CHAPTER 26 (FIN MAN); CHAPTER 11 (MAN) COST ALLOCATION AND ACTIVITY-BASED COSTING

Transcription

1 (FIN MAN); CHAPTER 11 (MAN) COST ALLOCATION AND ACTIVITY-BASED COSTING DISCUSSION QUESTIONS 1. Management desires accurate product costs so that its decisions regarding products are correct. Managers are concerned about the accuracy of product costs, which are used for decisions such as determining product mix, establishing product price, and determining whether to discontinue a product line. 2. A single plantwide overhead rate will provide accurate product costing if products use production department activity-base quantities in nearly the same ratio across departments. For example, if Product X used 2 hours of Department A and 4 hours of Department B activity-base quantities and Product Y used 1 hour of Department A and 2 hours of Department B activity-base quantities, then a single rate approach would not cause distortion. This is true because the ratio of activity-base usage quantity is 1:2 for both products across the two departments. Additionally, if the production departments have nearly the same factory overhead rate, then there would be no need to use the multiple production department rate method. 3. Under the multiple production department rate method, factory overhead rates are determined for each production department. Factory overhead is allocated to products depending on the amount of allocation base used in each department. Under the single plantwide rate method, one factory overhead rate is determined for the whole factory and is allocated to products depending on the amount of allocation base used in the factory. 4. The multiple production department factory overhead rate method would provide more accurate product costs than the single plantwide factory overhead method when there are significant differences in the factory overhead rates across different production departments, and when the products require different proportions of allocation-base usage in each production department. 5. Under activity-based costing, factory overhead costs are assigned to activity cost pools rather than production departments. The budgeted factory overhead in the activity pools is allocated to products based upon their own unique activity rates. 6. These activities are part of selling and administrative expenses, which must be treated as period expenses under generally accepted accounting principles (GAAP). Thus, they cannot be included as product costs under GAAP. 7. If the costs listed in Discussion Question 6 were included as product costs, then they would be part of the cost of inventory. If inventory increased, then the net income would be more than it would be under GAAP, since these selling and administrative expenses would be capitalized in inventory rather than being expensed as required. 8. Calculating product costs using activity rates may result in greater accuracy than using multiple production department overhead rates when products consume activities in proportions that are unrelated to departmental allocation bases. 9. -based costing would be preferred over the relative sales value method when the products use selling and administrative activities in proportions that are unrelated to their sales volumes. 10. Service companies can use activity-based costing to determine the cost of service offerings. This information can be used to determine customer service profitability, which in turn can be used to guide service pricing and strategy. 26-1

2 Cost Allocation and -Based Costing PE 26 1A (FIN MAN); PE 11 1A (MAN) a. Jeans: 20,000 units 0.10 direct labor hour = 2,000 direct labor hours Khakis: 20,000 units 0.10 direct labor hour = 2,000 4,000 direct labor hours b. Single plantwide factory overhead rate: $180,000 4,000 dlh = $45 per dlh PRACTICE EXERCISES c. Jeans: $45 per direct labor hour 0.10 dlh per unit = $4.50/unit Khakis: $45 per direct labor hour 0.10 dlh per unit = $4.50/unit PE 26 1B (FIN MAN); PE 11 1B (MAN) a. Speedboat: 250 units 12 direct labor hours = 3,000 direct labor hours Bass boat: 250 units 12 direct labor hours = 3,000 6,000 direct labor hours b. Single plantwide factory overhead rate: $600,000 6,000 dlh = $100 per dlh c. Speedboat: $100 per direct labor hour 12 dlh per unit = $1,200/unit Bass boat: $100 per direct labor hour 12 dlh per unit = $1,200/unit PE 26 2A (FIN MAN); PE 11 2A (MAN) a. Cutting: (20,000 jeans 0.04 dlh) + (20,000 khakis 0.06 dlh) = 2,000 direct labor hours Sewing: (20,000 jeans 0.06 dlh) + (20,000 khakis 0.04 dlh) = 2,000 direct labor hours b. Cutting Department rate: $60,000 2,000 dlh = $30 per dlh Sewing Department rate: $120,000 2,000 dlh = $60 per dlh c. Jeans: Cutting Department 0.04 dlh $30 = Sewing Department 0.06 dlh $60 = Total factory overhead per pair of jeans $ $4.80 Khakis: Cutting Department 0.06 dlh $30 = Sewing Department 0.04 dlh $60 = Total factory overhead per pair of khakis $ $

3 Cost Allocation and -Based Costing PE 26 2B (FIN MAN); PE 11 2B (MAN) a. Fabrication: (250 speedboats 8 dlh) + (250 bass boats 4 dlh) = 3,000 direct labor hours Assembly: (250 speedboats 4 dlh) + (250 bass boats 8 dlh) = 3,000 direct labor hours b. Fabrication Department rate: $420,000 3,000 dlh = $140 per dlh Assembly Department rate: $180,000 3,000 dlh = $60 per dlh c. Speedboat: Fabrication Department 8 dlh $140 = $1,120 Assembly Department 4 dlh $60 = 240 Total factory overhead per speedboat $1,360 Bass boat: Fabrication Department 4 dlh $140 = Assembly Department 8 dlh $60 = $ Total factory overhead per bass boat $1,

4 Cost Allocation and -Based Costing PE 26 3A (FIN MAN); PE 11 3A (MAN) a. Cutting: $18,000 2,000 direct labor hours = $9.00 per dlh Sewing: $36,000 2,000 direct labor hours = $18.00 per dlh Setup: $96,000 2,400 setups = $40.00 per setup Inspection: $30,000 5,000 inspections = $6.00 per inspection b. Jeans Khakis - Base - Base Usage Rate = Cost Usage Rate = Cost Cutting 800 dlh $9.00 /dlh $ 7,200 1,200 dlh $9.00 /dlh $10,800 Sewing 1,200 dlh $18.00 /dlh 21, dlh $18.00 /dlh 14,400 Setup 1,400 setups $40.00 /setup 56,000 1,000 setups $40.00 /setup 40,000 Inspections 3,000 insp. $6.00 /insp. 18,000 2,000 insp. $6.00 /insp. 12,000 Total $102,800 $77,200 Budgeted items 20,000 20,000 Factory overhead per unit $ 5.14 $

