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7/7/2013 1
11
Cost Allocation and
Activity-Based
Costing
Student Version
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1
Identify three methods
used for allocating factory
overhead costs to
products.
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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.
Product Costing
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Product Costing Allocation Methods
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2
Use a single plantwide
factory overhead rate
for product costing.
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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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Total budgeted factory overhead costs
Total budgeted plantwide allocation base
Computing Single Plantwide
Factory Overhead
$80 per direct
labor hour
=
$1,600,000
20,000 direct labor hours
(1,000 10 dlh) + (1,000 10 dlh)
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Snowmobile:
$80 per dlh 10 direct labor hours = $800
Lawnmower:
$80 per dlh 10 direct labor hours = $800
Factory
Overhead
Cost per Unit
2
Computing Single Plantwide
Factory Overhead
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3
Use multiple production
department factory
overhead rates for
product costing.
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Production Department Factory
Overhead Rates and Allocation
Fabrication Department Overhead Rate:
$1,030,000
10,000 direct labor hours
= $103 per dlh
Assembly Department Overhead Rate:
$570,000
10,000 direct labor hours
= $57 per dlh
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Allocating Factory Overhead
to ProductsRuiz Company
Exhibit 3
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Exhibit 4
Multiple Production Department
Rate MethodRuiz Company
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Distortion of Product Costs
The differences in factory overhead
for each product using the two
methods are shown below:
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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.
(continued)
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Condition 2: Differences among products in
the ratios of allocation base usage within a
department and across departments.
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Exhibit 5
Conditions for Product Cost
DistortionRuiz Company
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4
Use activity-based
costing for product
costing.
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The activity-based costing
(ABC) methodfocuses on the
cost of activities and then
allocates these costs to products
using a variety of activity bases.
Activity-Based Costing
(ABC) Method
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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
Activity Cost Pool Amount
Ruiz Company Example
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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 =
Budgeted Activity Cost
Activity Base
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Additional Data About the
Two Products
(continued)
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Additional Data About the
Two Products
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Exhibit 7
Activity BasesRuiz Company
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Exhibit 8
Activity RatesRuiz Company
Snowmobile 8,000 $53 $424,000
Lawnmower 2,000 53 106,000
Total 10,000 $530,000
Fabrication: DL Hours Rate Total
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(continued)
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Snowmobile 2,000 $7 $14,000
Lawnmower 8,000 7 56,000
Total 10,000 $70,000
Assembly: DL Hours Rate Total
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Exhibit 8
Activity RatesRuiz Company
(continued)
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4
Exhibit 8
Activity RatesRuiz Company
Snowmobile 100 $4,000 $400,000
Lawnmower 20 4,000 80,000
Total 120 $480,000
Setup: Setups Rate Total
(continued)
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4
Exhibit 8
Activity RatesRuiz Company
(continued)
Snowmobile 100 $3,000 $300,000
Lawnmower 4 3,000 12,000
Total 104 $312,000
Quality Control: Inspts. Rate Total
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Exhibit 8
Activity RatesRuiz Company
Snowmobile 12 $13,000 $156,000
Lawnmower 4 13,000 52,000
Total 16 $208,000
Engineering: Changes Rate Total
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Exhibit 9
Activity-Based Product
Cost Calculations
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Additional Data About the
Two Products
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5
Use activity-based
costing to allocate selling
and administrative
expenses to products.
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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.
Abacus Company Example
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Warranty Claim
Activity Rate
=
Budgeted Warranty
Claim Expenses
Estimated
Warranty Claims
Warranty Claim
Activity Rate
=
$150,000
100 claims
Warranty Claim
Activity Rate
= $1,500 per claim
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