cost accounting allocation of overhead mb-664 may 2009
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Cost AccountingCost AccountingAllocation of OverheadAllocation of Overhead
MB-664 May 2009
Managerial Cost ConceptsManagerial Cost Concepts
1.1. Direct materialsDirect materials: raw materials physically associated with the final product
2.2. Direct laborDirect labor: employees physically and directly associated with the final product
3.3. OverheadOverhead: variable manufacturing overhead tied directly to the final product while fixed manufacturing overhead is not.
4.4. Selling and administrativeSelling and administrative: Marketing expenses, office expenses and managerial salaries and benefits.
Sales BudgetSales Budget
Production BudgetProduction Budget
Direct MaterialsBudget
Direct MaterialsBudget
Direct LaborBudget
Direct LaborBudget
OverheadBudget
OverheadBudget
Selling and AdministrativeExpense Budget
Selling and AdministrativeExpense Budget
Budgeted IncomeStatement
Budgeted IncomeStatement
Budgeted Cash Flow Statement
Budgeted Cash Flow Statement
BudgetedBalance Sheet
BudgetedBalance Sheet
Budgets and Financial StatementsBudgets and Financial Statements
Capital expenditures
Capital expendituresCash BudgetCash Budget
Sales BudgetSales Budget
Production BudgetProduction Budget
Direct MaterialsBudget
Direct MaterialsBudget
Direct LaborBudget
Direct LaborBudget
OverheadBudget
OverheadBudget
Enterprise Budgets and The Master BudgetEnterprise Budgets and The Master Budget
Enterprise #1•Unit sales and expected price•Unit production and inventory•Direct materials used•Direct labor used•Manufacturing overhead
Enterprise #n•Unit sales and expected price•Unit production and inventory•Direct materials used•Direct labor used•Manufacturing overhead
Sales BudgetSales Budget
Production BudgetProduction Budget
Direct MaterialsBudget
Direct MaterialsBudget
Direct LaborBudget
Direct LaborBudget
OverheadBudget
OverheadBudget
Enterprise #1•Unit sales and expected price•Unit production and inventory•Direct materials used•Direct labor used•Manufacturing overhead
Enterprise #n•Unit sales and expected price•Unit production and inventory•Direct materials used•Direct labor used•Manufacturing overhead
Enterprise Budgets and The Master BudgetEnterprise Budgets and The Master Budget
Enterprise #1•Unit sales and expected price•Unit production and inventory•Direct materials used•Direct labor used•Manufacturing overhead
Examples of direct materials:•Purchase of corn.•Purchase of natural gas.•Purchase of other inputs used in the ethanol production process.
Examples of manufacturing overhead:•Variable manufacturing overhead examples include utilities, repairs and maintenance.•Fixed manufacturing overhead examples include property taxes, rent, insurance premiums, depreciation and legal and professional charges.
