1. Cost Allocation and Activity-Based Costing Managerial Accounting
Chapter 10
Cost Allocation and Activity-Based Costing
Managerial Accounting
8th Edition
Warren Reeve Fess
© Copyright 2004 South-Western, a division of Thomson Learning. All rights reserved.
Task Force Image Gallery clip art included in this electronic presentation is used with the permission of NVTech Inc.
PowerPoint Presentation by Douglas Cloud Professor Emeritus of Accounting Pepperdine University

2. Some of the action has been automated, so click the mouse when you see this lightning bolt in the lower right-hand corner of the screen. You can point and click anywhere on the screen.

3. After studying this chapter, you should be able to:
Objectives
1. Identify three methods used for allocating factory overhead costs to products.
2. Use a single plantwide factory overhead rate for product costing.
3. Use multiple production department factory overhead rates for product costing.
4. Use activity-based costing for product costing.
After studying this chapter, you should be able to:

4. Objectives
5. Use activity-based costing to allocate selling and administrative expenses to products.
6. Use activity-based costing in a service business.

5. Product Costing Allocation Methods
Plantwide Overhead Rate
Single Rate
Multiple Department Rates
Department
Department
Activity-Based Costing
Activity
Activity

6. Single Plantwide Factory Overhead Rate

7. Computing Single Plantwide Factory Overhead
Total budgeted factory overhead costs
Total budgeted plantwide allocation base
$80 per hour overhead rate
$1,600,000
20,000 direct labor hours =

8. Computing Single Plantwide Factory Overhead
Snowmobile:
$80 per dlh x 10 direct labor hours = $800
Factory Overhead cost per unit
Lawnmower:
$80 per dlh x 10 direct labor hours = $800

9. Plantwide factory
overhead
$1,600,000
$80 per direct labor hour
Snowmobile
$800 per unit
x 10 direct labor hours
Lawnmower
$800 per unit
x 10 direct labor hours

10. The greatest advantage of the single plantwide overhead rate is that it is simple and inexpensive to apply.

11. Multiple Production Department Factory Overhead Rate Method

12. Plantwide factory overhead
Single Plantwide Rate
Plantwide factory overhead
Plantwide rate
Products

13. Multiple Production Department Rate
Fabrication Department factory overhead
Assembly Department factory overhead
Assembly Department factory overhead rate
Fabrication Department factory overhead rate
Products

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

15. Production Department Factory Overhead Rates and Allocation
Snowmobile:
Fabrication: $103 x 8 dlh = $824
Assembly: $57 x 2 dlh = $938
Lawnmower:
Fabrication: $103 x 2 dlh = $206
Assembly: $57 x 8 dlh = $662

16. Multiple Production Department Rate Method—Ruiz Company
Fabrication Department $1,030,000
Assembly Department
$570,000
$103 x 8 dlh
$57 x 2 dlh
$938 per unit

17. Multiple Production Department Rate Method—Ruiz Company
Fabrication Department $1,030,000
Assembly Department
$570,000
$57 x 8 dlh
$103 x 2 dlh
$662 per unit

18. Distortion in Product Costs—Single Plantwide versus Multiple Production Department Overhead Rates
Factory Overhead Cost per Unit
Single Plantwide Rate
Multiple Production Department Rates
Snowmobile $800 $938
Lawnmower

19. Distortion in Product Costs—Single Plantwide versus Multiple Production Department Overhead Rates
The single plantwide factory overhead rate distorts product cost by averaging high and low factory overhead costs.

20. Conditions for Product Cost Distortion—Ruiz Company
Fabrication Department
Assembly Department
Condition 1:
Differences in production department factory overhead rates
$103 per direct
labor hour
$57 per direct
labor hour
Continued

21. Conditions for Product Cost Distortion—Ruiz Company
Differences in the ratios of allocation-base usage
8 direct labor hours
2 direct labor hours

22. Activity-Based Costing Method
Activity-based costing changes the way overhead costs are allocated.
When identifying specific activities, inefficiencies may be discovered and eliminated, reducing the product’s cost.
Traditional cost accounting undercosts complex products and overstates their profit margins.
ABC may be used for decision making but not necessarily for inventory valuation.

23. Production Department Rates
Multiple Production Department Factory Overhead versus ABC
Production Department Factory Overhead
Production Department Factory Overhead
Products
Production Department Rates
Continued

24. Multiple Production Department Factory Overhead versus ABC
Activity
Activity
Activity
Activity
Products
Activity Rates

25. Activity-Based Costing Method
Activity Amount Activity Rate
Fabrication $ 530,000
Assembly 70,000
Setup 480,000
Quality control 312,000
Engineering ,000
Total $1,600,000

26. Activity-Based Costing Method
Activity Amount Activity Rate
Fabrication $ 530,000 ÷ 10,000 dlh = $53
Assembly 70,000 ÷ 10,000 dlh = $7
Setup 480,000 ÷ 120 setups = $4,000
Quality control 312,000 ÷ 104 inspts. = $3,000
Engineering ,000 ÷ 16 changes = $13,000
Total $1,600,000
Cost Drivers
Snowmobile 8,000 $53 $424,000
Lawnmower 2, ,000
Total 10,000 $530,000
Fabrication: DL Hours Rate Total

