BUSI-033 - Sections 1 (PPT)
The Activity Base (Cost Driver)
A measure of what causes the incurrence of a variable cost - Units produced Machine hours Miles driven Labor hours
Suppose that your car could be sold now for $5,000. Is this a sunk cost? A. Yes, it is a sunk cost. B. No, it is not a sunk cost.
A. Yes, it is a sunk cost.
Suppose you are trying to decide whether to drive or take the train to Portland to attend a concert. You have ample cash to do either, but you don't want to waste money needlessly. Is the cost of the train ticket relevant in this decision? In other words, should the cost of the train ticket affect the decision of whether you drive or take the train to Portland? A. Yes, the cost of the train ticket is relevant. B. No, the cost of the train ticket is not relevant
A. Yes, the cost of the train ticket is relevant.
Traditional cost systems rely exclusively on allocation bases that are driven by the volume of production.
ABC defines five levels of activity that largely do not relate to the volume of units produced.
Chapter 7
Activity-Based Costing: A Tool to Aid Decision Making
Suppose you are trying to decide whether to drive or take the train to Portland to attend a concert. You have ample cash to do either, but you don't want to waste money needlessly. Is the annual cost of licensing your car relevant in this decision? A. Yes, the licensing cost is relevant. B. No, the licensing cost is not relevant.
B. No, the licensing cost is not relevant.
Cost Classifications for Predicting Cost Behavior *** commit this to memory
Behavior of Cost (within the relevant range) Cost - In Total Variable - Total variable cost increase and decrease in proportion to changes in the activity level. Cost - Per Unit Variable cost per unit remains constant Cost - In Total Fixed - Total fixed cost is not affected by chanages in the activity level within the relevant range. Cost - Per Unit Fixed cost per unit decreases as the activity level rises and increases as the activity level falls.
Examples of companies that would use job-order costing include:
Boeing (aircraft manufacturing) Bechtel International (large scale construction) Walt Disney Studios (movie production
Similarities Between Job-Order and Process Costing
Both systems assign material, labor, and overhead costs to products and they provide a mechanism for computing unit product costs. Both systems use the same manufacturing accounts, including Manufacturing Overhead, Raw Materials, Work in Process, and Finished Goods. The flow of costs through the manufacturing accounts is basically the same in both systems.
Which of the following costs would be variable with respect to the number of cones sold at a Baskins & Robbins shop? (There may be more than one correct answer.) A. The cost of lighting the store. B. The wages of the store manager. C. The cost of ice cream. D. The cost of napkins for customers.
C. The cost of ice cream. and D. The cost of napkins for customers.
Let's assume that PearCo incurred actual overhead of $650,000 during the period and worked a total of 170,000 direct labor hours. PearCo applies overhead at the rate of $4 per direct labor hour worked. How much overhead did PearCo apply to jobs during the period? PearCo would have applied $680,000 of overhead during the period. That is $4 per direct labor hour times the 170,000 direct labor hours actually worked.
Can you see our problem? Yes, the estimated POHR was greater that the actual overhead. We will have to apply the amount to COGS for a reduction
Job-Order Costing - An Example
Charge direct material and direct labor costs to each job as work is performed. Manufacturing Overhead, including indirect materials and indirect labor, are allocated to all jobs rather than directly traced to each job.
Types of Fixed Costs
Committed - Long-term, cannot be significantly reduced in the short term. Discretionary - May be altered in the short-term by current managerial decisions. Examples - Depreciation on Buildings and Equipment and Real Estate Taxes Examples - Advertising and Research and Development
Cost Classifications for Predicting Cost Behavior
Cost behavior refers to how a cost will react to changes in the level of activity. The most common classifications are: Variable costs. Fixed costs Mixed costs.
Differential Cost and Revenue
Costs and revenues that differ among alternatives. Example: You have a job paying $2,500 per month in your hometown. You have a job offer in a neighboring city that pays $3,000 per month. The commuting cost to the city is $300 per month. Your rent is $800 per month.
Direct materials used in production totaled $280,000. Direct labor was $375,000, and $180,000 of manufacturing overhead was added to production for the month. What were total manufacturing costs incurred for the month? $555,000 $835,000 $655,000 Cannot be determined.
DM = $280,00 DL = $375,000 MOH = $180,00 total manufacturing costs = $835,00
Classifications of Manufacturing Costs
Direct Materials Direct Labor Manufacturing Overhead
Assigning Costs to Cost Objects
Direct costs - Costs that can be easily and conveniently traced to a unit of product or other cost object. Examples: direct material and direct labor Indirect costs - Costs that cannot be easily and conveniently traced to a unit of product or other cost object. Example: manufacturing overhead
Cost Classifications for Decision Making
Every decision involves a choice between at least two alternatives. Only those costs and benefits that differ between alternatives are relevant in a decision. All other costs and benefits can and should be ignored as irrelevant.
Fixed Costs and the Relevant Range
For example, assume office space is available at a rental rate of $30,000 per year in increments of 1,000 square feet. Fixed costs would increase in a step fashion at a rate of $30,000 for each additional 1,000 square feet.
