1. Welcome Back
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2. Welcome Back
Time for Any Question
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3. Chapter 03
PROCESS Costing and
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4. PROCESS Costing and Analysis
Chapter 03
PROCESS Costing and Analysis
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5. Process Operations
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6. Process Operations
Used for production of small, identical, low-cost items.
Mass produced in automated continuous production process.
Costs cannot be directly traced to each unit of product.
Process operations involve the mass production of similar products in a continuous flow of sequential processes. A key feature of process operations is the high level of standardization needed if the system is to produce large volumes of products. Thus, process operations use a standardized process to make similar products; job order operations use a customized process to make unique products.
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7. Comparing Process and Job Order Costing Systems
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8. Comparing Job Order and Process Operations
Job Order Systems
Custom orders
Heterogeneous products
Low production volume
High product flexibility
Low to medium standardization
Process Systems
Repetitive operations
Homogeneous products
High production volume
Low product flexibility
High standardization
Both job order costing systems and process costing systems track direct materials, direct labor, and overhead costs. The measurement focus in a job order costing system is on the individual job or batch, whereas in a process costing system, it is on the individual process. Regardless of the measurement focus, we are ultimately interested in determining the cost per unit of product (or service) resulting from either system.
While both measure costs per unit, these two accounting systems differ in terms of how they do so. A job order system measures cost per unit upon completion of a job, by dividing the total cost for that job by the number of units in that job. As we showed in the previous chapter, job cost sheets accumulate the costs for each job. In a job order system, the cost object is a job. A process costing system measures unit costs at the end of a period (for example, a month) by combining the costs per equivalent unit from each separate department. In process costing, the cost object is the process.
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9. Comparing Job Order and Process Operations
Job order costing often uses only one Work in Process Inventory account; the balance in this account agrees with the accumulated balances across all the job cost sheets for the jobs still in process.
Process costing, however, uses separate Work in Process Inventory accounts for each department. When the production process is complete in process costing, the completed goods and the accumulated costs are transferred from the Work in Process Inventory account for the final department in the series of processes to the Finished Goods Inventory account.
Review what you have learned in the following NEED-TO-KNOW Slide.
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10. NEED-TO-KNOW
Complete the following table with either a yes or no regarding the attributes of job order and
process costing systems.
Job Order
Process
Use direct materials, direct labor, and overhead costs
Yes
Yes
Use job cost sheets to accumulate costs
Yes No
Typically use several Work in Process Inventory accounts No
Yes
Yield a cost per unit of product
Yes
Yes
Complete the following table with either a yes or no regarding the attributes of job order and process costing systems.
Use direct materials, direct labor, and overhead costs. This is true for both job order and process costing systems.
Use job cost sheets to accumulate costs. This is only true for job order costing; process costing does not use job sheets.
Typically use several Work in Process Inventory accounts. This is not true for job order costing. Instead, the detail of the Work in Process is held on the various job cost sheets. Under process costing, it is very common to have several Work in Process Inventory accounts.
And, both job order and process costing systems yield a cost per unit of product.
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11. Equivalent Units of Production
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12. Equivalent Units of Production (EUP)
EUP must be calculated for the Work in Process account.
Companies with process operations typically end each period with inventories of both finished goods and work in process.
A key idea in process costing is that of Equivalent Units of Production (EUP), a term that refers to the number of units that could have been started and completed given the costs incurred during the period.
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13. EUP for Materials and Conversion Costs
In many processes, the equivalent units of production for direct materials are not the same with respect to direct labor and overhead. For example, direct materials, like rubber for tennis ball cores, might enter production entirely at the beginning of a process; direct labor and overhead, in contrast, might be used continuously throughout the process. How does a manufacturer account for these timing differences? Again, by measuring equivalent units of production. For example, if all of the direct materials to produce 10,000 units have entered the production process, but those units have received only 20% of their direct labor and overhead costs, equivalent units would be computed as shown in this slide.
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14. Weighted Average versus FIFO
The weighted-average method combines units and costs across two periods in computing equivalent units. The FIFO method computes equivalent units based only on production activity in the current period. The objectives, concepts, and journal entries (but not amounts) are the same under the weighted-average and FIFO methods; the computations of equivalent units differ. While the FIFO method is generally considered to be more precise than the weighted-average method, it requires more calculations. Often, the differences between the two methods are not large. When using a just-in-time inventory system, these different methods will yield very similar results because inventories are immaterial.
FIFO
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15. Process Costing
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16. Process Costing Illustration
GenX uses a weighted average cost flow system with the following four steps:
Determine physical flow of units.
Compute equivalent units of production.
Compute cost per equivalent unit.
Assign and reconcile costs.
As with all situations involving inventory costs, we must choose a cost flow method. We will use the weighted average method for GenX. Process cost applications can be overwhelming if we do not use a well-planned approach. The four-step procedure will enable us to solve a process cost application in manageable parts. The four steps are:
1. Determine physical flow of units.
2. Compute equivalent units of production.
3. Compute cost per equivalent unit.
4. Assign and reconcile costs. C3
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17. Overview of GenX Company’s Process Operation
The GenX Company produces an organic trail mix called FitMix. Its target customers are active people who are interested in fitness and the environment. GenX sells FitMix to wholesale distributors, who in turn sell it to retailers. FitMix is manufactured in a continuous, two-process operation (roasting and blending), shown in this slide.
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18. Process Operations – GenX
Here we see the units processed and the completion percentages. Take a minute to become familiar with these numbers before moving on to the cost information. Process costing applications include lots of numbers and in the first process (roasting department), GenX roasts, oils, and salts organically grown peanuts. These peanuts are then passed to the blending department, the second process. In the blending department, machine blends organic chocolate pieces and organic dried fruits with the peanuts from the first process. The blended mix is then inspected and packaged for delivery. In both departments, direct materials enter production at the beginning of the process, while conversion costs occur continuously throughout each department’s processing.
Exhibit 3.5 presents production data (in units) for GenX’s roasting department. This exhibit includes the percentage of completion for both materials and conversion; for example, beginning work in process inventory is 100% complete with respect to materials but only 65% complete with respect to conversion.
The bottom graphic represents production cost data for GenX’s roasting department. We will use the data to illustrate the four-step approach to process costing.