5 Cost Allocation and -Based Costing PE 26 3B (FIN MAN); PE 11 3B (MAN) a. Fabrication: $204,000 3,000 direct labor hours = $68 per dlh Assembly: $105,000 3,000 direct labor hours = $35 per dlh Setup: $156, setups = $390 per setup Inspection: $135,000 1,500 inspections = $90 per inspection b. Speed Boat Bass Boat - - Base Base Usage Rate = Cost Usage Rate = Cost Fabrication 2,000 dlh $68 /dlh $136,000 1,000 dlh $68 /dlh $ 68,000 Assembly 1,000 dlh $35 /dlh 35,000 2,000 dlh $35 /dlh 70,000 Setup 300 setups $390 /setup 117, setups $390 /setup 39,000 Inspections 1,100 insp. $90 /insp. 99, insp. $90 /insp. 36,000 Total $387,000 $213,000 Budgeted items Factory overhead per unit $ 1,548 $

6 Cost Allocation and -Based Costing PE 26 4A (FIN MAN); PE 11 4A (MAN) a. Sales order processing activity: 5,000 orders $12 per order = $60,000 Shipping activity: 1,400 shipments $20 per shipment = 28,000 Total activity cost $88,000 b. $3.20 per unit ($88,000 27,500 units) PE 26 4B (FIN MAN); PE 11 4B (MAN) a. Sales order processing activity: 750 orders $20 per order = $15,000 Customer return activity: 80 returns $100 per return = 8,000 Total activity cost $23,000 b. $9.20 per unit ($23,000 2,500 units) PE 26 5A (FIN MAN); PE 11 5A (MAN) Teller transaction processing $42.00 (12 transactions $3.50) Check processing (100 checks $0.12) ATM transaction processing 2.00 (20 transactions $0.10) Total activity cost $56.00 PE 26 5B (FIN MAN); PE 11 5B (MAN) Guest check-in $ 8.00 (1 check-in $8.00) Room cleaning (3 nights $25.00) Meal service (3 meals $4.00) Total activity cost $

7 Cost Allocation and -Based Costing EXERCISES Ex (FIN MAN); Ex (MAN) ($560,000 8,000) 5,150 = $360,500 Ex (FIN MAN); Ex (MAN) a. Single Plantwide Factory Overhead Rate = = $188,000 4,700 direct labor hours* $40 per direct labor hour * Total direct labor hours: Direct Labor Hours per Unit = Trumpets 2,100 units 0.8 = Tubas = Trombones 1, = Total Budgeted Production Volume Direct Labor Hours 1,680 1,200 1,820 4,700 b. Single Plant- Direct Labor Hours wide Rate per Direct Labor Hour = Factory Overhead Factory Overhead per Unit (Factory Overhead Budgeted Production Volume) Trumpets 1,680 $40 = $ 67,200 $67,200 2,100 units = $32 Tubas 1, = 48,000 $48, units = $64 Trombones 1, = 72,800 $72,800 1,300 units = $56 Total 4,700 $188,

8 Cost Allocation and -Based Costing Ex (FIN MAN); Ex (MAN) a. Single Plantwide Factory Overhead Rate = = $153,000* 2,550 processing hours** $60 per direct processing hour * $196,000 $18,000 $25,000 The selling and administrative expenses are not factory overhead. ** Total processing hours: Budgeted Production Volume Processing Processing (Cases) Hours per Case = Hours Tortilla chips 4, = 800 Potato chips 5, = 750 Pretzels 2, = 1,000 Total 2,550 b. Single Plantwide Factory Overhead Rate per Factory Overhead per Case Processing Hours Processing Hour = Factory Overhead (Factory Overhead Budgeted Production Volume) Tortilla chips 800 $60 = $ 48,000 $48,000 4,000 cases = $12.00 Potato chips = 45,000 $45,000 5,000 cases = $9.00 Pretzels 1, = 60,000 $60,000 2,500 cases = $24.00 Total 2,550 $153,

9 Cost Allocation and -Based Costing Ex (FIN MAN); Ex (MAN) a. First, determine the total estimated labor hours consumed by the three products: Direct Labor Total Hours per Labor Volume Unit = Hours Pistons 7, = 1,440 Valves 28, = 4,320 Cams 1, = 384 Total estimated direct labor hours 6,144 Next, determine the plantwide overhead rate: Budgeted Factory Overhead Plantwide Allocation Base = $184,320 6,144 direct labor hours = $30.00 per dlh b. Factory Overhead Direct Labor Cost per Unit Hours per ($30.00 Direct Unit Labor Hours per Unit) Pistons 0.20 $6.00 Valves Cams Direct Labor Cost per Unit ($20.00 Direct Labor Hours per Unit) $ c. ORANGE COUNTY ENGINE PARTS INC. Product Line Budgeted Gross Profit Reports For the Year Ended December 31, 2016 Pistons Valves Cams Revenues (price unit volume) Direct materials (direct materials cost per unit unit volume) Direct labor [direct labor cost per unit (b) unit volume] Factory overhead [factory overhead cost per unit (b) unit volume] 1 $360,000 $180, , ,20010 $252,000 2 $288,000 $115, , ,60011 $331,200 $84,0003 $34,8006 7, ,52012 $54,000 Gross profit Gross profit percentage of sales $108, % $ (43,200) 15.0% $30, % 1 7,200 $ ,800 $ ,200 $ ,800 $ ,200 $ ,200 $ ,200 $ ,200 $ ,800 $ ,200 $ ,800 $ ,200 $9.60 d. Valves have the lowest (and negative) gross profit as a percent of sales. Valves may require a higher price or lower cost to manufacture in order to achieve the same profitability as the other two products. 26-9

10 Cost Allocation and -Based Costing Ex (FIN MAN); Ex (MAN) a. Production department factory overhead rates: Pattern Department Cut and Sew Department Total factory overhead $288,000 $412,500 Direct labor hours 2,880 dlh 3,300 dlh Departmental overhead rate $ /dlh $ /dlh b. Product cost allocation: Small Glove Pattern Department 0.10 dir. labor hr. $100/dlh = $10.00 Cut and Sew Department 0.12 dir. labor hr. $125/dlh = Total factory overhead per small glove $25.00 Medium Glove Pattern Department 0.12 dir. labor hr. $100/dlh = $12.00 Cut and Sew Department 0.14 dir. labor hr. $125/dlh = Total factory overhead per medium glove $29.50 Large Glove Pattern Department 0.14 dir. labor hr. $100/dlh = $14.00 Cut and Sew Department 0.16 dir. labor hr. $125/dlh = Total factory overhead per large glove $

