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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 New Mexico State University. - PowerPoint PPT Presentation
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16-16-11Copyright Houghton Mifflin Company. All rights reserved.
Chapter 16Chapter 16Operating Costs andOperating Costs and
Cost Allocation, Including Cost Allocation, Including Activity-Based CostingActivity-Based Costing
Belverd E. Needles, Jr.Belverd E. Needles, Jr.
Marian PowersMarian Powers
Sherry K. MillsSherry K. Mills
Henry R. AndersonHenry R. Anderson- - - - - - - - - - -- - - - - - - - - - -
Multimedia Slides by:Multimedia Slides by:
Dr. Paul J. RobertsonDr. Paul J. RobertsonNew Mexico State UniversityNew Mexico State University
Steve LeaskSteve LeaskNew Mexico State UniversityNew Mexico State University
16-16-22Copyright Houghton Mifflin Company. All rights reserved.
The Management CycleThe Management Cycle
OBJECTIVE 2OBJECTIVE 2
Define and give examples of the Define and give examples of the
three elements of product cost and three elements of product cost and
compute a product’s unit cost for compute a product’s unit cost for
a manufacturing organization.a manufacturing organization.
16-16-33Copyright Houghton Mifflin Company. All rights reserved.
Elements of Product CostsElements of Product Costs» There are three types of manufacturing There are three types of manufacturing
costs.costs.
1. Direct materials can be conveniently and 1. Direct materials can be conveniently and economically traced to specific units of product.economically traced to specific units of product.
2. Direct labor can be conveniently and 2. Direct labor can be conveniently and economically traced to specific units of product.economically traced to specific units of product.
3. Manufacturing overhead includes all 3. Manufacturing overhead includes all manufacturing costs that are not direct materials manufacturing costs that are not direct materials or direct labor costs.or direct labor costs.
16-16-44Copyright Houghton Mifflin Company. All rights reserved.
Manufacturing OverheadManufacturing Overhead» The following are examples of The following are examples of
manufacturing overhead:manufacturing overhead:
Indirect materials.Indirect materials.
Indirect labor.Indirect labor.
Depreciation associated with Depreciation associated with manufacturing operations.manufacturing operations.
Machinery and tool maintenance.Machinery and tool maintenance.
16-16-55Copyright Houghton Mifflin Company. All rights reserved.
Product Unit CostProduct Unit Cost
» A product’s unit cost equals:A product’s unit cost equals:
Total Direct Materials + Direct Labor +
Manufacturing Overhead for Units Produced
Total Units Produced
16-16-66Copyright Houghton Mifflin Company. All rights reserved.
Summary of the Use of ActualSummary of the Use of Actual or Estimated Costs in or Estimated Costs in
Three Cost-Measurement MethodsThree Cost-Measurement Methods
Product CostElements
ActualCosting
NormalCosting
StandardCosting
Directmaterials
Actualcosts
Actualcosts
Estimatedcosts
Direct labor Actualcosts
Actualcosts
Manufacturingoverhead
Actualcosts
Estimatedcosts
Estimatedcosts
Estimatedcosts
16-16-77Copyright Houghton Mifflin Company. All rights reserved.
Manufacturing Manufacturing Inventory AccountsInventory Accounts
OBJECTIVE 3OBJECTIVE 3
Describe the flow of product-related Describe the flow of product-related
activities, documents, and costs activities, documents, and costs
through the Materials Inventory, through the Materials Inventory,
Work in Process Inventory, and Work in Process Inventory, and
Finished Goods Inventory accounts.Finished Goods Inventory accounts.
16-16-88Copyright Houghton Mifflin Company. All rights reserved.
Product-Related ActivitiesProduct-Related Activities
» The flow of product-related activities The flow of product-related activities relates to:relates to:
1.1. Bringing materials into the organization.Bringing materials into the organization.
2.2. Converting raw materials into a finished Converting raw materials into a finished product.product.
3.3. Transferring completed products to Transferring completed products to finished goods storage.finished goods storage.
16-16-99Copyright Houghton Mifflin Company. All rights reserved.
Manufacturing Cost Flow:Manufacturing Cost Flow:An ExampleAn Example
Direct MaterialsInventory Account
Balance 1/1/00: Used during$10,000 2000:
Total direct $25,000materialspurchasedduring 2000:
20,000
Balance12/31/00:
$ 5,000
Work in ProcessInventory Account
Balance 1/1/00: Completed $ 2,000 during 2000:
$30,000Direct materialsused during 2000:
25,000Direct labor 2000:
12,000Manufacturingoverhead 2000:
6,000
Balance 12/31/00$ 15,000
16-16-1010Copyright Houghton Mifflin Company. All rights reserved.
