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Cost Accounting

Cost Accounting. Allocation of Overhead. MB-664 May 2009. Managerial Cost Concepts. Direct materials : raw materials physically associated with the final product Direct labor : employees physically and directly associated with the final product

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Cost Accounting

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  1. Cost Accounting Allocation of Overhead MB-664 May 2009

  2. Managerial Cost Concepts • Direct materials: raw materials physically associated with the final product • Direct labor: employees physically and directly associated with the final product • Overhead: variable manufacturing overhead tied directly to the final product while fixed manufacturing overhead is not. • Selling and administrative: Marketing expenses, office expenses and managerial salaries and benefits.

  3. Budgets and Financial Statements Sales Budget Production Budget Direct Materials Budget Direct Labor Budget Overhead Budget Selling and Administrative Expense Budget Capital expenditures Cash Budget Budgeted Income Statement Budgeted Balance Sheet Budgeted Cash Flow Statement

  4. Enterprise Budgets and The Master Budget • Enterprise #1 • Unit sales and expected price • Unit production and inventory • Direct materials used • Direct labor used • Manufacturing overhead Sales Budget Production Budget Direct Materials Budget Direct Labor Budget • Enterprise #n • Unit sales and expected price • Unit production and inventory • Direct materials used • Direct labor used • Manufacturing overhead Overhead Budget

  5. Enterprise Budgets and The Master Budget • Enterprise #1 • Unit sales and expected price • Unit production and inventory • Direct materials used • Direct labor used • Manufacturing overhead Sales Budget Production Budget Direct Materials Budget Direct Labor Budget • Enterprise #n • Unit sales and expected price • Unit production and inventory • Direct materials used • Direct labor used • Manufacturing overhead Overhead Budget

  6. Enterprise Budgets and The Master Budget • Examples of direct materials: • Purchase of corn. • Purchase of natural gas. • Purchase of other inputs used in • the ethanol production process. • Enterprise #1 • Unit sales and expected price • Unit production and inventory • Direct materials used • Direct labor used • Manufacturing overhead • 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.

  7. Use of ABC Accounting • Identify and classify activities and allocate overhead to cost pools. • Identify cost drivers – correlation between driver and use. • Calculate overhead rates or ABC rates. • Assign overhead costs to products – use of cost drivers. • Allocate overhead to individual products.

  8. Activity Based Cost Allocation Overhead Costs

  9. Activity Based Cost Allocation Overhead Costs Ordering and Receiving Materials Cost Pool Setting Up Machines Cost Pool Machining Cost Pool Assembly Cost Pool Inspecting and Testing Cost Pool Painting Cost Pool These are activity cost pools

  10. Activity Based Cost Allocation Overhead Costs Activity cost pools: Ordering and Receiving Materials Cost Pool Setting Up Machines Cost Pool Machining Cost Pool Assembly Cost Pool Inspecting and Testing Cost Pool Painting Cost Pool # of Tests # of Direct hours # of Machine hours # of Parts # of Setups # of Purchase orders These are cost drivers

  11. Activity Based Cost Allocation Overhead Costs Activity cost pools: Ordering and Receiving Materials Cost Pool Setting Up Machines Cost Pool Machining Cost Pool Assembly Cost Pool Inspecting and Testing Cost Pool Painting Cost Pool Cost drivers: # of Tests # of Direct hours # of Machine hours # of Parts # of Setups # of Purchase orders Products

  12. Example of ABC Accounting Step 1: calculate the ABC Overhead rate: Activity Cost Pool Process Driver AB overhead overhead activity rate Setting up machines $300,000 1,500 setups $200/setup Machining $500,000 50,000 hours $10/hour Inspecting $100,000 2,000 inspection $50/inspection Total $900,000 Divide the process overhead by level of driver activity to calculate the ABC overhead rate.

  13. Example of ABC Accounting Step 2: Assigning overhead driver activity to products: Activity Cost Pool Cost driver Driver Product 1Product 2 activity Setting up machines # setups 1,500 500 1,000 Machining Hours 50,000 30,000 20,000 Inspecting # 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.