11 Cost Allocation and -Based Costing Ex (FIN MAN); Ex (MAN) a. Plantwide overhead rate: Budgeted Factory Overhead = Plantwide Allocation Base $990,000 9,000 direct machine hours = $ per dmh Product costs: Commercial $110 per dir. mach. hr. 4.5 dmh = $495 Residential $110 per dir. mach. hr. 3.0 dmh = $330 b. Department factory overhead rates: Production department overhead $240,000 $750,000 Direct machine hours 3,000 dmh 6,000 Production department overhead rate $ /dmh $ Product cost allocation: Assembly Department Commercial Motor Assembly Department 1.5 dir. mach. hr. $80/dmh = $120 Testing Department 3.0 dir. mach. hrs. $125/dmh = 375 Total factory overhead per commercial motor $495 Residential Motor Assembly Department 1.0 dir. mach. hrs. $80/dmh = $ 80 Testing Department 2.0 dir. mach. hrs. $125/dmh = 250 Total factory overhead per residential motor $330 Testing Department c. The factory overhead determined under the single plantwide factory overhead rate and multiple production department factory overhead rate methods are the same. This is because the ratio of direct machine hours used by each product from the two departments is the same. The commercial motor uses 1.5 direct machine hour in the Assembly Department and 3.0 hours in the Testing Department, or a ratio of 1:2. The residential motor uses 1.0 direct machine hours in the Assembly Department and 2.0 hours in the Testing Department, also for a ratio of 1:2. Thus, even though the two production department overhead rates are different, this is not sufficient for the plantwide rate to cause product cost distortion. Thus, Pineapple should consider remaining with the easier single plantwide rate method in this situation. dmh /dmh 26-11

12 Cost Allocation and -Based Costing Ex (FIN MAN); Ex (MAN) a. Plantwide factory overhead rate: Budgeted Factory Overhead Plantwide Allocation Base = $800,000 10,000 direct labor hours = $80 per dlh Product costs: Gasoline engine $80 per dir. labor hr. 5.0 dlh = $400 Diesel engine $80 per dir. labor hr. 5.0 dlh = $400 b. Department factory overhead rates: Total production department factory overhead $550,000 $250,000 Direct labor hours 5,000 dlh 5,000 Production department overhead rate $ 110 /dlh $ 50 Product cost allocation: Fabrication Department Assembly Department Gasoline engine Fabrication Department 3.0 dir. labor hr. $110/dlh = $330 Assembly Department 2.0 dir. labor hrs. $50/dlh = 100 Total factory overhead per gasoline engine $430 Diesel engine Fabrication Department 2.0 dir. labor hrs. $110/dlh = $220 Assembly Department 3.0 dir. labor hr. $50/dlh = 150 Total factory overhead per diesel engine $370 c. Management should select the multiple department factory overhead rate method of allocating overhead costs. The single plantwide factory overhead rate method indicates that both products have the same factory overhead of $400 per unit. This is because each product uses a total of 5.0 direct labor hours per unit. However, each product uses these 5.0 direct labor hours much differently. The gasoline engine consumes 3.0 hours in the expensive Fabrication Department and 2.0 hours in the less expensive Assembly Department. The opposite is the case for diesel engines. Thus, the multiple production department rate method avoids the cost distortions of the single plantwide rate method by accounting for the overhead in each production department separately. In this case, there are both production department rate differences across the departments and differences in the ratios of allocation-base usage of the products across the departments (3.0:2.0 vs. 2.0:3.0). These conditions will cause the single plantwide rate method to distort product costs. dlh /dlh 26-12

13 Cost Allocation and -Based Costing Ex (FIN MAN); Ex (MAN) Accounting reports Customer return processing Electric power Human resources Inventory control Invoice and collecting Machine depreciation Materials handling Order shipping Payroll Production control Production setup Purchasing Quality control Sales order processes Base Number of accounting reports Number of customer returns Kilowatt hours used Number of employees Number of inventory transactions Number of customer orders Number of machine hours Number of material moves Number of customer orders Number of payroll checks processed Number of production orders Number of setups Number of purchase orders Number of inspections Number of sales orders Ex (FIN MAN); Ex (MAN) a. Sales order processing activity rate: $540,000 60,000 sales orders = $9 per sales order b. Sales order processing cost: $9 45,000 sales orders = $405,

14 Cost Allocation and -Based Costing Ex (FIN MAN); Ex (MAN) - - Elliptical Machines Treadmills Base Base Usage Rate = Cost Usage Rate = Cost Fabrication 800 mh $30 /mh $24, mh $30 /mh $15,000 Assembly 210 dlh $15 /dlh 3, dlh $15 /dlh 1,350 Setup 24 setups $50 /setup 1, setups $50 /setup 500 Inspecting 140 insp. $25 /insp. 3, insp. $25 /insp. 4,000 Production scheduling 20 prod. ord. $15 /prod. ord prod. ord. $15 /prod. ord. 150 Purchasing 85 purch. ord. $10 /purch. ord purch. ord. $10 /purch. ord. 600 Total activity cost $33,000 $21,600 Number of units cost per unit $ $

15 Cost Allocation and -Based Costing Ex (FIN MAN); Ex (MAN) a. Budgeted Total Cost Base = Rate Casting $127,750 3,650 mh $35 /mh Assembly 63,200 3,160 dlh $20 /dlh Inspecting 21,330 1,185 insp. $18 /insp. Setup 28, setups $125 /setup Materials handling 31, loads $40 /load b. Entry Lighting Fixtures - Dining Room Lighting Fixtures - Base Base Usage Rate = Cost Usage Rate = Cost Casting 2,500 mh $35 /mh $ 87,500 1,150 mh $35 /mh $ 40,250 Assembly 960 dlh $20 /dlh 19,200 2,200 dlh $20 /dlh 44,000 Inspecting 860 insp. $18 /insp. 15, insp. $18 /insp. 5,850 Setup 170 setups $125 /setup 21, setups $125 /setup 7,500 Materials handling 570 loads $40 /load 22, loads $40 /load 8,800 Total activity cost $166,230 $106,400 Number of units cost per unit $ 5, $ 2,