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19. Step 1: Determine Physical Flow of Units
A physical flow reconciliation is a report that reconciles (1) the physical units started in a period with (2) the physical units completed in that period. A physical flow reconciliation for GenX’s roasting department is shown in this slide for April.
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20. Step 2: Compute Equivalent Units of Production
The second step is to compute equivalent units of production for direct materials and conversion costs for April. Since direct materials and conversion costs typically enter a process at different rates, departments must compute equivalent units separately for direct materials and conversion costs. The top graphic shows the formula to compute equivalent units under the weighted-average method for both direct materials and conversion costs.
For GenX’s roasting department, we must convert the 120,000 physical units measure to equivalent units based on how each input has been used. The roasting department fully completed its work on 100,000 units, and partially completed its work on 20,000 units. Equivalent units are computed by multiplying the number of units accounted for (from Step 1) by the percentage of completion for each input—see the second graphic.
The first row of the second graphic reflects units transferred out in April. The roasting department entirely completed its work on the 100,000 units transferred out. These units have 100% of the materials and conversion required, or 100,000 equivalent units of each input (100,000 x 100%).
GenX ended the month with 20,000 partially completed units. For direct materials, the units in ending work in process inventory include all materials required, so there are 20,000 equivalent units (20,000 x 100%) of materials in the unfinished physical units. Regarding conversion, the units in ending work in process inventory include 25% of the conversion required, which implies 5,000 equivalent units of conversion (20,000 x 25%).
The final row reflects the total equivalent units of production, which is whole units of product that could have been manufactured with the amount of inputs used to create some complete and some incomplete units. For GenX, the amount of inputs used to produce 100,000 complete units and to start 20,000 additional units is equivalent to the amount of direct materials in 120,000 whole units and the amount of conversion in 105,000 whole units.
Review what you have learned in the following NEED-TO-KNOW Slide.
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21. NEED-TO-KNOW
A department began the month with 8,000 units in work in process inventory. These units were 100%
complete with respect to direct materials and 40% complete with respect to conversion. During the month,
the department started 56,000 units and completed 58,000 units. Ending work in process inventory includes
6,000 units, 100% complete with respect to direct materials and 70% complete with respect to
conversion. Use the weighted-average method of process costing to:
1. Compute the department’s equivalent units of production for the month for direct materials.
64,000
2. Compute the department’s equivalent units of production for the month for conversion.
62,200
Work in Process Inventory - Units
Beginning Units
8,000
Started
56,000
Total Units
64,000
Transferred out
58,000
Ending Units
6,000
Units Schedule (Physical Flow Reconciliation)
Units in Beginning Inventory
8,000
Units completed and transferred out
58,000
Units Started
56,000
Units in Ending Inventory
6,000
Total Units to Account For
64,000
Total Units Accounted For
64,000
A department began the month with 8,000 units in work in process inventory. These units were 100% complete with respect to direct materials and 40% complete with respect to conversion. During the month, the department started 56,000 units and completed 58,000 units. Ending work in process inventory includes 6,000 units, 100% complete with respect to direct materials and 70% complete with respect to conversion. Use the weighted-average method of process costing to:
1. Compute the department’s equivalent units of production for the month for direct materials.
2. Compute the department’s equivalent units of production for the month for conversion.
Before we do the calculations, I think it's really helpful to set up a T-account in terms of units. We had 8,000 units in beginning inventory and the department started an additional 56,000 units. There are 64,000 units to account for. By the end of the month, the department has completed and transferred out 58,000 units, leaving 6,000 units in ending inventory. This units T-account is very helpful to create the units schedule, the physical flow reconciliation. 8,000 units in beginning inventory plus 56,000 units started equals 64,000 units to account for. We account for the units by describing their location at the end of the period. By the end of the period, 58,000 units have been transferred out and 6,000 units remain in ending inventory. Total units accounted for, 64,000.
Using the weighted average method of process costing, we focus on the condition of the units at the end of the period. To calculate the equivalent units of production, we take the physical units, 58,000 units that have been transferred out and 6,000 units in ending inventory, a total of 64,000, and we multiplied by the percentage of completion to calculate the equivalent units of production (abbreviated as EUP). Since the units have been transferred out, they must be 100% complete with respect to materials and 100% complete with respect to conversion; otherwise the subsequent department would have rejected those units!
To calculate the equivalent units of production, we multiply the physical units by the percentage of completion. 58,000 units multiplied by 100% is 58,000 equivalent units of materials. 58,000 physical units that are 100% complete with respect to conversion is the equivalent of 58,000 units of production. The 6,000 units in ending inventory are 100% complete with respect to materials; 6,000 units multiplied by 100% is 6,000 equivalent units of materials. The ending inventory units are only 70% complete with respect to conversion; 6,000 units multiplied by 70% is 4,200 equivalent units of production. The 64,000 units represent 64,000 equivalent units of materials and 62,200 equivalent units of conversion.
% Completion
EUP
Physical Units
Materials
Conversion
Materials
Conversion
Transferred out
58,000
100%
100%
58,000
58,000
Ending Inventory
6,000
100%
70%
6,000
4,200
Total units
64,000
64,000
62,200
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22. Step 3: Compute Cost per Equivalent Unit
Under the weighted-average method, the computation of EUP does not separate the units in beginning inventory from those started this period, as shown above. Similarly, the weighted average method combines the costs of beginning work in process inventory with the costs incurred in the current period. This total cost is then divided by the equivalent units of production (from Step 2), to compute the average cost per equivalent unit. This process is illustrated in this slide. For direct materials, the cost averages $3.00 per EUP. For conversion, the cost per equivalent unit averages $4.62 per unit.
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23. Step 4: Assign and Reconcile Costs
The EUP from Step 2 and the cost per EUP from Step 3 are used in Step 4 to assign costs to units that the roasting department completed and transferred to the blending department (100,000 units), and (b) units that remain in process in the roasting department (20,000 units). This is illustrated in this slide.
Cost of Units Completed and Transferred - The 100,000 units completed and transferred to the blending department required 100,000 EUP of direct materials and 100,000 EUP of conversion. Thus, we assign $300,000 (100,000 EUP x $3.00 per EUP) of direct materials cost to those units. Similarly, we assign $462,000 (100,000 EUP x $4.62 per EUP) of conversion to those units. The total cost of the 100,000 completed and transferred units is $762,000 ($300,000 + $462,000) and their average cost per unit is $7.62 ($762,000 / 100,000 units).