Enterprise Budgets and The Master BudgetEnterprise Budgets and The Master Budget
Use of ABC AccountingUse of ABC Accounting
1. Identify and classify activitiesactivities and allocate overhead to cost pools.
2. Identify cost driverscost drivers – correlation between driver and use.
3. Calculate overhead rates or ABC ratesABC rates.
4. Assign overhead costs to products – use of cost drivers.
5. Allocate overhead to individual products.
Overhead Costs
Overhead Costs
Activity Based Cost AllocationActivity Based Cost Allocation
Overhead Costs
Overhead Costs
Orderingand
ReceivingMaterialsCost Pool
Orderingand
ReceivingMaterialsCost Pool
Setting Up
MachinesCostPool
Setting Up
MachinesCostPool
MachiningCostPool
MachiningCostPool
AssemblyCostPool
AssemblyCostPool
Inspectingand
TestingCostPool
Inspectingand
TestingCostPool
PaintingCostPool
PaintingCostPool
These are activity cost poolsThese are activity cost pools
Activity Based Cost AllocationActivity Based Cost Allocation
Overhead Costs
Overhead Costs
Orderingand
ReceivingMaterialsCost Pool
Orderingand
ReceivingMaterialsCost Pool
Setting Up
MachinesCostPool
Setting Up
MachinesCostPool
MachiningCostPool
MachiningCostPool
# ofPurchase
orders
# ofPurchase
orders
AssemblyCostPool
AssemblyCostPool
Inspectingand
TestingCostPool
Inspectingand
TestingCostPool
PaintingCostPool
PaintingCostPool
# ofSetups
# ofSetups
# ofMachine
hours
# ofMachine
hours
# ofParts
# ofParts
# ofTests
# ofTests
# ofDirecthours
# ofDirecthours
Activity cost pools:Activity cost pools:
These are cost drivers These are cost drivers
Activity Based Cost AllocationActivity Based Cost Allocation
Overhead Costs
Overhead Costs
Orderingand
ReceivingMaterialsCost Pool
Orderingand
ReceivingMaterialsCost Pool
Setting Up
MachinesCostPool
Setting Up
MachinesCostPool
MachiningCostPool
MachiningCostPool
# ofPurchase
orders
# ofPurchase
orders
AssemblyCostPool
AssemblyCostPool
Inspectingand
TestingCostPool
Inspectingand
TestingCostPool
PaintingCostPool
PaintingCostPool
# ofSetups
# ofSetups
# ofMachine
hours
# ofMachine
hours
# ofParts
# ofParts
# ofTests
# ofTests
# ofDirecthours
# ofDirecthours
Products
Products
Activity cost pools:Activity cost pools:
Cost drivers: Cost drivers:
Activity Based Cost AllocationActivity Based Cost Allocation
Example of ABC AccountingExample of ABC AccountingStep 1: calculate the ABC Overhead rate:Step 1: calculate the ABC Overhead rate:
Activity Cost Pool Process Driver AB overhead overhead activity rateSetting up machines $300,000 1,500 setups $200/setupMachining $500,000 50,000 hours $10/hourInspecting $100,000 2,000 inspection $50/inspection Total $900,000
Divide the process overhead by level of driver activityto calculate the ABC overhead rate.
Divide the process overhead by level of driver activityto calculate the ABC overhead rate.
Example of ABC AccountingExample of ABC Accounting
Step 2: Assigning overhead driver activity to products:Step 2: Assigning overhead driver activity to products:
Activity Cost Pool Cost driver Driver Product 1 Product 2 activity
Setting up machines # setups 1,500 500 1,000Machining Hours 50,000 30,000 20,000Inspecting # inspections 2,000 500 1,500
Allocate the activity levels to the 2 products. For example,500 of the setups are associated with product 1.
Allocate the activity levels to the 2 products. For example,500 of the setups are associated with product 1.
Step 2: Assigning overhead driver activity to products:Step 2: Assigning overhead driver activity to products:Activity Cost Pool Cost driver Driver Product 1 Product 2
activitySetting up machines # setups 1,500 500 1,000Machining Hours 50,000 30,000 20,000Inspecting # inspections 2,000 500 1,500
Step 3: Partitioning of process overhead:Step 3: Partitioning of process overhead: Overhead Product 1 Product 2___Setting up machines $300,000 (33%) $100,000 (67%) $200,000Machining $500,000 (60%) $300,000 (40%) $200,000Inspecting $100,000 (25%) $25,000 (75%) $75,000
500/1,500 x $300,000 or 500 units x $200/setup500/1,500 x $300,000 or 500 units x $200/setup
Example of ABC AccountingExample of ABC Accounting
Step 2: Assigning overhead driver activity to products:Step 2: Assigning overhead driver activity to products:Activity Cost Pool Cost driver Driver Product 1 Product 2
activitySetting up machines # setups 1,500 500 1,000Machining Hours 50,000 30,000 20,000Inspecting # inspections 2,000 500 1,500
Step 3: Partitioning of process overhead:Step 3: Partitioning of process overhead: Overhead Product 1 Product 2___Setting up machines $300,000 (33%) $100,000 (67%) $200,000Machining $500,000 (60%) $300,000 (40%) $200,000Inspecting $100,000 (25%) $25,000 (75%) $75,000
1,000/1,500 x $300,000 or 1,000 x $200/setup1,000/1,500 x $300,000 or 1,000 x $200/setup