16 Cost Allocation and -Based Costing Ex (FIN MAN); Ex (MAN) a. Product Procurement Scheduling Materials Handling Development Factory overhead $66,000 $4,120 $13,280 $8,100 base 660 purch. ords. 206 prod. ords. 415 moves 108 ECOs* rate $ 100 /purch. ord. $ 20 /prod. ord. $ 32 /move $ 75 /ECOs * Engineering Change Order b. - - Ovens Refrigerators Base Base Usage Rate = Cost Usage Rate = Cost Procurement 400 purch. ords. $100 /purch. ord. $ 40, purch. ords. $100 /purch. ord. $26,000 Scheduling 136 prod. ords. $20 /prod. ord. 2, prod. ords. $20 /prod. ord. 1,400 Materials handling 240 moves $32 /move 7, moves $32 /move 5,600 Product development 68 ECOs $75 /ECO 5, ECOs $75 /ECO 3,000 Total $55,500 $36,000 Unit volume cost per unit $ $

17 Cost Allocation and -Based Costing Ex (FIN MAN); Ex (MAN) a. Single plantwide rate: Indirect Labor Plantwide Allocation Base = $375,000 3,750 direct labor hours = $100 per direct labor hour Direct Labor Hours Plantwide Rate = Indirect Labor Cost Units = Cell phones 1,875 $100 /dlh = $187,500 93,750 = Tablets 1,875 $100 /dlh = $187,500 93,750 = Indirect Labor Cost per Unit $2.00 $2.00 b. -based rates: Production Setup Support Budgeted activity cost* $150,000 $225,000 base 2,000 setups 3,750 dlh rate $ /setup $ /dlh * Setup activity cost = $375,000 40% = $150,000 Production support activity cost = $375,000 60% = $225,

18 Cost Allocation and -Based Costing Ex (FIN MAN); Ex (MAN) (Concluded) c. Cell Phones Tablets - - Base Base Usage Rate = Cost Usage Rate = Cost Setup 600 setups $75.00 /setup $ 45,000 1,400 setups $75.00 /setup $105,000 Production support 1,875 dlh $60.00 /dlh 112,500 1,875 dlh $60.00 /dlh 112,500 Total $157,500 $217,500 Units cost per unit $ 93, $ 93, d. The per-unit indirect labor costs in (a) are distorted because setup activity is consumed by the products in a different ratio from the direct labor. Cell phones required 600 setups over a volume of 93,750 units (or 156 units per production run), while tablets required 1,400 setups over the same volume (approximately 67 units per production run). The activity-based costing method properly allocates the setup-related activity so that the tablets, the setup-intensive product, receive a larger portion of the setup activity cost, while the cell phones receive a smaller portion. The single rate system allocates overhead only on the basis of direct labor hours. Since the direct labor hours are equal for each product, the allocated indirect labor will also be equal. Again, this is clearly a distortion, since the setup activity (40% of the indirect labor) is not consumed equally by each product

19 Cost Allocation and -Based Costing Ex (FIN MAN); Ex (MAN) a. Production department factory overhead rates: Assembly Department Test and Pack Department Factory overhead $186,000 $120,000 Direct labor hours 3,000 3,000 Production department factory overhead rate $ 62 /dlh $ 40 /dlh b. Blender Toaster Oven Allocation- Base Allocation- Base Usage Rate = Cost Usage Rate = Cost Assembly Department 750 dlh $62 /dlh $ 46,500 2,250 dlh $62 /dlh $139,500 Test and Pack Department 2,250 dlh $40 /dlh 90, dlh $40 /dlh 30,000 Total $136,500 $169,500 Units 7,500 7,500 Factory overhead cost per unit $ $

20 Cost Allocation and -Based Costing Ex (FIN MAN); Ex (MAN) a. rates: Budgeted activity cost $105,000 1 $39,000 2 $162,000 base 3,000 dlh 3,000 dlh 180 setups rate $ 35 /dlh $ 13 /dlh $ 900 /setup 1 $186,000 $81,000 2 $120,000 $81,000 Assembly Test and Pack Setup b. Blender - - Toaster Oven Base Base Usage Rate = Cost Usage Rate = Cost Assembly activity 750 dlh $35 /dlh $ 26,250 2,250 dlh $35 /dlh $ 78,750 Test and pack activity 2,250 dlh $13 /dlh 29, dlh $13 /dlh 9,750 Setup activity 135 setups $900 /setup 121, setups $900 /setup 40,500 Total $177,000 $129,000 Units 7,500 7,500 Factory overhead cost per unit $ $

21 Cost Allocation and -Based Costing Ex (FIN MAN); Ex (MAN) (Concluded) Note to Instructors: If you assigned both Ex and Ex , then you can make the following observations: The activity-based costing approach provides unit factory overhead cost information that is opposite to that of the multiple production department factory overhead rate method. The reason is that the multiple production department factory overhead rate method allocates all factory overhead to the products on the basis of direct labor hours. However, factory overhead includes the setup activity. Setup activity is consumed by the products in ratios that are not equal to their direct labor consumption. Indeed, the blender uses three times as much setup activity as the toaster oven. The activity-based costing method correctly accounts for this difference, while the multiple production department factory overhead rate method incorrectly assumes that this activity is equal to both products (proportional to the direct labor hours or volume of production). Thus, the management of Four Finger Appliance should be encouraged to use activity-based costing information for product-based decisions

22 Cost Allocation and -Based Costing Ex (FIN MAN); Ex (MAN) a. Column A Column B Column C Single Rate Overhead ABC Overhead Percent Change Allocation Allocation in Allocation Product Volume Class per Unit per Unit (Col. B Col. A) Col. A 1 2 Low $30.00 $ % Medium % High % 1 (24 hours $200/hour) 160 units 2 [(24 hours $160/hour) + (14 setups $240/setup) + (38 sales orders $55/sales order)] 160 units 3 (225 hours $200/hour) 1,500 units 4 [(225 hours $160/hour) + (13 setups $240/setup) + (88 sales orders $55/sales order)] 1,500 units 5 (900 hours $200/hour) 6,000 units 6 [(900 hours $160/hour) + (9 setups $240/setup) + (120 sales orders $55/sales order)] 6,000 units b. The machine hour rate is greater under the single rate method than under the activitybased method because all the factory overhead is allocated by machine hours under the single rate method. However, only a portion of the factory overhead is allocated under the machine rate method using activity-based costing. The remaining factory overhead is allocated using the other two activity rates. Thus, the numerator for determining the machine hour rate under activity-based costing must be less than the numerator under the single machine hour rate method. c. Column C indicates that under activity-based costing the low-volume product has a higher per-unit cost than calculated under the single rate method. In contrast, under activity-based costing the high-volume product has a lower per-unit cost than calculated under the single rate method. This result will occur when there are activities that occur in proportions different from their volumes. In this case, lower-volume products have setups and sales orders occurring in higher proportions of total setups and sales orders than their proportion of machine hours to total machine hours. The opposite is the case for the high-volume product. Thus, the lower-volume products are produced and ordered in smaller batch sizes compared to the higher-volume product. This implies that Whirlpool may wish to simplify its product line by eliminating some of the low-volume products or by attempting to reduce the overall cost of setup and sales order processing activities. Note: The sum of the total overhead from Columns A and B is not equal because there are only three representative products, not all of the products