Cost of Units for Ending Work in Process - There are 20,000 incomplete units in work in process inventory at period-end. For direct materials, those units have 20,000 EUP of material (from Step 2) at a cost of $3.00 per EUP (from Step 3), which yields the materials cost of work in process inventory of $60,000 (20,000 EUP x $3.00 per EUP). For conversion, the in-process units reflect 5,000 EUP (from Step 2). Using the $4.62 conversion cost per EUP (from Step 3) we obtain conversion costs for in-process inventory of $23,100 (5,000 EUP x $4.62 per EUP). Total cost of work in process inventory at period-end is $83,100 ($60,000 + $23,100).
Review what you have learned in the following NEED-TO-KNOW Slide.
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24. NEED-TO-KNOW
A department began the month with conversion costs of $65,000 in its beginning work in process inventory.
During the month, the department incurred $55,000 of conversion costs. Equivalent units of production
for conversion for the month was 15,000 units. The department completed and transferred 12,000
units to the next department.
1. Compute the department’s cost per equivalent unit for conversion for the month.
$8.00
2. Compute the department’s conversion cost of units transferred to the next department for the month.
$96,000
Work in Process Inventory
Beginning Inventory
65,000
DL and OH
55,000
120,000
Transferred out
96,000
Ending Inventory
24,000
EUP
Cost
Allocated
Conversion
per EUP
Cost
Transferred out
12,000
$8.00
$96,000
Ending Inventory
3,000
$8.00
24,000
Total units
15,000
$120,000
A department began the month with conversion costs of $65,000 in its beginning work in process inventory. During the month, the department incurred $55,000 of conversion costs. Equivalent units of production for conversion for the month was 15,000 units. The department completed and transferred 12,000 units to the next department.
1. Compute the department’s cost per equivalent unit for conversion for the month. To calculate the cost per equivalent unit, we take the cumulative costs and divide by the total equivalent units of production. The cumulative costs include the beginning inventory cost of $65,000 plus the current month's cost of $55,000, a total of $120,000. When we divide by the total equivalent units of production, 15,000 equivalent units of conversion, the cost per equivalent unit of conversion is $8.
2. Compute the department’s conversion cost of units transferred to the next department for the month. Of the total 15,000 equivalent units of conversion, 12,000 units have been transferred out. 12,000 equivalent units of production multiplied by $8 per unit is a total allocated cost of $96,000. The remaining 3,000 equivalent units of production relate to the ending inventory, 3,000 equivalent units of production multiplied by $8 per unit is an allocated cost of $24,000. All $120,000 has been allocated. $96,000 of the conversion costs have been transferred out, with $24,000 of conversion costs remaining in ending inventory.
Cost per Equivalent Unit
Cumulative Costs
$120,000
Total EUP
15,000
$8.00
per equivalent unit of conversion
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25. Process Cost Summary
An important managerial accounting report for a process costing system is the process cost summary (also called production report), which is prepared separately for each process or production department. Three reasons for the summary are to (1) help department managers control and monitor their departments, (2) help factory managers evaluate department managers’ performances, and (3) provide cost information for financial statements. A process cost summary achieves these purposes by describing the costs charged to each department, reporting the equivalent units of production achieved by each department, and determining the costs assigned to each department’s output.
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26. Cost Data For GenX
This slide presents cost data for GenX. Roasting department costs are from earlier slides. We use these data next to show the journal entries in a process costing system.
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27. Accounting for Materials Costs
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28. Accounting for Material Costs
The summary entry for receipts of raw materials in April follows (dates in journal entries are omitted because they are summary entries, often reflecting two or more transactions or events).
The entry to record the use of direct materials by GenX’s production departments in April follows. These direct materials costs flow into each department’s separate Work in Process Inventory account.
The last entry records the cost of indirect materials used by GenX in April.
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29. Accounting for Labor Costs
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30. Accounting for Labor Costs
The first entry then records direct labor used. These direct labor costs flow into each department’s separate Work in Process Inventory account.
The second entry records these indirect labor costs.
After GenX posts these entries for direct and indirect labor, the Factory Payroll Payable account has a balance of $432,510 ($354,160 + $78,350). The final entry shows the payment of this total payroll. After this entry, the Factory Payroll Payable account has a zero balance.
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31. Accounting for Factory Overhead
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32. Accounting for Factory Overhead
The first entry records these other overhead costs for April.
GenX records its applied overhead with the second entry.
Review what you have learned in the following NEED-TO-KNOW Slides.
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33. NEED-TO-KNOW
Tower Mfg. estimates it will incur $200,000 of total overhead costs during the year. Tower allocates overhead
based on machine hours; it estimates it will use a total of 10,000 machine hours during the year. During
February, the assembly department of Tower Mfg. uses 375 machine hours. In addition, Tower incurred
actual overhead costs as follows during February: indirect materials, $1,800; indirect labor, $5,700;
depreciation on factory equipment, $8,000; factory utilities, $500.
1. Compute the company’s predetermined overhead rate for the year.
$20 per machine hour
Predetermined Overhead Rate =
Estimated Overhead Costs
$200,000
Estimated Activity Base
10,000 machine hours =
$20 per machine hour
Machine Hours Used
x Predetermined OH rate
= OH Applied
Assembly Dept.
375 hours
x $20 per hour
= $7,500 OH applied
Factory Overhead
Actual OH Incurred
OH Applied to Production
Tower Mfg. estimates it will incur $200,000 of total overhead costs during the year. Tower allocates overhead based on machine hours; it estimates it will use a total of 10,000 machine hours during the year. During February, the assembly department of Tower Mfg. uses 375 machine hours. In addition, Tower incurred actual overhead costs as follows during February: indirect materials, $1,800; indirect labor, $5,700; depreciation on factory equipment, $8,000; factory utilities, $500.
1. Compute the company’s predetermined overhead rate for the year. The predetermined overhead rate is calculated by taking the estimated overhead costs and dividing by the estimated activity base. $200,000 in estimated overhead costs divided by 10,000 machine hours is a predetermined overhead rate of $20 per machine hour. The predetermined overhead rate is used to assign overhead costs to production. During February, the assembly department used 375 machine hours. For each machine hour used, the production will be charged with $20 of overhead. The total amount of overhead applied to the units produced during February is $7,500. The Factory Overhead account is debited for the actual overhead costs incurred, and credited for the overhead applied to production.
