Accounting 202 - Exam 2: Ch. 17 Info
1) assumes that different products are similar in volume, complexity, and batch size 2) that departmental OH costs are directly proportional to the department allocation base
2 assumptions of Departmental
total OH cost allocated to each product line ÷ units produced
ABC Overhead cost per unit formula
Departmental is arguably more accurate than plantwide, only because it uses more rates
Is Plantwide or Departmental Rate more accurate?
Because it allocates costs based on measures of volume, it fails to accurately assign many OH costs, such as machine depreciation or utility costs, that are not driven by production volume
Main disadvantage of Departmental?
1) Allocate costs to each department 2) Apply to product based on usage of dept. Rate 1 x units per prod. = OH 1 Rate 2 x units per prod. = + OH 2 = Total OH
Two main stages of Departmental Rate:
Internal and External failure costs
(2 terms) examples of non-value-added costs, refers to the costs of making poor-quality items
Prevention and Appraisal Costs
(2 terms) examples of value-added costs, purpose is to reduce the chance the customer is provided a defective good or service
Activity cost pool
(term) a collection of costs that are related to the same or similar activity Ex: craftsmanship, setup, design modification, plant services
product-level
(term) activities performed on each product line (ex: product design is needed only for each product line)
unit-level
(term) activities performed on each product unit, (ex: the machining department needs electricity to power the machinery to produce each unit of product)
batch-level
(term) activities performed only on each batch or group of unit (ex: machine setup is needed only for each batch regardless of the units in that batch)
facility-level
(term) activities performed to sustain facility capability as a whole and are not caused by any specific product, (ex: rent and factory maintenance costs are incurred no matter what is being produced)
Value- added activities
(term) activities that add value to a product
Activity- Based Management (ABC)
(term) an outgrowth of ABC that draws on the link between activities and cost incurrence for better management, which is useful in distinguishing value-added activities from non-value-added activities
Costs of quality
(term) costs resulting from manufacturing defective products or providing services that do not meet customer expectations
cost pool
(term) estimated budget of costs
Prevention Activities
(term) focus on quality training and improvement programs to ensure quality is built into the product or service
Appraisal Costs
(term) includes the costs of inspections to ensure that materials and supplies meet specifications and inspections of finished goods
Internal failure costs
(term) incurred after a company has manufactured a defective product but before that product has been delivered to a customer - include the costs of reworking products, reinspecting reworked products, and scrap
External failure costs
(term) incurred after a customer has been provided a defective product or service - include cost of warranty repairs and costs of recalling products, also includes lost profits due to dissatisfied customers buying from other companies
Cost of quality report
(term) report that lists the costs of quality activities by category
cost object
(term) target of the cost assignment
activity cost driver
(term) the activity causing costs in the pool to be incurred - they serve as the allocation base for each activity cost pool
1) Plantwide overhead rate = total budgeted overhead cost ÷ total budgeted direct labor hours 2) Plantwide overhead rate x DLH per unit = OH
1) What is the formula for plantwide OH rate? 2) What is the formula to find plantwide OH?