23 Cost Allocation and -Based Costing Ex (FIN MAN); Ex (MAN) The selling and administrative expenses should not be allocated on the basis of relative sales dollars. The two product lines have very different attributes. The commercial product is relatively inexpensive to sell, while the home product has a number of additional costs associated with it. As a result, the relative sales dollar method of allocation will distribute too much selling and administrative cost to the commercial product and too little to the home product. The commercial product receives twice as much selling and administrative expense as the home product because it has twice the sales. An activity-based approach would trace the selling and administrative costs to the products based upon their actual consumption of activities. Such an allocation would show the commercial product to be more profitable than indicated and the home product to be less profitable than indicated. Ex (FIN MAN); Ex (MAN) a. Sales order processing activities: Number of Sales Orders Rate = Cost Generators 980 $80 $ 78,400 Air compressors 1, ,800 Total $171,200 Post-sale customer service activities: Number of Service Requests Rate = Cost Generators 150 $300 $ 45,000 Air compressors ,800 Total $181,800 Note to Instructor: $171,200 + $181,800 = $353,000, which is the total selling and administrative expense reported in the exercise

24 Cost Allocation and -Based Costing Ex (FIN MAN); Ex (MAN) (Concluded) b. VOLT-GEAR INC. Product Profitability Report For the Year Ended December 31 Air Generators Compressors Total Revenues $2,000,000 $1,400,000 $3,400,000 Cost of goods sold 1,400, ,000 2,380,000 Gross profit $ 600,000 $ 420,000 $1,020,000 Sales order processing $ 78,400 1 $ 92,800 3 $ 171,200 Post-sale customer service 2 45, , ,800 Total selling and administrative expense $ 123,400 $ 229,600 $ 353,000 Income from operations $ 476,600 $ 190,400 $ 667,000 Gross profit as a percentage of sales 30.00% % 7 Income from operations as a percentage of sales 23.83% % 8 1 $78,400 = 980 sales orders $80/sales order 2 $45,000 = 150 service requests $300/service request 3 $92,800 = 1,160 sales orders $80/sales order 4 $136,800 = 456 service requests $300/service request 5 $600,000 $2,000,000 6 $476,600 $2,000,000 7 $420,000 $1,400,000 8 $190,400 $1,400,000 c. The complete product profitability report provides much greater insight than did the original report. The air compressors have the lower income from operations to sales percentage because the product is a heavy user of Volt-Gear s sales and service activities. The air compressors are ordered in small quantities (hence a high number of sales orders) and have a high amount of post-sale service. All of these factors cause the air compressors to have less income from operations as a percent of sales than generators. In contrast, relative to the sales volume, the generators have much less activity and thus have the higher income from operations as a percent of sales. Volt-Gear can respond to this situation by rationing the amount of service to the air compressor product line, charging air compressor customers for some of the services, reducing the number of service requests by improving the product, or raising the price on the air compressors

25 Cost Allocation and -Based Costing Ex (FIN MAN); Ex (MAN) a. SCHNEIDER ELECTRIC Customer Profitability Report For the Year Ended December 31, 2016 (assumed data) Customer 1 Customer 2 Customer 3 Revenue $39,000 $26,000 $31,200 Cost of goods sold 24,180 13,520 15,600 Gross profit $14,820 $12,480 $15,600 Customer service activities: Bid preparation $ 2, $ 1,600 9 $ 5,000 Shipment Support standard items ,120 Support nonstandard items 4 1, , ,050 Total customer service activities $ 4,966 $ 4,994 $10,890 Income from operations after customer service activities $ 9,854 $ 7,486 $ 4,710 Gross profit as a percent of sales 38% 48% 50% Income from operations after customer service activities as a percent of sales 25% 29% 15% 1 $ bid requests 2 $16 16 shipments 3 $20 48 standard items 4 $75 18 nonstandard items 5 $200 8 bid requests 6 $16 24 shipments 7 $20 38 standard items 8 $75 30 nonstandard items 9 $ bid requests 10 $16 45 shipments 11 $20 56 standard items 12 $75 54 nonstandard items b. The gross profit as a percent of sales indicated that Customer 1 was the least profitable, while Customer 3 was the most profitable. After deducting the activity costs associated with customer service activities, Customer 3 became the least profitable, while Customer 1 became nearly as profitable as Customer 2. The reason is because Customer 3 consumed much more customer service activities than did either Customer 1 or Customer 2. Apparently, Customer 3 ordered nonstandard products that required specialized bid requests. In addition, Customer 3 required more shipments, indicating smaller shipments to a customer s location, rather than a few large shipments

26 Cost Allocation and -Based Costing Ex (FIN MAN); Ex (MAN) a. Patient Putin Patient Umit Usage Rate = Cost Usage Rate = Cost Room and meals 6 days $240 /day $ 1,440 4 days $240 /day $ 960 Radiology 4 images $215 /image images $215 /image 645 Pharmacy 6 orders $50 /order orders $50 /order 100 Chemistry lab 5 tests $80 /test tests $80 /test 320 Operating room 8 hrs. $1,000 /hr. 8,000 4 hrs. $1,000 /hr. 4,000 Total cost $11,000 $6,025 b. Patient Putin apparently had a different condition that required more extensive treatment than did Patient Umit. Patient Putin required more operating room hours, more tests and images, and more days to recover than did Patient Umit. Thus, the activity cost to Patient Putin is more than two times that of Patient Umit

