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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