Chapter 25

Cost Allocation and

Activity-Based Costing
Financial and Managerial Accounting
8th Edition
Warren Reeve Fess
© Copyright 2004 South-Western, a division
PowerPoint Presentation by Douglas Cloud of Thomson Learning. All rights reserved.
Professor Emeritus of Accounting
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 Objectives
1. Identify three methods used for
After studying
allocating factory overheadthis costs to
products. chapter, you should
be able to:
2. Use a single plantwide factory overhead
rate for product costing.
3. Use multiple production department
factory overhead rates for product
costing.
4. Use activity-based costing for product
costing.
 Objectives
5. Use activity-based costing to allocate
selling and administrative expenses to
products.
6. Use activity-based costing in a service
business.
Product Costing Allocation Methods
Plantwide Overhead Rate

Single Rate
P
Multiple Department Rates R
O
Department D
Department U
C
Activity-Based Costing T
Activity S
Activity
Single Plantwide Factory
Overhead Rate
 Computing Single Plantwide
Factory Overhead
Total budgeted factory overhead costs
Total budgeted plantwide allocation base

$1,600,000 $80 per hour

=
20,000 direct labor hours overhead rate
 Computing Single Plantwide
Factory Overhead

Snowmobile:
$80 per dlh x 10 direct labor hours = $800

Lawnmower:
$80 per dlh x 10 direct labor hours = $800
Factory
Overhead
cost per unit
 Plantwide factory
overhead
$1,600,000

$80 per direct labor hour

x 10 direct x 10 direct
labor hours labor hours

Snowmobile Lawnmower
$800 per unit $800 per unit
 The greatest advantage of the
single plantwide overhead rate
is that it is simple and
inexpensive to apply.
 Multiple Production
Department Factory
Overhead Rate Method
Single Plantwide Rate

Plantwide factory
overhead

Plantwide rate

Products
Multiple Production Department Rate

Fabrication Assembly
Department Department
factory overhead factory overhead

Fabrication Department Assembly Department

factory overhead rate factory overhead rate

Products
Production Department Factory
Overhead Rates and Allocation

Fabrication Department Overhead Rate:

$1,030,000
= $103 per hour
10,000 direct labor hours

Assembly Department Overhead Rate:

$570,000
= $57 per hour
10,000 direct labor hours
 Production Department Factory
Overhead Rates and Allocation

Snowmobile:
Fabrication: $103 x 8 dlh = $824
Assembly: $57 x 2 dlh = 114 $938
Lawnmower:
Fabrication: $103 x 2 dlh = $206
Assembly: $57 x 8 dlh = 456 $662
 Multiple Production Department
Rate Method—Ruiz Company
Fabrication Assembly
Department Department
$1,030,000 $570,000

$103 x 8 dlh
$57 x 2 dlh

$938 per unit

 Multiple Production Department
Rate Method—Ruiz Company
Fabrication Assembly
Department Department
$1,030,000 $570,000

$57 x 8 dlh
$103 x 2 dlh

$662 per unit

 Distortion in Product Costs—Single
Plantwide versus Multiple Production
Department Overhead Rates
Factory Overhead Cost per Unit

Single Plantwide Multiple Production

Rate Department Rates
Snowmobile $800 $938
Lawnmower 800 662
 Distortion in Product Costs—Single
Plantwide versus Multiple Production
Department Overhead Rates
The single plantwide factory
overhead rate distorts product
cost by averaging high and low
factory overhead costs.
 Conditions for Product Cost
Distortion—Ruiz Company
Fabrication Assembly
Department Department
Condition 1:
Differences in
production $103 per $57 per
department direct direct
factory labor hour labor hour
overhead rates

Continued
 Conditions for Product Cost
Distortion—Ruiz Company

Condition 2: 2 direct
8 direct
Differences in labor hours
labor hours
the ratios of
allocation-base 2 direct 8 direct
usage labor hours labor hours
 Activity-Based Costing Method
 Activity-based costing changes the way
overhead costs are allocated.
 When identifying specific activities,
inefficiencies may be discovered and
eliminated, reducing the product’s cost.
 Traditional cost accounting undercosts
complex products and overstates their
profit margins.
 ABC may be used for decision making but
not necessarily for inventory valuation.
 Multiple Production Department
Factory Overhead versus ABC
Production Department Production Department
Factory Overhead Factory Overhead

Production Department Rates

Products

Continued
 Multiple Production Department
Factory Overhead versus ABC
Activity Activity Activity Activity

Activity Rates

Products
 Activity-Based Costing Method
Activity Amount Activity Rate
Fabrication $ 530,000
Assembly 70,000
Setup 480,000
Quality control 312,000
Engineering 208,000
Total $1,600,000
 Activity-Based Costing Method
Activity Amount Activity Rate
Fabrication $ 530,000 ÷ 10,000 dlh = $53
Assembly 70,000 ÷ 10,000 dlh = $7
Setup 480,000 ÷ 120 setups = $4,000
Quality control 312,000 ÷ 104 inspts. = $3,000
Engineering 208,000 ÷ 16 changes = $13,000
Total $1,600,000

Fabrication: DL Hours Rate Total

Cost Drivers
Snowmobile 8,000 $53 $424,000
Lawnmower 2,000 53 106,000
Total 10,000 $530,000
 Activity-Based Costing Method
Activity Amount Activity Rate
Fabrication $ 530,000 ÷ 10,000 dlh = $53
Assembly 70,000 ÷ 10,000 dlh = $7
Setup 480,000 ÷ 120 setups = $4,000
Quality control 312,000 ÷ 104 inspts. = $3,000
Engineering 208,000 ÷ 16 changes = $13,000
Total $1,600,000

