1. 16-1 Copyright  Houghton Mifflin Company. All rights reserved. Chapter 16 Operating Costs and Cost Allocation, Including Activity-Based Costing Belverd E. Needles, Jr. Marian Powers Sherry K. Mills Henry R. Anderson - - - - - - - - - - - Multimedia Slides by: Dr. Paul J. Robertson New Mexico State University Steve Leask Steve Leask New Mexico State University

2. 16-2 Copyright  Houghton Mifflin Company. All rights reserved. The Management Cycle OBJECTIVE 2 Define and give examples of the three elements of product cost and compute a product’s unit cost for a manufacturing organization.

3. 16-3 Copyright  Houghton Mifflin Company. All rights reserved. Elements of Product Costs »There are three types of manufacturing costs. 1. Direct materials can be conveniently and economically traced to specific units of product. 2. Direct labor can be conveniently and economically traced to specific units of product. 3. Manufacturing overhead includes all manufacturing costs that are not direct materials or direct labor costs.

4. 16-4 Copyright  Houghton Mifflin Company. All rights reserved. Manufacturing Overhead »The following are examples of manufacturing overhead:  Indirect materials.  Indirect labor.  Depreciation associated with manufacturing operations.  Machinery and tool maintenance.

5. 16-5 Copyright  Houghton Mifflin Company. All rights reserved. Product Unit Cost »A product’s unit cost equals: Total Direct Materials + Direct Labor + Manufacturing Overhead for Units Produced Total Units Produced

6. 16-6 Copyright  Houghton Mifflin Company. All rights reserved. Summary of the Use of Actual or Estimated Costs in Three Cost-Measurement Methods Product Cost Elements Actual Costing Normal Costing Standard Costing Direct materials Actual costs Actual costs Estimated costs Direct laborActual costs Actual costs Manufacturing overhead Actual costs Estimated costs Estimated costs Estimated costs

7. 16-7 Copyright  Houghton Mifflin Company. All rights reserved. Manufacturing Inventory Accounts OBJECTIVE 3 Describe the flow of product-related activities, documents, and costs through the Materials Inventory, Work in Process Inventory, and Finished Goods Inventory accounts.

8. 16-8 Copyright  Houghton Mifflin Company. All rights reserved. Product-Related Activities »The flow of product-related activities relates to: 1.Bringing materials into the organization. 2.Converting raw materials into a finished product. 3.Transferring completed products to finished goods storage.

9. 16-9 Copyright  Houghton Mifflin Company. All rights reserved. Manufacturing Cost Flow: An Example Direct Materials Inventory Account Balance 1/1/00:Used during $10,0002000: Total direct $25,000 materials purchased during 2000: 20,000 Balance 12/31/00: $ 5,000 Work in Process Inventory Account Balance 1/1/00:Completed $ 2,000during 2000: $30,000 Direct materials used during 2000: 25,000 Direct labor 2000: 12,000 Manufacturing overhead 2000: 6,000 Balance 12/31/00 $ 15,000

10. 16-10 Copyright  Houghton Mifflin Company. All rights reserved. Manufacturing Cost Flow: An Example Factory Payroll Account Direct labor2000: earned during$12,000 2000: $12,000 Balance 12/31/00: $ 0 Work in Process Inventory Account Balance 1/1/00:Completed $ 2,000during 2000: $30,000 Direct materials used during 2000: 25,000 Direct labor 2000: 12,000 Manufacturing overhead 2000: 6,000 Balance 12/31/00 $ 15,000

11. 16-11 Copyright  Houghton Mifflin Company. All rights reserved. Manufacturing Cost Flow: An Example Manufacturing Overhead Control Account Total2000: manufacturing$ 6,000 overhead incurred during 2000: $ 6,000 Balance 12/31/00: $ 0 Work in Process Inventory Account Balance 1/1/00:Completed $ 2,000during 2000: $30,000 Direct materials used during 2000: 25,000 Direct labor 2000: 12,000 Manufacturing overhead 2000: 6,000 Balance 12/31/00 $ 15,000

12. 16-12 Copyright  Houghton Mifflin Company. All rights reserved. Manufacturing Cost Flow: An Example Work in Process Inventory Account Balance 1/1/00:Completed $ 2,000during 2000: $30,000 Direct materials used during 2000: 25,000 Direct labor 2000: 12,000 Manufacturing overhead 2000: 6,000 Balance 12/31/00 $ 15,000 Finished Goods Inventory Account Balance 1/1/00:Sold during 2000: $ 6,000$24,000 Completed during 2000: 30,000 Balance 12/31/00: $12,000

13. 16-13 Copyright  Houghton Mifflin Company. All rights reserved. Manufacturing Cost Flow: An Example Finished Goods Inventory Account Balance 1/1/00:Sold during 2000: $ 6,000$24,000 Completed during 2000: 30,000 Balance 12/31/00: $12,000 Cost of Good Sold Account Sold during 2000: $24,000

14. 16-14 Copyright  Houghton Mifflin Company. All rights reserved. Manufacturing and Reporting OBJECTIVE 4 Prepare a statement of cost of goods manufactured and an income statement for a manufacturing organization.