1) Overhead allocations based on at least two (but often many) rates 2) Overhead allocation rates based on activities that drive costs, such as number of batches of product produced
2 Characteristics of Activity- Based Costing:
1) Overhead allocations based on two or more rates 2) Overhead allocation rates based on volume-based measures such as direct labor hours, direct labor dollars, or machine hours
2 Characteristics of Departmental Rate:
1) Overhead allocations based on one rate 2) Overhead allocation rates based on volume-based measures such as direct labor hours, direct labor dollars, or machine hours
2 Characteristics of Plantwide Rate:
1) Costs to implement and maintain ABC --- requires management commitment and financial resources, collecting and analyzing data is expensive and so is maintaining an ABC system, managers must weigh costs vs benefits 2) Uncertainty with decisions remains --- must interpret data with caution in making decisions, managers must examine carefully the controllability of costs before making decisions
2 Disadvantages of ABC
1) OH costs are frequently too complex to be explained by one factor like direct labor hours or machine hours 2) Technological advances often lower direct labor costs as a percentage of total manufacturing costs, meaning direct labor hours might not be a good allocation base
2 Disadvantages of Plantwide and Departmental
1) OH costs change with the allocation base 2) all products use OH costs in the same proportions
2 critical assumptions of Plantwide
1) company applies lean thinking to eliminate waste in its accounting process 2) instead of using cost allocation methods such as ABC, the company develops alternative performance measures that better reflect the benefits of manufacturing process changes (ex: level of sales per employee)
2 key components of lean accounting:
1) existence of costs 2) demand for reliable cost information
2 requirements for ABC existence
1) They are based on readily available information 2) They are easy to implement 3) They are consistent with GAAP and can be used for external reporting needs
3 Advantages to Plantwide and Departmental
1) the single plantwide overhead rate method 2) the departmental overhead rate method 3) the activity-based costing method
3 methods of Overhead Allocation
1) Identify activities and the OH costs they cause 2) Trace OH costs to activity cost pools 3) Compute OH allocation rates for each activity 4) Use the activity OH rates to assign OH costs to cost objects (products)
4 steps to ABC method
1) unit-level 2) batch-level 3) product-level 4) facility-level
4 types of activities in ABC
1) MORE ACCURATE OH COST ALLOCATION --- because there are more cost pools, costs in each pool are more similar, and allocation is based on activities that cause OH costs 2) MORE EFFECTIVE OH COST CONTROL --- by identifying activities that can benefit from process improvement - can help managers effectively control OH costs by focusing on processes or activities such as setups, order processing, and design modifications instead of focusing only on direct labor or machine hours 3) FOCUS ON RELEVANT FACTORS --- ABC can be used to assign costs to any cost object that is of management interest - ABC generally provides better customer profitability information by including all resources consumed to serve a customer 4) BETTER MANAGEMENT OF ACTIVITIES --- helps managers identify the causes of costs and the activities driving them: Activity- based management (ABM) 5) COSTS OF QUALITY --- a focus on the costs of activities, via ABC and ABM, lends itself to assessments of the costs of quality - these costs can be summarized in a cost of quality report - leads to higher quality and lower costs
5 Advantages of ABC
OH = Activities consumed x Activity rate
Formula for ABC OH allocation (not the rate)
Total budgeted departmental overhead cost / total amount of departmental allocation base
Formula for Departmental Overhead Rate
OH costs assigned to pool ÷ Expected activity level
Formula for cost pool activity rate
these costs do not vary with the number of units, but varies with the number of batches
How do batch-level costs vary?
costs do not vary with what is manufactured, how many batches are produced, or the output quantity
How do facility-level costs vary?
are not affected by either the numbers of units or batches
How do product-level costs vary?
costs tend to change with the number of units produced
How do unit-level costs vary?
1) proper identification of the factor that drives the cost in each activity cost pool 2) proper measures of activities
Proper determination of activity rates depend on what 2 things?
1) Total budgeted overhead costs are combined into one overhead cost pool 2) This cost pool is then divided by the chosen allocation base to arrive at a single plantwide overhead rate. 3) This rate is then applied to assign costs to all products based on their usage of the allocation base
What are the 3 steps of plantwide rate?
OH costs commonly shift from standardized, high-volume products (P/w, Dpt) to low-volume, customized specialty products that consume more resources (ABC)
What happens to OH costs when ABC is used compared to Plantwide/Departmental?
1) Assign overhead costs to departmental cost pools 2) Select an allocation base for each department 3) Compute overhead allocation rates for each department 4) Use departmental overhead rates to assign overhead costs to cost objects (products)
What is the 4 step process of Departmental Rate?
An activity, which is a task, operation, or procedure, is what causes costs to be incurred. OH costs in each activity pool are allocated to products based on the cost of resources consumed by a product (input) rather than on how many units are produced (output)
What is the basic principle behind ABC?
The unit of the product
What is the cost object of plantwide rate?
Many companies have several departments that produce various products and consume overhead resources in substantially different ways. Under such circumstances, use of a single plantwide overhead rate can produce cost assignments that fail to accurately reflect the cost to manufacture a specific product
What is the main disadvantage of plantwide rate?
lean accounting
What type of accounting focuses on eliminating waste while satisfying customers?
Companies who manufacture few products, or are labor-intensive
What types of companies would plantwide rates be reasonable for?
It reduces the number of cost assignments required
Why is activity cost pooling important?
It helps managers set a price to cover product costs and yield a profit. Disparities between producer costs and market prices give managers insight into their efficiency relative to competitors.
Why is knowing accurate costs for producing, delivering, and servicing products important to managers?