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34. NEED-TO-KNOW
Tower Mfg. estimates it will incur $200,000 of total overhead costs during the year. Tower allocates overhead
based on machine hours; it estimates it will use a total of 10,000 machine hours during the year. During
February, the assembly department of Tower Mfg. uses 375 machine hours. In addition, Tower incurred
actual overhead costs as follows during February: indirect materials, $1,800; indirect labor, $5,700;
depreciation on factory equipment, $8,000; factory utilities, $500.
2. Prepare journal entries to record (a) overhead applied for the assembly department for the month and
(b) actual overhead costs used during the month.
General Journal
Debit
Credit a)
Work in Process Inventory
7,500
Factory Overhead (375 machine hours x $20 per MH)
7,500 b)
Factory Overhead
16,000
Raw Materials Inventory
1,800
Factory Wages Payable
5,700
Accumulated Depreciation - Factory Equipment
8,000
Utilities Payable
500
The journal entry to apply overhead to the assembly department for the month is a debit to Work in Process Inventory, $7,500, and a credit to Factory Overhead. The Factory Overhead account is credited for $7,500. The journal entry to record actual overhead costs used during the month will result in debits to the Factory Overhead account. Indirect materials result in a debit to Factory Overhead and a credit to Raw Materials Inventory. Indirect labor costs are debits to Factory Overhead and credits to Factory Wages Payable. Depreciation on factory equipment results in a debit to Factory Overhead and a credit to Accumulated Depreciation - Factory Equipment. And factory utilities result in debits to Factory Overhead and credits to Utilities Payable. The total actual overhead incurred is $16,000. For the month of February, actual overhead costs incurred exceed the amount of overhead applied. This results in an underapplied balance of $8,500.
Factory Overhead
Actual OH Incurred
OH Applied to Production
Ind. Materials
1,800
Ind. Labor
5,700
Fact. Deprec.
8,000
Fact. Utilities
500
16,000
7,500
Underapplied
8,500
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35. Accounting for Transfers across Departments
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36. Accounting for Transfers
The process cost summary for the roasting department shows that the 100,000 units transferred to the blending department are assigned a cost of $762,000. The entry to record this transfer is shown first.
At the end of the month, the blending department transferred 97,000 completed units, with a related cost of $1,262,940, to finished goods. The entry to record this transfer is shown second.
Assume that GenX sold 106,000 units of FitMix this period, and that its beginning finished goods inventory was 26,000 units with a cost of $338,520. Also assume that its ending finished goods inventory consists of 20,000 units at a cost of $260,400. Using this information, cost of goods sold is computed as $1,341,060.
The summary entry to record cost of goods sold for this period is shown last.
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37. Trends in Process Operations
Process design
Just-in-time production
Customer orientation
Automation
Services
Recent trends in process operations include:
Process design - Management concerns with production efficiency can lead companies to entirely reorganize production processes. For example, instead of producing different types of computers in a series of departments, a separate work center for each computer can be established in one department. The process cost system is then changed to account for each work center’s costs.
Just-in-time production - Companies are increasingly adopting just-in-time techniques. With a just-in-time inventory system, inventory levels can be minimal. If raw materials are not ordered or received until needed, a Raw Materials Inventory account might be unnecessary. Instead, materials cost is immediately debited to the goods in process inventory account. Similarly, a finished goods inventory account may not be needed. Instead, cost of finished goods may be immediately debited to the cost of goods sold account.
Automation - Advances in technology increasingly enable companies to automate their production processes. This allows them to reduce direct labor costs. Reflecting this, some companies focus on conversion costs per equivalent unit, which is the combined costs of direct labor and factory overhead per equivalent unit.
Continuous Processing - In some companies, materials move continuously through the manufacturing process. Pepsi Bottling uses a process in which inventory moves continuously through the system. In these cases, a materials consumption report summarizes the materials used and replaces materials requisitions.
Services - Service-based businesses are increasingly prevalent. For routine, standardized services like oil changes and simple tax returns, computing costs based on the process is simpler and more useful than a cost per individual job.
Customer orientation - Focus on customer orientation also leads to improved processes. A manufacturer of control devices improved quality and reduced production time by forming teams to study processes and suggest improvements. Oregon Ice Cream Company studied customer tastes to develop a more pleasing ice cream texture.
Continuous Processing
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38. Activity- Based Costing and
Chapter 04
Activity- Based Costing and
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39. Activity-Based Costing and Analysis
Chapter 04
Activity-Based Costing and Analysis
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40. Distinguish between the plantwide overhead rate method, the departmental overhead rate method, and the Activity-Based Costing method.
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41. Assigning Overhead Costs
Direct
Materials
Indirect
Factory Overhead
Allocate
Goods in Process
Finished Goods
Recall from Chapter 2 that factory overhead costs cannot be directly traced to products and must be allocated. We learned that we must develop a predetermined overhead rate to allocate the factory overhead to the goods in process.
Indirect
Cost of Goods Sold
Direct
Labor
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42. Assigning Overhead Costs
Overhead can be assigned to production in one of three ways:
Single plant-wide overhead rate
Activity-based - costing
Departmental overhead rates
Let’s take a look at the first method, the “single plantwide overhead rate method” or simply the “plantwide overhead rate method.”
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43. Allocate overhead costs to products using the plantwide overhead rate method.
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44. Plantwide Overhead Rate Method (Exhibit 4.2)
Indirect
Costs
Overhead Cost
Single Plantwide
Overhead Rate
Cost
Allocation
Base
Product 1
Product 2
Product 3
For this method, the target of the cost assignment, or cost object, is the unit of product. The rate is determined using volume-related measures such as direct labor hours, direct labor cost dollars, or machine hours, which are readily available in most manufacturing settings.
Under the single plantwide overhead rate method, total budgeted overhead costs are combined into one overhead cost pool. This cost pool is then divided by the chosen allocation base, such as total direct labor hours, to arrive at a single plantwide overhead rate. This rate then is applied to assign costs to all products based on the allocation base such as direct labor hours required to manufacture each product.
Let’s look at the Exhibit 4.3 in your text, as an example.