Manufacturing Cost Flow:Manufacturing Cost Flow:An ExampleAn Example
Factory PayrollAccount
Direct labor 2000:earned during $12,0002000:
$12,000
Balance12/31/00:
$ 0
Work in ProcessInventory Account
Balance 1/1/00: Completed $ 2,000 during 2000:
$30,000Direct materialsused during 2000:
25,000Direct labor 2000:
12,000Manufacturingoverhead 2000:
6,000
Balance 12/31/00$ 15,000
16-16-1111Copyright Houghton Mifflin Company. All rights reserved.
Manufacturing Cost Flow:Manufacturing Cost Flow:An ExampleAn Example
Manufacturing OverheadControl Account
Total 2000:manufacturing $ 6,000overheadincurred during2000:
$ 6,000
Balance12/31/00:
$ 0
Work in ProcessInventory Account
Balance 1/1/00: Completed $ 2,000 during 2000:
$30,000Direct materialsused during 2000:
25,000Direct labor 2000:
12,000Manufacturingoverhead 2000:
6,000
Balance 12/31/00$ 15,000
16-16-1212Copyright Houghton Mifflin Company. All rights reserved.
Manufacturing Cost Flow:Manufacturing Cost Flow:An ExampleAn Example
Work in ProcessInventory Account
Balance 1/1/00: Completed $ 2,000 during 2000:
$30,000Direct materialsused during 2000:
25,000Direct labor 2000:
12,000Manufacturingoverhead 2000:
6,000
Balance 12/31/00$ 15,000
Finished GoodsInventory Account
Balance 1/1/00: Sold during 2000:$ 6,000 $24,000
Completedduring 2000:
30,000
Balance12/31/00:
$12,000
16-16-1313Copyright Houghton Mifflin Company. All rights reserved.
Manufacturing Cost Flow:Manufacturing Cost Flow:An ExampleAn Example
Finished GoodsInventory Account
Balance 1/1/00: Sold during 2000:$ 6,000 $24,000
Completedduring 2000:
30,000
Balance12/31/00:
$12,000
Cost of Good SoldAccount
Sold during 2000:
$24,000
16-16-1414Copyright Houghton Mifflin Company. All rights reserved.
Manufacturing and ReportingManufacturing and Reporting
OBJECTIVE 4OBJECTIVE 4
Prepare a statement of cost of Prepare a statement of cost of
goods manufactured and an goods manufactured and an
income statement for a income statement for a
manufacturing organization.manufacturing organization.
16-16-1515Copyright Houghton Mifflin Company. All rights reserved.
Statement of Statement of Cost of Goods Manufactured: Step 1Cost of Goods Manufactured: Step 1
Angelo’s Rolling Suitcases, Inc. Statement of Cost of Goods ManufacturedFor 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
16-16-1616Copyright Houghton Mifflin Company. All rights reserved.
Statement of Statement of Cost of Goods Manufactured: Step 2Cost of Goods Manufactured: Step 2
Angelo’s Rolling Suitcases, Inc. Statement of Cost of Goods ManufacturedFor 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
16-16-1717Copyright Houghton Mifflin Company. All rights reserved.
Statement of Statement of Cost of Goods Manufactured: Step 3Cost of Goods Manufactured: Step 3
Angelo’s Rolling Suitcases, Inc. Statement of Cost of Goods ManufacturedFor 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
16-16-1818Copyright Houghton Mifflin Company. All rights reserved.
Income StatementIncome StatementAngelo’s Rolling Suitcases, Inc.
Income StatementFor 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 24,000Gross Margin $26,000Selling & Administrative Expenses 16,000Net Income $10,000
16-16-1919Copyright Houghton Mifflin Company. All rights reserved.
Cost AllocationCost Allocation
OBJECTIVE 5OBJECTIVE 5
Define Define cost allocationcost allocation and explain and explain
the process of manufacturing the process of manufacturing
overhead allocation using cost overhead allocation using cost
objects, cost pools, and cost objects, cost pools, and cost
drivers.drivers.
16-16-2020Copyright Houghton Mifflin Company. All rights reserved.
Cost AllocationCost Allocation
» A cost object is a: A cost object is a:
productproduct
processprocess
departmentdepartment
activityactivity
that the organization wishes to cost.that the organization wishes to cost.
16-16-2121Copyright Houghton Mifflin Company. All rights reserved.
Cost AllocationCost Allocation
» Cost allocation is the process of Cost allocation is the process of
assigning pooled indirect costs to assigning pooled indirect costs to
specific cost objects using an specific cost objects using an
allocation base that represents a allocation base that represents a
major function of a business.major function of a business.
