Activity Based Costing Flashcards

Unlike the paperboard basis weight plot that approximates a wave pattern, many setup patterns are possible within a tube mill subcycle. In a steel tube manufacturing environment, an optimal setup pattern is achieved by minimizing total setups while producing the required product mix in a two-month cycle. As shown in Figure VI, the optimal schedule attempts to minimize the “average” height of the bars representing setups over a production cycle. Short-term deviations from the schedule may appear to be favorable. For example, substituting a one-section changeover for a three-section changeover may appear to result in fewer section changes in the short run. However, the number of setups should be considered with respect to the entire production cycle. By introducing an unplanned setup, even if it appears to be less costly (as in the one-section venus three-section setup), the production cycle is extended.

He different approaches and outcomes from ABC and traditional costing are most accessible for illustration in the context of a product manufacturing example. Step Costs in the News Step costs are common – the cost of a new production facility, the cost of a new machine, supervision costs, marketing costs, etc., are all step costs. Are those activities that have a one-to-one correspondence with a unit of output. For example, a telescope manufacturer may have to perform some final calibration activity to each finished product. Thus, calibration may be seen as a unit-level activity. Timesheets from the direct labor workforce show total costs of $40,000, to be paid the next month.

What Are The Cost Hierarchies Used In Abc?

Activity-Based Costing and Activity-Based Management. A colleague states, “We produce one product, and our operations are relatively simple. Activity-based costing and activity-based management would be a waste of time for our company! Using the plantwide allocation method, calculate the product cost per unit for the desk and table products.

Divide your total utility bill by your cost driver to get your cost driver rate. Your overhead application rate is $20 ($20,000 / 1,000 hours).

To identify the opportunities for improvement and reduction of costs. Calculate the cost per unit for eachproduct using ABC. Difficult to identify the overall activities that influence costs. Fair allocation of overheads occupies a considerable portion in the total cost components.

• To minimize costs, Hewlett Packard and other large companies often “outsource” services like building maintenance and legal support (i.e., they have other companies provide the services for them).
• Think about the costs that come with having a factory.
• Examples of activities often identified by companies using activity-based costing, and how these activities fit in the cost hierarchy, appear in Table 3.2 “Cost Hierarchy Examples”.
• Administrative-level activities are operations of an organization that support an overall dimension but provide no greater information when broken down into any further dimension.
• Nevertheless, the per unit data suggest that the CAPlayer is losing money because the sales price is below the $64.44 unit cost.

It will help to give a competitive edge to the company in the market and hence, increase its sales and profitability. A work-in-progress is a partially finished good awaiting completion and includes such costs as overhead, labor, and raw materials. With the implementation of the ABC, it’s crucial that the evaluation of employee evaluation should derive from ABC data, it should not come out from other existing traditional costing system.

Activitybased Costing

These costs are administrative in nature and include building depreciation, property taxes, plant security, insurance, accounting, outside landscape and maintenance,. Calculate the direct materials cost per unit and direct labor cost per unit for each product. Calculate the service department costs allocated to each production department. Using the estimates for the year, compute the predetermined overhead rate for each activity (this is step 4 of the activity-based costing process). Perform step 3 of the activity-based costing process by identifying a possible cost driver for each activity. Ehrman Company identified the activities listed in the following as being most important (step 1 and step 2 of activity-based costing), and it formed cost pools for each activity.

However, the janitorial group may perform a major cleanup after each machine setup. https://personal-accounting.org/ For example, what object should bear the cost of landscaping the corporate office?

The most common activity levels used are direct labor hours or machine hours. Divide total overhead by the number of direct labor hours. These involve activities performed on each unit produced. These involve activities batch level activity examples performed whenever a batch of units is processed. APPLY COSTS TO OBJECTS — The final step is to utilize the activity-based rates in determining the amount of activity cost to allocate to each cost object.

Calculate the per unit profit for each product using the plantwide approach and the activity-based costing approach. Using the plantwide allocation method, calculate the product cost per unit for the regular and flat panel products. The predetermined overhead rate is 150 percent of direct labor cost. All overhead costs are assumed to be driven by volume of production.

What Are The Disadvantages Of Activity Based Costing?

The next section describes the manufacturing process for each industry and develops the logic supporting each theoretically optimal production schedule. David Kindness is a Certified Public Accountant and an expert in the fields of financial accounting, corporate and individual tax planning and preparation, and investing and retirement planning.

• The $800,000 costs of department S1 are allocated based on the number of employees in each production department.
• If demand does not exist for a product at the time of scheduled production, JIT principles suggest the product should not enter production.
• In other words, it helps to get the pricing right of the product.
• In this stage, the cost of consumed resources was allocated to activities.
• Batch-level activities are required to produce batches of products and include items such as machine setups and quality inspections.

However, these costs are accounted for regardless of the related production run’s size. Examples of these batch-level cost drivers can often include machine setups, maintenance, purchase orders, and quality tests. We believe product A is subsidizing products B and C. Assume San Juan Company uses the plantwide approach for allocating overhead costs and direct labor hours as the allocation base. Calculate the predetermined overhead rate, and explain how this rate will be used to allocate overhead costs.

Module 3: Activity

Minimizing this type of inaccuracy is a priority of cost measurement systems designed to support strategic decision making. The following are few examples of cost drivers with particular reference to their related activity levels.