  14. Example of ABC Accounting Step 2: Assigning overhead driver activity to products: Activity Cost Pool Cost driver Driver Product 1Product 2 activity Setting up machines # setups 1,500 500 1,000 Machining Hours 50,000 30,000 20,000 Inspecting # inspections 2,000 500 1,500 Step 3: Partitioning of process overhead: OverheadProduct 1 Product 2___ Setting up machines $300,000 (33%) $100,000 (67%) $200,000 Machining $500,000 (60%) $300,000 (40%) $200,000 Inspecting $100,000 (25%) $25,000 (75%) $75,000 500/1,500 x $300,000 or 500 units x $200/setup

  15. Example of ABC Accounting Step 2: Assigning overhead driver activity to products: Activity Cost Pool Cost driver Driver Product 1Product 2 activity Setting up machines # setups 1,500 500 1,000 Machining Hours 50,000 30,000 20,000 Inspecting # inspections 2,000 500 1,500 Step 3: Partitioning of process overhead: OverheadProduct 1 Product 2___ Setting up machines $300,000 (33%) $100,000 (67%) $200,000 Machining $500,000 (60%) $300,000 (40%) $200,000 Inspecting $100,000 (25%) $25,000 (75%) $75,000 1,000/1,500 x $300,000 or 1,000 x $200/setup

  16. Example of ABC Accounting Step 2: Assigning overhead driver activity to products: Activity Cost Pool Cost driver Driver Product 1Product 2 activity Setting up machines # setups 1,500 500 1,000 Machining Hours 50,000 30,000 20,000 Inspecting # inspections 2,000 500 1,500 Step 3: Partitioning of process overhead: OverheadProduct 1 Product 2___ Setting up machines $300,000 (33%) $100,000 (67%) $200,000 Machining $500,000 (60%) $300,000 (40%) $200,000 Inspecting $100,000 (25%) $25,000 (75%) $75,000 30,000/50,000 x $500,000 or 30,000 x $10/hour

  17. Example of ABC Accounting Step 2: Assigning overhead driver activity to products: Activity Cost Pool Cost driver Driver Product 1Product 2 activity Setting up machines # setups 1,500 500 1,000 Machining Hours 50,000 30,000 20,000 Inspecting # inspections 2,000 500 1,500 Step 3: Partitioning of process overhead: OverheadProduct 1 Product 2___ Setting up machines $300,000 (33%) $100,000 (67%) $200,000 Machining $500,000 (60%) $300,000 (40%) $200,000 Inspecting $100,000 (25%) $25,000 (75%) $75,000 20,000/50,000 x $500,000 or 20,000 x $10/hour

  18. Example of ABC Accounting Step 2: Assigning overhead driver activity to products: Activity Cost Pool Cost driver Driver Product 1Product 2 activity Setting up machines # setups 1,500 500 1,000 Machining Hours 50,000 30,000 20,000 Inspecting # inspections 2,000 500 1,500 Step 3: Partitioning of process overhead: OverheadProduct 1 Product 2___ Setting up machines $300,000 (33%) $100,000 (67%) $200,000 Machining $500,000 (60%) $300,000 (40%) $200,000 Inspecting $100,000 (25%) $25,000 (75%) $75,000 500/2,000 x $100,000 or 500 x $50/inspection

  19. Example of ABC Accounting Step 2: Assigning overhead driver activity to products: Activity Cost Pool Cost driver Driver Product 1Product 2 activity Setting up machines # setups 1,500 500 1,000 Machining Hours 50,000 30,000 20,000 Inspecting # inspections 2,000 500 1,500 Step 3: Partitioning of process overhead: OverheadProduct 1 Product 2___ Setting up machines $300,000 (33%) $100,000 (67%) $200,000 Machining $500,000 (60%) $300,000 (40%) $200,000 Inspecting $100,000 (25%) $25,000 (75%) $75,000 1,500/2,000 x $100,000 or 1,500 x $50/inspection

  20. Example of ABC Accounting Step 3: Partitioning of process overhead: OverheadProduct 1Product 2 Setting up machines $300,000 $100,000 $200,000 Machining $500,000 $300,000 $200,000 Inspecting $100,000$25,000$75,000 Total $900,000 $425,000 $475,000 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

  21. Example of ABC Accounting Step 3: Partitioning of process overhead: OverheadProduct 1Product 2 Setting up machines $300,000 $100,000 $200,000 Machining $500,000 $300,000 $200,000 Inspecting $100,000$25,000$75,000 Total $900,000 $425,000 $475,000 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 $30 = $900,000 / (25,000 + 5,000)

  22. Example of ABC Accounting Product 1Product 2 COP unit costs with ABC costing: Direct materials $40 $30 Direct labor $12 $12 ABC manufacturing overhead $17$95 Total unit costs $69 $137 COP unit costs with traditional costing: Direct materials $40 $30 Direct labor $12 $12 Traditional 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!

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