Complete the following questions using Microsoft Excel:
Consider the following information for Hamburg Corporation:
Items
Units
Beginning inventory
85,000
Units started during the year
1
55,000
Ending inventory
61,000
Inventory is 100% complete as to materials and 60% complete as to conversion.
Items
Materials
Conversion
Beginning costs (SAR)
4
25,000
686,000
Costs added during the period (SAR)
1,255,000
980,000
Using the WEIGHTED AVERAGE method:
Calculate the number of units completed during the period.
Calculate equivalent units for conversion during the period.
Calculate cost per equivalent units for materials.
Mannheim Corporation manufactures small camping tents and family camping tents. The estimated direct labor time to produce each type of tent is as follows:
Items
Small
Family
Estimated tents produced
24,500
11,000
Direct labor hours
per tent
2.5
4.5
Estimated overhead for the period = 1,300,000 SAR.
Compute the overhead cost assigned to each type of tent assuming direct labor hours are used to allocate overhead costs.
The controller is not satisfied with the traditional method of allocating overhead because he believes that most of the overhead costs relate to the family tent product line because of its complexity. He, therefore, developed the following three activity cost pools and related cost drivers to better understand the costs.
Activity Cost Pools
Expected Use of Cost Drivers
Estimated Overhead Costs (SAR)
Setting up machines
1,000 setups
25,000
Assembling
90,000 labor hours
980,000
Inspection
1,200 inspections
230,000
Calculate the activity-based overhead rates for these three cost pools.
Compute the cost that is assigned to each tent using activity-based costing system, given the following information.
Expected Use of Cost Drivers per Product
ItemsSmallFamily
Number of setups
130
825
Direct labor hours
29,000
55,000
Number of inspections
125
1,125
Chapter 4
Activity-Based
Costing
Learning Objectives
• Obj. 1: Describe three methods used for allocating factory
overhead costs to products.
• Obj. 2: Illustrate the use of a single plantwide factory
overhead rate for product costing.
• Obj. 3: Use multiple production department factory
overhead rates for product costing.
• Obj. 4: Use activity-based costing for product costing.
• Obj. 5: Use activity-based costing to allocate selling and
administrative expenses to products.
• Obj. 6: Use activity-based costing in a service business.
• Obj. 7: Describe and illustrate the use of activity-based
costing information in decision making.
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Product Costing Allocation Methods
(slide 1 of 2)
Determining the cost of a product is termed
product costing.
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Allocation of Factory Overhead Costs
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Product Costing Allocation Methods
(slide 2 of 2)
• The most common methods of allocating factory
overhead using predetermined factory overhead
rates are:
o Single plantwide factory overhead rate method
o Multiple production department factory overhead rate
method
o Activity-based costing method
• The choice of allocation method is important to
managers because the allocation affects the
product cost.
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Single Plantwide Factory Overhead
Rate Method (slide 1 of 5)
• Under the single plantwide factory overhead rate method, factory
overhead costs are allocated to products using only one rate.
• Assume that Ruiz Company, which manufactures snowmobiles and
riding mowers in a single factory, has total budgeted factory
overhead costs of $1,600,000 for the year and 20,000 total
budgeted direct labor hours. The total budgeted direct labor hours
are computed as follows:
Particulars
Snowmobiles
Riding Mowers
Planned production
for the year
1,000 units
1,000 units
Direct labor hours
per unit
10 hours
10 hours
10,000 hours
10,000 hours
Budgeted direct
labor hours
Total
20,000 hours
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Single Plantwide Factory Overhead
Rate Method (slide 2 of 5)
• Under the single plantwide factory overhead rate
method, the $1,600,000 budgeted factory
overhead is applied to all products by using one
rate.
• This rate is computed as follows:
Single Plantwide Factory Overhead Rate =
Total Budgeted Factory Overhead
Total Budgeted Plantwide Allocation Base
o The budgeted allocation base is a measure of
operating activity in the factory.
▪ Common allocation bases would include direct labor hours,
direct labor dollars, and machine hours.
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Single Plantwide Factory Overhead
Rate Method (slide 3 of 5)
• Ruiz allocates factory overhead using budgeted
direct labor hours as the plantwide allocation
base.
