Prepared by: C. Douglas Cloud Professor Emeritus of Accounting Pepperdine University © 2011 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. Cost Allocation and Activity-Based Costing Chapter 26 Student Version These slides should be viewed using the presentation mode (left click your mouse on the icon).

© 2011 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. Learning Objective 1 Identify three methods used for allocating factory overhead costs to products.

© 2011 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. 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. Product Costing Allocation Methods LO 1

© 2011 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.  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 Product Costing Allocation Methods LO 1

© 2011 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. Learning Objective 2 Use a single plantwide factory overhead rate for product costing.

© 2011 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.  Under the single plantwide factory overhead rate method, all of the factory overhead is allocated to all products using only one rate. Single Plantwide Factory Overhead Rate Method LO 2

© 2011 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. 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. Ruiz Company Illustration LO 2 Ruiz Company

© 2011 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. Each product is budgeted 10,000 direct labor hours as shown below: Ruiz Company Illustration LO 2 Ruiz Company

© 2011 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. Total Budgeted Factory Overhead Costs Total Budgeted Plantwide Allocation Base $80 per direct labor hour = $1,600,000 20,000 direct labor hours Ruiz Company Illustration LO 2 The plantwide rate is calculated as follows: (continued) (1,000 × 10 dlh) + (1,000 × 10 dlh) Ruiz Company

© 2011 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. Snowmobile: $80 per dlh × 10 direct labor hours = $800 Riding Mower: $80 per dlh × 10 direct labor hours = $800 Factory Overhead Cost per Unit Ruiz Company Illustration LO 2 Ruiz Company

© 2011 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.  The primary advantage of the single plantwide overhead rate method is that it is simple and inexpensive to apply in practice. Single Plantwide Factory Overhead Rate Method LO 2

© 2011 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. Learning Objective 3 Use multiple production department factory overhead rates for product costing.

© 2011 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.  The multiple production department factory overhead rate method uses different rates for each production department to allocate factory overhead costs to products. Multiple Production Department Factory Overhead Rate Method LO 3

© 2011 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. Fabrication Department Factory Overhead Rate: $1,030,000 10,000 direct labor hours = $103 per dlh Assembly Department Factory Overhead Rate: $570,000 10,000 direct labor hours = $57 per dlh Department Overhead Rates and Allocation Ruiz Company LO 3

© 2011 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. Department Overhead Rates and Allocation Ruiz Company LO 3

© 2011 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. The differences in factory overhead for each product using the two methods are shown below: Distortion of Product Costs LO 3 Ruiz Company

© 2011 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.  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. Distortion of Product Costs LO 3

© 2011 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. Learning Objective 4 Use activity- based costing for product costing.

© 2011 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.  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. Activity-Based Costing Method LO 4

© 2011 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. LO 4 Activity-Based Costing Method Ruiz Company Fabrication$ 530,000 Assembly70,000 Setup480,000 Quality-control inspections312,000 Engineering changes 208,000 Total budgeted activity costs$1,600,000 Activity Budgeted Activity Cost Cutting metal to shape the product Manually assembling machined pieces Changing tooling in machines in preparation for making a new product Inspecting the product for conformity to specifications An engineering change order (ECO) initiates changing a product or process.

© 2011 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. Activity Rate = Budgeted Activity Cost Total Activity Base Usage Activity Rates and Allocation LO 4  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.  The term activity base, rather than allocation base, is used because the base is related to an activity.

© 2011 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. (continued) LO 4 Activity-Based Costing Method Ruiz Company

© 2011 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. LO 4 Activity-Based Costing Method (continued) Ruiz Company

© 2011 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. LO 4 Activity-Based Costing Method (continued) Ruiz Company

© 2011 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. LO 4 Activity-Based Costing Method Ruiz Company

© 2011 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. LO 4 Activity-Based Costing Method Ruiz Company

© 2011 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. LO 4 Distortion of Product Costs Ruiz 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).

© 2011 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. Learning Objective 5 Use activity-based costing to allocate selling and administrative expenses to products.

© 2011 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. Warranty Claim Activity Rate = Budgeted Warranty Claim Expenses Estimated Warranty Claims Warranty Claim Activity Rate = $150, claims Warranty Claim Activity Rate = $1,500 per claim LO 5 ( continued ) Activity-Based Costing for Selling and Administrative Expenses

© 2011 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. LO 5 Assuming that Ipso had 10 warranty claims and Facto had 90 warranty claims, the field service activity expense 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 Activity-Based Costing for Selling and Administrative Expenses

© 2011 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. Learning Objective 6 Use activity- based costing in a service business.

© 2011 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. Hopewell Hospital uses an activity-based costing system to determine how hospital overhead is allocated to patients. Activity-Based Costing in Service Businesses LO 6 Hopewell Hospital

© 2011 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. Activity-Based Costing in Service Businesses LO 6 The budgeted costs for radiological testing are $96,000, based on total estimated activity-base usage of 3,000 images. Activity Rate = Budgeted Activity Cost Total Activity Base Usage Radiological Testing Activity Rate $960,000 3,000 images = = $320 per image

© 2011 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. (continued) Hopewell Hospital Activity-Based Costing in Service Businesses LO 6

© 2011 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. Hopewell Hospital Activity-Based Costing in Service Businesses LO 6 (continued)

© 2011 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. 6 Activity-Based Costing in Service Businesses LO 6

Prepared by: C. Douglas Cloud Professor Emeritus of Accounting Pepperdine University © 2011 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. Cost Allocation and Activity-Based Costing The End