27 Cost Allocation and -Based Costing Ex (FIN MAN); Ex (MAN) a. SAFETY FIRST INSURANCE COMPANY Product Profitability Report For the Year Ended December 31 Workers Auto Comp. Homeowners Premium revenue $5,750,000 $6,240,000 $8,160,000 Less estimated claims 4,312,500 4,680,000 6,120,000 Underwriting income $1,437,500 $1,560,000 $2,040,000 Administrative activities:* New policy processing $ 158,400 $ 180,000 $ 489,600 Cancellation processing 84,000 42, ,000 Claim audits 123,200 38, ,200 Claim disbursements processing 49,920 22,464 87,360 Premium collection processing 201,600 43, ,000 Total administrative expenses $ 617,120 $ 326,064 $1,622,160 Income from operations $ 820,380 $1,233,936 $ 417,840 Income from operations as a percent of premium revenue 14% 20% 5% * The activity costs are determined by multiplying the activity rate by the activity-based usage quantity. For example, the administrative activity costs for the Auto line is as follows: $158,400 = $1,320 new policies $120 per new policy $84,000 = $480 cancellations $175 per cancellation $123,200 = $385 audits $320 per claim audit $49,920 = $480 disbursements $104 per disbursement $201,600 = $8,400 premiums collected $24 per collection b. All three insurance lines have the same percentage of underwriting income to premium revenue (25%). The differences among the insurance lines are in the way they consume administrative activities. For example, the Homeowners insurance line has the least profitability due to its high use of administrative activities. Specifically, the Homeowners line has smaller and more frequent claims that require more auditing and disbursement processing than do the other two lines. In addition, the Homeowners line has a much higher rate of cancellation relative to the other two lines (over 50% of new policies). Lastly, the Homeowners line has more premium collections compared to the other two lines. Possibly, the Homeowners line is collected in smaller amounts from more customers than the other two lines. In contrast, the Workers Compensation line consumes the fewest administrative activities, causing it to be very profitable. The Auto line is in between these two

28 Cost Allocation and -Based Costing PROBLEMS Prob. 26 1A (FIN MAN); Prob. 11 1A (MAN) 1. a. Direct labor overhead rate: $220,800 1,725 direct labor hours b. Machine hour overhead rate: $220,800 4,600 machine hours = = $128 per direct labor hour $48 per machine hour 2. Automobile Bumpers Valve Covers Wheels a. Direct labor hours: Stamping Department 560 dlh 300 dlh 340 dlh Plating Department Total direct labor hours 730 dlh 480 dlh 515 dlh Direct labor overhead rate $128 /dlh $128 /dlh $128 /dlh Allocated factory overhead $93,440 $61,440 $65,920 b. Machine hours: Stamping Department 800 mh 560 mh 600 mh Plating Department 1, Total machine hours 1,970 mh 1,270 mh 1,360 mh Machine hour overhead rate $48 /mh $48 /mh $48 /mh Allocated factory overhead $94,560 $60,960 $65,280 Instructor s Note: The allocated factory overhead is the same for both allocation bases because their usage is proportional across product

29 Cost Allocation and -Based Costing Prob. 26 2A (FIN MAN); Prob. 11 2A (MAN) 1. Stamping Plating Dept. Dept. Production department factory overhead totals $115,200 $105,600 rate 1,200 dlh 2,640 mh Production department rate $ 96 /dlh $ 40 /mh 2. Automobile bumpers Stamping Department 560 dir. labor hrs. $96/dlh = $ 53,760 Plating Department 1,170 dir. mach. hrs. $40/dmh = 46,800 Total factory overhead for bumpers $100,560 Valve covers Stamping Department 300 dir. labor hrs. $96/dlh = $ 28,800 Plating Department 710 dir. mach. hrs. $40/dmh = 28,400 Total factory overhead for valve covers $ 57,200 Wheels Stamping Department 340 dir. labor hrs. $96/dlh = $ 32,640 Plating Department 760 dir. mach. hrs. $40/dmh = 30,400 Total factory overhead for wheels $ 63,

30 Cost Allocation and -Based Costing Prob. 26 3A (FIN MAN); Prob. 11 3A (MAN) 1. Production department rates: Cutting Department Finishing Department Factory overhead Direct labor hours $315,000 6,000 $540,000 6,000 Production department rate $ 52.5 /dlh $ 90.0 /dlh 2. Production Direct Department Labor Hours Rate = Snowboards: Cutting Department 4,000 $52.5 /dlh = Finishing Department 2,000 $90.0 /dlh = Total factory overhead Number of units Factory overhead per unit Skis: Cutting Department 2,000 $52.5 /dlh = Finishing Department 4,000 $90.0 /dlh = Total factory overhead Number of units Factory overhead per unit Factory Overhead $210, ,000 $390,000 6,000 $ $105, ,000 $465,000 6,000 $ based rates: Production Materials Cutting Finishing Control Handling Department Department Factory overhead $237,000 $270,000 $156,000 $192,000 base 500 prod. runs 7,500 moves 6,000 dlh 6,000 dlh rate $ /prod. run $ 36.0 /move $ 26.0 /dlh $ 32.0 /dlh 26-30

31 Cost Allocation and -Based Costing Prob. 26 3A (FIN MAN); Prob. 11 3A (MAN) (Concluded) 4. Snowboards Skis Usage Rate = Cost Usage Rate = Cost Production control 430 prod. runs $474 /prod. run $203, prod. runs $474 /prod. run $ 33,180 Materials handling 5,000 moves $36 /move 180,000 2,500 moves $36 /move 90,000 Cutting Department 4,000 dlh $26 /dlh 104,000 2,000 dlh $26 /dlh 52,000 Finishing Department 2,000 dlh $32 /dlh 64,000 4,000 dlh $32 /dlh 128,000 Total Number of units $551,820 6,000 $303,180 6,000 cost per unit $ $ The activity-based overhead allocation reveals that snowboards consume more factory overhead on a per-unit basis than do skis. The multiple production department factory overhead rate method does not show this because all factory overhead is assumed to be proportional to direct labor hours. The activity-based method separately accounts for the production control and materials handling activity costs. Snowboards have more production control and materials handling activities than do skis. This is because snowboards are made in smaller lots, representing a wide variety of styles. Thus, snowboards have higher activity costs per unit than skis