Job Order Costing vs. Process Costing
In order to figure out how much their product costs to produce, firms may use either job order or process costing. Which method is appropriate depends on the type of product that is being produced.
ABC vs. traditional job order costing
Indirect costs are accumulated into "buckets" An allocation base related to the indirect cost is picked and used to apply overhead to products for each activity. The terminology is different ("activity rate" instead of "predetermined overhead rate"), and the buckets are based on activities instead of departments, but we're doing exactly the same thing. The other main difference is that there are many activity rates rather than one or two predetermined overhead rates.
Chapter 3
Job-Order Costing
Job-Order Costing: An Overview
Job-order costing systems are used when: Many different products are produced each period. Products are manufactured to order. The unique nature of each order requires tracing or allocating costs to each job, and maintaining cost records for each job.
Manufacturing Overhead
Manufacturing costs that cannot be easily traced directly to specific units produced Examples: Indirect materials and indirect labor
Indirect materials
Materials used to support the production process. Examples: lubricants and cleaning supplies used in the automobile assembly plant.
The second major difference between ABC and traditional cost accounting is that some manufacturing costs may be excluded from product costs. This is because ABC only assigns a cost to a product if decisions concerning that product will cause changes in the cost. ABC excludes two types of costs from product costs:
Organization-sustaining costs (which will be formally defined later); and The costs of unused or idle capacity.
Overhead Application Rate
PearCo estimates that it will require 160,000 direct labor-hours to meet the coming period's estimated production level. In addition, the company estimates total fixed manufacturing overhead at $200,000, and variable manufacturing overhead costs of $2.75 per direct labor hour. Y = a + bX Y = $200,000 + ($2.75 per direct labor-hour × 160,000 direct labor-hours) Y = $200,000 + $440,000 Y = $640,000 POHR = 640,000/160,000 =$4.00
Differences Between Job-Order and Process Costing
Process costing: Is used when a single product is produced on a continuing basis or for a long period of time. Job-order costing is used when many different jobs having different production requirements are worked on each period. Systems accumulate costs by department. Job-order costing systems accumulated costs by individual jobs. Systems compute unit costs by department. Job-order costing systems compute unit costs by job on the job cost sheet.
Direct Materials (DM)
Raw materials that become an integral part of the product and that can be traced directly to it on a cost effective basis. Example: A radio installed in an automobile
Job Order Costing
Recall that an employee worked a total of 8 hours on Job A-143. Our predetermined overhead rate is $4 per direct labor-hour, so we will apply $32 (8 hours times $4 per direct labor-hour) of overhead to this job. The computation is shown in the manufacturing overhead section of the job cost sheet and in the summary section.
Nonmanufacturing Costs
Selling Costs - Costs necessary to secure the order and deliver the product. Administrative Costs - All executive, organizational, and clerical costs.
Sunk Costs
Sunk costs have already been incurred and cannot be changed now or in the future. These costs should be ignored when making decisions. Example: Suppose you had purchased gold for $400 an ounce, but now it is selling for $250 an ounce. Should you wait for the gold to reach $400 an ounce before selling it?
There are three reasons why the reported product margins for the two costing systems differ from one another.
The first reason is that the traditional cost system allocates all manufacturing overhead to products. The ABC system only assigns manufacturing overhead costs consumed by products to those products. More specifically, the ABC system does not assign the manufacturing overhead costs consumed by the customer relations activity to products because these costs are caused by customers, not specific products. The ABC system does not assign the manufacturing overhead costs included in the "other" activity to products because these organization-sustaining and unused capacity costs are not caused by products.
Opportunity Cost
The potential benefit that is given up when one alternative is selected over another. Example: What would you be doing if you weren't going to school? What is your total cost to go to school at Pacific?
Manufacturing Overhead Application
The predetermined overhead rate (POHR) used to apply overhead to jobs is determined before the period begins. POHR = Estimated total manufacturing overhead cost for the coming period ----------------------------------------------------------------------------- Estimated total units in the allocation base for the coming period
Computing Predetermined Overhead Rates
The predetermined overhead rate is computed before the period begins using a four-step process. Estimate the total amount of the allocation base (the denominator) that will be required for next period's estimated level of production. Estimate the total fixed manufacturing overhead cost for the coming period and the variable manufacturing overhead cost per unit of the allocation base. Use the following equation to estimate the total amount of manufacturing overhead: Compute the predetermined overhead rate.
Compute the total cost and average cost per unit of a job.
The total direct material, direct labor, and manufacturing overhead costs assigned to Job A-143 is $236. Since this particular job included 2 units of production, the average cost per unit is $118. We calculated the average cost by dividing the total cost of $236 by the 2 crates produced. The average unit cost should not be interpreted as the costs that would actually be incurred if another unit was produced. The fixed overhead would not change if another unit were produced, so the incremental cost of another unit is something less than $118.
An activity measure is an allocation base in an activity-based costing system. The term cost driver is also used to refer to an activity measure.
