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Job-Order Costing System

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					     Activity Based Costing: A
     Tool to Aid Decision Making

UAA – ACCT 202
Principles of Managerial Accounting
Dr. Fred Barbee


                               Chapter
   Cost
Measurement
                   Cost
               Accumulation
                                     Cost
                                  Assignment

 Direct
Materials

 Direct       Work-in-     Finished    Cost-of
 Labor        Process       Goods     Goods Sold

  Mfg.
Overhead
                     Goal: Accurately costed
                     products.
Actual       Actual DM
             Actual DL
Costing     Actual MOH
System

Normal               Measuring
             Actual DM
Costing      Actual DL
                       Costs
           Estimated MOH
System

Standard
            Standard DM
Costing     Standard DL
 System    Standard MOH
      Cost Accounting Systems
               Product Costs

Job-Order Costing          Process Costing




              Total/Unit Cost
Assigning Manufacturing Costs



              Functional Based
                  Costing




                      Activity Based
                         Costing
 Activity Based Costing (ABC)

ABC is designed to          ABC is a
                        good supplement
  provide managers      to our traditional
with cost information      cost system
                                             I agree!
   for strategic and
 other decisions that
   potentially affect
     capacity and
   therefore “fixed”
         costs.
  Activity Based Costing (ABC)
 Both manufacturing
                                                   A number
and nonmanufacturing
                                              of cost pools each
    costs may be
                                             allocated to a product
     assigned to
                                                 or cost object.
      products.

                      Some manufacturing
                     costs may be excluded
                          from product
                             costs.

Allocation bases often
                                             Overhead rates may
      differ from
                                             be based on activity
  traditional costing
                                                 at capacity.
       systems.
 How Costs are Treated Under
 Activity-Based Costing
                  Activity Based
                     Costing


        Departmental
         Overhead
           Rates


Plantwide
Overhead
   Rate
                  Overhead Allocation
Functional Based
(Traditional) Costing
       Departmental Overhead Rates
                   Indirect        Indirect           Other
                    Labor          Materials         Overhead
Stage One:
Costs assigned
to pools
                 Department       Department        Department
Cost pools
                     1                2                 3
                 Direct       Machine               Raw
Stage Two:       Labor         Hours               Materials
Costs applied    Hours                              Cost
to products
                                      Products

                          Departmental Allocation Bases
Peanut-butter costing describes a
cost approach that uniformly
assigns (“spreads” or “smooths
out”) the cost of resources to cost
objects.
Functional-Based
Management         Cost View
Model
                      Resources



Operational View

    Efficiency                    Performance
                      Functions
    Analysis                        Analysis




                       Products
The problem with this approach
is that individual products,
services, etc., may use those
resources in a nonuniform way.
The end result is that some
products will be overcosted
while others will be
undercosted.
   Refining a Cost System

 Reclassify    indirect costs as direct
 costs.
 Define   more cost pools.
 Identify   cost drivers.
 Use   Activity-Based Costing.
Activity-Based
Management         Cost View
Model
                      Resources



Operational View

      Driver                        Performance
                       Activities
     Analysis                         Analysis




                     Products &
                     Customers
Designing an ABC System

 Cost Objects
(e.g., products    Activities
and customers)

                  Consumption
                  of Resources



                     Cost
   Designing an ABC System

1. Identify and define activities and activity
   cost pools.
2. Whenever possible, directly trace costs
   to activities and cost objects.
3. Assign costs to activity cost pools.
4. Calculate activity rates.
   Designing an ABC System

5. Assign costs to cost objects using the
   activity rates and activity measures.
6. Prepare management reports.
Identify and Define
Activities and Activity
Cost Pools
Step #1:Identify and Define
Activities and Activity Cost Pools

  An Activity Cost        $$
 Pool is a “bucket” in     $
    which costs are       $$$
  accumulated that
   relate to a single
 activity measure in
  the ABC system.
Activity Levels (Step #1)

Batch                               Product
Level                                Level

                 Activity
                 Levels

 Unit                              Customer
Level                                Level


        Organization-Sustaining Level
   Step #1: Identify and Define
  Step #1 For Classic Brass
   Activities and Activity Cost Pools
At Classic Brass, the ABC team, selected the
   following activity cost pools and activity
                   measures:
       Activity Cost Pools at Classic Brass
Activity Cost Pool       Activity Measure
Customer orders          Number of customer orders
Product design           Number of product designs
Order size               Machine-hours
Customer relations       Number of active customers
Other                    Not applicable
      Step #1:Identify and Define
      Activities and Activity Cost Pools
   Customer Orders - assigned all costs of
    resources that are consumed by taking and
    processing customer orders.
   Product Designs - assigned all costs of
    resources consumed by designing
    products.
   Order Size - assigned all costs of
    resources consumed as a consequence of
    the number of units produced.
     Step #1:Identify and Define
     Activities and Activity Cost Pools
   Customer Relations – assigned all costs
    associated with maintaining relations
    with customers.
   Other – assigned all overhead costs that
    are not associated with the other cost
    pools.
Whenever Possible,
Directly Trace Overhead
Costs to Activities and
Cost Objects.
The overhead costs at Classic Brass