Batch level costing is a part of the broader activity-based cost accounting method. Other than this, activity-based cost accounting includes activities at the unit level, customer level, product level, and organization level. While the cost of the unit-level and product-level activities is variable, the cost of organization-level activities is generally fixed. The cost of the batch-level activities usually is fixed irrespective of the number of units in the batch. It is only variable in the sense that it is directly related to the number of batches of goods produced throughout the year.

Calculate the plantwide predetermined overhead rate using machine hours as the base. Calculating Plantwide Predetermined Overhead Rate. Manufacturing overhead costs totaling $5,000,000 are expected for this coming year.

Implementing Lease Accounting

The allocated cost from the catalog preparation pool was $2.50 per unit. This is not the total cost; this is just the allocated amount. The total cost would also include the directly traceable amounts (printing, postage, etc.). This catalog cost, along with other customer-related costs, would be compiled in a summary report. Managers would then have a measure of how much it costs to support one additional customer.

One limitation of ABC is that external reporting must be based on traditional absorption costing methods. Absorption costing requires the traditional division between product costs and period costs, with inventory absorbing all of the manufacturing costs and none of the period costs. As a result, ABC may produce results that differ from those required under generally accepted accounting principles . Therefore, ABC is usually viewed as supplemental in nature. It is used for internal management decision making, but it may not be suitable for public reporting if results differ materially from absorption methods.

Material movement costs are attached to the batch of products following the movement. This article evaluates activities that occur prior to performing the batch activity. For example, the specifications of a previous product may make a subsequent setup more difficult.

These costs can be changed over a short time horizon based on how many units management chooses to produce. Batch-level activities are costs related to the production of a batch of one product. Batch-level activities can include machine setup, quality testing, maintenance, and purchase orders. Batch-level activities are part of a five-faceted structure of activity-based costing. Batch level costing can also help identify cost-driving processes that have become obsolete or redundant and need proper examination and change. Accurate costing helps to evaluate costs that can be curtailed or eliminated by changing the methods in use. It can enable us to move to more efficient and effective overhead cost drivers.

The only difference is that this problem uses activity-based costing to allocate overhead costs rather than one plantwide rate. Recall that inventory beginning balances were $25,000 for raw materials inventory, $35,000 for work-in-process inventory, and $90,000 for finished goods inventory. Southwest, Inc., has two production departments and three service departments . The $800,000 costs of department S1 are allocated based on the number of employees in each production department. The $300,000 costs of department S2 are allocated based on the square footage of space occupied by each production department. The $600,000 costs of department S3 are allocated based on hours of computer support used by each production department.

Rather than applying all factory overhead on some simple basis such as labor hours, it requires the development of numerous cost pools that must be individually allocated. Provide at least two reasons why management might prefer machine hours as the overhead allocation base rather than direct labor hours or activity-based costing. Refer to the estimated cost driver activity provided. Calculate the percent of each activity consumed by each product (e.g., the desk product issued 900 of the 1,000 purchase orders issued in total and therefore consumes 90 percent of this activity).

• Calculate the predetermined overhead rate for each department, and explain how these rates will be used to allocate overhead costs to products.
• The activities that cause costs to be incurred are also called cost drivers.
• Minimizing this type of inaccuracy is a priority of cost measurement systems designed to support strategic decision making.
• You have to pay taxes, provide custodial services, and pay for all of the utilities needed to run the factory on a day-to-day basis.
• Product engineers’ design-for-manufacturability efforts, which aim to design products with fewer and more common parts, reduce the demands for product-sustaining resources.
• This creates an incentive for the company’s service departments to provide services at a reasonable cost.

Companies that measure these costs of quality typically calculate the costs in each category as a percent of total revenue. The goal is to steadily shift costs toward the prevention and appraisal categories and away from the internal and external failure categories. As organizations concentrate more on preventing defects, total quality costs as a percent of revenue tends to decline and product quality improves. Table 3.3 “Summary of Quality Costs” provides a summary of the four classifications of quality-related costs. Table 3.3 “Summary of Quality Costs” provides a summary of the four classifications of quality-related costs.

Direct costs are the same under both traditional costing and ABC. For direct costs, accountants measure a product unit cost for each direct cost category. The two costing methods differ, however, in the way they assign values to so-called indirect costs for products. Management of Custom Furniture Company would like to use activity-based costing to allocate overhead costs totaling $1,140,000 rather than one plantwide rate based on direct labor hours. The following estimates are for the activities and related cost drivers identified as having the greatest impact on overhead costs. Recall from the chapter discussion that SailRite uses one plantwide rate based on direct labor hours to allocate manufacturing overhead costs to the company’s two sailboat products—Basic and Deluxe.

Company

If demand does not exist for a product at the time of scheduled production, JIT principles suggest the product should not enter production. Holding costs, including financial carrying costs, damage, and obsolescence, may result from rigid adherence to an optimal production schedule that does not consider market demand. Plantwide Versus Department Allocations of Overhead. San Juan Company expects to incur $600,000 in overhead costs this coming year—$100,000 in the Cutting department, $300,000 in the Assembly department, and $200,000 in the Finishing department.

Sarah Kolster, manager of the quality testing department, is not happy with receiving cafeteria cost allocations. She is evaluated based on meeting a cost budget established at the beginning of the fiscal year, which does not include the cafeteria allocation, and she clearly has an incentive to minimize costs. The company recorded $243,000 in actual overhead costs for the year. The company recorded $302,500 in actual overhead costs for the year. The Machining department uses a rate of $55 per machine hour, and the Assembly department uses a rate of $35 per direct labor hour. Describe the five steps required to implement activity-based costing.