32 Cost Allocation and -Based Costing Prob. 26 4A (FIN MAN); Prob. 11 4A (MAN) Materials 1. Production Setup Handling Inspection Engineering Total activity cost $264,000 $96,000 $9,600 $50,000 $150,000 Total activity base 2,200 mh 400 setups 480 no. parts 1,000 insp. hours 500 eng. hours rate $ 120 /mh $ 240 /setup $ 20 /part $ 50 /hour $ 300 /hour 2. I8 - Base Production Usage 400 mh Rate $120 /mh = Cost $ 48,000 Setup 220 setups $240 /setups 52,800 Material handling 250 parts $20 /part 5,000 Inspection 250 insp. hours $50 /hour 12,500 Engineering 200 eng. hours $300 /hour 60,000 Total activity cost Number of units cost per unit $178, $ Base Usage M5 Rate = Cost Production 1,000 mh $120 /mh $120, mh $120 /mh $ 96,000 Setup 60 setups $240 /setup 14, setups $240 /setups 28,800 Material handling 80 parts $20 /part 1, no parts $20 /part 3,000 Inspection 450 insp. hours $50 /hour 22, insp. hours $50 /hour 15,000 Engineering 125 eng. hours $300 /hour 37, eng. hours $300 /hour 52,500 Total activity cost Number of units cost per unit $196,000 1,250 $ $195,300 1,000 $ Z4 Rate = Cost - Base Usage 26-32

33 Cost Allocation and -Based Costing Prob. 26 4A (FIN MAN); Prob. 11 4A (MAN) (Concluded) 3. The unit costs are different even though each product requires 0.8 machine hour because the products consume many activities in ratios different from the volume. For example, the I8 consumes setup, moving, shipping, and product engineering activities proportionately greater than its volume, while the M5 consumes the same activities proportionately less than its volume

34 Cost Allocation and -Based Costing Prob. 26 5A (FIN MAN); Prob. 11 5A (MAN) 1. Customer Project Engineering Service Bidding Support cost $83,720 $61,360 $86,800 base 322 sr* 104 bids 217 dc* rate $ 260 /sr $ 590 /bid $ 400 /dc 2. Good Knowledge University Customer service 60 sr $260/sr = $15,600 Project bidding 36 bids $590/bid = 21,240 Engineering support 45 dc $400/dc = 18,000 Total nonmanufacturing activity costs $54,840 Hot Shotz Arena Customer service 52 sr $260/sr = $13,520 Project bidding 18 bids $590/bid = 10,620 Engineering support 30 dc $400/dc = 12,000 Total nonmanufacturing activity costs $36,140 Break-a-Leg Hospital Customer service 210 sr $260/sr = $ 54,600 Project bidding 50 bids $590/bid = 29,500 Engineering support 142 dc $400/dc = 56,800 Total nonmanufacturing activity costs $140,900 * sr stands for service request; dc stands for design change

35 Cost Allocation and -Based Costing Prob. 26 5A (FIN MAN); Prob. 11 5A (MAN) (Concluded) 3. COLD ZONE MECHANICAL INC. Customer Profitability Report For the Year Ended December 31 Good Knowledge Hot Shotz Break-a-Leg University Arena Hospital Revenues $1,650,000 $1,050,000 $450,000 Less cost of goods sold 1,320, , ,0006 Gross profit $ 330,000 $ 210,000 $90,000 Less selling and administrative activities: Customer service $ 15,600 $ 13,520 $ 54,600 Project bidding 21,240 10,620 29,500 Engineering support 18,000 12,000 56,800 $ 54,840 $ 36,140 $140,900 Income from operations $ 275,160 $ 173,860 $ (50,900) 1 $75, units 4 $60, units 2 $75, units 5 $60, units 3 $75,000 6 units 6 $60,000 6 units 4. Break-a-Leg Hospital is unprofitable, while the other two customers have acceptable margins. This is because Break-a-Leg Hospital requires many customer service, project bidding, and design change activities. For example, Break-a-Leg Hospital awards contracts on only 12% of the bid efforts (6 contracts 50 bids); it requests a large amount of service; and it requires extensive design change effort. The company's options include: a. Stop bidding Break-a-Leg Hospital projects. This does not necessarily mean that all the costs can be avoided. The costs only will be eliminated if the reduced activity translates into lower headcount (dismissals). Thus, the company should evaluate the contribution margin of this customer relationship before making this decision. b. Reprice Break-a-Leg Hospital work. Charge Break-a-Leg Hospital a higher price to compensate for the higher activities required to serve it. However, the customer may not accept the price increase required to move it to a profitable relationship. c. Encourage Break-a-Leg Hospital to reduce the amount of design changes and customer service requests. The design changes are probably driving the customer service requests. This may be appealing, but there may be no incentive for Breaka-Leg Hospital to change its behavior. d. Charge a price for customer service and design change separately. That is, unbundle the pricing of goods from the support services. This is a good longterm solution. In addition, improve the bidding process in order to improve the hit rate or the percentage of awarded contracts to bids

36 Cost Allocation and -Based Costing Prob. 26 6A (FIN MAN); Prob. 11 6A (MAN) 1. Cost Base = Rate Scheduling and admitting $ 432,000 6,000 patients = $72 /patient Housekeeping 4,212,000 27,000 pds* = $156 /pd Nursing 5,376, ,000 wcus* = $28 /wcu Total $10,020,000 * "pd" stands for patient day; "wcu" stands for weighted care unit 2. Usage Rate = Total Cost by Procedure Procedure A Scheduling and admitting 280 patients $72 /patient Housekeeping 1,680 pds $156 /pd Nursing 19,200 wcus $28 /wcu $ 20, , ,600 $819,840 Procedure B Scheduling and admitting 650 patients $72 /patient Housekeeping 3,250 pds $156 /pd Nursing 6,000 wcus $28 /wcu $ 46, , ,000 $721,800 Procedure C Scheduling and admitting 1,200 patients Housekeeping 4,800 pds Nursing 24,000 wcus $72 /patient $ 86,400 $156 /pd 748,800 $28 /wcu 672,000 $1,507,

