26
Cost Allocation and
Activity-Based
Costing
Student Version
26-1
1-1
1
Identify three methods
used for allocating factory
overhead costs to
products.
26-2
1-2
1
Product Costing
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1-3
Most companies have accounting
systems that trace revenues to
individual product lines. In
addition, they need to subtract the
cost of manufacturing their product
from revenues in order to
determine the profit from sales.
Determining the cost of the product
is termed product costing.
1
Product Costing Allocation Methods
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1-4
2
Use a single plantwide
factory overhead rate
for product costing.
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1-5
2
Ruiz Company Illustration
Ruiz Company manufactures two
products, snowmobiles and
lawnmowers. Both products are
manufactured in a single factory.
There is $1,600,000 of factory
overhead budgeted for the period.
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2
Ruiz Company Illustration
Each product is budgeted 10,000 direct
labor hours as shown below:
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1-7
2
Computing Single Plantwide
Factory Overhead
Total budgeted factory overhead costs
Total budgeted plantwide allocation base
$1,600,000
$80 per direct
= labor hour
20,000 direct labor hours
(1,000 × 10 dlh) + (1,000 × 10 dlh)
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1-8
2
Computing Single Plantwide
Factory Overhead
Snowmobile:
$80 per dlh × 10 direct labor hours = $800
Lawnmower:
$80 per dlh × 10 direct labor hours = $800
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1-9
Factory
Overhead
Cost per Unit
3
Use multiple production
department factory
overhead rates for
product costing.
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1-10
3
Production Department Factory
Overhead Rates and Allocation
Fabrication Department Overhead Rate:
$1,030,000
= $103 per dlh
10,000 direct labor hours
Assembly Department Overhead Rate:
$570,000
= $57 per dlh
10,000 direct labor hours
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3
Exhibit 3
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1-12
Allocating Factory Overhead
to Products—Ruiz Company
3
Exhibit 4
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Multiple Production Department
Rate Method—Ruiz Company
3
Distortion of Product Costs
The differences in factory overhead
for each product using the two
methods are shown below:
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3
In general, the following conditions may indicate
that a single plantwide factory overhead rate will
lead to distorted product costs.
Condition 1: Differences in production
department factory overhead rates.
Condition 2: Differences among products in
the ratios of allocation base usage within a
department and across departments.
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1-15
(continued)
3
Exhibit 5
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1-16
Conditions for Product Cost
Distortion—Ruiz Company
4
Use activity-based
costing for product
costing.
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4
Activity-Based Costing
(ABC) Method
The activity-based costing
(ABC) method focuses on the
cost of activities and then
allocates these costs to products
using a variety of activity bases.
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1-18
4
Ruiz Company Example
Activity Cost Pool
Amount
Fabrication
$ 530,000
Assembly
70,000
Setup
480,000
Quality control inspections
312,000
Engineering changes
208,000
Total budgeted factory overhead costs $1,600,000
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1-19
4
Activity Rates
The activity cost pools are
assigned to products, using factory
overhead rates for each activity.
These rates are called activity
rates.
Activity Rate =
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1-20
Budgeted Activity Cost
Activity Base
4
Additional Data About the
Two Products
(continued)
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4
Additional Data About the
Two Products
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4
Exhibit 7
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Activity Bases—Ruiz Company
4
Exhibit 8
Fabrication:
Snowmobile
Lawnmower
Total
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1-24
Activity Rates—Ruiz Company
DL Hours
8,000
2,000
10,000
(continued)
Rate
$53
53
Total
$424,000
106,000
$530,000
4
Exhibit 8
Assembly:
Snowmobile
Lawnmower
Total
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1-25
Activity Rates—Ruiz Company
DL Hours
2,000
8,000
10,000
(continued)
Rate
$7
7
Total
$14,000
56,000
$70,000
4
Exhibit 8
Setup:
Snowmobile
Lawnmower
Total
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1-26
Activity Rates—Ruiz Company
Setups
100
20
120
Rate
$4,000
4,000
(continued)
Total
$400,000
80,000
$480,000
4
Exhibit 8
Activity Rates—Ruiz Company
Quality Control:
Snowmobile
Lawnmower
Total
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1-27
Inspts. Rate
100
$3,000
4
3,000
104
(continued)
Total
$300,000
12,000
$312,000
4
Exhibit 8
Engineering:
Snowmobile
Lawnmower
Total
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1-28
Activity Rates—Ruiz Company
Changes
Rate
12
$13,000
4
13,000
16
Total
$156,000
52,000
$208,000
4
Exhibit 9
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Activity-Based Product
Cost Calculations
4
Additional Data About the
Two Products
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5
Use activity-based
costing to allocate selling
and administrative
expenses to products.
20-31
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1-31
5
Abacus Company Example
The selling and administrative expenses
of Abacus Company are allocated to its
two products, Ipso and Facto, on the basis
of warranty claims. Abacus Company has
a budgeted cost of $150,000. One
hundred warranty claims are estimated for
the period.
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1-32
5
Warranty Claim
=
Activity Rate
Warranty Claim
Activity Rate =
Budgeted Warranty
Claim Expenses
Estimated
Warranty Claims
$150,000
100 claims
Warranty Claim
= $1,500 per claim
Activity Rate
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