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2016-17 Term 1

ACCT112 Management Accounting


Week 3

a) Product Costing
b) Activity-Based
Costing
2016-17-T1-Aug to Dec 2016

Seminar Outline
(a) Product Costing
Compute pre-determined overhead rates
and explain why estimated overhead costs
rather than actual overhead costs are used
in the costing process
Allocate Manufacturing Overhead using the
traditional method and compute the cost of
the product
Normal costing: disposal of underapplied
and overapplied overhead
Prepare an income
statement
using2
2016-17-T1-Aug
to Dec 2016

Recap
To produce a product, we need:
DM
Traceable to the product; thus
DL directly assigned to product
Manu OH:Common costs used to produce
multiple products; thus Manu OH are
allocated or applied to the
products so that the costs are
shared among the products.
We use the WIP account to record
manufacturing costs incurred to produce
the product.
2016-17-T1-Aug to Dec 2016

Cost
Assignment

Schema of Product Costing


Direct
Materials

Direct
Labour

Overheads

Cost
Allocation

Cost Tracing

Product
A A
WIP: Product

Beg WIPA
DMA
DLA
Applied
OHA
Ending
WIPA

Product
B
WIP:
Product B

Beg
DM
WIPBB
COG
DL
MA
Applied
B
OHB
Ending
2016-17-T1-Aug to Dec
2016
WIP
B

COG
MB

Cost Allocation
Common Costs $C e.g. $6,000
rental
How to share the $C among the
cost objects?
$C x

Q1

$C x

Q2

$C x

Cost object can


be a product; or
dept; or anything
that we want to
find out the cost

Q3

(Q1+Q2+Q3)
(Q1+Q2+Q3)
(Q1+Q
2+Q3)
Cost
Cost
Cost
object 2
object 3
object 1
Consumed
Consumed
Consumed
e.g.
Q3
Q1to share space rental
Q2 cost,
Q2 = 2000
Q3 = 3000
Q1 = 1000
sqm
sqm
sqm
Q is the appropriate cost driver of the
common costs and (Q1+Q2+Q3) is the
2016-17-T1-Aug to Dec 2016
5
cost allocation base

Cost Allocation Base (Q1 + Q2 + )


The factory produces Product A, Product B, Product C
and Product D.
Product D is
Machine used to produce Product
handcrafted
A, B, C.
and does not
Machine rental $10,000 per
require the
month
machine
Product A
Product
Product B
Product C
2,000 units 3,000 units 5,000 units
D
Space: 10
1,000
Space: 12
Space: 20
sqm
units
sqm
sqm
4,000 DM$
Space: 5
7,000 DM$ 10,000 DM$
2,000 mach
sqm
3,000
mach
How would you
allocate 5,000
the machine
rental
hr
3,000 DLH
mach hr
hr
cost
to
the
products?
What is the cost driver of the machine rental
0 mach hr
overhead
cost?
What is the
cost allocation base?
2016-17-T1-Aug to Dec 2016

$C = Actual Manu OH: Allocate Actual


Yummy Cupcakes allocates
manufacturing overhead
OH?
based on units produced. DM and DL to make 1
vanilla cupcake = $1.00 and 1 red velvet = $0.50
January
Incurred $5,000 overhead to produce 4,000 vanilla
cup cakes and 6,000 red velvets. Thus $5,000 will be
allocated
as follows:
Vanilla:
$5,000
* [4,000/(4,000+6,000)]= $2,000
RV: $5,000 * [6,000/(4000+6,000)] = $3,000
WIP: Vanilla
Jan
Bal
$0 COGM$6,00
DM, DL 4,000
0
Manu OH2,000

WIP: Red Velvet


Jan
Bal
$0 COGM $6,00
DM, DL 3,000
0
Manu OH3,000

Jan: Cost per cupcake


Vanilla = $6,000/4,000 = $1.50; RV = $6,000/6,000
= $1.00
2016-17-T1-Aug to Dec 2016
7

February: In addition to the usual $5,000 overhead,


Yummy spent $3,000 on preventive maintenance.
4,000 vanilla cup cakes and 6,000 red velvets were
produced during Feb. Total actual OH = $8,000,
Vanilla:
allocated
as $8,000
follows:* [4,000/(4,000+6,000)]= $3,200
RV: $8,000 * [6,000/(4000+6,000)] = $4,800
WIP: Vanilla
Jan
Bal
$0 COGM$6,00
DM, DL 4,000
0
Manu OH2,000
Feb
Bal
$0 COGM$7,2
DM, DL 4,000
00
Manu OH3,200