Cost
Objects
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45. Plantwide Overhead Rate Method Illustration (exhibits 4.3 & 4.4)
Let’s look at an example. KartCo. manufactures two models of go-karts, standard and custom. They use a plantwide rate and use direct labor hours as the allocation base To calculate total direct labor hours, multiply the number of product units by direct labor hours per unit per product. Kartco’s budgeted overhead cost consists of indirect labor costs of $4,000,000 and factory utilities of $800,000 for a total of $4,800,000. This number will also be needed to calculate the plantwide overhead rate.
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46. Plantwide Overhead Rate Method Illustration
Total budgeted overhead costs
Total budgeted DLH =
Plantwide overhead rate is equal to total budgeted overhead cost divided by total budgeted direct labor hours.
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47. Plantwide Overhead Rate Method Illustration
$4,800,000
100,000 DLH =
Dividing $4,800,000 by 100,000 hours gives us a plant overhead rate of $48 per DLH (direct labor hour). This plantwide overhead rate is then used to allocate overhead cost to products based on the number of direct labor hours required to produce each unit as follows.
Overhead allocated to each product unit = Plantwide overhead rate X DLH per unit. =
$48/DLH
Overhead allocated to each unit produced =
$48 x DLH per unit
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48. Plantwide Overhead Rate Method Illustration
Using the overhead rate of $48 per direct labor hour KartCo can determine the amount of factory overhead to allocate to each go-kart. They can then use this information to determine the total unit cost of each go-kart.
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49. Allocate overhead costs to products using the departmental overhead rate method.
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50. Departmental Overhead Rate Method (exhibit 4.5)
Overhead Cost
Indirect
Costs
Cost
Pools
Department A
Department B
Exhibit 4.5 in your text, shows that under the departmental overhead rate method, overhead costs are first determined separately for each production department. Next, an overhead rate is computed for each production department to allocate the overhead costs of each product to products passing through that department. The departmental overhead rate method allows each department to have its own overhead rate and its own allocation base.
Cost
Allocation
Base
Department A
Overhead Rate
Department B
Overhead Rate
Cost
Objects
Product 1
Product 2
Product 3
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51. Departmental Overhead Rate Method: First Step
Overhead Cost
$4,800,000
Let’s return to KartCo and calculate their departmental overhead rates. The first stage requires that KartCo assign its $4,800,000 overhead cost to its two production departments. KartCo determines from an analysis of its indirect labor and factory utilities that $4,200,000 of its overhead costs are traceable to its machining department and the remaining $600,000 are traceable to its assembly department.
Machining Dept.
$4,200,000
Assembly Dept.
$600,000
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52. Departmental Overhead Rate Method: Second Step
Machining Dept.
Overhead Rate based on machine hours (MH)
Assembly Dept.
Overhead Rate based on direct labor hours (DLH)
The second step requires each department to determine an allocation base. For KartCo, the Machining Department uses machine hours (MH) as a base for allocating its overhead and the Assembly Department uses direct labor hours (DLH) as the base for allocating its overhead.
Product 2
Product 3
Product 1
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53. Departmental Overhead Rate Method: Second Step
Here is the departmental information about KartCo’s machining and assembly departments. They will be using machine hours as the allocation base in Machining, and direct labor hours in Assembly.
P 2

54. Departmental Overhead Rate Method: Third Step (Exhibit 4.6)
Total budgeted departmental overhead costs
Total amount of departmental allocation base
Departmental Overhead Rate =
In the third step, each department computes its own overhead rate using the following formula:
Departmental overhead rate = Total budgeted departmental overhead costs / Total amount of departmental allocation base.
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55. Departmental Overhead Rate Method: Third Step
Machining Department Overhead Rate =
$4,200,000
70,000 MH
$60/MH
Assembly Department Overhead Rate =
$600,000
30,000 DLH
$20/DLH
For KartCo, it’s departmental overhead rates are computed as follows:
Machining department overhead rate = $4,200,000 / 70,000 MH
= $60 per MH
Assembly department overhead rate = $600,000 / 30,000 DLH
= $20 per DLH
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56. Departmental Overhead Rate Method: Fourth Step
Step 4 is to apply overhead costs to each product based on departmental overhead rates. For KartCo, since each standard go-kart requires 10 MH from the Machining Department and 5 DLH from the Assembly Department, the overhead cost allocated to each standard go-kart is $600 from Machining Department (10 MH X $60/MH) and $100 from the Assembly Department (5 DLH X $20/DLH). The same procedure is applied for its custom go-kart. Next, we can compare the allocated overhead costs for standard and custom go-karts under the single plant wide overhead rate and the departmental overhead rate methods. The overhead cost allocated to each standard go-kart decreased from $720 under the plant wide overhead rate method to $700 under the departmental overhead rate method, whereas overhead cost allocated to each custom go-kart increased from $1,200 to $1,300. These differences occur because the custom go-kart requires more hours in the machining department (20 MH) than the standard go-kart requires (10 MH).
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57. NEED-TO-KNOW
A manufacturer reports the following budgeted data for its two production departments.
Machining
Assembly
Manufacturing overhead costs
$600,000
$300,000
Machine hours to be used (MH)
20,000
Direct labor hours to be used (DLH)
20,000
5,000
1. What is the company’s single plantwide overhead rate based on direct labor hours?
Total Plant Overhead Costs
$900,000
$36
per DLH
Total Direct Labor Hours
25,000 DLH
2. What are the company’s departmental overhead rates if the machining department assigns overhead
based on machine hours and the assembly department assigns overhead based on direct labor hours?
Overhead Costs - Machining Dept.
$600,000
$30
per MH
Machine Hours - Machining Dept.
20,000 MH
Overhead Costs - Assembly Dept.
$300,000
$60
per DLH
Direct Labor Hours - Assembly Dept.
5,000 DLH
Need to Know 4.1:
A manufacturer reports the following budgeted data for its two production departments.
1. What is the company’s single plantwide overhead rate based on direct labor hours?
To calculate the plantwide overhead rate, we divide the total overhead costs incurred in the plant,$600,000 in the Machining Department and $300,000 in the Assembly Department, $900,000,
by the total direct labor hours used in the plant (20,000 hours in the Machining Department and 5,000 hours in the Assembly Department)
25,000 total direct labor hours. The plantwide overhead rate is $36 per direct labor hour.
