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Cost Assignment

Overview

Cost Assignment
Product/Service Costing
Cost Assignment Systems

Actual, Normal, Budgeted & Standard Costing

Normal Costing System


Indirect Cost Assignment
Traditional Volume-Based Costing vs.
Activity-Based Costing

Cost Assignment
Direct Costs
traced

Cost Object
allocated
on the basis of cost
drivers/activity levels

Indirect Costs

Product Costing
Direct Materials,
Direct Labour
traced

Product
allocated
on the basis of cost
drivers/activity levels

Indirect Manufacturing
Costs

Service Costing
Direct Labour
traced

Service
allocated
on the basis of cost
drivers/activity levels

Indirect Costs

Cost Assignment Systems

Actual costing
Normal costing

Budgeted costing

low volume of customized products

customized service

Standard costing

high volume of homogeneous (standard)


products

Actual Costing
Direct costs
e.g., direct materials
direct labour

Actual input quantity


X
Actual input (price) rate

Indirect costs
e.g., indirect
manufacturing
costs

Actual input quantity


X
Actual indirect cost rate

Class Example
Actual Costing
Actual Operating Data
Units produced
Direct materials
Direct labour
Variable manufacturing OH
Fixed manufacturing OH
Cost per unit

January
5,000
$10,000
$30,000
$5,000
$75,000

February
2,000
$4,000
$12,000
$2,000
$75,000

Drawbacks of Actual Costing

Normal Costing (Manufacturing)


Direct costs
e.g., direct materials
direct labour

Actual input quantity


X
Actual input (price) rate

Indirect costs
e.g., indirect
manufacturing
costs

Actual input quantity


X
Budgeted indirect cost rate

Budgeted Costing (Service)


Direct costs
e.g., direct labour

Actual input quantity


X
Budgeted input (price) rate

Indirect costs
e.g., administrative
support costs

Actual input quantity


X
Budgeted indirect cost rate

Standard Costing
Direct costs
e.g., direct materials
direct labour

Standard input quantity


X
Budgeted input (price) rate

Indirect costs
e.g., indirect
manufacturing
costs

Standard input quantity


X
Budgeted indirect cost rate

Comparison of
Cost Assignment Systems
Actual
Direct costs
e.g., DM, DL

Normal

Budgeted

Standard

Actual input Actual input


Actual input
Standard input
quantity
quantity
quantity
quantity
X
X
X
X
Actual input Actual input
Budgeted input Budgeted input
(price) rate (price) rate
(price) rate
(price) rate

Actual input
Indirect costs
quantity
e.g., OH
X
Actual rate

Actual input
Actual input
quantity
quantity
X
X
Budgeted rate Budgeted rate

Standard input
quantity
X
Budgeted rate

Normal Costing
indirect cost allocated =
actual input qty x budgeted indirect cost rate

WHERE
budgeted indirect cost rate =
budgeted indirect cost / denominator activity

overhead allocated =
actual input qty x budgeted overhead rate

WHERE
budgeted overhead rate =
budgeted overhead / denominator activity

Budgeted Overhead Rate

Choice of Denominator Activity

Budgeted Overhead

Choice of Denominator Activity

Unit of Measurement

physical units of output


units of input, e.g., Direct Labour Hour (DLH),
Machine Hour (m/c hr)

Level of activity

Theoretical capacity
Practical capacity
Master budget volume
Normal volume

Budgeted Overhead

Monthly budget
Quarterly budget
Annual budget

Class Example
Normal Costing OH Allocation
Budgeted data:
Planned production
= 5,000 units
Planned machine hours for 5,000 units
= 10,000 machine hours
Denominator activity for manufacturing overhead
= 10,000 machine hours
Budgeted overhead
= $30,000
Actual data:
Actual production
= 5,000 units
Actual machine hours for 5,000 units produced
= 10,400 machine hours
Actual overhead
= $32,500

Class Example
Normal Costing OH Allocation
Budgeted OH rate
OH allocated
Over- (Under-) allocated OH

Adjustments of Normal Costing

Underallocated overhead

Overallocated overhead

Underallocated Overhead
If

actual overhead
> overhead allocated

then
difference = underallocated overhead

Underallocated overhead arises due to poor


performance
a)
increase cost of goods sold, if
insignificant
b)
increase work in process, finished goods,
and cost of goods sold on a pro rata
basis, if significant

Overallocated Overhead
If

actual overhead
< overhead allocated

then
difference = overallocated overhead

Overallocated overhead arises due to good


performance
a)
decrease cost of goods sold, if
insignificant
b)
decrease work in process, finished goods,
and cost of goods sold on a pro rata
basis, if significant

Class Example:
Budgeted Costing
Taylor and Associates, a consulting firm uses a
budgeted costing system. It has a single
direct cost category (professional labour) and
a single indirect cost category (client
support). Indirect costs are allocated to
jobs/clients on the basis of professional
labour costs.
The condensed budget for Year 10 for Taylor
and Associates is given as follows:

Class Example:
Budgeted Costing
Revenues

$20,000,000

Total costs
Direct costs

Professional labour

$ 5,000,000

Indirect costs

Client support

13,000,000

Total costs

$18,000,000

Operating income

$ 2,000,000

Class Example:
Budgeted Costing
1.

