Chapter 17

ABC Method Steps

1. Identify activities and the overhead costs they cause. 2. Trace overhead costs to activity cost pools. 3. Compute overhead allocation rates for each activity. 4. zudr the activity overhead rates to assign overhead costs to cost objects (products).

Usefulness of Overhead Allocations

1. Overhead costs change --> Allocation Base 2. Overhead costs --> same proportions

Focus on relevance factors

ABC can be used to assign costs to any cost object thats of management interest ABC provides better customer probability information Managers make better pricing decisions on custom orders Managers better manage customers by focusing on those that are most profitable

More effective overhead cost control

ABC can be used to identify activities that an benefit from process improvement Identification of costly processes and activities allow managers to make better production and pricing decisions

Uncertainty with decision Remains

As with all cost information managers must interpret ABC data with caution in making decisions Mangers must examine carefully the controllability of costs before making decisions Some product cost distortion remains

Plantwide Overhead Rate Method

Combines all overhead costs into a single rate, usually based on direct labor hours, machine hours, or direct labor cost. One rate Based on volume-based measures Logical to use to assign overhead costs to products

Disadvantages of ABC

Costs to implement and maintain Some product cost distortion remains Uncertainty with decisions remains

Costs to Implement and Maintain

Designing and implementing and activity-based costing system requires management commitment and financial resources A thorough analysis of cost activities must be performed and appropriate cost pools must be determined. The collection and analysis of cost data is expensive Managers must weigh the costs of an ABC system against the potential benefits.

Total Unit Cost Equation

Direct Material Cost per Unit + Direct Labor Cost per Unit + Overhead Cost per Unit

Product Costs Include

Direct Materials Direct Labor Overhead (Not directly related to product costs)

Activity Based Costing Method

Links overhead costs to activities and assigns overhead based on how much of each activity is required for a product. At least two (but often many) rates Based on activities that drive costs

Advantages of ABC

More effective overhead cost control Better production and pricing decisions Additional uses - Allocate S & A costs expensed by GAAP to activities and determine probability of various market segments or customers

Departmental Overhead Rate Method

Multiple departmental overhead rates that include overhead costs traceable to departments. 2+ rates

Cost pool activity rate equation

Overhead costs assigned to pool/ expected activity level

Product - Level Activities

Performed on each product line are not affected by either the numbers of units or batches Cost do not vary with the number of units or batches produced

Unit-Level Activities

Performed on each product unit Cost tend to change with the number of units produced

Batch-Level activities

Performed only on each batch or group of units Costs do not vary with the number of units but instead with the number of batches

Facility - Level Activities

Performed to sustain facility capacity as a whole and are not caused by any specific product Cost s do not vary with what s manufactured how many batches are produced, or the output quantity

Overhead Applied Equation

Plantwide Overhead Rate x Actual Machine-Hours

Overhead Allocated to Each Product Unit Equation

Plantwide Overhead Rate x Usage of Allocation Base

Advantages of Plantwide Overhead and Departmental Overhead Rate Methods

Reliance on readily available information Ease of Implementation In conformity with GAAP

Allocate Overhead Costs to Products Using the Departmental Overhead Rate Method

Step 1: Assign Overhead Costs to departmental cost pools Step 2: Select an allocation base for each department Step 3: Compute overhead allocation rates for each department Step 4: Use departmental overhead rates to assign overhead costs to cost objects (products).

Disadvantages of Plantwide Overhead and Departmental Overhead Rate Methods

Too complex to be explained by one factor Can distort product costs

Plantwide Overhead Rate Equation

Total Budgeted Overhead Cost/Total Budgeted Amount of Chosen Allocation Base

Departmental Overhead Rate Equation:

Total budgeted departmental overhead costs/ Total amount of departmental allocation base

4 Types of activities that cause overhead costs

Unit Batch Product Facility

The departmental overhead rate method _____________ to accurately assign overhead costs that are not driven by production volume.

fails

The departmental overhead rate method is __________ refined than the plantwide overhead rate method.

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