Managerial Accounting Ch. 4
What are the four steps in the departmental overhead rate method?
1. Assign overhead costs to departmental cost pools 2. Select an allocation base for each department (each department determines an allocation base for its operations) 3. Compute overhead allocation rates for each department 4. Use departmental overhead rates to assign overhead costs to each product
Disadvantages of Activity-based costing?
1. Costs to implement and maintain ABC are expensive 2. Some product cost distortion remains
What are the assumptions of the departmental overhead rate method?
1. Different products are similar in volume and complexity and batch size 2. Departmental overhead costs are directly proportional to the department allocation base
What are the steps of activity based costing?
1. Identify activities involved in manufacturing products and match those activities with the cost they cause. 2. The homogeneous activities (those caused by the same factor) are grouped into activity cost pools 3. Trace overhead costs to activity cost pools 4. Compute overhead allocation rates for each activity 5. Use the activity overhead rates to assign overhead costs to cost objects (products)
What are the benefits of ABC?
1. It recognizes that overhead costs are complex 2. Emphasizes activities and costs of these activities 3. Reflects the complex nature of overhead costs and how these costs are used in making products
Advantages of Activity-based costing?
1. More accurate overhead cost allocation -- because there are more cost pools and activity rates than other methods. 2. More effective overhead cost control 3. Better production and pricing decisions -- because it can reduce cost distortions 4. ABC also has other uses -- for beyond product cost 5. Helps managers to understand before levels of overhead costs 6. Costs of quality -- costs resulting from manufacturing defective products or providing services that do not meet customer expectations
What are the two general steps to determine departmental overhead rate?
1. Overhead costs are determined separately for each production department 2. An overhead rate is computed for each production department to allocate the overhead
What two assumptions are the basis for the usefulness of the single plant-wide overhead rate?
1. Overhead costs change with the allocation base 2. All products use overhead costs in the same proportions
What are the three Overhead Allocation methods?
1. Plant-wide overhead rate method (aka Single Plant-wide overhead rate method) 2. Departmental overhead rate method 3. Activity based costing
What are the three main advantages of using the departmental overhead rate method and Plantwide overhead rate method? As opposed to activity-based overhead rate method.
1. They are based on readily available information 2. They are easy to apply 3. They are consistent with GAAP and therefore can be used for external reporting
What are the four types of activities in activity-based costing?
1. Unit-level activities -- performed on each product unit and costs tend to change with the number of units produces. 2. Batch-level activities -- performed only on each batch or group of units. Costs do not vary with the number of units, but rather with the number of batches. 3. Product-level activities -- performed on each product line and are not affected by the number of units or batches. 4. Facility-level activities -- performed to sustain facility capacity as a whole and are not caused by any specific product. Costs do not vary with what is manufactured or output quantity.
What is an activity cost pool?
A collection of costs that are related to the same or similar activity.
What system is used to assign overhead costs?
An allocation system.
What is Activity Based Costing (ABC)?
An attempt to more accurately assign overhead costs by focusing on activities.
What type of companies can use the single plant-wide method?
Companies that manufacture few products or are labor intensive.
What do Product Costs consist of?
Direct labor Direct Materials Overhead
What is the problem with using a single Plant-wide overhead rate?
It can produce cost assignments that do not reflect the cost to manufactured products.
What are the benefits of the departmental overhead rate method?
It can result in better overhead cost allocations and it can improve management decisions.
What are costs of quality?
Prevention appraisal Internal failure External failure costs
What are activities?
Tasks, operations, or procedures, which cause costs to be incurred. (All activities of an organization can be linked to the use of resources)
What is the Plant-wide Overhead Rate method?
The rate is determined using a volume-related measure such as direct labor hours or machine hours.
How do you apply the Plant-wide overhead rate method?
The total budgeted overhead costs / the chosen allocation base = rate : the rate is then applied to all products.