Accounting Chapter 17 Redo
Plantwide Overhead Rate Method
- For the Plantwide Overhead rate, the Cost Object (target of the cost assignment) is the unit of the product. - Applying Plantwide OH rate: Total budgeted overhead/ chosen allocation base= plantwide overhead rate. It is then applied to assign overhead cost to all produts based on their actual usage (ex. Plantwide overhead rate is $15 per DL hour; 2 DL hours per product. So 30 overhead per produt.
Plantide OH rate method vs Departmental OH rate method vs Activity-based costing
- Plantwide and departmental use volume-based measures, such as DL hours or machine hours to allocate overhead cost to products. Activity-based costing focuses on activites, not just volume and their costs; rates are based on these activites, such as number of batches of product produced, are used to assign overhead to products in proportion to the amount of activity required to produce them. - Plantwide uses a single rate for allocating overhead cost to its products. The departmental rate uses at least two rates, which is why its more accurate. ABC typically uses the most rates. - Advantages and Disadvantages: Departmenal and Plantwide have 3 advantages: based on readily avalibale info, easy to implement, consist with GAAP. Disadvantage? Ovehead costs are too complex to be explained by one factor; both suffer from this. - Other differences: Plantwide depends on two assumptions: 1. overhead cost change with the allocation base 2. - -All products use overhead cost in the same proportions. For companies with many different products or those with products that use overhead costs in different ways, the plantwide overhead rate is not reasonable. Departmental assumes that different products are similar in volume, complxity, and batch size; departmental overhead costs are directly proportional to the allocation base. - ABC advantages and disadvantages: More effective cost control, better prodcution and pricing,. Disavdavatges: Cost to implement and maintain, some distrotin still remains, uncertainty with decsions remains
Cost distortion (traditional costing methods)
A big problem with traditonal costing methods is that is assigns ovehead based on only production volume realted measures, even though many products do not consume overhead in proportion to how much is produced. Some product's overhead is driven by nonvoume related factors, such as size and complexity, which causes distortion, which means overhead is allocated to much to some products and too little to others. This type of distortion is called crossed subsides, and ABC generally fixes it by seperating overhead into different cost catergories called cot pools, which group cost that are caused/dirven by the same activity together and then allocated to products using an approproaite measrue of the activity volume. - Production volume: too little overhead is allocated to low volume products, and too much is allocated to high volume . - Product size: Small is undercosted and large is overcosted. - Product Complexity:Complex products are undercosted, and simple products are overcosted. - Product material requirements: For those that require mant unique parts, they tend to be undercosted. The reverse is true - Product machiene setup requirement: For those with many, long machiene setups, they tend to be undercosted. The reverse is true.
Activity Levels and Cost Management
Activites causing overheadcost can be seperaed into four levels: 1. Unit-level activites: Performed on each product unit. Tend to change with the number of units produced Ex. Electicity being needed to power the machinery to produce each unit of a product, cutting parts, assembling componets, printing checks 2. Batch Level: Are preformed on a batch (group of units). Needed for each batch, regardless of the units in the batch; cost varies with the number of batches. Ex. Calibrating macheines, receving shipments, sampling product quality, recycling haserdous waste 3. Product-level: performed on each product line and are not affected by either the number of units or batches. Ex. Designing modficaitons, organzing production, contorlling inventory. 4. Facility-level activtes: performed to sustain facility capacity and are not casued by any specific product. Ex. cleaning workplace, providing electricity, providing personnel support, recycling greenhouse gas emissons.
Activity Based Costing
An activity (task, operation, or procedure) is what causes cost to be incurred. An Acitivty Cost Pool is a collection of costs that are related to the same activity (ex. Handling raw materials requires several activites, including wages of employees, derpreation on forklift, etc; these axtivites can all be grouped into the same cost pool because they all caused the same amount of materials to be moved). - Four steps: 1. Identify activtes and the overhead costs they cause: breakdown total overhead into its cost per activity 2. Trace overhead cost to activity cost pools: group activites and their cost into broader sub catergories. 3. Compute activty cost pool rates rates for each activity: depends on 1. Proper identification of the factor that drives cost (cost driver) in each activity cost pool 2. Proper measure of activity. The cost driver is an activity that causes cost in the pool to be incurred. Cost pool activity rate= overhead costs assigned to pool / expected activity level 4. Use he acitivty overhead rate to assign overhead cost to the cost object (the product)
Departmental Overhead Rate Method
Many companies have several departments that produce various products using different amounts of overhead. Under such circumstnaces, a single plantwide overhead rate can produce cost assignments that do not reflect the cost to manufactor products. - Four step process: 1. Assign cost to departmentl cost pools 2. Select an alloation base for each department 3. Compute overhead allocation rates for each department: Departmental overhead rate= total budgeted overhead cost/ total amount of departmentl alloction base 4. Use departmental overhead rates to assign overhead costs to cost objects (products)