WIP: Red Velvet


Jan
Bal
$0 COGM $6,00
DM, DL 3,000
0
Manu OH3,000
Feb
Bal
$0 COGM $7,80
DM, DL 3,000
0
4,800
Manu
OH

Cost per cupcake


Feb: Vanilla = $7,200/4,000 = $1.80; RV =
Jan:
Vanilla = =
$6,000/4,000
= $1.50; RV
8 =
$7,800/6,000
$1.30

Or $C = Estimated Manu OH: Allocate


Est.
OH?
At the beginning of the year, Yummy plans to $3,000
in Feb and Aug for preventive maintenance. Usual
monthly manu overhead is estimated to be $5,000.
Planned production is 4,000 vanilla and 6,000 red
velvet.
Estimated Manu OH for 12 mth = $66,000
Estimated Prod Qty for 12 mth = 120,000
cupcakes
Estimated Manu OH for 1 cupcake = $0.55 per
Pre-determined
cupcake
overhead rate (POR)
computed at the
beginning of the period
before production starts

2016-17-T1-Aug to Dec 2016

Or $C = Estimated Manu OH: Allocate


Est.
Estimated Manu OH
for OH?
1 cupcake (POR) =
$0.55
per cupcake
Jan: Produced
4,000 vanilla and 6,000 red velvet
Applied Manu OH (vanilla) = 4,000 * $0.55 =
$2,200
Applied Manu OH (red velvet) = 6,000 * $0.55 =
WIP: Red Velvet
$3,300WIP: Vanilla
Jan
Bal
$0 COGM$6,20
DM, DL 4,000
0
Manu OH2,200

Jan
Bal
$0 COGM $6,30
DM, DL 3,000
0
Manu OH3,300

Jan: Cost per cupcake


Vanilla = $6,200/4,000 = $1.55; RV = $6,300/6,000
= $1.05
2016-17-T1-Aug to Dec 2016

10

Feb: Produced 4,000 vanilla and 6,000 red velvet


WIP: Vanilla
Jan
Bal
$0 COGM$6,20
DM, DL 4,000
0
Manu OH2,200
Feb
Bal
$0 COGM$6,2
DM, DL 4,000
00
Manu OH2,200

WIP: Red Velvet


Jan
Bal
$0 COGM $6,30
DM, DL 3,000
0
Manu OH3,300
Feb
Bal
$0 COGM $6,30
DM, DL 3,000
0
Manu OH3,30
0

Feb: Cost per cupcake


Vanilla = $6,200/4,000 = $1.55; RV = $6,300/6,000
= $1.05
Jan:
Cost per cupcake
Vanilla = $6,200/4,000 = $1.55; RV = $6,300/6,000
= $1.05

Does this make better


sense?2016-17-T1-Aug to Dec 2016

11

Why Use Predetermined Overhead


Appendix
Rate?
5A

Consider:
(1)Timing of incurring of costs vs enjoying
benefits e.g. repairs incurred in Jan but will
benefit production for rest of the
year
(2)Seasonal factors in overhead costs or in
allocatione.g.
base
electricity costs higher in winter
than summer but product is the
same, whether produced in winter
or summer
(3)Timeliness of information: when will actual
OH rate be known?
Actual OH not known until end of
the year
2016-17-T1-Aug to Dec 2016

12

Popular Approach: Normal Costing


Normal Costing: A company normalizes or
averages the costs of works in different periods to
even out spending for indirect resources e.g.
preventive maintenance incurred in one period but
benefitting other periods.
Product Cost

Actual
Costing
Normal

DM
Actual
Cost
Actual

DL
Actual
Cost
Actual

Costing

Cost

Cost

OH
Actual
Cost
Applied
OH
= POR x Actual Cost
Driver

Predetermin
Estimated manu overhead cost $
ed
for the year
Overhead
Estimated amt of the allocation base
Rate =
for the
year
2016-17-T1-Aug to Dec 2016
13
(POR)

Normal Costing (1)


