Appendix 6A Cost Flows in an -Based Costing System 6A-1 Cost Flows in an -Based Costing System In Chapter 4, we discussed the flow of costs in a job-order costing system. The flow of costs through raw materials, work in process, and other accounts is the same under activitybased costing. The only difference in ABC is that more than one predetermined overhead rate is used to apply overhead costs to products. Our purpose in this section is to provide a detailed example of cost flows in an ABC system. An Example of Cost Flows The company in the following example has five activity cost pools and therefore must compute five predetermined overhead rates (i.e., activity rates). Except for that detail, the journal entries, T-accounts, and general cost flows are the same as described in Chapter 4. Consider the following data for Sarvik Company. BASIC DATA Raw materials.................... Work in process.................. Finished goods................... Know A CC10 : Describe the flow of costs in an activity-based costing system. Apply A CC11 : Record the flow of costs in an activity-based costing system. $3,000 4,000 0 Selected transactions recorded by the company during the year are as follows: a. Raw materials were purchased on account, $915,000. b. Raw materials were requisitioned for use in production, $900,000 ($810,000 direct and $90,000 indirect). c. Labour costs were incurred in the factory, $370,000 ($95,000 direct labour and $275,000 indirect labour). d. Depreciation was recorded on factory assets, $180,000. e. Miscellaneous manufacturing overhead costs were incurred, $230,000. f. The company uses an ABC system to apply manufacturing overhead costs to products. The following data pertain to overhead allocation: Cost Pool (1) Machine related Purchase orders Machine setups Product testing General factory Measure (2) Machine-hours Number of orders Number of setups Number of tests Direct labour-hours Rate (3) Actual (4) Applied Overhead Cost (3) 3 (4) $35 per MH $90 per order $200 per setup $800 per test $12 per DLH 4,600 MHs 800 orders 500 setups 190 tests 23,000 DLHs $161,000 72,000 100,000 152,000 276,000 $761,000 g. Goods costing $1,650,000 to manufacture were completed during the year. 6A-1
6A-2 Appendix 6A TRACKING THE FLOW OF COSTS The following journal entries would be used to record transactions (a) through (g) shown previously: a. Raw Materials........................ 915,000 Accounts Payable.................. 915,000 b. Work in Process....................... 810,000 Manufacturing Overhead.............. 90,000 Raw Materials..................... 900,000 c. Work in Process....................... 95,000 Manufacturing Overhead.............. 275,000 Salaries and Wages Payable.......... 370,000 d. Manufacturing Overhead.............. 180,000 Accumulated Depreciation.......... 180,000 e. Manufacturing Overhead.............. 230,000 Accounts Payable.................. 230,000 f. Work in Process....................... 761,000 Manufacturing Overhead........... 761,000 g. Finished Goods....................... 1,650,000 Work in Process................... 1,650,000 The T-accounts corresponding to the previous journal entries follow: Raw Materials Bal. 3,000 (b) 900,000 (a) 915,000 Bl. 18,000 Work in Process Bal. 4,000 (g) 1,650,000 (b) 810,000 (c) 95,000 (f) 761,000 Bal. 20,000 Bal. 0 (g) 1,650,000 Finished Goods Accumulated Depreciation (d) 180,000 Accounts Payable (a) 915,000 (e) 230,000 Salaries and Wages Payable (c) 370,000 Manufacturing Overhead (b) 90,000 (f) 761,000 (c) 275,000 (d) 180,000 (e) 230,000 775,000 761,000 Bal. 14,000 The overhead is underapplied by $14,000. This can be determined directly, as shown, or by reference to the balance in the manufacturing overhead T-account. Actual manufacturing overhead incurred........... $775,000 Manufacturing overhead applied.................. 761,000 Overhead underapplied.......................... $ 14,000
Cost Flows in an -Based Costing System 6A-3 LEARNING OBJECTIVE SUMMARY EXPLAIN COST FLOWS IN AN ACTIVITY-BASED COSTING SYSTEM. The flow of costs in an ABC system is essentially the same as in a traditional cost system. The only difference is that an ABC system consists of multiple predetermined activity rates as compared to a single predetermined overhead rate in the traditional system. APPLICATION COMPETENCY SUMMARY FOR APPENDIX 6A APPLICATION COMPETENCY DELIVERABLE SOURCE DOCUMENTS AND KEY INFORMATION STEPS KNOWLEDGE COMPETENCY Record the flow of costs in an ABC system. CC11 A Key Information Account debits, credits, and balances Report/Document Updated account ledgers Resource Acquisition Records Purchase and consumption transaction details (date, quantity, cost) Resource Consumption Records Allocation of costs 1. Identify the different ledgers/t-accounts. 2. Post transactions in the appropriate T-accounts as debit or credit entries, depending on the nature of the transaction. Cost flows CC10 A BRIEF EXERCISE FOR APPENDIX 6A BRIEF EXERCISE 6A 1 Tracking Cost Flows in an ABC System ( CC10 A, 11 A ) Larker Corporation implemented activity-based costing several years ago and uses it for its external financial reports. The company has four activity cost pools, which are listed below: Cost Pool Machine related..................... Purchase orders..................... Machine setups...................... General factory...................... Rate $24 per MH $85 per order $175 per setup $16 per DLH Raw materials..................... $18,000 Work in process................... 24,000 Finished goods.................... 46,000 Selected transactions recorded by the company during the year follow: a. Raw materials were purchased on account, $854,000. b. Raw materials were requisitioned for use in production, $848,000 ($780,000 direct and $68,000 indirect). c. Labour costs were incurred in the factory, $385,000 ($330,000 direct labour and $55,000 indirect labour). d. Depreciation was recorded on factory assets, $225,000.