Example of ABC AccountingExample of ABC Accounting
Step 2: Assigning overhead driver activity to products:Step 2: Assigning overhead driver activity to products:Activity Cost Pool Cost driver Driver Product 1 Product 2
activitySetting up machines # setups 1,500 500 1,000Machining Hours 50,000 30,000 20,000Inspecting # inspections 2,000 500 1,500
Step 3: Partitioning of process overhead:Step 3: Partitioning of process overhead: Overhead Product 1 Product 2___Setting up machines $300,000 (33%) $100,000 (67%) $200,000Machining $500,000 (60%) $300,000 (40%) $200,000Inspecting $100,000 (25%) $25,000 (75%) $75,000
30,000/50,000 x $500,000 or 30,000 x $10/hour30,000/50,000 x $500,000 or 30,000 x $10/hour
Example of ABC AccountingExample of ABC Accounting
Step 2: Assigning overhead driver activity to products:Step 2: Assigning overhead driver activity to products:Activity Cost Pool Cost driver Driver Product 1 Product 2
activitySetting up machines # setups 1,500 500 1,000Machining Hours 50,000 30,000 20,000Inspecting # inspections 2,000 500 1,500
Step 3: Partitioning of process overhead:Step 3: Partitioning of process overhead: Overhead Product 1 Product 2___Setting up machines $300,000 (33%) $100,000 (67%) $200,000Machining $500,000 (60%) $300,000 (40%) $200,000Inspecting $100,000 (25%) $25,000 (75%) $75,000
20,000/50,000 x $500,000 or 20,000 x $10/hour20,000/50,000 x $500,000 or 20,000 x $10/hour
Example of ABC AccountingExample of ABC Accounting
Step 2: Assigning overhead driver activity to products:Step 2: Assigning overhead driver activity to products:Activity Cost Pool Cost driver Driver Product 1 Product 2
activitySetting up machines # setups 1,500 500 1,000Machining Hours 50,000 30,000 20,000Inspecting # inspections 2,000 500 1,500
Step 3: Partitioning of process overhead:Step 3: Partitioning of process overhead: Overhead Product 1 Product 2___Setting up machines $300,000 (33%) $100,000 (67%) $200,000Machining $500,000 (60%) $300,000 (40%) $200,000Inspecting $100,000 (25%) $25,000 (75%) $75,000
500/2,000 x $100,000 or 500 x $50/inspection500/2,000 x $100,000 or 500 x $50/inspection
Example of ABC AccountingExample of ABC Accounting
Step 2: Assigning overhead driver activity to products:Step 2: Assigning overhead driver activity to products:Activity Cost Pool Cost driver Driver Product 1 Product 2
activitySetting up machines # setups 1,500 500 1,000Machining Hours 50,000 30,000 20,000Inspecting # inspections 2,000 500 1,500
Step 3: Partitioning of process overhead:Step 3: Partitioning of process overhead: Overhead Product 1 Product 2___Setting up machines $300,000 (33%) $100,000 (67%) $200,000Machining $500,000 (60%) $300,000 (40%) $200,000Inspecting $100,000 (25%) $25,000 (75%) $75,000
1,500/2,000 x $100,000 or 1,500 x $50/inspection1,500/2,000 x $100,000 or 1,500 x $50/inspection
Example of ABC AccountingExample of ABC Accounting
Step 3: Partitioning of process overhead:Step 3: Partitioning of process overhead: Overhead Product 1 Product 2Setting up machines $300,000 $100,000 $200,000Machining $500,000 $300,000 $200,000Inspecting $100,000 $25,000 $75,000 Total $900,000 $425,000 $475,000
Step 4: Process overhead costs per unit:Step 4: Process overhead costs per unit:Units produced 25,000 5,000 Process overhead cost per unit $17 $95
$17 = $425,000 / 25,000$95 = $475,000 / 5,000
$17 = $425,000 / 25,000$95 = $475,000 / 5,000
Example of ABC AccountingExample of ABC Accounting
Step 3: Partitioning of process overhead:Step 3: Partitioning of process overhead: Overhead Product 1 Product 2Setting up machines $300,000 $100,000 $200,000Machining $500,000 $300,000 $200,000Inspecting $100,000 $25,000 $75,000 Total $900,000 $425,000 $475,000
Step 4: Process overhead costs per unit:Step 4: Process overhead costs per unit:Units produced 25,000 5,000 Process overhead cost per unit $17 $95
Traditional process overhead cost per unit $30 $30
Example of ABC AccountingExample of ABC Accounting
$30 = $900,000 / (25,000 + 5,000)$30 = $900,000 / (25,000 + 5,000)
Product 1 Product 2COP unit costs with COP unit costs with ABC costingABC costing::Direct materials $40 $30Direct labor $12 $12ABC manufacturing overhead $17 $95 Total unit costs $69 $137
COP unit costs with COP unit costs with traditional costingtraditional costing::Direct materials $40 $30Direct labor $12 $12Traditional manufacturing overhead $30 $30 Total unit costs $82 $72
Traditional overhead costing suggests that Product 2 is cheaper to produce
than Product 1, which is not true!
Traditional overhead costing suggests that Product 2 is cheaper to produce
than Product 1, which is not true!
Example of ABC AccountingExample of ABC Accounting