11/25/2016 Accounting II Chapter 17 Outline | Evernote Web Accounting II Chapter 17 Outline ActivityBased Costing and Analysis CONCEPTUAL Distinguish between the Plantwide Overhead Rate Method, and the Activity BasedCosting Method Reminder: Goal of Managerial Accounting Activities like product pricing, product mix decisions, and cost control depend on accurate product cost information. Distorted cost info can lead to poor decisions So ensuring this information is accurate and updated is key to yielding profit Since prices are set by Supply and Demand, managers must assess whether the market is worth entering by looking at product costs — which gives insight into efficiency Since overhead is not directly related to products, it must be allocated somehow and overhead costs as a percentage of total costs have been steadily increasing which makes it more relevant to control costs as best as possible 3 Overhead Allocation Methods Single Plantwide Overhead Rate Method Departmental Overhead Rate Method More accurate cost allocations than Single Rate AcitvtiyBased Costing Method Focuses on a captivities and the costs of executing. https://www.evernote.com/Home.action#n=39b33d36a0774468954b2cb5051a27b7&b=4fae50684571494cb3c9996c9ae98ad4&ses=4&sh=1&sds=5& 1/9 11/25/2016 Accounting II Chapter 17 Outline | Evernote Web Explain Cost Flows for Activity Based Costing Key Term — ActivityBased Costing (ABC): Attempts to more accurately assign overhead costs to the users of overhead by focusing on Activities Activity: Task, operation, procedure that causes costs to be incurred Fortunately, all activities of an organization can be linked to an activity or use of resources Activity Cost Pool: Collection of costs that are related to the same or similar activity Activity Overhead Pool Rate: Costs that are incurred by the same activity that reduces the number of cost assignments required 2 Stage Process 1. Identify Costs of Activities (Cost Objects) 1. Match those activities with the costs they drive 2. Group Homogenous Activities (Caused by the same factor) into an Activity Cost Pool 3. Compute an Activity Rate for each Cost Pool 4. Use rate to Allocate OH costs to product (Cost objects of second stage) Describe the Four Types of Activities that Cause Overhead Costs Unit Level Activities Performed on each product unit Ex: electricity to power machinery to produce each unit of product Craftsmanship pool Change with the number of units produced Batch Level Activities Activities performed each time a batch is handled/processed regardless of how big/small it is Ex: Setup Pool Product Level Activities Specific to prodcuts — independent of units produced or batches handled Ex: designmodification Facility Level Activities Activities that relate to overall production and cannot be traced to specific products Pertain to plant’s general manufacturing process Ex: Plant services https://www.evernote.com/Home.action#n=39b33d36a0774468954b2cb5051a27b7&b=4fae50684571494cb3c9996c9ae98ad4&ses=4&sh=1&sds=5& 2/9 11/25/2016 Accounting II Chapter 17 Outline | Evernote Web ANALYTICAL Identify and Assess Advantages and Disadvantages of the Plant wide Overhead and Departmental Overhead Rate Methods Advantages Based on readily available information, like direct labor hours Easy to interpret Consistent with GAAP and can be used for external reporting needs Disadvantage OH costs are often too complex to be explained by one single factor Technological advances lower direct labor costs Plantwide Overhead Method Critical Assumptions OH costs change with allocation base All products use OH costs the same proportions Advantage For Which makes this useful for companies with labor intensive operations Disadvantage For Companies with many different products, or products that use OH differently Can distort costs when costs aren’t related to the allocation base (like depreciation) Departmental OH Rate Method More refined than the Plantwide Method Critical Assumptions Different products are similar in volume, complexity, and batch size OH Costs are directly proportional to the department allocation base Disadvantage When products differ in batch size and complexity, they consume different amounts of OH Allocation based on measures closely related to production can lead to failure to properly and accurately assign OH costs based on measures closely related to production, some costs can be improperly reflected (Depreciation, Utility) Identify and Assess Advantages and Disadvantages of ActivityBased Costing Advantages More Accurate Overhead Cost Allocation Most firms use Plantwide OH or Departmental, because its more straightforward for external reporting https://www.evernote.com/Home.action#n=39b33d36a0774468954b2cb5051a27b7&b=4fae50684571494cb3c9996c9ae98ad4&ses=4&sh=1&sds=5& 3/9 11/25/2016 Accounting II Chapter 17 Outline | Evernote Web Overhead