• Thus, Ruiz’s single plantwide factory overhead
rate is computed as follows:
$1,600,000
Single Plantwide Factory Overhead Rate =
20,000 direct labor hours
= $80 per hour
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Single Plantwide Factory Overhead
Rate Method (slide 4 of 5)
• Ruiz uses the plantwide rate of $80 per direct
labor hour to allocate factory overhead to
snowmobiles and riding mowers, computed as
follows:
Products
Single Plantwide
Factory Overhead Rate
×
Factory
Direct Labor
= Overhead Cost
Hours per Unit
per Unit
Snowmobile
$80 per direct labor hour
×
10 direct labor
hours
=
$800
Riding
Mower
$80 per direct labor hour
×
10 direct labor
hours
=
$800
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Single Plantwide Factory Overhead Rate
Method—Ruiz Company
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Single Plantwide Factory Overhead
Rate Method (slide 5 of 5)
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Check Up Corner
Single Plantwide Factory
Overhead Rate
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Check Up Corner
Single Plantwide Factory Overhead
Rate Solution
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Multiple Production Department Factory Overhead
Rate Method (slide 1 of 3)
• When production departments differ significantly
in their manufacturing processes, factory
overhead costs are normally incurred differently
in each department.
• In such cases, factory overhead costs may be
more accurately allocated using multiple
production department factory overhead rates.
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Multiple Production Department Factory Overhead
Rate Method (slide 2 of 3)
• The multiple production department factory
overhead rate method uses different rates for
each production department to allocate factory
overhead costs to products.
• In contrast, the single plantwide rate method uses
only one rate to allocate factory overhead costs.
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Comparison of Single Plantwide Rate and
Multiple Production Department Rate Methods
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Multiple Production Department Factory Overhead
Rate Method (slide 3 of 3)
• Assume that Ruiz Company uses the following two production
departments in the manufacture of snowmobiles and riding
mowers:
o
Fabrication Department, which cuts metal to the shape of the
product.
o
Assembly Department, which manually assembles pieces into a
final product.
• The total budgeted factory overhead for Ruiz is $1,600,000
divided into the Fabrication and Assembly departments as
follows:
Particulars
Budgeted Factory Overhead Costs ($)
Fabrication Department
1,030,000
Assembly Department
570,000
Total budgeted factory overhead costs
1,600,000
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Department Overhead Rates and
Allocation
Production Department Factory Overhead Rate =
Department
Budgeted Department Factory Overhead
Budgeted Department Allocation Base
Snowmobile
Riding Mower
Fabrication Department
8 hours
2 hours
Assembly Department
2 hours
8 hours
Direct labor hours per unit
10 hours
10 hours
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Allocating Factory Overhead to Products—
Ruiz Company
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Multiple Production Department Rate Method—
Ruiz Company
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Distortion of Product Costs
(slide 1 of 5)
• The differences in Ruiz Company’s factory overhead
for each snowmobile and riding mower using the
single plantwide and the multiple production
department factory overhead rate methods are as
follows:
Particulars
Single Plantwide
Method ($)
Multiple Production
Department Method ($)
Difference ($)
Snowmobile
$800
$938
(138)
Riding Mower
800
662
138
• The single plantwide factory overhead rate distorts
product cost of both the snowmobile and riding
mower.
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Distortion of Product Costs
(slide 2 of 5)
o That is, the snowmobile is not allocated enough cost
and, thus, is undercosted by $138.
o In contrast, the riding mower is allocated too much
cost and is overcosted by $138 ($800 – $662).
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Distortion of Product Costs
(slide 3 of 5)
• The preceding cost distortions are caused by
averaging the differences between the high factory
overhead costs in the Fabrication Department and
the low factory overhead costs in the Assembly
Department.
• Using the single plantwide rate, it is assumed that all
factory overhead is directly related to a single
allocation base for the entire plant. However, this
assumption is not realistic for Ruiz.
o
Thus, using a single plantwide rate distorted the product
costs of snowmobiles and riding mowers.
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Distortion of Product Costs
(slide 4 of 5)
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Distortion of Product Costs
(slide 5 of 5)
• Condition one exists for Ruiz because the factory overhead
rate for the Fabrication Department is $103 per direct labor
hour, whereas the rate for the Assembly Department is only
$57 per direct labor hour.
• Condition two also exists for Ruiz because the snowmobile
consumes 8 direct labor hours in the Fabrication Department,
whereas the riding mower consumes only 2 direct labor hours.
o
Thus, the ratios of allocation base usage for the Fabrication and
Assembly departments are computed as follows:
Ratio of Allocation Base Usage in the Fabrication Department =
Direct Labor Hours for Snowmobiles
8 hours
=
= 4:1
Direct Labor Hours for Riding Mowers 2 hours
Ratio of Allocation Base Usage in the Assembly Department =
Direct Labor Hours for Snowmobiles
2 hours
=
= 1:4
Direct Labor Hours for Riding Mowers 8 hours
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Conditions for Product Cost Distortion—
Ruiz Company
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Check Up Corner
Multiple Production Department
Factory Overhead Rates
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Check Up Corner
Multiple Production Department Factory
Overhead Rates Solution (Slide 1 of 2)
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Check Up Corner
Multiple Production Department Factory
Overhead Rates Solution (Slide 2 of 2)
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Activity-Based Costing Method
(slide 1 of 2)
• The activity-based costing (ABC) method
provides an alternative approach for allocating
factory overhead that uses multiple factory
overhead rates based on different activities.
o Activities are the types of work, or actions, involved
in a manufacturing or service process.