16-16-2222Copyright Houghton Mifflin Company. All rights reserved.
Allocation of Allocation of Manufacturing OverheadManufacturing Overhead
The pooling of manufacturing The pooling of manufacturing
overhead costs that are affected by a overhead costs that are affected by a
common activity.common activity.
The selection of a cost driver whose The selection of a cost driver whose
activity level causes a change in the activity level causes a change in the
cost pool.cost pool.
» The allocation of manufacturing The allocation of manufacturing overhead requires the following:overhead requires the following:
16-16-2323Copyright Houghton Mifflin Company. All rights reserved.
Cost AllocationCost Allocation
» A cost pool is a pool of overhead A cost pool is a pool of overhead costs related to a cost object.costs related to a cost object.
» A cost driver is an activity that A cost driver is an activity that causes the cost pool to increase in causes the cost pool to increase in amount as the cost driver increases.amount as the cost driver increases.
16-16-2424Copyright Houghton Mifflin Company. All rights reserved.
Manufacturing Overhead Manufacturing Overhead Allocation Using the Allocation Using the Traditional ApproachTraditional Approach
OBJECTIVE 6OBJECTIVE 6
Calculate product unit cost using Calculate product unit cost using
the traditional allocation of the traditional allocation of
manufacturing overhead costs.manufacturing overhead costs.
16-16-2525Copyright Houghton Mifflin Company. All rights reserved.
Predetermined Overhead RatePredetermined Overhead Rate» The use of one predetermined The use of one predetermined
overhead rate to apply manufacturing overhead rate to apply manufacturing overhead to a product is appropriate overhead to a product is appropriate if organizations:if organizations:
1.1. Manufacture only one product, orManufacture only one product, or
2.2. Manufacture a few very similar products Manufacture a few very similar products that require the same production that require the same production processes and production-related processes and production-related activities.activities.
16-16-2626Copyright Houghton Mifflin Company. All rights reserved.
Traditional Activity BasesTraditional Activity Bases
» Traditional activity bases are Traditional activity bases are volume-related bases such as:volume-related bases such as:
Direct labor hours.Direct labor hours.
Direct labor costs.Direct labor costs.
Machine hours.Machine hours.
Units of production.Units of production.
16-16-2727Copyright Houghton Mifflin Company. All rights reserved.
Assignment of Manufacturing Assignment of Manufacturing Overhead Costs:Overhead Costs:
Traditional ApproachTraditional Approach
= $5 per Direct Labor Hour
Predetermined Overhead Rate =
$200,000
40,000 DirectLabor Hours
Step 1: Calculate the predetermined overhead rate.
16-16-2828Copyright Houghton Mifflin Company. All rights reserved.
Assignment of Manufacturing Assignment of Manufacturing Overhead Costs:Overhead Costs:
Traditional ApproachTraditional ApproachStep 2: Apply manufacturing overhead costs to production.
Regular
Cost Driver Level Cost Applied
Overhead costs applied:
Manufacturing overhead:$5 per DLH
X 25,000 DLH $125,000
10,000Number of units
$ 12.50Manufacturing overheadcost per unit
16-16-2929Copyright Houghton Mifflin Company. All rights reserved.
Assignment of Manufacturing Assignment of Manufacturing Overhead Costs:Overhead Costs:
Traditional ApproachTraditional ApproachStep 2: Apply manufacturing overhead costs to production.
Deluxe
Cost Driver Level Cost Applied
Overhead costs applied:
Manufacturing overhead:$5 per DLH
X 15,000 DLH $ 75,000
5,000Number of units
$ 15.00Manufacturing overheadcost per unit
16-16-3030Copyright Houghton Mifflin Company. All rights reserved.
Product Unit Cost:Product Unit Cost: Traditional Approach Traditional Approach
Step 3: Product Unit Cost
RegularRolling Suitcase
DeluxeRolling 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
16-16-3131Copyright Houghton Mifflin Company. All rights reserved.
Activity-Based CostingActivity-Based Costing
OBJECTIVE 7OBJECTIVE 7
Define and explain Define and explain
activity-based costing.activity-based costing.
16-16-3232Copyright Houghton Mifflin Company. All rights reserved.
Product Costing SystemsProduct Costing Systems» Increased competition from foreign Increased competition from foreign
companies identified a weakness in companies identified a weakness in the product costing systems of many the product costing systems of many U.S. organizations.U.S. organizations.
Product costing systems did not Product costing systems did not accurately assign manufacturing accurately assign manufacturing overhead costs to product lines.overhead costs to product lines.