27. Activity-Based Costing Method
Activity Amount Activity Rate
Fabrication $ 530,000 ÷ 10,000 dlh = $53
Assembly 70,000 ÷ 10,000 dlh = $7
Setup 480,000 ÷ 120 setups = $4,000
Quality control 312,000 ÷ 104 inspts. = $3,000
Engineering ,000 ÷ 16 changes = $13,000
Total $1,600,000
Snowmobile 2,000 $7 $14,000
Lawnmower 8, ,000
Total 10,000 $70,000
Assembly: DL Hours Rate Total

28. Activity-Based Costing Method
Activity Amount Activity Rate
Fabrication $ 530,000 ÷ 10,000 dlh = $53
Assembly 70,000 ÷ 10,000 dlh = $7
Setup 480,000 ÷ 120 setups = $4,000
Quality control 312,000 ÷ 104 inspts. = $3,000
Engineering ,000 ÷ 16 changes = $13,000
Total $1,600,000
Snowmobile 100 $4,000 $400,000
Lawnmower , ,000
Total 120 $480,000
Setup: Setups Rate Total

29. Activity-Based Costing Method
Activity Amount Activity Rate
Fabrication $ 530,000 ÷ 10,000 dlh = $53
Assembly 70,000 ÷ 10,000 dlh = $7
Setup 480,000 ÷ 120 setups = $4,000
Quality control 312,000 ÷ 104 inspts. = $3,000
Engineering ,000 ÷ 16 changes = $13,000
Total $1,600,000
Snowmobile 100 $3,000 $300,000
Lawnmower , ,000
Total 104 $312,000
Quality Control: Inspts. Rate Total

30. Activity-Based Costing Method
Activity Amount Activity Rate
Fabrication $ 530,000 ÷ 10,000 dlh = $53
Assembly 70,000 ÷ 10,000 dlh = $7
Setup 480,000 ÷ 120 setups = $4,000
Quality control 312,000 ÷ 104 inspts. = $3,000
Engineering ,000 ÷ 16 changes = $13,000
Total $1,600,000
Snowmobile 12 $13,000 $156,000
Lawnmower , ,000
Total 16 $208,000
Engineering: Changes Rate Total

31. Activity-Based Costing Method
Cost Allocation Summary:
Activity Snowmobile Mower Total
Fabrication $ 424,000 $106,000 $ 530,000
Assembly 14,000 56,000 70,000
Setup 400,000 80, ,000
Quality control 300,000 12, ,000
Engineering , , ,000
Total $1,294,000 $306,000 $1,600,000
Budgeted units 1, ,000
Cost per unit $1,294 $306

32. Activity-Based Costing Method—Ruiz Company
Quality Control Inspection Activity $312,000
Engineering Change Activity $208,000
Fabrication Activity $530,000
Assembly Activity $70,000
Setup Activity $480,000
$53 per dlh
$7 per dlh
$4,000 per setup
$3,000 per inspection
$13,000 per engineering change
$1,294 per unit
$306 per unit

33. Factory Overhead Cost per Unit— Three Cost Allocation Methods
Distortion in Product Costs—Multiple Production Department Factory Overhead Rate Method versus Activity-Based Costing
Factory Overhead Cost per Unit—
Three Cost Allocation Methods
Single Plantwide Multiple Production
Rate Department Rates ABC
Snowmobile $ $ 938 $1,294
Lawnmower

34. Activity-Based Costing for Selling and Administrative Activities
Selling and administrative activities may include:
1. Post-sale technical support
2. Order writing
3. Promotional support
4. Order entry
5. Customer return processing
6. Shipping document preparation
7. Shipping and handling
8. Field service

35. $200 per operating room hour
Activity-Based Costing in Service Businesses
Hopewell Hospital—Activity-Based Costing
Admitting
$180 per admission P A T I E N S
Radiological
Testing
$320 per image
$200 per operating room hour
Operating
Room
Pathological
Testing
$120 per specimen
Dietary and
Laundry
$150 per day

36. $200 per operating room hour
Activity-Based Costing in Service Businesses P A T I E N S
Hopewell Hospital—Activity-Based Costing
Admitting
Radiological
Testing
Operating
Room
Pathological
Dietary and
Laundry
$180 per admission
$320 per image
$200 per operating room hour
$120 per specimen
$150 per day
Cost Budget $960,000
Estimated Activity ,000 images
Radiological Testing Activity Rate:
= $320 =

37. Activity Costs Allocated to a Patient
Patient Name: Mary Wilson
Activity-Base Activity Activity
Activity Usage Rate Cost
Admitting 1 admission $180 $ 180
Radiology testing 2 images
Operating room 4 hours
Pathological testing 1 specimen
Dietary and laundry 7 days ,050
Total $2,790 x =
The overhead cost associated with services can be related to the customers that use the service.

38. Customer Profitability Report
Hopewell Hospital
Customer (Patient) Profitability Report
For the Period Ending December 31, 2006
Adcock, Kim
Birini, Brian
Conway, Don
Wilson, Mary
Revenues $9,500 $21,400 $5,050 $3,300
Less: Patient costs
Drugs and supplies $ 400 $ 1,000 $ 300 $ 200 Admitting
Radiological testing 1,280 2,560 1,
Operating room 2,400 6,400 1,
Pathological testing
Dietary and laundry 4, , , ,050
Total patient costs $8,700 $25,440 $4,530 $2,990
Income from operations $ $ (4,040) $ $ 310

39. Chapter 10
The End