(1)At the BEGINNING of the
period
Predetermined Overhead Rate (POR)
e.g. Budgeted
=
Estimated Overhead
$
OH
Estimated Cost Allocation
Base
E.g.
Budgeted Prodn;
Normal Prodn; etc. Prodn
can be represented by no.
of finished units; DLH,
(2) DURING the period whenDM,
theetc.
products are

manufactured
Applied
x Actual
Cost
Applied overhead
overhead=isPOR
recorded
inQty
the of
WIP
when
Driver
the units of products are produced.
Is Estimated Overhead the same as Applied
Overhead?
2016-17-T1-Aug to Dec 2016

14

Normal Costing (2)


(3) At the END of the period when actual results are
known:
(a) Determine the under- or over-applied OH

Under- or Over-applied OH = Applied Overhead Actual Overhead


Budgeted OH
Actual OH
(b) Dispose of the under- or over-applied overhead so
that the accounting records eventually reflect the
actual overhead incurred.
Note that external financial reporting must reflect
actual costs. If there is no adjustment for
under-/over-applied overhead, then what is
reported will be _____________ overhead.
2016-17-T1-Aug to Dec 2016

15

Normal Costing: Manu Overhead


Allocation
E.g. on 1 Jan 2015, ZZ
Ltd planned to rent a machine
for a year at $95,000. Manufacturing supplies and
other variable overheads are estimated to be $5,000.
ZZ Ltd planned to produce 50,000 units of A and
50,000 units of B in the year.
At 31 Dec 2015, ZZ noted that actual production
during the year comprised 50,000 units of A and
45,000 units of B. Actual manufacturing overhead
amounted to $110,000 . Direct materials and direct
labour for A and B were $3 and $5 respectively.
During the year, 48,000 units of A were sold at $10
each and 42,000 units of B were sold for $15 each.
ZZ uses units of production
as the cost
2016-17-T1-Aug to Dec 2016
16

Normal Costing: Manu Overhead


Allocation
E.g. on 1 Jan 2015, ZZ
Ltd planned to rent a machine
for a year at $95,000. Manufacturing supplies and
other variable overheads are estimated to be $5,000.
ZZ Ltd planned to produce 50,000 units of A and
50,000 units of B in the year.
ZZ uses units of production as the cost
allocation base.

2016-17-T1-Aug to Dec 2016

17

Normal Costing: Manu Overhead


Allocation
At the BEGINNING of the period, compute the
predetermined OH rate (POR)
Budgeted OH

= $100,000

Budgeted production = 50,000 A + 50,000 B


(given cost allocation base) = 100,000 units
POR

= Planned OH/Planned
production
= $1/unit

2016-17-T1-Aug to Dec 2016

18

Normal Costing: Manu Overhead


Allocation
DURING the period,
when units are produced,
record Applied OH in the WIP
*assume no beg or end WIP

Applied OHJ = POR x Prod


QtyJan
Applied OHF = POR x Prod
QtyFeb

*WIP Control

Jan
DM
D
Applied
L
Feb
OHJ
DM
D
Applied
L
OHF
Mar
DM
Dec
D
Applied
OH
L

COGMJ

COGMF

COGM

Total Applied OH during the


year
=
POR x (Prod QtyJan + Prod QtyFeb + + Prod QtyDec)
= POR x Actual Prod Qty during the year
2016-17-T1-Aug to Dec 2016

19

Normal Costing: Manu Overhead


At 31 Dec 2015, ZZ Allocation
noted that actual production
during the year comprised 50,000 units of A and
45,000 units of B.
Total OH applied to A

= $1 x 50,000 units
= $50,000

Total OH applied to B

= $1 x 45,000
= $45,000

Total Applied OH

= $95,000 (i.e. recorded in WIP)

2016-17-T1-Aug to Dec 2016

20

Normal Costing: Manu Overhead


Allocation
At 31 Dec 2015, Actual
manufacturing overhead
amounted to $110,000 .
At the END of the period, determine the underor over-applied overhead
Actual OH
incurred)

= $110,000 (actual amt

Total Applied OH

= $50,000 + $45,000
= $95,000 (recorded in WIP)

Under-applied OH

= $95,000 - 110,000
= $15,000

2016-17-T1-Aug to Dec 2016

21

OH Cost Flow
Planned OH
=
$100,000;
Planned
prod =
100,000
units

90,000 Units
Sold (include
$90,000
Applied OH)

