Chapter 11

1. Chapter 11 These slides should be viewed using the presentation mode (left click your mouse on the icon). Cost Allocation and Activity-Based Costing Principles of Managerial Accounting 11e Student Version Prepared by: C. Douglas Cloud Professor Emeritus of Accounting Pepperdine University Reeve Warren Duchac

2. Learning Objective 1 Identify three methods used for allocating factory overhead costs to products.

3. LO 1 0 Product Costing Allocation Methods Most companies have accounting systems that trace revenues to individual product lines. In addition, they need to subtract the cost of manufacturing their products from revenues in order to determine the profit from sales. Determining the cost of a product is termed product costing.

4. LO 1 Product Costing Allocation Methods • Three methods of allocating factory overhead costs are: • Single plantwide factory overhead rate method • Multiple production department factory overhead rate method • Activity-based costing method

5. 0 Learning Objective 2 Use a single plantwide factory overhead rate for product costing.

6. LO 2 0 Single Plantwide Factory Overhead Rate Method • Under the single plantwide factoryoverhead rate method, all of the factory overhead is allocated to all products using only one rate.

7. LO 2 0 Ruiz Company Illustration Ruiz Company Ruiz Company Illustration Ruiz Company manufactures two products, snowmobiles and riding mowers. Both products are manufactured in a single factory. There is $1,600,000 of factory overhead budgeted for the period.

8. LO 2 0 Ruiz Company Illustration Ruiz Company Each product is budgeted 10,000 direct labor hours as shown below:

9. Total Budgeted Factory Overhead Costs Total Budgeted Plantwide Allocation Base $80 per direct labor hour = $1,600,000 20,000 direct labor hours (1,000 × 10 dlh) + (1,000 × 10 dlh) LO 2 0 Ruiz Company Illustration Ruiz Company The plantwide rate is calculated as follows:

10. LO 2 0 Ruiz Company Illustration Ruiz Company Snowmobile: $80 per dlh × 10 direct labor hours = $800 Riding Mower: $80 per dlh × 10 direct labor hours = $800 Factory Overhead Cost per Unit

11. 0 Learning Objective 3 Use multiple production department factory overhead rates for product costing.

12. Multiple Production Department Factory Overhead Rate Method 0 LO 3 • Themultiple production department factoryoverhead rate methoduses different rates for each production department to allocate factory overhead costs to products.

13. $1,030,000 10,000 direct labor hours = $103 per dlh Assembly Department Factory Overhead Rate: $570,000 10,000 direct labor hours = $57 per dlh Department Overhead Rates and Allocation LO 3 0 Ruiz Company Fabrication Department Factory Overhead Rate:

14. Department Overhead Rates and Allocation LO 3 0 Ruiz Company

15. 0 Learning Objective 4 Use activity-based costing for product costing.

16. LO 4 0 Activity-Based Costing Method • The activity-based costing method provides an alternative approach for allocating factory overhead that uses multiple factory overhead rates based on different activities. • Activities are the types of work, or actions, involved in a manufacturing or service process.

17. LO 4 0 Activity-Based Costing Method Ruiz Company Budgeted Activity Cost Cutting metal to shape the product Activity Manually assembling machined pieces Fabrication $ 530,000 Assembly 70,000 Setup 480,000 Quality-control inspections 312,000 Engineering changes 208,000 Total budgeted activity costs $1,600,000 Changing tooling in machines in preparation for making a new product Inspecting the product for conformity to specifications An engineering change order (ECO) initiates changing a product or process.

18. Budgeted Activity Cost Total Activity Base Usage Activity Rate = LO 4 0 Activity Rates and Allocation • The budgeted activity costs are assigned to products using factory overhead rates for each activity. These rates are called activity rates because they are related to activities. • The term activity base, rather than allocation base, is used because the base is related to an activity.

19. LO 4 0 Activity-Based Costing Method Ruiz Company

20. LO 4 Activity-Based Costing Method Ruiz Company

21. LO 4 0 Activity-Based Costing Method Ruiz Company

22. LO 4 Activity-Based Costing Method Ruiz Company

23. LO 4 0 Activity-Based Costing Method Ruiz Company

24. LO 4 Distortion of Product Costs Ruiz Company If Ruiz Company used the $800 factory overhead cost allocation (single plantwide rate) instead of activity-based costing, the following would likely result: • The snowmobile would be underpriced because its factory overhead cost is understated by $494 ($1,294 – $800). • The riding mower would be overpriced because its factory overhead cost is overstated by $494 ($800 – $306).

25. 0 Learning Objective 5 Use activity-based costing to allocate selling and administrative expenses to products.

26. Warranty Claim Activity Rate $150,000 100 claims = Warranty Claim Activity Rate = $1,500 per claim Activity-Based Costing for Selling and Administrative Expenses 0 LO 5 Budgeted Warranty Claim Expenses Warranty Claim Activity Rate = Estimated Warranty Claims

27. Activity-Based Costing for Selling and Administrative Expenses LO 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: $15,000 = 10 warranty claims x $1,500 per warranty claim Facto: $135,000 = 90 warranty claims x $1,500 per warranty claim

28. 0 Learning Objective 6 Use activity-based costing in a service business.

29. Activity-Based Costing in Service Businesses 0 LO 6 Hopewell Hospital Hopewell Hospital uses an activity-based costing system to determine how hospital overhead is allocated to patients.

30. Budgeted Activity Cost Total Activity Base Usage Activity Rate = Radiological Testing Activity Rate $960,000 3,000 images = Activity-Based Costing in Service Businesses LO 6 Hopewell Hospital The budgeted costs for radiological testing are $96,000, based on total estimated activity-base usage of 3,000 images. =$320 per image

31. Activity-Based Costing in Service Businesses LO 6 Hopewell Hospital

32. Activity-Based Costing in Service Businesses 6 0 LO 6 Hopewell Hospital

33. Cost Allocation and Activity-Based Costing The End