2. What are the company’s departmental overhead rates if the Machining Department assigns overhead based on machine hours and the Assembly Department assigns overhead based on direct labor hours?
To calculate the Machining Department’s overhead rate, we divide the overhead costs incurred in the Machining Department, $600,000,
by the 20,000 machine hours used in the Machining Department; the overhead rate is $30 per machine hour.
To calculate the Assembly Department’s overhead rate, we divide the overhead costs incurred in the Assembly Department, $300,000, by the 5,000 direct labor hours used in the Assembly Department; the overhead rate is $60 per direct labor hour.
3. Using the departmental overhead rates from part 2, how much overhead should be assigned to a job that uses 16 machine hours in the Machining
Department and 5 direct labor hours in the Assembly Department?
For each of the 16 machine hours used in the Machining Department, the job will be charged with $30 of Machining overhead costs, $480 of overhead.
For each of the 5 direct labor hours used in the Assembly Department, the job will be charged with $60 of Assembly overhead costs, $300 of overhead. Total overhead charged to the job is $780.
3. Using the departmental overhead rates from part 2, how much overhead should be assigned to a job
that uses 16 machine hours in the machining department and 5 direct labor hours in the assembly
department?
Overhead Costs - Machining Dept.
16 MHs x
$30 per MH =
$480
Overhead Costs - Assembly Dept.
5 DLHs x
$60 per DLH =
300
Total Overhead Cost assigned to Job
$780
P 2
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58. Identify and assess advantages and disadvantages of the plantwide overhead and departmental overhead rate methods.
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59. Plantwide Overhead Rate Method Advantages and Disadvantages
Information is readily available
Easy to implement
Consistent with GAAP and can be used for external reporting needs
Disadvantages
Overhead costs may not bear any relationship with direct labor hours
All products may not use overhead costs in the same proportion
Take a moment to review the advantages and disadvantages of allocating overhead using the Plantwide Overhead Rate
A 1
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60. Departmental Overhead Rate Method Advantages and Disadvantages
Can distort product costs
Assumes that products are similar in volume, complexity, batch size
Assumes that departmental overhead costs are proportional to the allocation base
Advantages
More accurate overhead allocations
More refined than the plantwide overhead rate method
Now let’s take a moment to look at the advantages and disadvantages of using departmental overhead rates.
A 1

61. Explain cost flows for Activity-Based Costing.
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62. Cost Flows Under Activity-Based Costing Method (Exhibit 4.9)
Indirect Costs
Overhead Cost
Activity
Cost
Pool X
Activity
Cost
Pool Y
Activity
Cost
Pool Z
Cost Pools
Activity-based costing (ABC) attempts to more accurately assign overhead costs to the users of overhead by focusing on activities.
The basic principle underlying activity-based costing is that activities, which are tasks, operations, or procedures, are what cause costs to be incurred. An activity cost pool is a collection of costs that are related to the same or similar activity. Pooling costs to determine an activity overhead (pool) rate for all costs incurred by the same activity reduces the number of cost assignments required.
The four basic steps to the ABC method are:
Identify activities and the overhead costs they cause.
Trace overhead costs to cost pools.
Determine activity rates.
Use the activity overhead rates to assign overhead costs to cost objects (products).
……..Let’s take a closer look at the four basic steps of activity based costing.
Cost
Allocation
Base
Activity Overhead
rate
Activity Overhead
rate
Activity Overhead
rate
Cost
Objects
Product 1
Product 2
Product 3
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63. Allocate overhead costs to products using activity-based costing.
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64. Applying Activity-Based Costing
4 STEPS:
Identify activities and the costs they cause.
Trace overhead costs to cost pools.
Determine activity rates.
Assign overhead costs to cost objects (products).
ABC differs from using multiple departmental rates in how overhead cost pools are identified and in how overhead cost in each pool is allocated.
ABC accumulates costing overhead costs into activity pools and then allocates those costs to products using activity rates. This involves four steps:
1. Identify activities and the costs they cause.
2. Trace overhead costs to cost pools.
3. Determine activity rates.
4. Assign overhead costs to cost objects.
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65. Step One: Identify Activities and the Costs They Cause
Machine setup
Engineer
salaries
Machine repair
Assembly
line power
Step 1 in applying ABC is to identify activities and the costs they cause. This is one of the biggest challenges. This is done mainly through discussions with employees in the production departments and reviewing production activities. However, tracking too many activities makes the system cumbersome and costly to maintain. The aim of this first step is to understand actions performed in the organization that drive costs.
Factory
maintenance
Heating and
lighting
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66. Step One: Identify Activities and the Costs They Cause
Recall that a premise of ABC is that operations are a series of activities that cause costs to be incurred. Instead of combining costs from different activities into one plant wide pool or multiple departmental pools, ABC focuses on activities as the cost object in the first step of cost assignment. We are then able to trace costs to a cost object and then combine activities that are used by products in similar ways to reduce the number of cost allocations.
KartCo has total overhead cost of $4,800,000 consisting of $4,000,000 indirect labor costs and $800,000 factory utilities cost. Details gathered by KartCo about its overhead costs are shown in Exhibit Column totals for indirect labor and factory utilities correspond to amounts in previous exhibits. ABC provides more detail about the activities and the costs they cause than is provided from traditional costing methods.
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67. Step Two: Trace Overhead Costs to Cost Pools
Activity
Cost Pool (Craftsmanship)
Activity
Cost Pool (Setup)
Activity
Cost Pool (Design Modification)
Activity
Cost Pool (Plant Services)
Step 2 in applying ABC is to assign activities and their overhead costs to cost pools. Overhead costs are commonly accumulated by each department in a traditional accounting system. After review and analysis of its activities, KartCo management assigns its overhead costs into four activity cost pools: Craftsmanship, Setup, Design modification and Plant Services
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68. Step Two: Trace Overhead Costs to Cost Pools
Exhibit 4.11 shows how KartCo’s management assigned its overhead costs into the four activity cost pools. To form cost pools we look for costs that are caused by the same activities within each activity level. For KartCo, there is only one activity driver within each activity pool, but that is not always the case. It is common to see several different activity drivers within each level of activity pool. We pool only those costs that are related to the same driver.