15. 16-15 Copyright  Houghton Mifflin Company. All rights reserved. Statement of Cost of Goods Manufactured: Step 1 Angelo’s Rolling Suitcases, Inc. Statement of Cost of Goods Manufactured For the Year Ended December 31, 20xx Direct Materials Used: Direct Materials Inventory, 1/1/xx$10,000 Direct Materials Purchased 20,000 Cost of Direct Materials Available for Use$30,000 Less Direct Materials Inventory, 12/31/xx 5,000 Cost of Direct Materials Used $25,000

16. 16-16 Copyright  Houghton Mifflin Company. All rights reserved. Statement of Cost of Goods Manufactured: Step 2 Angelo’s Rolling Suitcases, Inc. Statement of Cost of Goods Manufactured For the Year Ended December 31, 20xx Cost of Direct Materials Used$25,000 Direct Labor 12,000 Manufacturing Overhead 6,000 Total Manufacturing Costs$43,000

17. 16-17 Copyright  Houghton Mifflin Company. All rights reserved. Statement of Cost of Goods Manufactured: Step 3 Angelo’s Rolling Suitcases, Inc. Statement of Cost of Goods Manufactured For the Year Ended December 31, 20xx Total Manufacturing Costs$43,000 Add Work in Process Inventory, 1/1/xx 2,000 Total Cost of Work in Process During the Year$45,000 Less Work in Process Inventory, 12/31/xx 15,000 Cost of Goods Manufactured$30,000

18. 16-18 Copyright  Houghton Mifflin Company. All rights reserved. Income Statement Angelo’s Rolling Suitcases, Inc. Income Statement For the Year Ended December 31, 20xx Sales$50,000 Cost of Goods Sold: Finished Goods Inventory, 1/1/xx$ 6,000 Cost of Goods Manufactured 30,000 Total Cost of Finished Goods Available for Sale$36,000 Less Finished Goods Inventory, 12/31/ xx 12,000 Cost of Goods Sold 24,000 Gross Margin$26,000 Selling & Administrative Expenses 16,000 Net Income$10,000

19. 16-19 Copyright  Houghton Mifflin Company. All rights reserved. Cost Allocation OBJECTIVE 5 Define cost allocation and explain the process of manufacturing overhead allocation using cost objects, cost pools, and cost drivers.

20. 16-20 Copyright  Houghton Mifflin Company. All rights reserved. Cost Allocation »A cost object is a:  product  process  department  activity that the organization wishes to cost. that the organization wishes to cost.

21. 16-21 Copyright  Houghton Mifflin Company. All rights reserved. Cost Allocation »Cost allocation is the process of assigning pooled indirect costs to specific cost objects using an allocation base that represents a major function of a business.

22. 16-22 Copyright  Houghton Mifflin Company. All rights reserved. Allocation of Manufacturing Overhead  The pooling of manufacturing overhead costs that are affected by a common activity.  The selection of a cost driver whose activity level causes a change in the cost pool. »The allocation of manufacturing overhead requires the following:

23. 16-23 Copyright  Houghton Mifflin Company. All rights reserved. Cost Allocation »A cost pool is a pool of overhead costs related to a cost object. »A cost driver is an activity that causes the cost pool to increase in amount as the cost driver increases.

24. 16-24 Copyright  Houghton Mifflin Company. All rights reserved. Manufacturing Overhead Allocation Using the Traditional Approach OBJECTIVE 6 Calculate product unit cost using the traditional allocation of manufacturing overhead costs.

25. 16-25 Copyright  Houghton Mifflin Company. All rights reserved. Predetermined Overhead Rate »The use of one predetermined overhead rate to apply manufacturing overhead to a product is appropriate if organizations: 1.Manufacture only one product, or 2.Manufacture a few very similar products that require the same production processes and production-related activities.

26. 16-26 Copyright  Houghton Mifflin Company. All rights reserved. Traditional Activity Bases »Traditional activity bases are volume-related bases such as:  Direct labor hours.  Direct labor costs.  Machine hours.  Units of production.