Produced
95,000 Units
=>
Manu Costs =
(a)Applied
OH
$95,000 +
(b)DM & DL
$375,000

POR =
$1/unit

DM & DL: A = $3/unit


DM & DL: B = $5/unit

undercoste
d

P/L COGS
(include $90,000
Applied OH)
2016-17-T1-Aug to Dec 2016

5,000 Units
Unsold
(include $5,000
Applied OH)

B/S FG Inventory
(include $5,000
Applied OH)
22

Disposal of Under- or Over-Applied


Appendix
OH: Method 1
5B

Method 1: Direct write-off method: Close out to


Add
Underapplied OH to COGS
Cost of Goods
Sold
Less Overapplied OH from
COGSProduct A Product B
Total
DM & DL per unit

$3

$5

Applied OH

$1

$1

Cost per unit

$4

$6

48,000
units

42,000
units

90,000
units

$192,000

$252,000

$444,000

Sales Qty
COGS before
adjustment
+ Underapplied
OH
Adjusted COGS

$15,000
2016-17-T1-Aug to Dec 2016

23

$459,000

Disposal of Under- or Over-Applied


Appendix
OH: Method 1
5B

Income Statement

Product A

Product B

Total

Sales

$480,000

$630,000

$1,110,000

COGS before
adjustment

$192,000

$252,000

$444,000

+ Underapplied OH

$15,000

Adjusted COGS

$459,000

Net Profit

$651,000

2016-17-T1-Aug to Dec 2016

24

Disposal of Under- or Over-Applied


OH: Method
2a(based on
Method 2a: Proportional
method
ending bal)
E.g. RSK Ltd. uses a POR of $2/DLH to cost its products. It
produced 20,000 units during the year. Each unit required 1
DLH. The ending balances of its WIP, FG and COGS are given
in the table below.
End Bal
Proportion Overapplie End Bal
before
d OH
after
adjustmen
adjustment adjustmen
t
t
WIP

$10,000

FG

$30,000

COG
S

$60,000
$100,000

2016-17-T1-Aug to Dec 2016

25

Disposal of Under- or Over-Applied


OH: Method
2a(based on
Method 2a: Proportional
method
ending bal)
Actual OH incurred for the year was $30,000.
Applied
OH = (20,000
units x 1)
DLH x $2/DLH
= $40,000
Overapplied
OH = $40,000
$30,000
= $10,000
End Bal
Proportion Overapplie
before
d OH
adjustmen
adjustment
t

End Bal
after
adjustmen
t

WIP

$10,000

10%

10% x
$10,000 =
$1,000

$9,000

FG

$30,000

30%

30% x
$10,000 =
$3,000

$27,000

COG
S

$60,000

60%

60% x
26
$10,000 =

$54,000

2016-17-T1-Aug to Dec 2016

Disposal of Under- or Over-Applied


OH: Method 2b
Method 2b: Proportional method (based on
applied ovhd): Allocate among WIP, FG and
COGS in proportion to the overhead applied
during the current period in ending balances
Ending Bal
before
adjustmen
t

Applied
OH
(assume
this is
given)

Overapplie End Bal


d OH to be after
adjusted
adjustmen
t

WIP

$10,000

$4,800
(12%)

12% x
$10,000 =
$1,200

$8,800

FG

$30,000

$11,200
(28%)

28% x
$10,000 =
$2,800

$27,200

COG $60,000
S

$24,000
60% x
$54,000
2016-17-T1-Aug to Dec 2016
(60%)
$10,000 =27

Disposal of Under- or Over-Applied


OH: Method 2b
Method 2b: Proportional method (based on
applied ovhd): Allocate among WIP, FG and
COGS in proportion to the overhead applied
during the current period in ending balances
Ending Bal
before
adjustmen
t

Applied
OH
(assume
this is
given)

Overapplie End Bal


d OH to be after
adjusted
adjustmen
t

WIP

$10,000

$4,800
(12%)

12% x
$10,000 =
$1,200

$8,800

FG

$30,000

$11,200
(28%)