2.

3.

Compute the budgeted indirect cost rate for Taylor


and Associates.
Determine the markup % of professional labour costs
to produce a 10% operating income-to-revenue
margin.
Taylor is bidding for a consulting job for Red Rooster.
The budgeted breakdown of professional labour on the
job is 3 hours of director, 16 hours of partner, 40
hours of associate and 160 hours of assistant whose
wage rate are $200, $100, $50 and $30, respectively.
Compute the budgeted costs and bidding price for the
Red Rooster job.

Indirect cost rate


Budgeted indirect cost rate

Markup Percentage
Revenue to professional labour costs

Markup % of professional labour costs

Red Roosters Bid


Budgeted professional labour costs

Bidding price

Red Roosters Profitability


Revenue
Contract Costs
Professional labour costs
Indirect costs
Total costs
Operating income
Operating income to revenue

Indirect Cost Assignment

Traditional Volume-Based Costing

Activity Based Costing

Cost Assignment Example


Product
Units produced
Number of batches
m/c hour per unit
DM & DL per unit

Red pen Orange pen


1,000,000 units 10,000 units
10 batches
0.01 m/c hr
$0.05

10 batches
0.01 m/c hr
$0.05

Total machine setup costs for the production period


were $1,010.

Traditional Volume-Based Costing


Direct Costs
traced

Cost Object
allocated on the basis
machine hours

Indirect Costs

Traditional Volume-Based Costing


Product
DM & DL
Indirect costs
Total product costs
Product costs/unit
Indirect costs rate

Red Pen Orange Pen

Activity-Based Costing
Direct Costs
traced

Cost Object

Indirect Costs

Cost Assignment Example


Product
DM & DL
Indirect costs
Total product costs
Product costs/unit
Indirect costs rate

Red Pen

Orange Pen

Cost Assignment Example


Product cost per unit
Traditional Volume-Based
Costing

Activity-Based Costing

Red Pen

Orange Pen

Traditional Volume-Based Costing

one indirect cost pool, one cost driver


volume-based cost driver, e.g., DLH,
m/c hr
Problems

does not reflect resource consumption


overcosting high volume products
undercosting low volume products

Activity Based Costing

two-stage cost assignment system;


more than one indirect cost pools;
more than one cost drivers
volume-based and non-volume-based
cost drivers (e.g., batches)
cause-effect relationship between
activity cost pools and cost drivers

Activity-Based Costing
Stage 1:

Resources
Trace costs of resources to
activities

Activities

Stage 2:

Activity Cost Pools


Cost assignment
using activity drivers

Cost Object
Direct Cost

Cost tracing

Benefits of Activity Based Costing

More accurate product costing

Cause-effect relationship between cost drivers


and activity costs
Reflects resource consumption
Hierarchical classification of costs (i.e., unitlevel, batch-level, product-level, facility-level)

Better product decision-making


Activity-based management (value-added
activities vs. non-value-added activities)

Applications of
Activity-Based Costing

Product profitability analysis

Customer profitability analysis

Product Profitability Analysis

More accurate product costing

Diverse products
Complex production process
Products with short life cycle
Strong competition

Customer Profitability Analysis

More accurate customer costing in


assessing profitability of specific
customers or group of customers

Customer specific costs


Distribution channel costs
Customer support costs
Corporate sustaining costs

Customer profitability profile

Class Example
Activity-Based Costing
Gideon specializes in manufacturing two
models of the desktop DNA machine: The
Diagnostic and The Profiler.

Operating data for October are as follows:


Costs
Direct materials

The Diagnostic

The Profiler

$5.50 per unit

$26.50 per unit

Direct labour

$28 per DLH $19,600

$19,600

Materials
handling

$7,200

5 setups

10 setups

Machining

$9,800

210 m/c hours

490 m/c hours

Assembly

$3,230

600 units

350 units

Quality control

$1,820

5% of units made 10% of units made

Indirect manufacturing costs include the materials handling,


machining, assembly and quality control activities.

1.

2.

Determine the cost per unit with one single


indirect cost pool using DLH as the cost
driver.
Determine the cost per unit using activitybased costing.

Traditional Volume-Based Costing


Direct labour hours

Indirect cost rate

Traditional Volume-Based Costing


The
Diagnostic

Direct materials
Direct labour
Indirect mfg costs
Total manufacturing costs
Units produced
Cost per unit

The
Profiler

Activity-Based Costing
Activity
Materials
handling
Machining
Assembly
Quality
control

Driver

Rate

Activity- Based Costing


Direct materials
Direct labour
Materials handling @$48
Machining @$14
Assembly @$3.40
Quality control @$28

Total manufacturing costs


Cost per unit

Diagnostic
Profiler
$1,650
$15,900
19,600

19,600