27. 16-27 Copyright  Houghton Mifflin Company. All rights reserved. Assignment of Manufacturing Overhead Costs: Traditional Approach = $5 per Direct Labor Hour Predetermined Overhead Rate = $200,000 40,000 Direct Labor Hours Step 1: Calculate the predetermined overhead rate.

28. 16-28 Copyright  Houghton Mifflin Company. All rights reserved. Assignment of Manufacturing Overhead Costs: Traditional Approach Step 2: Apply manufacturing overhead costs to production. Regular Cost Driver LevelCost Applied Overhead costs applied: Manufacturing overhead: $5 per DLH X 25,000 DLH$125,000  10,000Number of units $ 12.50Manufacturing overhead cost per unit

29. 16-29 Copyright  Houghton Mifflin Company. All rights reserved. Assignment of Manufacturing Overhead Costs: Traditional Approach Step 2: Apply manufacturing overhead costs to production. Deluxe Cost Driver LevelCost Applied Overhead costs applied: Manufacturing overhead: $5 per DLH X 15,000 DLH$ 75,000  5,000Number of units $ 15.00Manufacturing overhead cost per unit

30. 16-30 Copyright  Houghton Mifflin Company. All rights reserved. Product Unit Cost: Traditional Approach Step 3: Product Unit Cost Regular Rolling Suitcase Deluxe Rolling Suitcase Product costs per unit: Direct materials$40.00$42.00 Direct labor 37.50 45.00 Manufacturing overhead 12.50 15.00 Product unit cost$90.00$102.00

31. 16-31 Copyright  Houghton Mifflin Company. All rights reserved. Activity-Based Costing OBJECTIVE 7 Define and explain activity-based costing.

32. 16-32 Copyright  Houghton Mifflin Company. All rights reserved. Product Costing Systems »Increased competition from foreign companies identified a weakness in the product costing systems of many U.S. organizations.  Product costing systems did not accurately assign manufacturing overhead costs to product lines.  These inaccurate product unit costs led to poor decisions and lost market share.

33. 16-33 Copyright  Houghton Mifflin Company. All rights reserved. Activity-Based Costing (ABC) »In the search for more accurate product costing, many organizations embraced activity-based costing.

34. 16-34 Copyright  Houghton Mifflin Company. All rights reserved. ABC Cost Assignment »ABC is an approach to cost assignment that:  Categorizes all indirect costs by identifying activity cost pools.  Traces costs to those activity pools.  Assigns activity costs to products using a cost driver that is related to the cause of the cost.

35. 16-35 Copyright  Houghton Mifflin Company. All rights reserved. Activity-Based Costing »ABC is particularly useful for organizations that have:  Product diversity.  Products that vary in the amounts of production-related activities or complexity required in their manufacture, store, move, package, or ship.

36. 16-36 Copyright  Houghton Mifflin Company. All rights reserved. Manufacturing Overhead Allocation Using ABC OBJECTIVE 8 Calculate product unit cost using activity-based costing to assign manufacturing overhead costs.

37. 16-37 Copyright  Houghton Mifflin Company. All rights reserved. ABC Approach »When ABC is used, manufacturing costs are grouped into smaller activity cost pools.

38. 16-38 Copyright  Houghton Mifflin Company. All rights reserved. ABC Approach »Costs from activity cost pools are assigned to cost objects using cost drivers.  Cost drivers are identified and cost driver levels are estimated for each cost pool.  Each cost pool rate is calculated by dividing the estimated cost amount by the cost driver level.  Manufacturing overhead is applied to the product’s cost by multiplying the cost pool rate by the actual cost driver amount.

39. 16-39 Copyright  Houghton Mifflin Company. All rights reserved. ABC Systems »ABC systems assign costs to cost objects based on each cost object’s consumption of activities. »The total applied manufacturing overhead cost is added to the cost of direct materials and direct labor to determine the total product cost. »The product unit cost is the total product cost divided by the total units produced.

40. 16-40 Copyright  Houghton Mifflin Company. All rights reserved. ABC Costing Systems »Problems with product costs produced by traditional volume- based costing systems include:  Traditional volume-based system, low- volume products are undercosted and high-volume products are overcosted.  Organizations face greater risk of making poor decisions when significant product cost distortions exist.

41. 16-41 Copyright  Houghton Mifflin Company. All rights reserved. Cost Driver Level Estimated Cost Driver Level Cost DriverRegularDeluxeTotal Number of setups300400700 Number of inspections150350500 Packaging hours6001,4002,000 Machine hours4,0006,00010,000

42. 16-42 Copyright  Houghton Mifflin Company. All rights reserved. Using ABC to Allocate Manufacturing Overhead Cost to Production Setup $70,000 Inspection $60,000 Packaging $50,000 Building $20,000 Regular Deluxe