Activity-Based Costing

If the company does not inventory these by-products and uses the cost reduction method, the entries are as follows. The allocations based on sales values at the split-off point (See Exhibit 6-17) are more acceptable from both the financial reporting and decision perspectives. From the management decision perspective, these results are not useful, but at least they do not support an incorrect decision with regard to product D. To illustrate the advantages of the dual rate or flexible budget method, consider the revised information that appears in Exhibit 6-9. This exhibit shows the same data that appears in Exhibit 6-3 except service costs are separated into fixed and variable elements.

• Internal failure costs include the costs of reworking products, reinspecting reworked products, and scrap.
• Activity-based costing is a more precise way to allocate costs to cost objects.
• Building quality into products by focusing on costs of good quality.
• If machine set up is one of your activity cost pools, the allocation base could be the number of setups that will be done over the year.

Product C would sell for $60 per pound and would require an additional cost of $24 per pound to produce. You have been given the following information about the production of Horatio Co., and are asked to provide the plant manager with information for a meeting the vice president of operations. Which of the following best defines https://business-accounting.net/ a facility-level activity? I.An activity that is performed to support the entire company. Ii.An activity that is performed to support a specific product line. The premise of ABC is that activities are what cause costs to be incurred. Traditional volume-based methods are easier to use and less costly to implement and maintain.

Examples of Overhead Rates

The mass production of similar products in a conti… The first production department of Stone Incorpora… The choice of both activities and cost drivers might be inappropriate. The same five steps used in manufacturing organizations can also be used in service organizations. To understand how ABC could be used in a service organization.

Some examples that most readers can relate to include allocating the costs of federal, state and local governments to their constituents. Federal and state income taxes are based on the “ability to bear” logic, i.e., they are progressive in that those with higher incomes pay a higher percentage of their incomes than those with lower incomes. Whether either of these tax allocation schemes is also “fair and equitable” is subjective and therefore controversial.

What is true about the plantwide overhead rate?

The bottom shows the overheadcost per unit for each product. This information includes an estimate of the level of activity for each cost driver, which is needed to calculate a predetermined rate for each activity. Identifying cost drivers requires gathering information and interviewing key personnel in various areas of the organization, such as purchasing, production, quality control, and accounting. The idea is that activities are required to produce products—activities such as purchasing materials, setting up machinery, assembling products, and inspecting finished products. ABC systems and traditional systems often result in vastly different product costs. It allocates all of a company’s costs of operations to specific activities that the company carries out.

Resolving this conflict leads back to the previous method, i.e., go one step further and subtract an average profit margin. Of course, this leads back to the controversy discussed above. This approach involves allocating the joint costs to products in proportion to these estimated sales values.

When a plantwide factory overhead rate is used?

Exhibit 17.11 shows how KartCo’s management assigned its overhead costs into the four activity cost pools. To form cost pools we look for costs that are caused by the same activities within each activity level. For KartCo, there is only one activity driver within each activity pool, but that is not always the case.

• Cost allocations are needed to value inventory for external reporting purposes, for planning and monitoring the cost of activities and processes, and for various short term and long term strategic decisions.
• There may appear to be some double counting in the Power and Maintenance Departments, but this a normal result when solving simultaneous equations.
• Examples of volume-related measures include direct labor hours and machine hours.
• Why do joint costs need to be allocated to the products involved?
• Activity-based costing is a system that tallies the costs of overhead activities and assigns those costs to products.
• However, there are some differences in the values that appear in the equations.
• Overhead costs are often affected by many issues and are frequently too complex to be explained by any one factor.

When a firm buys components and raw materials globally, it is called _____. On the income statement, which of the following would be classified as a period cost? On October 1, White Way Stores Inc. is considering leasing a building and purchasing the necessary equipment to operate a retail store.

True or false the cost object of the plantwide overhead rate method is the unit of product

Which stage I cost allocation methods consider reciprocal services? The total producing department costs, after all allocations, is equal to the total direct costs budgeted, i.e., $500,000 (See the note at the bottom of Exhibit 6-4). 1) Develop equations for each department fully recognizing all the reciprocal relationships and self services. The equations for the reciprocal method are also developed from equations and above. However, there are some differences in the values that appear in the equations. First, the service department costs are different because all of the self service and reciprocal relationships are considered in determining these amounts.

Crinkle Cut Clothes Company manufactures two products CC1 and CC2. Current direct material and direct labor costs are detailed below. Next year the company wishes to use a plantwide overhead rate with direct labor hours as its allocation base. The direct labor and direct materials costs are estimated to be consistent with the current year. Direct labor costs $28 per hour and the company expects to manufacture 22,000 units of CC1 and 91,000 units of CC2 next year. Step 4 applies overhead costs to each product using departmental overhead rates. The same procedure is applied for its custom go-kart.

What are the advantages of using a plantwide overhead rate?

It is common to see several different activity drivers within each level of activity pool. We pool only those costs that are related to the same driver. Recall that a premise of ABC is that operations are a series of activities that cause costs to be incurred. Instead of combining costs from different activities the cost object of the plantwide overhead rate method is: into one plant wide pool or multiple departmental pools, ABC focuses on activities as the cost object in the first step of cost assignment. We are then able to trace costs to a cost object and then combine activities that are used by products in similar ways to reduce the number of cost allocations.

• When using the plantwide overhead rate method, total budgeted overhead costs are combined into one overhead cost pool.
• Calculate the rate used by each department to allocate overhead costs.
• In previous posts, we discussed plantwide overhead rates and departmental overhead ratesto allocate overhead costs to cost objects.
• For example, for the purposes related to product costing, (e.g., external reporting, planning and monitoring, pricing) costs are typically allocated to products based on the “cause and effect” logic.

The dual rate or flexible budget method refers to using separate rates, or allocations for fixed and variable service costs. The purpose of this method is to prevent the actual cost allocations to users from being influenced by the quantity of service consumed by other users. Allocating fixed and variable service costs using a single actual rate can result in a variety of cost distortions.

For example, situations arise where a user’s budgeted and actual consumption of a service are the same, but the actual service cost allocation to the user is greater than the budgeted allocation. The allocations for the step-down method are presented in Exhibit 6-5.

If the problem states that there are 15 setups, look at your rates for the one that is marked “$/setup” and use that one. At the beginning of June, Circuit Country has a balance in inventory of $3,000. Assuming that Circuit Country uses a perpetual inventory system, record the transactions. Prepare the top section of the multiple-step income statement through gross profit for the month of June.

2 Approaches to Allocating Overhead Costs

Apply the ABC rates using actual quantity for each activity. Identify the allocation base for each of your activities and estimate the quantity for each allocation base. Now that you have your allocation bases set for each activity, estimate the quantity for each allocation base. Please describe and provide the calculation for the “Percentage of Completion Method” for Long Term Contracts Revenue Recognition.

The unit of product is the cost object when the plant wide overhead rate method is used. The departmental overhead rate method uses a four-step process to allocate cost object. T/F The cost object of the plantwide overhead rate method is the unit of product. The cost flows are the same for an activity-based costing system, with one exception.