object is a: • product • process • department • activity that the organization wishes to cost.

  21. Cost Allocation • Cost allocation is the process of assigning pooled indirect costs to specific cost objects using an allocation base that represents a major function of a business.

  22. Allocation of Manufacturing Overhead • The pooling of manufacturing overhead costs that are affected by a common activity. • The selection of a cost driver whose activity level causes a change in the cost pool. • The allocation of manufacturing overhead requires the following:

  23. Cost Allocation • A cost pool is a pool of overhead costs related to a cost object. • A cost driver is an activity that causes the cost pool to increase in amount as the cost driver increases.

  24. Manufacturing Overhead Allocation Using the Traditional Approach OBJECTIVE 6 Calculate product unit cost using the traditional allocation of manufacturing overhead costs.

  25. Predetermined Overhead Rate • The use of one predetermined overhead rate to apply manufacturing overhead to a product is appropriate if organizations: 1. Manufacture only one product, or 2. Manufacture a few very similar products that require the same production processes and production-related activities.

  26. Traditional Activity Bases • Traditional activity bases are volume-related bases such as: • Direct labor hours. • Direct labor costs. • Machine hours. • Units of production.

  27. $200,000 40,000 Direct Labor Hours Predetermined Overhead Rate = $5 per Direct Labor Hour = Assignment of Manufacturing Overhead Costs:Traditional Approach Step 1: Calculate the predetermined overhead rate.

  28. Assignment of Manufacturing Overhead Costs:Traditional Approach Step 2: Apply manufacturing overhead costs to production. Regular Cost Driver Level Cost Applied Overhead costs applied: Manufacturing overhead: X 25,000 DLH $125,000 $5 per DLH Number of units ¸ 10,000 Manufacturing overhead cost per unit $ 12.50

  29. Assignment of Manufacturing Overhead Costs:Traditional Approach Step 2: Apply manufacturing overhead costs to production. Deluxe Cost Driver Level Cost Applied Overhead costs applied: Manufacturing overhead: X 15,000 DLH $ 75,000 $5 per DLH Number of units ¸ 5,000 Manufacturing overhead cost per unit $ 15.00

  30. Product Unit Cost: Traditional Approach Step 3: Product Unit Cost Regular Deluxe Rolling Suitcase Rolling Suitcase Product costs per unit: Direct materials $40.00 $42.00 Direct labor 37.50 45.00 12.50 15.00 Manufacturing overhead Product unit cost $90.00 $102.00

  31. Activity-Based Costing OBJECTIVE 7 Define and explain activity-based costing.

  32. Product Costing Systems • Increased competition from foreign companies identified a weakness in the product costing systems of many U.S. organizations. • Product costing systems did not accurately assign manufacturing overhead costs to product lines. • These inaccurate product unit costs led to poor decisions and lost market share.

  33. Activity-Based Costing (ABC) • In the search for more accurate product costing, many organizations embraced activity-based costing.

  34. ABC Cost Assignment • ABC is an approach to cost assignment that: • Categorizes all indirect costs by identifying activity cost pools. • Traces costs to those activity pools. • Assigns activity costs to products using a cost driver that is related to the cause of the cost.

  35. Activity-Based Costing • ABC is particularly useful for organizations that have: • Product diversity. • Products that vary in the amounts of production-related activities or complexity required in their manufacture, store, move, package, or ship.

  36. Manufacturing Overhead Allocation Using ABC OBJECTIVE 8 Calculate product unit cost using activity-based costing to assign manufacturing overhead costs.

  37. ABC Approach • When ABC is used, manufacturing costs are grouped into smaller activity cost pools.

  38. ABC Approach • Costs from activity cost pools are assigned to cost objects using cost drivers. • Cost drivers are identified and cost driver levels are estimated for each cost pool. • Each cost pool rate is calculated by dividing the estimated cost amount by the cost driver level. • Manufacturing overhead is applied to the product’s cost by multiplying the cost pool rate by the actual cost driver amount.

  39. ABC Systems • ABC systems assign costs to cost objects based on each cost object’s consumption of activities. • The total applied manufacturing overhead cost is added to the cost of direct materials and direct labor to determine the total product cost. • The product unit cost is the total product cost divided by the total units produced.

  40. ABC Costing Systems • Problems with product costs produced by traditional volume-based costing systems include: • Traditional volume-based system, low-volume products are undercosted and high-volume products are overcosted. • Organizations face greater risk of making poor decisions when significant product cost distortions exist.

  41. Estimated Cost Driver Level Cost Driver Regular Deluxe Total Number of setups 300 400 700 Number of inspections 150 350 500 Packaging hours 600 1,400 2,000 Machine hours 4,000 6,000 10,000 Cost Driver Level

  42. Setup $70,000 Inspection $60,000 Building $20,000 Packaging $50,000 Regular Deluxe Using ABC to Allocate Manufacturing Overhead Cost to Production

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