37 Cost Allocation and -Based Costing Prob. 26 6A (FIN MAN); Prob. 11 6A (MAN) (Concluded) 3. Procedure A Procedure B Procedure C Reimbursement (patient days reimbursement rate)* $ 682,080 $1,319,500 $1,948,800 Total activity cost (from 2.) 819, ,800 1,507,200 Excess (deficiency) of reimbursement over activity cost $(137,760) $ 597,700 $ 441,600 * 1,680 patient days $406/patient day = $682,080 3,250 patient days $406/patient day = $1,319,500 4,800 patient days $406/patient day = $1,948, Procedure A requires more activity cost than is being reimbursed by the insurance company. As a result, the hospital may wish to determine if the costs of providing Procedure A are too high. Hospital management may wish to investigate the nursing effort, because the weighted average care units are averaging nearly 11.4 (19,200 1,680) wcus per patient day for Procedure A, which compares to 1.8 (6,000 3,250) and 5 (24,000 4,800) wcus per patient day for Procedures B and C, respectively. Alternatively, the hospital may wish to negotiate for a higher reimbursement from the insurance company for Procedure A. Note to Instructors: The total activity costs and activity-base quantities for the three procedures are less than the totals because these are only three selected procedures out of a larger population

38 Cost Allocation and -Based Costing Prob. 26 1B (FIN MAN); Prob. 11 1B (MAN) 1. a. Direct labor overhead rate: $299,700 1,620 direct labor hours b. Machine hour overhead rate: $299,700 2,700 machine hours = = $185 per direct labor hour $111 per machine hour 2. Whole Milk Skim Milk Cream a. Direct labor hours: Blending Department 260 dlh 245 dlh 215 dlh Packing Department Total direct labor hours 730 dlh 545 dlh 345 dlh Direct labor overhead rate $185 /dlh $185 /dlh $185 /dlh Allocated factory overhead $135,050 $100,825 $63,825 b. Machine hours: Blending Department 650 mh 710 mh 260 mh Packing Department Total machine hours 1,150 mh 1,125 mh 425 mh Machine hour overhead rate $111 /mh $111 /mh $111 /mh Allocated factory overhead $127,650 $124,875 $47,

39 Cost Allocation and -Based Costing Prob. 26 2B (FIN MAN); Prob. 11 2B (MAN) 1. Blending Packing Dept. Dept. Production department factory overhead totals $178,200 $121,500 base 1,620 mh 900 dlh Production department rate $ 110 /mh $ 135 /dlh 2. Whole milk Blending Department 650 dir. mach. hrs. $110/dmh = $ 71,500 Packing Department 470 dir. labor hrs. $135/dlh = 63,450 Total factory overhead for whole milk $134,950 Skim milk Blending Department 710 dir. mach. hrs. $110/dmh = $ 78,100 Packing Department 300 dir. labor hrs. $135/dlh = 40,500 Total factory overhead for skim milk $118,600 Cream Blending Department 260 dir. mach. hrs. $110/dmh = $ 28,600 Packing Department 130 dir. labor hrs. $135/dlh = 17,550 Total factory overhead for cream $ 46,

40 Cost Allocation and -Based Costing Prob. 26 3B (FIN MAN); Prob. 11 3B (MAN) 1. Production department rates: Subassembly Department Final Assembly Department Factory overhead Direct labor hours $420,000 1,400 $294,000 1,400 Production department rate $ 300 /dlh $ 210 /dlh 2. Production Direct Department Labor Hours Rate = Receivers: Subassembly Department 875 $300 /dlh = Final Assembly Department 525 $210 /dlh = Total factory overhead Number of units Factory overhead per unit Loudspeakers: Subassembly Department 525 $300 /dlh = Final Assembly Department 875 $210 /dlh = Total factory overhead Number of units Factory overhead per unit Factory Overhead $262, ,250 $372,750 7,000 $ $157, ,750 $341,250 7,000 $ based rates: Quality Subassembly Final Assembly Setup Control Department Department Factory overhead $138,600 $261,800 $198,800 $114,800 base 400 setups 2,200 insp. 1,400 dlh 1,400 dlh rate $ /setup $ 119 /insp. $ 142 /dlh $ 82 /dlh 26-40

41 Cost Allocation and -Based Costing Prob. 26 3B (FIN MAN); Prob. 11 3B (MAN) (Concluded) 4. Receivers Loudspeakers Usage Rate = Cost Usage Rate = Cost Setup 80 setups $ /setup $ 27, setups $ /setup $110,880 Quality control 450 insp. $119 /insp. 53,550 1,750 insp. $119 /insp. 208,250 Subassembly Dept. 875 dlh $142 /dlh 124, dlh $142 /dlh 74,550 Final Assembly Dept. 525 dlh $82 /dlh 43, dlh $82 /dlh 71,750 Total Number of units $248,570 7,000 $465,430 7,000 cost per unit $ $ The activity-based overhead allocation reveals that loudspeakers are more costly on a per-unit basis than are the receivers. The multiple production department rate method determines that the per-unit factory overhead is nearly the same for the two products. The multiple production department factory overhead rate method distorts the unit costs because all factory overhead is assumed to be proportional to direct labor hours. Since each product consumes the same total direct labor hours, the factory overhead allocation is nearly equal. The activity-based method separately accounts for the setup and quality-control activity costs. Loudspeakers have more setups and inspection activities than do receivers. Thus, loudspeakers have higher activity costs per unit than do receivers

42 Cost Allocation and -Based Costing Prob. 26 4B (FIN MAN); Prob. 11 4B (MAN) 1. Production Setup Inspection Shipping Customer Service Total activity cost $500,000 $144,000 $44,000 $115,000 $84,000 Total activity base 10,000 mh 450 setups 1,100 insp. 5,750 cust. ord. 600 req. rate $ 50 /mh $ 320 /setup $ 40 /insp. $ 20 /cust. ord. $ 140 /req. 2. White Sugar Base Usage Rate = Cost - Base Production Usage 2,500 mh Rate $50 /mh = Cost $125,000 Setup 195 setups $320 /setup 62,400 Inspection 550 insp. $40 /insp. 22,000 Shipping 2,000 cust. ord. $20 /cust. ord. 40,000 Customer service 190 requests $140 /request 26,600 Total activity cost $276,000 Units cost per unit $ 5, Brown Sugar Base Usage Rate = Cost Production 5,000 mh $50 /mh $250,000 2,500 mh $50 /mh $125,000 Setup 85 setups $320 /setup 27, setups $320 /setup 54,400 Inspection 220 insp. $40 /insp. 8, insp. $40 /insp. 13,200 Shipping 1,150 cust. ord. $20 /cust. ord. 23,000 2,600 cust. ord. $20 /cust. ord. 52,000 Customer service 60 requests $140 /request 8, requests $140 /request 49,000 Total activity cost $317,400 $293,600 Units cost per unit $ 10, $ 5, Powdered Sugar 26-42