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Activity-Based Costing Method
(slide 2 of 2)
• Under activity-based costing, factory overhead
costs are initially budgeted for activities,
sometimes called activity cost pools, such as
machine usage, inspections, moving, production
setups, and engineering activities.
• In contrast, when multiple production department
factory overhead rates are used, factory overhead
costs are first accounted for in production
departments.
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Multiple Production Department Factory Overhead
Rate Method versus Activity-Based Costing
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Activity-Based Costing Method—Ruiz
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Activity Rates
• Budgeted activity costs are assigned to products
using factory overhead rates for each activity.
o These rates are called activity rates.
Budgeted Activity Cost
Activity Rate =
Total Activity-Base Usage
• The term activity base, rather than allocation
base, is used because the base is related to an
activity.
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Activity Rates and Allocation
(slide 1 of 2)
• Assume that snowmobiles are a new product for
Ruiz Company, and engineers are still making
minor design changes. Ruiz has produced riding
mowers for many years. Activity-base usage for
the two products is as follows:
Particulars
Estimated units of total
production
Snowmobile
1,000 units
Riding Mower
1,000 units
Estimated setups
100 setups
20 setups
Quality control inspections
100 inspections (10%)
4 inspections (0.4%)
Estimated engineering
change orders
12 change orders
4 change orders
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Activity Rates and Allocation
(slide 2 of 2)
• The number of direct labor hours used by each
product is 10,000 hours, computed as follows:
Particulars
Direct Labor
Number of Units
Hours per Unit of Production
Total Direct
Labor Hours
Snowmobile Fabrication
Department
8 hours
1,000
8,000
Snowmobile Assembly
Department
2 hours
1,000
2,000
Total
10,000
Riding Mower
Fabrication Department
2 hours
1,000
2,000
Riding Mower Assembly
Department
8 hours
1,000
8,000
Total
10,000
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Activity Bases—Ruiz Company
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Activity Rates—Ruiz Company
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Allocating Costs
• Overhead costs of each activity rate are
allocated to a product using the following
formula:
Activity Overhead Allocated = Activity-Base Usage Activity Rate
• The estimated total factory overhead for a
product is the sum of the product’s individual
activity allocations.
o The factory overhead cost per unit is determined by
the following formula:
Factory Overhead Cost per Unit =
Total Factory Overhead Cost
Total Units of Estimated Production
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Activity-Based Product Cost Calculations
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Activity Bases—Ruiz Company (slide 2 of 2)
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Overhead Cost Allocation Methods—
Ruiz Company
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Dangers of Product Cost Distortion—Ruiz
Company
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Check Up Corner
Activity-Based Costing
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Check Up Corner
Activity-Based Costing
Solution
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Activity-Based Costing for Selling and Administrative
Expenses (slide 1 of 5)
• Generally accepted accounting principles (G A A P) require
that selling and administrative expenses be reported as
period expenses on the income statement.
• However, selling and administrative expenses may be
allocated to products for managerial decision making.
o One method of allocating selling and administrative
expenses to the products is based on sales volume.
▪ However, products may consume activities in ways that are
unrelated to their sales volumes.
– When this occurs, activity-based costing may be a more accurate
method of allocation.
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Activity-Based Costing for Selling and Administrative
Expenses (slide 2 of 5)
• Assume that Abacus Company has two products,
Ipso and Facto. Both products have the same total
sales volume. However, Ipso and Facto consume
selling and administrative activities differently.
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Selling and Administrative Activity Product
Difference
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Activity-Based Costing for Selling and Administrative
Expenses (slide 3 of 5)
• If Abacus’s selling and administrative expenses are
allocated on the basis of sales volume, then the same
amount of expense would be allocated to Ipso and
Facto.
o This is because Ipso and Facto have the same sales
volume.
▪ However, such an allocation would be misleading.
• The activity-based costing method can be used to
allocate the selling and administrative activities to Ipso
and Facto.
o This is because activity-based costing allocates selling
and administrative expenses based on how each product
consumes activities.
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Activity-Based Costing for Selling and Administrative
Expenses (slide 4 of 5)
• Assume that Abacus’s field warranty service
activity has a budgeted cost of $150,000.
