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Cost Allocation and Activity-Based Costing

26. Cost Allocation and Activity-Based Costing. Student Version. 1. Identify three methods used for allocating factory overhead costs to products. 26-2. 1. 0. Product Costing.

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Cost Allocation and Activity-Based Costing

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  1. 26 Cost Allocation and Activity-Based Costing Student Version

  2. 1 Identify three methods used for allocating factory overhead costs to products. 26-2

  3. 1 0 Product Costing Most companies have accounting systems that trace revenues to individual product lines. In addition, they need to subtract the cost of manufacturing their product from revenues in order to determine the profit from sales. Determining the cost of the product is termed product costing.

  4. 1 Product Costing Allocation Methods

  5. 0 2 Use a single plantwide factory overhead rate for product costing. 26-5

  6. 2 0 Ruiz Company Illustration Ruiz Company manufactures two products, snowmobiles and lawnmowers. Both products are manufactured in a single factory. There is $1,600,000 of factory overhead budgeted for the period.

  7. 2 0 Ruiz Company Illustration Each product is budgeted 10,000 direct labor hours as shown below:

  8. $1,600,000 20,000 direct labor hours $80 per direct labor hour = (1,000 × 10 dlh) + (1,000 × 10 dlh) 2 0 Computing Single Plantwide Factory Overhead Total budgeted factory overhead costs Total budgeted plantwide allocation base

  9. 2 0 Computing Single Plantwide Factory Overhead Snowmobile: $80 per dlh × 10 direct labor hours = $800 Lawnmower: $80 per dlh × 10 direct labor hours = $800 Factory Overhead Cost per Unit

  10. 0 3 Use multiple production department factory overhead rates for product costing. 26-10

  11. $1,030,000 10,000 direct labor hours = $103 per dlh Assembly Department Overhead Rate: $570,000 10,000 direct labor hours = $57 per dlh 3 0 Production Department Factory Overhead Rates and Allocation Fabrication Department Overhead Rate:

  12. 3 0 Allocating Factory Overhead to Products—Ruiz Company Exhibit 3

  13. 3 0 Multiple Production Department Rate Method—Ruiz Company Exhibit 4

  14. 3 0 Distortion of Product Costs The differences in factory overhead for each product using the two methods are shown below:

  15. 3 0 In general, the following conditions may indicate that a single plantwide factory overhead rate will lead to distorted product costs. 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. (continued)

  16. 3 0 Conditions for Product Cost Distortion—Ruiz Company Exhibit 5

  17. 0 4 Use activity-based costing for product costing. 26-17

  18. 4 0 Activity-Based Costing (ABC) Method The activity-based costing (ABC) method focuses on the cost of activities and then allocates these costs to products using a variety of activity bases.

  19. 4 0 Ruiz Company Example Activity Cost Pool Amount Fabrication $ 530,000 Assembly 70,000 Setup 480,000 Quality control inspections 312,000 Engineering changes 208,000 Total budgeted factory overhead costs $1,600,000

  20. 4 0 Activity Rates The activity cost pools are assigned to products, using factory overhead rates for each activity. These rates are called activity rates. Budgeted Activity Cost Activity Base Activity Rate =

  21. 4 0 Additional Data About the Two Products (continued)

  22. 4 Additional Data About the Two Products

  23. 4 0 Activity Bases—Ruiz Company Exhibit 7

  24. Fabrication: DL Hours Rate Total Snowmobile 8,000 $53 $424,000 Lawnmower 2,000 53 106,000 Total 10,000 $530,000 4 0 Exhibit 8 Activity Rates—Ruiz Company (continued)

  25. Assembly: DL Hours Rate Total Snowmobile 2,000 $7 $14,000 Lawnmower 8,000 7 56,000 Total 10,000 $70,000 4 0 Exhibit 8 Activity Rates—Ruiz Company (continued)

  26. Setup: Setups Rate Total Snowmobile 100 $4,000 $400,000 Lawnmower 20 4,000 80,000 Total 120 $480,000 4 0 Exhibit 8 Activity Rates—Ruiz Company (continued)

  27. Quality Control: Inspts. Rate Total Snowmobile 100 $3,000 $300,000 Lawnmower 4 3,000 12,000 Total 104 $312,000 4 Exhibit 8 Activity Rates—Ruiz Company (continued)

  28. Engineering: Changes Rate Total Snowmobile 12 $13,000 $156,000 Lawnmower 4 13,000 52,000 Total 16 $208,000 4 Exhibit 8 Activity Rates—Ruiz Company

  29. 4 Activity-Based Product Cost Calculations Exhibit 9

  30. 4 Additional Data About the Two Products

  31. 0 5 Use activity-based costing to allocate selling and administrative expenses to products. 20-31

  32. 5 0 Abacus Company Example The selling and administrative expenses of Abacus Company are allocated to its two products, Ipso and Facto, on the basis of warranty claims. Abacus Company has a budgeted cost of $150,000. One hundred warranty claims are estimated for the period.

  33. $150,000 100 claims Warranty Claim Activity Rate = Warranty Claim Activity Rate = $1,500 per claim 5 0 Budgeted Warranty Claim Expenses Warranty Claim Activity Rate = Estimated Warranty Claims

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