28% x
$10,000 =
$2,800

$27,200

COG $60,000
S

$24,000
60% x
$54,000
2016-17-T1-Aug to Dec 2016
(60%)
$10,000 =28

Absorption Costing
Accounting standards require products to be costed
using Absorption Costing for external reporting.
Using absorption costing (also know as full product
costing), the product cost included ALL
manufacturing costs including fixed manufacturing
costs.
E.g.
Product A

Product
B

DM & DL per
unit

$3

$5

Applied OH

$1

$1

Cost per unit

$4

$6

Variable
Variable &
Fixed Manu
OH

2016-17-T1-Aug to Dec 2016

29

Seminar Outline
(b) Activity-Based Costing
(ABC)
Understand ABC and how it differs from
traditional costing system
Compute activity rates for cost pools
Assign costs to the cost object
Use ABC to compute product and customer
margin
Understand the usefulness and limitations of
ABC
2016-17-T1-Aug to Dec 2016

30

OH Allocation Traditional vs ABC


E.g. LMN company produces Product A and
Product B.
The products are first cut by machines in the
Machining Dept and then manually
assembled
Machinin
in the Assembly Dept.
g
Assembly
Overhead costs
Machine rental, electricity, etc.
Supervisor salary

$90,000
$10,000

Resources consumed in the depts:


By Product A (machine hours)
2,500
By Product B (machine hours)
7,500
By Product A (DLH)
2,000
By Product B (DLH)
18,000
Total resources consumed
in
10,000 MH
20,000 DLH
2016-17-T1-Aug to Dec 2016
31
each dept

Single POR: Plantwide Overhead Rate


Plantwide overhead rate: ALL overhead costs
are put into ONE pool and allocated using ONE
cost driver.
Machini Assembl
ng
y
Overhead costs
Machine rental,
electricity, etc.
$90,000
Supervisor salary
$10,000
Single cost
pool
$100,000
If the allocation base is machine
hours,
POR = $100,000/(2,500 + 7,500) MH =
$10.00/MH
OH Applied to Product A = $10 x 2,500 MH =
$25,000
OH Applied to Product B = $10 x 7,500 MH =
2016-17-T1-Aug to Dec 2016
32
$75,000

Departmental Overhead Rates


Departmental overhead rates: ONE overhead
allocation rate for EACH department to enable
each department to use the most appropriate
allocation base in determining the overhead
allocation rate.
Machining Dept will use machine hours as the
allocation base.
POR (Maching Dept) = $90,000/10,000MH =
Assembly Dept where parts are manually put
$9/MH
together will use direct labour hours as the
allocation base.
POR (Assembly Dept) = $10,000/20,000DLH =
$0.5/DLH
2016-17-T1-Aug to Dec 2016

33

Departmental Overhead Rates


OH Applied to Product A
= $9/MH x 2,500MH (share of Machining Dept
OH)
+ $0.5/DLH x 2,000DLH (share of Assembly
Dept OH)
= $23,500
OH Applied to Product B
= $9/MH x 7,500MH (share of Machining Dept
OH)
+ $0.5/DLH x 18,000DLH (share of Assembly
Dept OH)
= $76,500
2016-17-T1-Aug to Dec 2016

34

Overhead Application Single POR vs


Dept Rates
Machini Assembl
Total OH
ng
y
$100,00
0
$90,000

Overhead costs
Machine rental,
electricity, etc.
Supervisor salary
$10,000
$100,000 Overhead
Allocated to:
Product A Product B

Total

Plantwide
rate

$25,000

$75,000

$100,000

Dept rate

$23,500

$76,500

$100,000

2016-17-T1-Aug to Dec 2016

35

Illustration LMN Co. with more


details about
OH
Machining
Assembly
Product design
$70,000
Setup for each production run
$9,000
Machine rental
$5,000
Electricity
$6,000
Supervisor salary
$10,000
Total overhead costs
$90,000
$10,000
Resources consumed to produce the products:
Product A
Product B
Product design time
18 hours
2 hours
Total production qty
5,000 units
25,000 units
Qty per production run
2,000 units
5,000 units
Machine hour per unit
0.5 hr
0.3 hr
Kwh per unit
0.1 kwh
0.1 kwh
Direct labour hour per unit
0.4 hr
0.72 hr
Fair to allocate $90,000 Machining Dept OH to Prod A
and Prod B using machine hours?
2016-17-T1-Aug to Dec 2016

36

Activity-Based Costing (ABC)


Activity

Consumption of
Resources in the
Activity depends on:

Design

Complexity of the design;


no. of designs for each
product

Activity Driver

Set up the Frequency of setup; time


machines spent for each setup time
Production

Machine
rental

Machine hrs used; no. of


units produced

Electricit
y

Kwh used; no. of units


produced

Supervisi No. of production


on
workers;
no. oftoDLH;
2016-17-T1-Aug
Dec 2016no.