The two most common types of activity measures are: Two types of activity measures include: 1. Transaction drivers - simple counts of the number of times that an activity occurs such as the number of bills sent out to customers. 2. Duration drivers — measures of the amount of time needed to perform an activity such as the time spent preparing individual bills for customers.
Job WR53 at NW Fab, Inc. required $200 of direct materials and 10 direct labor hours at $15 per hour. Estimated total overhead for the year was $760,000 and estimated direct labor hours were 20,000. What would be recorded as the cost of job WR53? a. $200. b. $350. c. $380. d. $730.
This problem may take a while to solve, but it will be well worth your time to work it carefully. Remember, we are interested in the total cost of the job. To answer this question, we will need all three elements of product cost at NW Fab, Inc. POHR = 760,000/20,000 = $38 DM = $200 DL = $150 (10x15) MOH = $380 (10x38) total cost of the job = $730
Direct Labor (DL)
Those labor costs that can be easily traced to individual units of product. Example: Wages paid to automobile assembly workers
In an activity-based cost system, companies typically combine their activities into the following five classifications:
Unit-level activities are performed each time a unit is produced. For example, providing power to run processing equipment would be a unit-level activity. Batch-level activities are performed each time a batch is handled or processed, regardless of how many units are in the batch. For example, setting up equipment and shipping customer orders are batch-level activities. Product-level activities relate to specific products and must be carried out regardless of how many batches are run or units are produced or sold. For example, designing or advertising a product would be product-level activities. Customer-level activities relate to specific customers and are not tied to any specific product. For example, sales calls and catalog mailings would be customer-level activities. Organization-sustaining activities are carried out regardless of which customers are served, which products are produced, how many batches are run, or how many units are made. For example, heating a factory and cleaning executive offices are organization-sustaining activities.
The Need for a POHR
Using a predetermined rate makes it possible to estimate total job costs sooner. Actual overhead for the period is not known until the end of the period.
indirect labor
Wages paid to employees who are not directly involved in production work. Examples: maintenance workers, janitors, and security guards.
When should you use ABC instead of "regular" job order costing?
While a single plant wide (or departmental) overhead rate(s) work well for in some situations, other companies find that they don't do a good job estimating product costs. Simple overhead allocations don't tend to work well when there is a lot of variety in the production process between products (one product needs a lot of labor, another uses a lot of machine time) ABC takes the variety into account and allocates indirect costs more accurately.
What effect will the overapplied overhead have on PearCo's net operating income? a. Net operating income will increase. b. Net operating income will be unaffected. c. Net operating income will decrease
a. net operating income will increase ***** review this question*****
Tiger, Inc. had actual manufacturing overhead costs of $1,210,000 and a predetermined overhead rate of $4.00 per machine hour. Tiger, Inc. worked 290,000 machine hours during the period. Tiger's manufacturing overhead is: a. $50,000 overapplied. b. $50,000 underapplied. c. $60,000 overapplied. d. $60,000 underapplied.
actual manufacturing OHC of $1,210,000 est. OHC $1,160,000 (4 x 290,000) $50,000 was under applied Underapplied overhead exists when the amount of overhead applied to jobs during the period using the predetermined overhead rate is less than the total amount of overhead actually incurred during the period.
Beginning finished goods inventory was $130,000. The cost of goods manufactured for the month was $760,000. And the ending finished goods inventory was $150,000. What was the cost of goods sold for the month? $ 20,000 $740,000 $780,000 $760,000
beg inv. 130,000 COG manufact. = 760,00 total = 890,000 minus end. goods manufact = 150,000 total of COGS = $740,000
Beginning raw materials inventory was $32,000. During the month, $276,000 of raw material was purchased. A count at the end of the month revealed that $28,000 of raw material was still present. What is the cost of direct material used?
beg. Inv = $32,000 purch inv. $276,000 amount available = $308,00 - end. Inv. = $28,000 Cost of Direct material used = $280,000
Beginning work in process was $125,000. Manufacturing costs added to production for the month were $835,000. There were $200,000 of partially finished goods remaining in work in process inventory at the end of the month. What was the cost of goods manufactured during the month? $1,160,000 $ 910,000 $ 760,000 Cannot be determined.
beg. WIP = $125,000 cost added = $835,000 total = $960,000 minus partially finished goods = $200,000 COG manufactured = $760,00
Finished goods
consist of completed units of product that have not been sold to customers.
Work in process
consists of units of production that are only partially complete and will require further work before they are ready for sale to customers.
Period costs
include all selling costs and administrative costs. examples: Property taxes on corporate headquarters. Sales commissions.
Raw materials
include any materials that go into the final product.
Product costs
include direct materials, direct labor, and manufacturing overhead. examples: Manufacturing equipment depreciation. Direct materials costs. Electrical costs to light the production facility.
Cost of goods manufactured
include the manufacturing costs associated with the goods that were finished during the period
Fixed costs
is a cost that remains constant in total regardless of changes in the level of activity.
Variable costs
varies, in total, in direct proportion to changes in the level of activity. (activity base is a measure of whatever causes the incurrence of a variable cost) activity base is also referred to as a cost driver.
