Activity Accounting: Another Way to Measure Costs Understanding Costs For Management Decisions: Precision Worldwide, Inc. April 24, 2017 Activity Accounting: Another Way to Measure Costs UAA – ACCT 650 Seminar in Executive Uses of Accounting Dr. Fred Barbee Dr. Fred Barbee

Managerial Accounting

Issues in Managerial Accounting Mgmt. Acct. Yeah! A look at managerial accounting issues!

Cost Measurement Cost Accumulation Cost Assignment Direct Materials Labor Mfg. Overhead Work-in- Process Finished Goods Cost-of Goods Sold Goal: Accurately costed products.

Cost Measurement Mgmt. Acct.

Standard Costing System Understanding Costs For Management Decisions: Precision Worldwide, Inc. April 24, 2017 Actual Costing System Measuring Costs Normal Costing System Standard Costing System Dr. Fred Barbee

Cost Accumulation Mgmt. Acct.

Cost Accounting Systems Product Costs Job-Order Costing Process Costing Total/Unit Cost

Cost Assignment Mgmt. Acct.

Assigning Manufacturing Costs Functional Based Costing Activity Based Costing

Functional Based Costing

Timeliness is critical Goal: Accurately costed products Direct Materials Direct Labor Work-in- Process Finished Goods Cost-of Goods Sold Product Costs Mfg. Overhead Sold Timeliness is critical Sales - Cost of Goods Sold Income Statement = Gross Margin - Nonmanufacturing Expenses Period Costs = Net Income

These are not a problem. We can directly trace these to the product. Materials Direct Labor Work-in- Process Finished Goods Cost-of Goods Sold Mfg. Overhead The problem lies here - in the manufacturing overhead.

Do you like peanut butter as much as I do?

How do you make a peanut butter sandwich?

OK, let’s apply that same idea to product costing.

Peanut-butter costing describes a cost approach that uniformly assigns (“spreads” or “smooths out”) the cost of resources to cost objects. When, in fact, the individual product, services, etc., may use those resources in a nonuniform way.

Functional-Based Management Model Cost View Resources Operational View Efficiency Analysis Functions Performance Analysis Products

These are not a problem. We can directly trace these to the product. Materials Direct Labor Work-in- Process Finished Goods Cost-of Goods Sold Mfg. Overhead The problem lies here - in the manufacturing overhead.

Estimated Activity Base Predetermined Overhead Rate (POR) Estimated Overhead Budgeted Overhead POR = --------------------------------------- Budgeted Activity Usage Estimated Activity Base

Let’s take a closer look at calculating the predetermined overhead rate (POR)

Functional-Based Costing: Plantwide Rate Overhead Costs Assign Costs Direct Tracing Plantwide Pool Stage One: Pool Formation Assign Costs Unit-Level Driver Products Stage Two: Costs Assigned

Plantwide Rates; Overhead Variance Exercise 4-2 Plantwide Rates; Overhead Variance

Brooks Manufacturing uses a normal costing system Brooks Manufacturing uses a normal costing system. Budgeted overhead for the coming year is $1,500,000. Expected actual activity is 400,000 direct labor hours. During the year, Brooks worked a total of 384,000 direct labor hours and actual overhead totaled $1,400,000.

Required: Compute the POR for Brooks Manufacturing. Compute the applied overhead. Compute the overhead variance and label it as underapplied or overapplied. Explain why predetermined rates are used.

Summary of Overhead Concepts The amount of estimated overhead costs. The amount of overhead costs actually incurred. Actual Overhead Cost The amount of overhead costs applied to WIP. Applied Overhead Cost

Compute the Predetermined Overhead Rate (POR) . . . Estimated Total MOH Costs POR = -------------------------------------------- Estimated Total Units in Base Estimated Total MOH Costs POR = -------------------------------------------- Estimated Direct Labor Hours

Compute the Predetermined Overhead Rate (POR) . . . Estimated Total MOH Costs POR = -------------------------------------------- Estimated Direct Labor Hours $1,500,000 ------------------- = $3.75 Per DLH 400,000

Required: Compute the POR for Brooks Manufacturing. Compute the applied overhead. Compute the overhead variance and label it as underapplied or overapplied. Explain why predetermined rates are used.

Manufacturing Costs Balance Sheet Unused DM DM Inv. Directly Traced Used Used Unfinished DL WIP WIP Inv. Applied MOH Finished FG Inv. Overhead is applied by multiplying the number of direct labor hours actually worked times the predetermined overhead rate (POR). 384,000 x $3.75 = $1,440,000

Required: Compute the POR for Brooks Manufacturing. Compute the applied overhead. Compute the overhead variance and label it as underapplied or overapplied. Explain why predetermined rates are used.

Summary of Overhead Concepts Compare These The amount of estimated overhead costs. Estimated Overhead Cost The amount of overhead costs actually incurred. Actual Overhead Cost Difference equals Under- or Over- applied Overhead. The amount of overhead costs applied to WIP. Applied Overhead Cost

The Manufacturing Overhead Account Amounts rarely agree Actual Overhead Costs MOH Control A “Clearing” Account xxx Overhead Applied to WIP

Calculating the Overhead Variance Actual OH Given Calculated Applied OH Overhead Control $1,400,000 $1,440,000 $40,000 Overapplied Overhead

Functional-Based Costing: Departmental Rates Overhead Costs Same Song Different Verse Assign Costs Department A Pool Stage One: Pool Formation Department B Pool Assign Costs Unit-Level Drivers Assign Costs Products Stage Two: Costs Assigned Products

Refining A Cost System

Refining a Cost System Reclassify indirect costs as direct costs. Define more cost pools. Identify cost drivers. Use Activity-Based Costing.