6A-4 Appendix 6A e. Miscellaneous manufacturing overhead costs were incurred, $194,000. f. Manufacturing overhead cost was applied to production. Actual activity during the year was as follows: Cost Pool Machine related................ Purchase orders................ Machine setups................ General factory................ Actual 3,800 MHs 700 orders 400 setups 22,000 DLHs g. Completed products were transferred to the company s finished goods warehouse. According to the company s costing system, these products cost $1,690,000. Required: 1. Prepare journal entries to record transactions (a) through (g). 2. Post the entries in part (1) to T-accounts, and calculate the ending balance for each T-account. 3. Compute the under- or overapplied overhead cost in the manufacturing overhead account. PROBLEM FOR APPENDIX 6A CHECK FIGURE (4) Overapplied overhead: $386,500 PROBLEM 6A 1 Recording ABC Cost Flows and Income Statement (LO2 CC6, 7; CC10 A, 11 A ) Aucton Corporation is a manufacturing company that uses ABC for its external financial reports. The company s activity cost pools and associated data for the coming year appear below: Estimated Expected Cost Pool Measure Overhead Cost Machining........... Machine-hours $270,000 1,000 MHs Purchase orders...... Number of orders 90,000 450 orders Parts management.... Number of part types 90,000 300 part types Testing.............. Number of tests 150,000 150 tests General factory....... Direct labour-hours 420,000 14,000 DLHs Raw materials......................... $12,000 Work in process........................ 6,000 Finished goods........................ 8,000 The following transactions were recorded for the year: a. Raw materials were purchased on account, $895,000. b. Raw materials were withdrawn from the storeroom for use in production, $900,000 ($820,000 direct and $80,000 indirect). c. The following costs were incurred for employee services: direct labour, $120,000; indirect labour, $200,000; sales commissions, $185,000; administrative salaries, $205,000. d. Sales travel costs were incurred, $38,000. e. Various factory overhead costs were incurred, $437,000. f. Advertising costs were incurred, $190,000. g. Depreciation was recorded for the year, $370,000 ($290,000 related to factory operations and $80,000 related to selling and administrative activities).
Cost Flows in an -Based Costing System 6A-5 h. Manufacturing overhead was applied to products. Actual activity for the year was as follows: Cost Pool Machining..................... Purchase orders................. Parts management.............. Testing........................ General factory................. Actual 1,050 MHs 580 orders 330 part types 265 tests 21,000 DLHs i. Goods were completed and transferred to the finished goods warehouse. According to the company s ABC system, these finished goods cost $2,000,000 to manufacture. j. Goods were sold on account to customers during the year for a total of $2,600,000. According to the company s ABC system, the goods cost $1,950,000 to manufacture. Required: 1. Compute the predetermined overhead rate (i.e., activity rate) for each activity cost pool. 2. Prepare journal entries to record transactions (a) through (j). 3. Post the entries in part (2) to T-accounts. 4. Compute the under- or overapplied manufacturing overhead cost. Prepare a journal entry to close any balance in the manufacturing overhead account to cost of goods sold. Post the entry to the appropriate T-accounts. 5. Prepare an income statement for the year.