The exhibit above shows that $600,000 of its overhead costs are assigned to the craftsmanship activity pool, $2,000,000 to the set-up cost pool, $1,200,000 to the design modification cost pool, and $1,000,000 to the plant services cost pool. This reduces the potential number of overhead rates from six (one for each of its six activities) to four (one for each pool).
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69. Step Three: Determine Activity Rates
Cost Pool (Craftsmanship)
Activity
Cost Pool (Setup)
Activity
Cost Pool (Design Modification)
Activity
Cost Pool (Plant Services)
Activity Overhead
rate ?
Activity Overhead
Rate ?
Activity Overhead
rate ?
Activity Overhead
rate ?
Step 3 is to compute the activity rates used to assign overhead costs to final cost objects such as products.
Step 3 is to compute the activity rates used to assign overhead costs to final cost objects such as products.
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70. Step Three: Determine Activity Rates
Proper determination of activity rates depends on:
and
Proper identification of the factor that drives the cost
Proper measures of activities
Proper determination of activity rates depends on:
Proper identification of the factor that drives the cost in each activity cost pool.
Proper measures of activities.
A cost driver is that activity causing the costs in the pool to be incurred. An activity driver is a measure of activity level and is determined for use as the allocation base.
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71. Step Three: Determine Activity Rates
Overhead costs assigned to pool
Expected activity level
Cost Pool Activity Rate =
For example: Craftsmanship cost pool activity rate= $600,000 / 30,000 DLH = $20 per DLH
In this step the activity rate is determined by dividing the overhead costs assigned to an activity pool by the expected activity level.
For example:
For KartCo, the activity rate for the craftsmanship cost pool is computed as:
Craftsmanship cost pool activity rate = $600,000 divided by 30,000 direct labor hours equals $20 per direct labor hour.
The activity rate computations for KartCo are summarized on the next slide.
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72. Step Three: Determine Activity Rates =
Take a moment to review how the activity rates were calculated for each of the pools.
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73. Step Four: Assign Overhead Costs to Cost Objects
Activity Overhead
rate
Product 1
Product 2
Product 3
Step 4 is to assign overhead costs in each activity cost pool to final cost objects using activity rates.
Step 4 is to assign overhead costs in each activity cost pool to final cost objects using activity rates.
To do this, overhead costs are allocated to products based on the actual levels of activities used.
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74. Step Four: Assign Overhead Costs to Cost Objects
To illustrate, the overhead costs in the craftsmanship pool are allocated to standard go-karts as follows:
Overhead allocated from craftsmanship pool to standard go-kart =
Activities consumed X Activity rate
25,000 DLH x $20 per DLH = $500,000
To illustrate, the $500,000 of overhead costs in the craftsmanship pool is allocated to standard go-karts as follows:
Overhead allocated to standard go-kart = Activities consumed X Activity rate
=25,000 DLH x $20
=$500,000
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75. Step Four: Assign Overhead Costs to Cost Objects
Overhead costs allocated to Standard and Custom Go-karts under ABC for KartCo are summarized in Exhibit This exhibit uses the activity rates from exhibit 4.12 to assign costs to Standard Go-karts and Custom Go-karts. We know that Standard Go-karts require 25,000 direct labor hours and the activity rate for craftsmanship is $20 per direct labor hour. Multiplying the number of direct labor hours by the activity rate yields the craftsmanship costs assigned to Standard Go-karts. Custom Go-karts consumed 5,000 direct labor hours, so we assign $100,000 (5,000 $20/DLH) to that product line. Similarly, we assign set-up costs, design modification costs, and plant services costs based on the quantity of activities related to costs consumed to produce each type of go-kart.
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76. Step Four: Assign Overhead Costs to Cost Objects
The unit overhead costs is computed by dividing total overhead cost allocated to each product by the number of product units. KartCo’s overhead cost per unit for it’s standard and custom go-karts is computed and shown in Exhibit 4.14.
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77. Comparison of Overhead Allocations by Method (Exhibit 4.15)
Does the method of overhead allocation really make a difference? Overhead allocation to the standard go-karts is much less under ABC than under either of the volume-based costing methods. One reason for this difference is the large design modification costs that were spread over all go-karts under both the plantwide and departmental rate methods even though standard go-karts require no engineering modification.
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78. Identify and assess advantages and disadvantages of Activity-Based Costing.
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79. Activity-Based Costing Advantages and Disadvantages
Advantages (Continued)
Costs of Quality
Advantages:
More accurate overhead cost allocation
More effective overhead cost control
Focus on relevant factors
Better management of activities
Disadvantages:
Costs to implement and maintain
Uncertainty with decisions remains
Not acceptable under GAAP
Take a minute to look over the advantages and disadvantages of activity based costing. As with all cost information, managers must be able to interpret the data and must use caution when making management decisions. While activity based costing improves the overall accuracy of the overhead cost allocations to products, it also has its limitations, and these must be weighed to determine the best approach for the company. It is also important to note that ABC is not acceptable under GAAP for external financial reporting.
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80. NEED-TO-KNOW
A manufacturer makes two types of snowmobiles, Basic and Deluxe, and reports the following data to be used in applying
activity-based costing. The company budgets production of 6,000 Basic snowmobiles and 2,000 Deluxe snowmobiles.
Activity Cost Pool
Activity Cost Driver
Cost Assigned to Pool
Basic
Deluxe
Machine setup
Number of setups
$150,000
200 setups
300 setups
Materials handling
Number of parts
250,000
10 parts per unit
20 parts per unit
Machine depreciation
Machine hours (MH)
720,000
1 MH per unit
1.5 MH per unit
$1,120,000
1. Compute overhead activity rates for each cost pool using ABC.
Machine setup costs
$150,000
$300.00
per setup
Number of setups ( )
500 setups
Materials handling costs
$250,000
$2.50
per part
Number of parts (6,000 x 10) + (2,000 x 20)
100,000 parts
Depreciation cost
$720,000
$80.00
per MH
Number of MHs (6,000 x 1) + (2,000 x 1.5)
9,000 MHs
2. Compute the total amount of overhead cost to be allocated to each of the company’s product lines using ABC.
Need-to-Know 4.2
A manufacturer makes two types of snowmobiles, Basic and Deluxe, and reports the following data to be used in applying activity-based costing.
The company budgets production of 6,000 Basic snowmobiles and 2,000 Deluxe snowmobiles.