Assembly: DL Hours Rate Total

Snowmobile 2,000 $7 $14,000
Lawnmower 8,000 7 56,000
Total 10,000 $70,000
 Activity-Based Costing Method
Activity Amount Activity Rate
Fabrication $ 530,000 ÷ 10,000 dlh = $53
Assembly 70,000 ÷ 10,000 dlh = $7
Setup 480,000 ÷ 120 setups = $4,000
Quality control 312,000 ÷ 104 inspts. = $3,000
Engineering 208,000 ÷ 16 changes = $13,000
Total $1,600,000

Setup: Setups Rate Total

Snowmobile 100 $4,000 $400,000
Lawnmower 20 4,000 80,000
Total 120 $480,000
 Activity-Based Costing Method
Activity Amount Activity Rate
Fabrication $ 530,000 ÷ 10,000 dlh = $53
Assembly 70,000 ÷ 10,000 dlh = $7
Setup 480,000 ÷ 120 setups = $4,000
Quality control 312,000 ÷ 104 inspts. = $3,000
Engineering 208,000 ÷ 16 changes = $13,000
Total $1,600,000

Quality Control: Inspts. Rate Total

Snowmobile 100 $3,000 $300,000
Lawnmower 4 3,000 12,000
Total 104 $312,000
 Activity-Based Costing Method
Activity Amount Activity Rate
Fabrication $ 530,000 ÷ 10,000 dlh = $53
Assembly 70,000 ÷ 10,000 dlh = $7
Setup 480,000 ÷ 120 setups = $4,000
Quality control 312,000 ÷ 104 inspts. = $3,000
Engineering 208,000 ÷ 16 changes = $13,000
Total $1,600,000

Engineering: Changes Rate Total

Snowmobile 12 $13,000 $156,000
Lawnmower 4 13,000 52,000
Total 16 $208,000
 Activity-Based Costing Method
Cost Allocation Summary:
Activity Snowmobile Mower Total
Fabrication $ 424,000 $106,000 $ 530,000
Assembly 14,000 56,000 70,000
Setup 400,000 80,000 480,000
Quality control 300,000 12,000 312,000
Engineering 156,000 52,000 208,000
Total $1,294,000 $306,000 $1,600,000
Budgeted units 1,000 1,000
Cost per unit $1,294 $306
 Activity-Based Costing Method—Ruiz Company

Quality
Assembl Engineering
Fabrication Setup Control
y Change
Activity Activity Inspectio
Activity Activity
$530,000 $480,000 n Activity
$70,000 $208,000
$312,000

$53 per $7 per $4,000 $3,000 per $13,000 per

dlh dlh per setup inspection engineering
change

$1,294 per unit $306 per unit

 Distortion in Product Costs—Multiple
Production Department Factory Overhead
Rate Method versus Activity-Based Costing
Factory Overhead Cost per Unit—
Three Cost Allocation Methods
Single Plantwide Multiple Production
Rate Department Rates ABC
Snowmobile $ 800 $ 938 $1,294
Lawnmower 800 662 306
Activity-Based Costing for Selling
and Administrative Activities
Selling and administrative activities may include:
1. Post-sale technical support
2. Order writing
3. Promotional support
4. Order entry
5. Customer return processing
6. Shipping document preparation
7. Shipping and handling
8. Field service
Activity-Based Costing in Service Businesses
Hopewell Hospital—Activity-Based Costing
Admitting $180 per admission

Radiological P
$320 per image
Testing A
T
Operating $200 per operating I
Room room hour
E
N
Pathological
$120 per specimen T
Testing
S
Dietary and
$150 per day
Laundry
Activity-Based Costing in Service Businesses
Hopewell Hospital—Activity-Based Costing
Admitting $180 per admission

Radiological P
$320 per image
Testing A
T
Operating
Radiological $200 per
Testing operating
Activity Rate: I
CostRoom
Budget room $960,000
hour
E
= = $320
Estimated Activity 3,000 images N
Pathological
$120 per specimen T
Testing
S
Dietary and
$150 per day
Laundry
 Activity Costs Allocated to a Patient
Patient Name: Mary Wilson
Activity-Base Activity Activity
Activity Usage Rate Cost
Admitting 1 admission x $180 = $ 180
Radiology testing 2 images x 320 = 640
Operating room 4 hours x 200 = 800
Pathological testing 1 specimen x 120 = 120
Dietary and laundry 7 days x 150 = 1,050
Total $2,790

The overhead cost associated with

services can be related to the
customers that use the service.
 Customer Profitability Report
Hopewell Hospital
Customer (Patient) Profitability Report
For the Period Ending December 31, 2006
Adcock, Birini, Conway, Wilson,
Kim Brian Don Mary
Revenues $9,500 $21,400 $5,050 $3,300
Less: Patient costs
Drugs and supplies $ 400 $ 1,000 $ 300 $ 200
Admitting 180 180 180 180
Radiological testing 1,280 2,560 1,280 640
Operating room 2,400 6,400 1,600 800
Pathological testing 240 600 120 120
Dietary and laundry 4,200 14,700 1,050 1,050
Total patient costs $8,700 $25,440 $4,530 $2,990
Income from operations $ 800 $ (4,040) $ 520 $ 310
Chapter 25

The End