37

Activity-Based Costing (ABC)


Cost Objects generate
(e.g., products
Activities
and customers)

Trace
Trace &
&
Allocate
Allocate
using
using
Activities
Activities

2016-17-T1-Aug to Dec 2016

Consumption
of Resources

Cost

38

Types of Activities and their Cost


Drivers
Cost
UNIT-LEVEL ACTIVITIES
Are performed each time a unit is produced e.g. cost
of machine operations
BATCH-LEVEL ACTIVITIES
Are performed each time a batch is handled or
processed, regardless of how many units are in the
batch e.g. machine setup cost
PRODUCT-LEVEL ACTIVITIES
Are performed to produce and sell a specific product
or service e.g. product design cost; product
advertising cost
CUSTOMER-LEVEL ACTIVITIES
Are performed to serve specific customers; not tied to
any product e.g. shipment cost, sales calls
FACILITY-LEVEL or ORGANISATIONAL-SUSTAINING
ACTIVITIES
Are performed to provide general capacity to produce
goods or services e.g. factory rental cost;
providing computer network
2016-17-T1-Aug to Dec 2016

39

driven by
volume
(no. of
units) of
production

Cost NOT
driven by
volume of
production

ABC Overview and Steps


Direct
Direct Costs
Costs

Overhead
Overhead Costs
Costs

First Stage
Allocation
Trace

Cost
Cost Pool
Pool Cost
Cost Pool
Pool Cost
Cost Pool
Pool
Second

Driver
Driver

Driver
Driver

Driver
Driver

Stage

Activity
Activity
Activity
Activity Rate
Rate
Activity Rate
Rate
Activity Rate
Rate
Allocation
Cost
Cost Objects:
Objects:
Products,
Products, Customer
Customer Orders,
Orders, Customers
Customers
2016-17-T1-Aug to Dec 2016

40

ABC Illustration: First Stage Allocation


(LMN Co.)
Step 1) Identify cost pools.

Activity

Overhead Cost

Product design
Setup for each
production run

$70,000

Machine rental

$5,000

Electricity

$6,000

Supervisor salary

$10,000

$9,000

Total overhead costs

2016-17-T1-Aug to Dec 2016

$100,000

41

ABC Illustration: Identify Activity


Drivers

Step 2a) Identify activity driver for


each activity.
Activity
Overhead
Cost
Activity
Cost
Hierarchy
Driver
Product design $70,000 Product level Design
hours
Setup for each
$9,000
Batch level
No. of
production run
setups
Machine rental
$5,000
Unit level
Machine
hours
Electricity
$6,000
Unit level No. of units
Supervisor
$10,000
Unit level
DLH
salary
Total
$100,000
overhead
2016-17-T1-Aug to Dec 2016
42
costs

ABC Illustration: Determine Cost


Allocation
Base
Step 2b) Determine
cost allocation
base for each

Product A Product B
activity using given info:
Product design time
18 hours
2 hours
25,000
Total production qty
5,000 units
units
Qty per production
run
2,000 units 5,000 units
Machine hour per unit
0.5 hr
0.3 hr
Kwh per unit
0.1 kwh
0.1 kwh
Direct labour hour per
unit
0.4 hr
0.72 hr

Cost
Allocation
Base
No. of design hours
18 hrs
2 hrs
20 design hrs
No. of setups
3 setups
5 setups
8 setups
Machine hours
2,500
10,000 MH
2016-17-T1-Aug
to Dec 2016 7,500
43

ABC Illustration: Compute Activity


Rates
Step 2c) Compute the Activity Rates
Overhea
d
Step 1
Product
design
Setup
Machine
rental
Electricity
Supervisor
salary

$5,000

Cost
Activity Rate
Allocation
Step 2c
Base
Step 2a, 2b
20 design hrs $3,50 per design
0
hr
8 setups
$1,12 per setup
5
10,000 MH $0.5 per MH