These inaccurate product unit costs led These inaccurate product unit costs led to poor decisions and lost market share.to poor decisions and lost market share.
16-16-3333Copyright Houghton Mifflin Company. All rights reserved.
Activity-Based Costing Activity-Based Costing (ABC)(ABC)
» In the search for more accurate In the search for more accurate
product costing, many organizations product costing, many organizations
embraced activity-based costing.embraced activity-based costing.
16-16-3434Copyright Houghton Mifflin Company. All rights reserved.
ABC Cost AssignmentABC Cost Assignment» ABC is an approach to cost ABC is an approach to cost
assignment that:assignment that:
Categorizes all indirect costs by Categorizes all indirect costs by identifying activity cost pools.identifying activity cost pools.
Traces costs to those activity pools.Traces costs to those activity pools.
Assigns activity costs to products Assigns activity costs to products using a cost driver that is related to the using a cost driver that is related to the cause of the cost.cause of the cost.
16-16-3535Copyright Houghton Mifflin Company. All rights reserved.
Activity-Based CostingActivity-Based Costing» ABC is particularly useful for ABC is particularly useful for
organizations that have:organizations that have:
Product diversity.Product diversity.
Products that vary in the amounts of Products that vary in the amounts of
production-related activities or production-related activities or
complexity required in their complexity required in their
manufacture, store, move, package, or manufacture, store, move, package, or
ship.ship.
16-16-3636Copyright Houghton Mifflin Company. All rights reserved.
Manufacturing Overhead Manufacturing Overhead Allocation Using ABCAllocation Using ABC
OBJECTIVE 8OBJECTIVE 8
Calculate product unit cost using Calculate product unit cost using
activity-based costing to assign activity-based costing to assign
manufacturing overhead costs.manufacturing overhead costs.
16-16-3737Copyright Houghton Mifflin Company. All rights reserved.
ABC ApproachABC Approach
» When ABC is used, manufacturing When ABC is used, manufacturing
costs are grouped into smaller costs are grouped into smaller
activity cost pools.activity cost pools.
16-16-3838Copyright Houghton Mifflin Company. All rights reserved.
ABC ApproachABC Approach» Costs from activity cost pools are assigned Costs from activity cost pools are assigned
to cost objects using cost drivers.to cost objects using cost drivers.
Cost drivers are identified and cost driver Cost drivers are identified and cost driver levels are estimated for each cost pool.levels are estimated for each cost pool.
Each cost pool rate is calculated by Each cost pool rate is calculated by dividing the estimated cost amount by the dividing the estimated cost amount by the cost driver level.cost driver level.
Manufacturing overhead is applied to the Manufacturing overhead is applied to the product’s cost by multiplying the cost pool product’s cost by multiplying the cost pool rate by the actual cost driver amount.rate by the actual cost driver amount.
16-16-3939Copyright Houghton Mifflin Company. All rights reserved.
ABC SystemsABC Systems» ABC systems assign costs to cost ABC systems assign costs to cost
objects based on each cost object’s objects based on each cost object’s consumption of activities.consumption of activities.
» The total applied manufacturing The total applied manufacturing overhead cost is added to the cost of overhead cost is added to the cost of direct materials and direct labor to direct materials and direct labor to determine the total product cost.determine the total product cost.
» The product unit cost is the total The product unit cost is the total product cost divided by the total units product cost divided by the total units produced.produced.
16-16-4040Copyright Houghton Mifflin Company. All rights reserved.
ABC Costing SystemsABC Costing Systems» Problems with product costs Problems with product costs
produced by traditional volume-produced by traditional volume-based costing systems include:based costing systems include:
Traditional volume-based system, low-Traditional volume-based system, low-volume products are undercosted and volume products are undercosted and high-volume products are overcosted.high-volume products are overcosted.
Organizations face greater risk of Organizations face greater risk of making poor decisions when significant making poor decisions when significant product cost distortions exist.product cost distortions exist.
16-16-4141Copyright Houghton Mifflin Company. All rights reserved.
Cost Driver LevelCost Driver Level
Estimated Cost Driver Level
Cost Driver Regular Deluxe Total
Number of setups 300 400 700
Number of inspections 150 350 500
Packaging hours 600 1,400 2,000
Machine hours 4,000 6,000 10,000
16-16-4242Copyright Houghton Mifflin Company. All rights reserved.
Using ABC to Allocate Using ABC to Allocate Manufacturing Overhead Cost to Manufacturing Overhead Cost to
ProductionProduction
Setup$70,000
Inspection$60,000
Packaging$50,000
Building$20,000
Regular Deluxe