CHAPTER 5CHAPTER 5

PowerPoint Author:LuAnn Bean, Ph.D., CPA, CIA, CFE

Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

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Labor Intensive Labor Intensive ProcessProcess

Overhead costs are Overhead costs are relatively small.relatively small.

Overhead allocations Overhead allocations may be inaccurate,may be inaccurate,but the amounts are but the amounts are relatively relatively insignificant. insignificant.

Automated ProcessAutomated ProcessOverhead costs are Overhead costs are

relatively large.relatively large.

Inaccurate overhead Inaccurate overhead allocation can lead allocation can lead to questionable to questionable product cost product cost information.information.

The Development of a The Development of a Single Companywide Cost Single Companywide Cost DriverDriver

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Overhead is allocated to jobs using directlabor hours. If overhead is $120, how much

overhead is allocated to each job?

Overhead is allocated to jobs using directlabor hours. If overhead is $120, how much

overhead is allocated to each job?

The Development of a Single The Development of a Single Companywide Cost Driver (Labor-Companywide Cost Driver (Labor-Intensive)Intensive)

$120 / (2 + 6) = $15/ hourJob 1: $15 x 2 = $30Job 2: $15 x 6 = $90

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Overhead Rate = $420 ÷ 3 direct labor hoursOverhead Rate = $140 per direct labor hour

Job 1 = 2 hours × $140 per hour = $280Job 2 = 1 hour × $140 per hour = $140

The Effects of Automation on the The Effects of Automation on the Selection of a Cost DriverSelection of a Cost Driver

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Level of C

omplexity

Overhead Allocation

Companywide

OverheadRate

Activity BasedCosting

Many companies are using activity- based cost drivers to improve product

costing.

Activity-Based Cost Activity-Based Cost DriversDrivers

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Activity-Based Cost Activity-Based Cost DriversDrivers

Allocating setup costs using a volume-based allocation rate (number of cans)

Overhead per can = $95,040 ÷ 1,188,000 cansOverhead per can = $0.08 per can

Vegetable = 954,000 cans × $0.08 per can = $76,320Tomato = 234,000 cans × $0.08 per can = $18,720

Vegetable Tomato Total

Number of Cans 954,000 234,000 1,188,000

Number of Batches 180 180 360

Number of Setups 180 180 360

Cost per Setup 264$ 264$ 528$

Total overhead = 360 setups × $264 per setup = 95,040$

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Activity-Based Cost DriversActivity-Based Cost DriversAllocating setup costs using an activity-based

allocation rate (number of setups).

Overhead per setup = $264

Vegetable = 180 setups × $264 per setup = $47,520

Tomato = 180 setups × $264 per setup = $47,520

Vegetable Tomato Total

Number of Cans 954,000 234,000 1,188,000

Number of Batches 180 180 360

Number of Setups 180 180 360

Cost per Setup 264$ 264$ 528$

Total overhead = 360 setups × $264 per setup = 95,040$

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Activity-Based CostingActivity-Based Costing

Activity-based costing (ABC) is a two-stage allocationprocess that employs a variety of cost drivers.

Stage 1Assign costs to pools

according to activities that cause costs to be incurred.

Stage 2Allocate costs in the

activity pools to products.

The first step is toidentify essential

activities and costsrequired to perform

the activities.

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Types of Production Types of Production ActivitiesActivities

Batch-Level Activity

Product-LevelActivity

Unit-LevelActivity

Facility-LevelActivity

Overhead costs associatedwith each category are pooled togetherand allocated to products according to

how those products benefit fromthe activities.

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Types of Production Types of Production ActivitiesActivities

Unterman decides to implement ABC andcategorizes activities into four activity cost centers.

Unit-levelActivities

Batch-levelActivities

Product-levelActivities

Facility-levelActivities

Incurred each timea shirt is made.

Incurred each time a batch ofshirts (casual or dress) is made.

Supports either dressor casual shirts.

Benefits the entire process,not a line of specific shirts.

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Unit-level Activity Unit-level Activity CenterCenter

Unterman identifies the following unit-leveloverhead costs ($1,296,000 of the total $5,730,000):

Unterman identifies the following unit-leveloverhead costs ($1,296,000 of the total $5,730,000):

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Using the InformationUsing the Information

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Using the InformationUsing the Information

Traditional costing resulted in undercosting the casual shirt line and overcosting the dress shirt line.

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Costs that companies incur to assure quality conformance may be classified as: Prevention costs Appraisal costs Internal failure costs External failure costs

Total Quality Total Quality ManagementManagement

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Minimizing Total Minimizing Total Quality CostsQuality Costs

Total Quality cost

Percent of Products without Defects

Cos

t pe

r U

nit

($)

Voluntary costs (Prevention and

Appraisal)

Failure cost (internal and external)

0 100

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Amount Percentage Amount Percentage Prevention Costs 106,000$ 13.87% 106,000$ 13.45% Appraisal Costs 150,000 19.63% 60,000 7.61% Internal Failure Costs 298,000 39.01% 182,000 23.10% External Failure Costs 210,000 27.49% 440,000 55.84% Total Quality Costs 764,000$ 100.00% 788,000$ 100.00%

2010 2009

Unterman Shirt CompanyQuality Cost Report

Quality Cost ReportsQuality Cost Reports

Should Unterman spend more on preventionand appraisal in an effort to reduce failure costs?

How do the costs differ from 2009 to 2010?

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End of Chapter 5End of Chapter 5