Activity-Based Management Model Cost View Resources Operational View Driver Analysis Activities Performance Analysis Products & Customers

Activity Vs. Plantwide OH Rates; Resource Drivers; Activity Drivers; Exercise 4-8 Activity Vs. Plantwide OH Rates; Resource Drivers; Activity Drivers;

Milan Machining Company has identified the following OH activities, costs, and activity drivers for the coming year: Activity Expected Cost Activity Driver Activity Capacity Setup $60,000 # of Setups 300 Inspecting 45,000 Insp. Hours 4,500 Grinding 90,000 MH 18,000 Receiving 25,000 # of Parts 50,000

The company produces several different machine subassemblies used by other manufacturers. Information on separate batches for two of these subassemblies follows:

Item Subassembly A B Direct Materials $850 $950 Direct Labor $600 Units Completed 100 50 Number of Setups 1 Inspection Hours 4 2 Machine Hours 20 30 Parts Used 40

The company’s normal activity is 4,000 direct labor hours. Each batch uses 50 hours of direct labor.

Required: Upon investigation, you discover that receiving employs one worker who spends half his time on the receiving activity and half his time on inspecting products. His salary is $40,000.

Receiving also uses a forklift, at a cost of $5,000 per year for depreciation and fuel. The forklift is used only in receiving. Verify the cost of the receiving activity given above. What resource driver was used?

Receiving: Cost Cost of Labor (0.5 x $40,000) $20,000 Forklift (Direct Tracing) 5,000 Total Cost of Receiving $25,000 The resource driver used was labor time (50% on receiving and 50% on inspections).

Required: Determine the unit cost for each product using direct labor hours to apply overhead. This is an FBC approach. DLH is a Unit-Level Driver.

Normal Activity in DLH Calculate the POR using DLH. Expected Cost Activity Driver Activity Capacity Setup $60,000 # of Setups 300 Inspecting 45,000 Insp. Hours 4,500 Grinding 90,000 MH 18,000 Receiving 25,000 # of Parts 50,000 Normal Activity in DLH POR=$220,000/4,000 = $55 / DLH

Remember . . . This is FBC! Subassembly Sub. A Sub. B Direct Materials $850 $950 Direct Labor 600 Overhead ($55 x 50) 2,750 Total Costs $4,200 $4,300 Units 100 50 Unit Cost $42.00 $86.00 Each batch uses 50 DLH Remember . . . This is FBC!

We assume that products consume OH in the same proportions. Subassembly Sub. A Sub. B Direct Materials $850 $950 Direct Labor 600 Overhead ($55 x 50) 2,750 Total Costs $4,200 $4,300 Units 100 50 Unit Cost $42.00 $86.00 Each batch uses 50 DLH We assume that products consume OH in the same proportions.

Required: Determine the unit cost for each product using the four activity drivers. i.e., Let's use ABC

Nonunit-Level Drivers Pool Rates: Pool PORs Setup: $60,000/300 = $200/Setup Inspecting: $45,000/4,500 = $10/IH Grinding: $90,000/18,000 = $5/MH Receiving $25,000/50,000 = $0.50/Part Nonunit-Level Drivers Unit-Level Drivers

Now . . . Use the Pool Rates we just calculated Activity Expected Cost Activity Driver Activity Capacity Setup $60,000 # of Setups 300 Inspecting 45,000 Insp. Hours 4,500 Grinding 90,000 MH 18,000 Receiving 25,000 # of Parts 50,000 Setup: $60,000/300 = $200/Setup Inspecting: $45,000/4,500 = $10/IH Grinding: $90,000/18,000 = $5/MH Receiving $25,000/50,000 = $0.50/Part Now . . . Use the Pool Rates we just calculated

These are the activities for each subassembly. Item Subassembly A B Direct Materials $850 $950 Direct Labor $600 Units Completed 100 50 Number of Setups 1 Inspection Hours 4 2 Machine Hours 20 30 Parts Used 40 These are the activities for each subassembly.

These haven’t changed. Sub. A Sub. B Direct Materials $850 $950 Direct Labor 600 Overhead: Setup ($200x1; $200x1) 200 Inspecting ($10x4; $10x2) 40 20 Grinding ($5x20; $5x30) 100 150 Receiving ($.5x20; $.5x40) 10 Total Costs $1,800 $1,940 Units 50 Unit Cost $18.00 $38.80 These haven’t changed.

Here is the MOH using ABC. Sub. A Sub. B Direct Materials $850 $950 Direct Labor 600 Overhead: Setup ($200x1; $200x1) 200 Inspecting ($10x4; $10x2) 40 20 Grinding ($5x20; $5x30) 100 150 Receiving ($.5x20; $.5x40) 10 Total Costs $1,800 $1,940 Units 50 Unit Cost $18.00 $38.80 Here is the MOH using ABC.

Sub. A Sub. B Direct Materials $850 $950 Direct Labor 600 Overhead: Setup ($200x1; $200x1) 200 Inspecting ($10x4; $10x2) 40 20 Grinding ($5x20; $5x30) 100 150 Receiving ($.5x20; $.5x40) 10 Total Costs $1,800 $1,940 Units 50 Unit Cost $18.00 $38.80

Compare the two FBC ABC Sub. A Sub. B Direct Materials $850 $950 Direct Labor 600 Overhead: Setup ($200x1; $200x1) 200 Inspecting ($10x4; $10x2) 40 20 Grinding ($5x20; $5x30) 100 150 Receiving ($.5x20; $.5x40) 10 Total Costs $1,800 $1,940 Units 50 Unit Cost $18.00 $38.80 Subassembly Sub. A Sub. B Direct Materials $850 $950 Direct Labor 600 Overhead ($55 x 50) 2,750 Total Costs $4,200 $4,300 Units 100 50 Unit Cost $42.00 $86.00 Compare the two FBC ABC