$6,000
$10,000

30,000 units
20,000 DLH

$70,000
$9,000

2016-17-T1-Aug to Dec 2016

$0.2 per unit


$0.5 per DLH

44

ABC Illustration: Allocate OH to


Products (LMN)

Step 2d) Allocate or Apply OH to the


Applied OH
Products.
Overhe Activity Rate Product Produc Produ Produ Total
ad
A
tB
ct A ct B
Product $3,500 per
18 hrs
2 hrs $63,0 $7,000 $70,000
design
design
00
hr
Setup
$1,125 per
3 setups
5
$3,37 $5,625 $9,000
setup
5
Machine $0.5 per MH
2,500
7,500 $1,25 $3,750 $5,000
rental
0
Electricit $0.2 per unit 5,000
25,000 $1,00 $5,000 $6,000
y
0
Supervis $0.5 per DLH 2,000
18,000 $1,00 $9,000 $10,000
or
0
Total
$69,6 $30,3 $100,00
25
75
0
2016-17-T1-Aug to Dec 2016

45

Traditional & ABC Compared


HighAllocated OH to: volume,
Low-volume,
complex
Product A Product simple
B
Total
product
Production
5,000
25,000product

Qty

units

units

Plantwide
rate

$25,000

$75,000

$100,000

Dept rates
ABC

$23,500
$69,625

$76,500
$30,375

$100,000
$100,000

Using traditional method (i.e. Plantwide rate and


Dept rates),
Product ___A_ will be undercosted; and
Product __B__ will be overcosted.
=> Cross-subsidization
2016-17-T1-Aug to Dec 2016

46

Customer Profitability Report: using


ABC
Jet Ltd uses ABC to allocate overhead:
Activity Pool
Activity Rate
Machining
$20.00
per
Order processing
$250.00
per
Design
$300.00
per
Customer service
$400.00
per

unit
order
design
customer

Prepare the customer profitability report for


Customer NJK who ordered the following products
during the year.

Standard Model Custom Model


Total no. of units
20
4
No. of orders
2
3
No. of designs
0
3
Selling price per
unit
$1,000
$2,000
Prime cost per unit
$100
$200
2016-17-T1-Aug to Dec 2016

47

Custom
Dont b

Customer Profitability Report: using


ABC
Customer Margin for
Customer NJK

Sales
Less
Prime Costs
Machining
Order
processing
Design
Customer
service
Customer
Margin

Standard
Model
$20,000

Custom
Model
$8,000

Total
$28,000

$2,000
$400

$800
$80

$2,800
$480

$500
$0

$750
$900

$1,250
$900
$400

2016-17-T1-Aug to Dec 2016

48

$22,170

Benefits & Limitations of ABC


Benefits
Focus on activities
Which activities add value and which do
not
Identify non-value add activities -eliminate waste, decrease processing
time, and reduce defects
Do not eliminate subjectivity but more
accurate cost information for making
Limitations
decisions, performance measures,
Costly
and time-consuming
to implement
profitability
assessment
and maintain
May not conform to accounting standards
2016-17-T1-Aug to Dec 2016

49

Traditional Product Costing vs ABC


Companies use ABC for the purposes of
managing overhead and making decisions.
ABC is ordinarily used as a supplement to,
rather than as a replacement for, a
companys usual costing system. Most
organisations that use ABC have 2 costing
systems the official costing system that is
used for preparing external financial reports
and the ABC for internal decision-making
and for managing activities.

2016-17-T1-Aug to Dec 2016

50

Traditional Product Costing vs ABC


Traditional Cost
Systems
Use allocation bases that
are driven by volume of
production e.g. number
of units produced, DL
hours, Machine hours, etc.
ALL manufacturing costs
are assigned to products

ABC
Use allocation bases that
can be driven by volume of
production (no. of units);
batches; products;
customers; organisation
Some manufacturing costs
may not be allocated to
products if there is no
appropriate cost driver
avoid arbitrary allocation
e.g. cost of factory security
guards; cost of idle capacity

Some non-manufacturing
ALL non-manufacturing
costs may be assigned
to
costs are expensed2016-17-T1-Aug
off
to Dec 2016
51
product e.g. shipping cost