Accounting principles, 13th edition appxh

Accounting Principles Thirteenth Edition Weygandt Kimmel Kieso Appendix H Time Just-in-Time Processing and Activity-Based Costing Prepared by Coby Harmon University of California, Santa Barbara Westmont College Chapter Outline Learning Objectives LO Explain just-in-time (JIT) processing and activitybased costing (ABC) LO Apply activity-based costing to a manufacturer Copyright ©2018 John Wiley & Son, Inc Just-in-Time Processing ILLUSTRATION H.1 LO Copyright ©2018 John Wiley & Son, Inc Just-in-Time Processing Objective of JIT Processing To eliminate all manufacturing inventories Elements of JIT Processing Dependable suppliers Multiskilled work force Total quality control system LO Copyright ©2018 John Wiley & Son, Inc Just-in-Time Processing Benefits of JIT Processing Significant reduction or elimination of manufacturing inventories Enhanced product quality Reduction or elimination of rework costs and inventory storage costs Production cost savings from the improved flow of goods through the processes LO Copyright ©2018 John Wiley & Son, Inc Activity-Based Costing Conventional cost system uses a single unit-level basis to allocate overhead costs to products ABC recognizes that more than one basis of allocating activity costs to products is needed ABC seeks to identify cost drivers that measure activities performed on the product Cost driver: Any factor or activity that has a direct cause–effect relationship with resources consumed LO Copyright ©2018 John Wiley & Son, Inc Activity-Based Costing Two important assumptions must be met in order to obtain accurate product costs under ABC: All overhead costs related to activity must be driven by the cost driver used to assign costs to products All overhead costs related to activity should respond proportionally to changes in activity level of the cost driver LO Copyright ©2018 John Wiley & Son, Inc Activity-Based Costing ILLUSTRATION H.2 Activities and cost drivers in ABC Activity Ordering raw materials Receiving raw materials Materials handling Cost Driver Ordering hours; number of orders Receiving hours; number of shipments Number of requisitions; weight of materials; handling hours Production scheduling Machine setups Machining (fabricating, assembling, etc.) Number of orders Setup hours; number of setups Machine hours Quality control inspections Factory supervision Number of inspections Number of employees LO Copyright ©2018 John Wiley & Son, Inc Applying Activity-Based Costing Activity-Based costing involves the following four steps Identify and classify activities involved in the manufacture of specific products and assign overhead to cost pools Identify the cost driver that has a strong correlation to the costs accumulated in each cost pool Compute the activity-based overhead rate for each cost pool LO Allocate overhead costs to products using overhead rates determined for each pool Copyright ©2018 John Wileycost & Son, Inc Applying Activity-Based Costing Assume Atlas Company produces two abdominal fitness products— the Ab Bench and the Ab Coaster Each year, the company produces 25,000 Ab Benches but only 5,000 Ab Coasters Each unit produced requires one hour of direct labor, for a total of 30,000 labor hours (25,000 + 5,000) The direct labor cost is $12 per unit for each product The direct materials cost per unit is $40 for the Ab Bench and $30 for the Ab Coaster Atlas also expects to incur annual manufacturing overhead costs of $900,000 Atlas allocates overhead using a single predetermined overhead rate based on the 30,000 direct labor hours it expects to use The predetermined overhead rate is $30 per direct labor hour ($900,000 / 30,000 direct labor hours) Since both products require one direct labor hour per unit, both products are allocated overhead costs of $30 per unit under traditional costing LO Copyright ©2018 John Wiley & Son, Inc 10 Applying Activity-Based Costing Illustration shows the total unit costs for the Ab Bench and the Ab Coaster ILLUSTRATION H.3 Total unit costs—traditional costing Atlas Company LO Manufacturing Costs Direct materials Ab Bench $40 Direct labor Overhead Total direct cost per unit 12 30 $82 Copyright ©2018 John Wiley & Son, Inc Ab Coaster $30 12 30 $72 11 Identify and Classify Activities and Assign Overhead to Cost Pools (Step 1) Illustration H.4 shows the five cost pools, along with the estimated overhead assigned to each cost pool Atlas Company Activity Cost Pools Manufacturing Setups Purchase ordering Product development Facility management Total LO ILLUSTRATION H.4 Activity cost pools and estimated overhead Estimated Overhead $500,000 100,000 50,000 200,000 50,000 $900,000 Copyright ©2018 John Wiley & Son, Inc 12 Identify Cost Drivers (Step 2) Cost driver must accurately measure the actual consumption of the activity by the various products Activity Cost Pools Cost Drivers Expected