Compute overhead activity rates for each cost pool using ABC.
The activity rate for machine setups is calculated by taking the setup cost of $150,000 and dividing by the total setups (200 basic setups and 300 deluxe setups) 500 setups. The activity rate is $300 per setup.
The activity rate for materials handling is calculated by taking the materials handling cost of $250,000 and dividing by the total number of parts.
Each of the 6,000 Basic snowmobiles has 10 parts; 60,000 parts for Basic snowmobiles.
Each of the 2,000 Deluxe snowmobiles has 20 parts; 40,000 parts for Deluxe snowmobiles. $250,000 divided by 100,000 total parts is an activity rate of $2.50 per part.
The activity rate for machine depreciation is calculated by taking the depreciation cost of $720,000 and dividing by the total number of machine hours.
Each of the 6,000 Basic snowmobiles requires 1 machine hour; 6,000 machine hours for Basic snowmobiles.
Each of the 2,000 Deluxe snowmobiles requires 1.5 machine hours; 3,000 machine hours for Deluxe snowmobiles. $720,000 divided by 9,000 total machine hours is an activity rate of $80 per machine hour.
2. Compute the total amount of overhead cost to be allocated to each of the company’s product lines using ABC.
The Basic snowmobiles require 200 setups. For each setup, $300 of machine setup cost is assigned; $60,000.
The Basic snowmobiles used 60,000 parts (6,000 units x 10 parts per unit).
For each part, $2.50 of materials handling cost is assigned; $150,000.
The Basic snowmobiles used 6,000 machine hours (6,000 units x 1 MH per unit).
For each machine hour, $80 of depreciation cost is assigned; $480,000.
Total overhead assigned to the Basic snowmobiles, $690,000.
The Deluxe snowmobiles require 300 setups. For each setup, $300 of machine setup cost is assigned; $90,000.
The Deluxe snowmobiles used 40,000 parts (2,000 units x 20 parts per unit).
For each part, $2.50 of materials handling cost is assigned; $100,000.
The Deluxe snowmobiles used 3,000 machine hours (2,000 units x 1.5 MHs per unit).
For each machine hour, $80 of depreciation cost is assigned; $240,000.
Total overhead assigned to the Deluxe snowmobiles, $430,000.
All $1,120,000 of overhead costs have been assigned; $690,000 to Basic and $430,000 to Deluxe.
Activity Cost Pool
Activity Pool Rate
Basic
Deluxe
Machine setup
$300 per setup
200 setups x $300
$60,000
300 setups x $300
$90,000
Materials handling
$2.50 per part
60,000 parts x $2.50
150,000
40,000 parts x $2.50
100,000
Machine depreciation
$80 per MH
6,000 MHs x $80
480,000
3,000 MHs x $80
240,000
Totals
$690,000
$430,000
A 2
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81. NEED-TO-KNOW
A manufacturer makes two types of snowmobiles, Basic and Deluxe, and reports the following data to be used in applying
activity-based costing. The company budgets production of 6,000 Basic snowmobiles and 2,000 Deluxe snowmobiles.
3. Compute the overhead cost per unit for each product line using ABC.
Activity Cost Pool
Activity Pool Rate
Basic
Deluxe
Machine setup
$300 per setup
200 setups x $300
$60,000
300 setups x $300
$90,000
Materials handling
$2.50 per part
60,000 parts x $2.50
150,000
40,000 parts x $2.50
100,000
Machine depreciation
$80 per MH
6,000 MHs x $80
480,000
3,000 MHs x $80
240,000
Totals
$690,000
$430,000
Units produced
6,000
2,000
Cost per unit
$115/unit
$215/unit
Need-to-Know 4.2 (continued)
3. Compute the overhead cost per unit for each product line using ABC.
$690,000 in total overhead divided by 6,000 Basic snowmobiles produced is a cost of $115 per unit.
$430,000 in overhead divided by the 2,000 Deluxe snowmobiles produced is a cost of $215 per unit.
A 2
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82. Describe the four types of activities that cause overhead costs.
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83. Four types of activities that cause overhead costs
Unit-level
Batch-level
Product-level
There are four types of activities that cause overhead costs. As mentioned earlier in this presentation, one of the biggest challenges is to identify the activities which cause the costs to occur.
Activities causing overhead cost in an organization are typically separated into four levels:
Unit-level activities
Batch-level activities
Product-level activities
Facility-level activities
Facility-level
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84. Levels of Activities 1) Unit-level
Unit-level activities are performed on each product unit; for example, providing electricity to power machinery in the machining department is needed to produce each unit of product.
Unit-level activities are those tasks that must be performed on each unit of product. For example, each unit may require that materials be cut, or components be assembled.
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85. Levels of Activities 2) Batch-level
Batch-level activities are performed only on each batch or group of units.
Batch-level activities are performed only on each batch or group of units; for example, machine setup is needed only for each batch regardless of the units in that batch, and customer order processing must be performed for each order regardless of the number of units ordered. Batch-level costs do not vary with the number of units, but instead with the number of batches.
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86. Levels of Activities 3) Product-level
Product-level activities are performed on each product line and are not affected by either numbers of units or batches.
Product-level activities are performed on each product line and are not affected by either numbers of units or batches; for example, product design is needed only for each product line. Product-level costs do not vary with the number of units or batches produced.
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87. Levels of Activities 4) Facility-level
Facility-level activities are performed to sustain facility capacity as a whole and are not caused by any specific product.
Facility-level activities are performed to sustain facility capacity as a whole and are not caused by any specific product; for example, factory maintenance costs are incurred to keep the plant clean and safe no matter what is being produced, and so is paying rent on a factory building. Facility-level costs do not vary with what is manufactured, how many batches are produced, or the output quantity.
C 3
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88. Happiness is having all homework up to date
Homework assignment
Using Connect – 8 Questions for 60 Points; Chapter 3.
Using Connect – 7 Questions for 60 Points; Chapter 4.
Complete EXAM # 1 on Connect – 3 parts for 60 Points, at Home; from 7/17 to 7/18 at 11:59 PM.
Prepare chapters:
5 “Cost Behavior and Cost-Value-Profit Analysis.”
6 “Variable Costing and Analysis.”
Happiness is having all homework up to date
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89. Thank you and See You On Wednesday at the Same Time, Take Care
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