                           Exhibit 8-2
Assign Costs to
Activity Cost Pools
The overhead costs at Classic Brass




                           Exhibit 8-2
           Assign Costs to Activity Cost Pools
     At Classic Brass the following distribution of resource
     consumption across activity cost pools is determined.
                                           Activity Cost Pools
                                       Customer Product        Order    Customer
                                        Orders      Design     Size     Relations   Other    Total
Production Department
   Indirect factory wages                   25%        40%        20%        10%        5%     100%
   Factory equipment depreciation           20%         0%        60%         0%       20%     100%
   Factory utilities                         0%        10%        50%         0%       40%     100%
   Factory building lease                    0%         0%         0%         0%      100%     100%
Shipping costs **
General Administrative Department
   Administrative wages and salaries        15%         5%        10%        30%       40%     100%
   Office equipment depreciation            30%         0%         0%        25%       45%     100%
   Administrative building lease             0%         0%         0%         0%      100%     100%
Marketing Department
   Marketing wages and salaries             20%        10%         0%        60%       10%     100%
   Selling expenses                         10%         0%         0%        70%       20%     100%
    **Not included because they are directly traced to customer orders.
            Assign Costs to Activity Cost Pools
                                                                        Overhead Costs at Classic Brass
                                                                     (Manufacturing and NonManufacturing)

                                                       Production Department
                                           Activity   CostIndirect factory wages
                                                           Pools                             $    500,000
                                                          Factory equipment depreciation          300,000
                                       Customer       Product         Order       Customer
                                                          Factory utilities                       120,000
                                        Orders            Factory building lease Relations
                                                      Design           Size                        Other $
                                                                                                   80,000           Total
                                                                                                                1,000,000
Production Department                                  Shipping costs traced to customer orders                    40,000
                                                       General Administrative Department
   Indirect factory wages              $ 125,000
                                                          Administrative wages and salaries       400,000
   Factory equipment depreciation                         Office equipment depreciation            50,000
   Factory utilities                                      Administrative building lease            60,000        510,000
   Factory building lease                              Marketing Department
                                                          Marketing wages and salaries            250,000
General Administrative Department
                                                          Selling expenses                         50,000         300,000
   Administrative wages and salaries                   Total overhead costs                                 $   1,850,000
   Office equipment depreciation
   Administrative building lease
Marketing Department
   Marketing wages and salaries
   Selling expenses
Total
                               Indirect factory wages              $500,000
                               Percent consumed by customer orders     25%
                                                                   $125,000
            Assign Costs to Activity Cost Pools
                                                                        Overhead Costs at Classic Brass
                                                                     (Manufacturing and NonManufacturing)

                                                       Production Department
                                           Activity   CostIndirect factory wages
                                                           Pools                             $    500,000
                                                          Factory equipment depreciation          300,000
                                       Customer       Product         Order       Customer
                                                          Factory utilities                       120,000
                                        Orders            Factory building lease Relations
                                                      Design           Size                        Other $
                                                                                                   80,000           Total
                                                                                                                1,000,000
Production Department                                  Shipping costs traced to customer orders                    40,000
                                                       General Administrative Department
   Indirect factory wages              $ 125,000
                                                          Administrative wages and salaries       400,000
   Factory equipment depreciation         60,000          Office equipment depreciation            50,000
   Factory utilities                                      Administrative building lease            60,000        510,000
   Factory building lease                              Marketing Department
                                                          Marketing wages and salaries            250,000
General Administrative Department
                                                          Selling expenses                         50,000         300,000
   Administrative wages and salaries                   Total overhead costs                                 $   1,850,000
   Office equipment depreciation
   Administrative building lease
Marketing Department
   Marketing wages and salaries
   Selling expenses
Total
                               Factory equipment depreciation      $300,000
                               Percent consumed by customer orders     20%
                                                                   $ 60,000
            Assign Costs to Activity Cost Pools

                                           Activity Cost Pools
                                       Customer     Product       Order      Customer
                                        Orders      Design        Size       Relations     Other         Total
Production Department
   Indirect factory wages              $ 125,000   $ 200,000     $ 100,000   $ 50,000    $ 25,000    $   500,000
   Factory equipment depreciation         60,000         -         180,000        -        60,000        300,000
   Factory utilities                         -        12,000        60,000        -        48,000        120,000
   Factory building lease                    -           -             -          -        80,000         80,000
General Administrative Department
   Administrative wages and salaries      60,000      20,000        40,000     120,000     160,000       400,000
   Office equipment depreciation          15,000         -             -        12,500      22,500        50,000
   Administrative building lease             -           -             -           -        60,000        60,000
Marketing Department
   Marketing wages and salaries           50,000      25,000           -       150,000      25,000       250,000
   Selling expenses                        5,000         -             -        35,000      10,000        50,000
Total                                  $ 315,000   $ 257,000     $ 380,000   $ 367,500   $ 490,500   $ 1,810,000
Calculate the
Activity Rates
   Step #1: Identify and Define
   Activity Cost Pools For
   Activities and
   Classic Brass Activity Cost Pools
At Classic Brass, the ABC team, selected the
   following activity cost pools and activity
                   measures:
       Activity Cost Pools at Classic Brass
Activity Cost Pool       Activity Measure
Customer orders          Number of customer orders
Product design           Number of product designs
Order size               Machine-hours
Customer relations       Number of active customers
Other                    Not applicable
     Calculate Activity Rates
The ABC team determines that Classic Brass will
  have these total activities for each activity cost
                     pool . . .
    1,000 customer orders
    200 new designs
    20,000 machine-hours
    100 customer relations activities
    Now the team can compute the individual
    activity rates by dividing the total cost for
     each activity by the total activity levels.
      Calculate Activity Rates