Additionally, assume that 100 warranty claims
are estimated for the period. Using warranty
claims as an activity base, the warranty claim
activity rate is computed as follows:
Budgeted Activity Cost
Activity Rate =
Total Activity-Base Usage
Budgeted Warranty Claim Expenses
Warranty Claim Activity Rate =
Total Estimated Warranty Claims
$150, 000
=
= $1,500 per warranty claim
100 claims
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Activity-Based Costing for Selling and Administrative
Expenses (slide 5 of 5)
• Assuming that Ipso had 10 warranty claims and
Facto had 90 warranty claims, the field service
activity expenses would be allocated as follows:
Ipso: 10 warranty claims $1,500 per warranty claim = $15,000
Facto: 90 warranty claims $1,500 per warranty claim = $135,000
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Activity-Based Costing in Service Businesses
(slide 1 of 6)
• In service companies, the use of single and multiple
department overhead rate methods may lead to
distortions to those of manufacturing firms. Thus,
many service companies use activity-based costing
for determining the cost of services.
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Activity-Based Costing in Service Businesses
(slide 2 of 6)
• Assume that Hopewell Hospital uses activity-based costing
to allocate hospital overhead to patients. Hopewell applies
activity-based costing as follows:
Step 1: Identifying activities.
o Step 2: Determining activity rates for each activity.
o Step 3: Allocating overhead costs to patients based upon activitybase usage.
o
• Hopewell has identified the following activities:
Admission
o Radiological testing
o Operating room
o Pathological testing
o Dietary and laundry
o
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Activity-Based Costing Method—
Hopewell Hospital
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Activity-Based Costing in Service Businesses
(slide 3 of 6)
• Assume that the budgeted costs for radiological testing
are $960,000 and the total estimated activity-base usage
is 3,000 images.
• The activity rate per radiological image is computed as
follows:
Budgeted Activity Cost
Total Activity-Base Usage
Budgeted Radiological Testing Costs
Radiological Testing Activity Rate =
Total Estimated Images
$960, 000
=
= $320 per image
3, 000 images
Activity Rate =
• The activity rates for the other activities are determined
in a similar manner.
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Activity-Based Costing in Service Businesses
(slide 4 of 6)
• These activity rates along with the patient activity-base
usage are used to allocate costs to patients as follows:
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Activity-Based Costing in Service Businesses
(slide 5 of 6)
• Assume that Mia Wilson was a patient of the hospital.
The hospital overhead services (activities) performed for
Mia Wilson were as follows:
Particulars
Patient (Mia Wilson) Activity-Base Usage
Admission
1 admission
Radiological testing
2 images
Operating room
4 hours
Pathological testing
1 specimen
Dietary and laundry
7 days
• Based on the preceding services (activities), the
Hopewell Hospital overhead costs allocated to Mia
Wilson total $2,790, as computed in slide 62.
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Hopewell Hospital Overhead Costs
Allocated to Mia Wilson
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Activity-Based Costing in Service Businesses
(slide 6 of 6)
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Customer Profitability Report—
Hopewell Hospital
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Check Up Corner
Activity-Based Costing for a
Service Business
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Check Up Corner
Activity-Based Costing for a
Service Business Solution
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Analysis for Decision Making
(slide 1 of 4)
• Activity-based costing can be used to improve
the cost of a product.
• Consider Lee Corporation, that assembles LCD
monitors.
• The activity information is shown in slide 70.
o All of the activity cost is related to labor.
o Management is seeking to remove $3.00 of activity
cost from the product in order to remain price
competitive.
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Analysis for Decision Making
(slide 2 of 4)
Activity-Base
Usage
(hours per unit)
×
Activity Rate
per Hour ($)
=
Activity
Cost ($)
Assembly
0.80
×
14
=
11.20
Setup
0.30
×
20
=
6.00
Production control
0.15
×
32
=
4.80
Materials control
0.10
×
32
=
3.20
Moving
0.40
×
12
=
4.80
Testing
0.25
×
24
=
6.00
Activity
Activity cost per unit
$36.00
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Analysis for Decision Making
(slide 3 of 4)
• The activity cost reduction can be accomplished by:
o
Improving operations so that the activity-base usage per
unit is either reduced or eliminated.
o
Changing the classification of employees doing an activity
and thereby decreasing the activity rate.
• Assume the following:
o
The process was improved so that the setup activity
required one-third less time to complete per unit.
o
The moving distance was cut in half.
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Analysis for Decision Making
(slide 4 of 4)
Activity-Base
Usage
(hours per unit)
×
Activity Rate
per Hour ($)
=
Activity
Cost ($)
Assembly
0.80
×
14
=
11.20
Setup
0.20
×
20
=
4.00
Production control
0.15
×
32
=
4.80
Materials control
0.10
×
32
=
3.20
Moving
0.20
×
12
=
2.40
Testing
0.25
×
24
=
6.00
Activity
Activity cost per unit
$36.00
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
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