costs to a product are allocated based on the resources a product consumes rather than the units produced More Cost pools Costs in each pool are most similar Allocation is based on the actual activities that cause overhead costs More Effective Overhead Cost Control Sometimes allocation bases aren’t reflective of actual cost drivers This can lead to mispricing, and a poor grasp of costs because these drivers can be misleading ABC can be used to ID activities that can benefit from process ABC helps managers control overhead directly by focusing on processes ABC directly influences the ability to make pricing decisions Focus on Relevant Factors ABC costing can be used to manage any cost deemed as relevant be it Marketing, design, other “period” costs Better Management of Activities Managers must use resources efficiently — this ultimately comes down to cost control Actvity Based Management Costs of Quality The focus on activities allows for monitoring the CoQ — the costs resulting form manufacturing defective products or providing services that do no meet customer expectations Prevention and Appraisal costs are incurred before a good/service is provided They reduce the chance the customer is provided a defective good/service Prevention focuses on quality training and improvement programs to ensure quality is built into the product or service Appraisal costs include inspections to ensure materials and supplies meet standards Internal Failure Costs are incurred before a good or service is provided to a customer Costs: Reworking products, reinspecting reworked products, scrap External Failure Costs incurred after a customer has been provided a defective product/serve Costs: Warranty repairs, costs of recalling products Focus on activities and quality costs can lead to higher quality and lower costs Disadvantages of ActivityBased Costing Costs to Implement and maintain ABC Designing and implementing ABC requires management commitment and financial resources Thorough analysis of cost activities Collecting and analyzing cost data and maintaining ABC are expensive Uncertainty with Decisions Remains Decision making require human input and analysis which subjects it to error PROCEDURAL Allocate overhead costs to products using the PlantWide Overhead Rate Method Cost Flows under Plantwide Overhead Rate Method https://www.evernote.com/Home.action#n=39b33d36a0774468954b2cb5051a27b7&b=4fae50684571494cb3c9996c9ae98ad4&ses=4&sh=1&sds=5& 4/9 11/25/2016 Accounting II Chapter 17 Outline | Evernote Web The Target of the Cost Assignment/Cost Object — unit of product Direct labor hours, direct labor cost dollars, machine hours, etc. When overhead costs are closely related to these measures, its logical to use it Applying the Plantwide Overhead Rate Method Overhead is combined into one giant cost pool Cost pool is divided by the allocation base Rate is applied to cost objects by multiplying it by the Cost Object per Unit Example Allocate Overhead Costs to Products Using the Departmental Overhead Rate Method https://www.evernote.com/Home.action#n=39b33d36a0774468954b2cb5051a27b7&b=4fae50684571494cb3c9996c9ae98ad4&ses=4&sh=1&sds=5& 5/9 11/25/2016 Accounting II Chapter 17 Outline | Evernote Web Departmental OH Rate Method typically results in more accurate overhead allocations than the Plantwide OH Rate Method Cost Flows Under Departmental Overhead Rate Method Many firms have departments that produce different products and as a result consume overhead resources in different ways If the consumption of overhead is different, then the standard blanket method of the Plantwide system wouldn’t accurately reflect costs Which is why the Departmental Overhead Rate Method uses a different overhead rate for each production department. This must be done through 2 Stages 1st with the Departments themselves Separate OH Rates are determined for each department Each department has its own OH rate and allocation base 2nd with the Cost Objects Example https://www.evernote.com/Home.action#n=39b33d36a0774468954b2cb5051a27b7&b=4fae50684571494cb3c9996c9ae98ad4&ses=4&sh=1&sds=5& 6/9 11/25/2016 Accounting II Chapter 17 Outline | Evernote Web Allocate Overhead Costs to Produce using ActivityBased Costing Ex: Identify total costs Identify cost pools Identify cost drivers https://www.evernote.com/Home.action#n=39b33d36a0774468954b2cb5051a27b7&b=4fae50684571494cb3c9996c9ae98ad4&ses=4&sh=1&sds=5& 7/9 11/25/2016 Accounting II Chapter 17 Outline | Evernote Web Assigning OH to Products https://www.evernote.com/Home.action#n=39b33d36a0774468954b2cb5051a27b7&b=4fae50684571494cb3c9996c9ae98ad4&ses=4&sh=1&sds=5& 8/9 11/25/2016 Accounting II Chapter 17 Outline | Evernote Web https://www.evernote.com/Home.action#n=39b33d36a0774468954b2cb5051a27b7&b=4fae50684571494cb3c9996c9ae98ad4&ses=4&sh=1&sds=5& 9/9
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