                                                               ÷
                  Computation of Activity Rates
                          (a)             (b)               (a) (b)
Activity Cost Pools   Total Cost    Total Activity       Activity Rate
Customer orders       $ 315,000    1,000 orders      $315 per order
Product design          257,000    200 designs       $1,285 per design
Order size              380,000    20,000 MHs        $19 per MH
Customer relations      367,500    100 customer      $3,675 per customer
Other                   490,500    Not applicable    Not applicable
Activity-Based Costing at Classic Brass
 Direct         Direct     Shipping
                                             Overhead Costs
Materials       Labor       Costs




 Traced        Traced       Traced




                     Cost Objects:
          Products, Customer Orders, Customers
Activity-Based Costing at Classic Brass
 Direct      Direct       Shipping
                                               Overhead Costs
Materials    Labor         Costs

                      First-Stage Allocation


    Order     Customer        Product     Customer
                                                          Other
    Size       Orders         Design      Relations




                  Cost Objects:
       Products, Customer Orders, Customers
Activity-Based Costing at Classic Brass
 Activity-Based Costing at Classic Brass
  Direct      Direct        Shipping
                                                Overhead Costs
 Materials    Labor          Costs

                       First-Stage Allocation


     Order      Customer       Product     Customer
                                                            Other
     Size        Orders        Design      Relations

                    Second-Stage Allocations

      $/MH        $/Order       $/Design     $/Customer


                 Cost Objects:                            Unallocated
      Products, Customer Orders, Customers
Assign Costs to
Cost Objects
   Assigning Costs to Cost Objects
   Let’s take a look at how our system works for just one
                 customer – Windward Yachts.
Standard Stanchions (no design required)
1. 400 units ordered with 2 separate orders.
2. Each stanchion required 0.5 machine-hours .
3. Selling price is $34 each.
4. Direct materials total $2,110.
5. Direct labor totals $1,850.
6. Shipping costs total $180.
               Custom Compass Housing (requires new design)
               1. One order during the year.
               2. Each housing required 4 machine-hours .
               3. Selling price is $650 each.
               4. Direct materials total $13.
               5. Direct labor totals $50.
               6. Shipping costs total $25.
                                  Computation of Activity Rates
                                          (a)             (b)               (a) (b)
                Activity Cost Pools   Total Cost    Total Activity       Activity Rate
                Customer orders       $ 315,000    1,000 orders      $315 per order
                Product design          257,000    200 designs       $1,285 per design
                Order size              380,000    20,000 MHs        $19 per MH
                Customer relations      367,500    100 customer      $3,675 per customer
                Other                   490,500    Not applicable    Not applicable




Standard Stanchions (no design required)
1. 400 units ordered with 2 separate orders.
2. Each stanchion required 0.5 machine-hours .
3. Selling price is $34 each.
4. Direct materials total $2,110.
5. Direct labor totals $1,850.
6. Shipping costs total $180.
Custom Compass Housing (requires new design)
1. One order during the year.
2. Each housing required 4 machine-hours .
3. Selling price is $650 each.
4. Direct materials total $13.
5. Direct labor totals $50.
6. Shipping costs total $25.




                                    Computation of Activity Rates
                                            (a)             (b)               (a) (b)
                  Activity Cost Pools   Total Cost    Total Activity       Activity Rate
                  Customer orders       $ 315,000    1,000 orders      $315 per order
                  Product design          257,000    200 designs       $1,285 per design
                  Order size              380,000    20,000 MHs        $19 per MH
                  Customer relations      367,500    100 customer      $3,675 per customer
                  Other                   490,500    Not applicable    Not applicable
Prepare
Management
Reports
   Product Margins
      Traditional Cost Accounting System
                                      Standard            Compass
                                    Stanchions            Housing
   Sales                            $     13,600          $   650
   Costs
      Direct materials                        (2,110)          (13)
      Direct labor                            (1,850)          (50)
      Manufacturing overhead                 (10,000)         (200)
   Product margin                   $           (360)     $    387


400 units x 0.5 MH/unit x $50/MH = $10,000


Predetermined manufacturing         $1,000,000
                            =                           = $50/MH
       overhead rate                20,000 MH

				
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