Use of Cost Drivers per Activity Manufacturing Setups Purchase ordering Product development Property and plant Machine hours Number of setups Number of purchase orders Products developed Square footage 50,000 machine hours 2,000 setups 2,500 purchase orders products developed 25,000 square feet ILLUSTRATION H.5 Cost drivers and their expected use LO Copyright ©2018 John Wiley & Son, Inc 13 Compute Activity-Based Overhead Rates (Step 3) ILLUSTRATION H.6 Formula for computing activity-based overhead rate Estimated Overhead per Activity = Activity-Based Expected Use of Cost Drivers per Activity Overhead Rate Estimated Expected Use of Cost Activity-Based Activity Cost Pools Overhead ÷ Drivers per Activity = Overhead Rates Manufacturing Setups Purchase ordering Product development Property and plant Total LO $500,000 100,000 50,000 200,000 50,000 $900,000 ILLUSTRATION H.7 Computation of activity-based overhead rates 50,000 machine hours 2,000 setups 2,500 purchase orders products developed 25,000 square feet $10 per machine hour $50 per setup $20 per order $100,000 per product $2 per square foot Copyright ©2018 John Wiley & Son, Inc 14 Allocate Overhead Costs to Products (Step 4) In allocating overhead costs, it is necessary to know the expected use of cost drivers for each product Because of its low volume and higher number of components, the Ab Coaster requires more setups and purchase orders than the Ab Bench Activity Cost Pools Manufacturing Setups Purchase ordering Product development Property and plant LO Cost Drivers Machine hours Number of setups Number of purchase orders Products developed Square footage ILLUSTRATION H.8 Expected use of cost drivers per product Expected Use of Cost Drivers per Activity Expected Use of Cost Drivers per Product Ab Bench Ab Coaster 50,000 machine hours 2,000 setups 2,500 purchase orders 25,000 square feet Copyright ©2018 John Wiley & Son, Inc 30,000 500 $750 10,000 20,000 1,500 1,750 15,000 15 Allocate Overhead Costs (Step 4) To allocate overhead costs, Atlas multiplies the activity-based overhead rates per cost driver (Ill H.7) by the number of cost drivers expected to be used per product (Ill H.8) Ab Bench Activity Cost Pools Expected Use of Cost Drivers per Product Manufacturing 30,000 Setups 500 Purchase ordering 750 Product development Property and plant 10,000 Total costs allocated Units produced Overhead cost per unit (rounded) LO ILLUSTRATION H.9 Allocation of activity cost pools to products Activity-Based Overhead Cost x Rates = Allocated $10 $50 $20 $100,000 $2.00 Copyright ©2018 John Wiley & Son, Inc $300,000 25,000 15,000 100,000 20,000 $460,000 25,000 $18.40 16 Allocate Overhead Costs (Step 4) To allocate overhead costs, Atlas multiplies the activity-based overhead rates per cost driver (Ill H.7) by the number of cost drivers expected to be used per product (Ill H.8) Ab Coaster Activity Cost Pools Expected Use of Cost Drivers per Product Manufacturing 20,000 Setups 1,500 Purchase ordering 1,750 Product development Property and plant 15,000 Total costs allocated Units produced Overhead cost per unit (rounded) LO ILLUSTRATION H.9 Allocation of activity cost pools to products Activity-Based Overhead Cost x Rates = Allocated $10 $50 $20 $100,000 $2.00 Copyright ©2018 John Wiley & Son, Inc $200,000 75,000 35,000 100,000 30,000 $440,000 5,000 $88.00 17 Comparing Unit Costs ILLUSTRATION H.10 Comparison of unit product costs Ab Bench Manufacturing Costs Direct materials Direct labor Overhead Total direct cost per unit Traditional Costing Ab Coaster ABC $40.00 12.00 30.00 $82.00 $40.00 12.00 18.40 $70.40 Overstated $11.60 Traditional Costing $30.00 12.00 30.00 $72.00 ABC $30.00 12.00 88.00 $130.00 Understated $58.00 Negative consequences of a traditional costing system include overpricing its Ab Benches and thereby possibly losing market share to competitors and sacrificing profitability by underpricing the Ab Coaster LO Copyright ©2018 John Wiley & Son, Inc 18 Benefits of ABC ABC has three primary benefits: More cost pools, therefore more accurate product costing Enhanced control over overhead costs Better management decisions LO Copyright ©2018 John Wiley & Son, Inc 19 Benefits of ABC More cost pools, therefore more accurate product costing Enhanced control over overhead costs Better management decisions Limitations of ABC Can be expensive to use Some arbitrary allocations continue LO Copyright ©2018 John Wiley & Son, Inc 20 Copyright Copyright © 2018 John Wiley & Sons, Inc All rights reserved Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Act without the express written permission of the copyright owner is unlawful Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc The purchaser may make back-up copies for his/her own use only and not for distribution or resale The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein Copyright ©2018 John Wiley & Son, Inc 21