Cost Allocation and

Activity-Based Costing
When a manufacturing firm has several
departments that incur overhead costs relating to
different activity levels, departmental overhead
application rates are preferable.

CLASSIFICATION OF DEPARTMENTS

Producing = directly engaged in the manufacturing

activities (assembly, finishing, packaging)

Service = assist indirectly by rendering services

(purchasing, medical, maintenance)
 Objectives
Objectives
1. Identify three methods used for
allocating After
After studying
factorystudying
overheadthis
this costs to
products. chapter,
chapter, you
you should
should
be
be able
able to:
to:factory overhead
2. Use a single plantwide
rate for product costing.
3. Use multiple production department
factory overhead rates for product
costing.
4. Use activity-based costing for product
costing.
 Objectives
Objectives
5. Use activity-based costing to allocate
selling and administrative expenses to
products.
6. Use activity-based costing in a service
business.
PROCEDURES FOR
DEPARTMENTALIZATION

Calculate department predetermined

overhead application rates.
Apply the predetermined overhead
rates to production on a department
basis.
Record actual manufacturing overhead
costs by departments in the department
overhead sheet.
Application of departmental overhead application rates
Prepare a budget of total direct OH costs of Prod. Dept and
Service dept. at diff. activity levels.
Conduct factory survey to determine the bases to be used
in allocating indirect mfg. OH costs and service
departments.
Set up an application rates worksheet to facilitate cost
distribution by dept.
Enter budgeted costs that can be traced directly to specific
dept. as direct departmental costs.
Allocate budgeted mfg OH costs that cannot be traced to
specific depts. According to base selected.
Distribute or reallocate budgeted service departments
costs to producing departments.
Compute departmental predetermined rates by dividing the
total budgeted overhead costs charged to each producing
depts. By base selected.
Direct departmental overhead costs:
Repairs and Maintenance traced to
maintenance dept
Indirect Labor traced to payroll
summaries of department.
Indirect Materials traced through stores
requisitions of the department
Depreciation of equipment traced to
department using the equipment.
Product
Product Costing
Costing Allocation
Allocation Methods
Methods
Plantwide Overhead Rate

Single Rate
P
Multiple Department Rates R
O
Department D
Department U
C
Activity-Based Costing T
Activity S
Activity
Single
Single Plantwide
Plantwide Factory
Factory
Overhead
Overhead Rate
Rate
 Computing
Computing Single
Single Plantwide
Plantwide
Factory
Factory Overhead
Overhead
Total budgeted factory overhead costs
Total budgeted plantwide allocation base

$1,600,000 $80 per hour

=
20,000 direct labor hours overhead rate
 Computing
Computing Single
Single Plantwide
Plantwide
Factory
Factory Overhead
Overhead

Snowmobile:
$80 per dlh x 10 direct labor hours = $800

Lawnmower:
$80 per dlh x 10 direct labor hours = $800
Factory
Factory
Overhead
Overhead
cost
cost per
per unit
unit
 Plantwide
Plantwide factory
factory
overhead
overhead
$1,600,000
$1,600,000

$80 per direct labor hour

x 10 direct x 10 direct
labor hours labor hours

Snowmobile
Snowmobile Lawnmower
Lawnmower
$800
$800 per
per unit
unit $800
$800 per
per unit
unit
 The
The greatest
greatest advantage
advantage of
of the
the
single
single plantwide
plantwide overhead
overhead rate
rate isis
that
that itit isis simple
simple and
and inexpensive
inexpensive
to
to apply.
apply.
 Multiple
Multiple Production
Production
Department
Department Factory
Factory
Overhead
Overhead Rate
Rate Method
Method
Single
Single Plantwide
Plantwide Rate
Rate

Plantwide
Plantwide factory
factory
overhead
overhead

Plantwide rate

Products
Multiple
Multiple Production
Production Department
Department Rate
Rate

Fabrication
Fabrication Assembly
Assembly
Department
Department Department
Department
factory
factory overhead
overhead factory
factory overhead
overhead

Fabrication Department Assembly Department

factory overhead rate factory overhead rate

Products
Production
Production Department
Department Factory
Factory
Overhead
Overhead Rates
Rates and
and Allocation
Allocation

Fabrication Department Overhead Rate:

$1,030,000
= $103 per hour
10,000 direct labor hours

Assembly Department Overhead Rate:

$570,000
= $57 per hour
10,000 direct labor hours
 Production
Production Department
Department Factory
Factory
Overhead
Overhead Rates
Rates and
and Allocation
Allocation

Snowmobile:
Fabrication: $103 x 8 dlh = $824
Assembly: $57 x 2 dlh = 114 $938
Lawnmower:
Fabrication: $103 x 2 dlh = $206
Assembly: $57 x 8 dlh = 456 $662
 Multiple
Multiple Production
Production Department
Department
Rate
Rate Method
MethodRuiz
Ruiz Company
Company
Fabrication
Fabrication Assembly
Assembly
Department
Department Department
Department
$1,030,000
$1,030,000 $570,000
$570,000

$103 x 8 dlh
$57 x 2 dlh

$938 per unit

 Multiple
Multiple Production
Production Department
Department
Rate
Rate Method
MethodRuiz
Ruiz Company
Company
Fabrication
Fabrication Assembly
Assembly
Department
Department Department
Department
$1,030,000
$1,030,000 $570,000
$570,000

$57 x 8 dlh
$103 x 2 dlh

$662 per unit

Indirect Departmental Cost that requires allocation and
suggested basis:

COSTS DIST. BASIS

Factory Rent Square footage
Depreciation-Factory Bldg. Square footage
Fire Insurance on Bldg. Square footage
Repairs and Maintenance Square footage
Telephone No. of employees or
Telephones
Light Kilowatt hour
Freight-In Materials used
Allocating Service Dept. Costs:
SERVICE DEPT. ALLOC. BASIS
Procurement # of orders/cost of mtls.
Receiving Cost of materials/# of units/#
of orders
Storeroom Cost of materials/# of
requests/# of units handled
Factory Office # of employees/labor
hrs./labor costs
Personnel No. of employees/labor
hrs./labor cost
Bldg. Maintenance Floor space occupied
Power Plant Kilowatt hrs. of power usage
DIRECT METHOD
Costs of each service department
are allocated only to producing
departments.
STEP METHOD
(Refer to page 239 of your book)
RECIPROCAL METHOD
(Refer to 240-241 of your book)
Recording (Refer to 243-244)
 Activity-Based
Activity-Based Costing
Costing Method
Method
An allocation method that measures a variety of
different factory activities and their
relationship to overhead costs. In ABC
company develops a system that matches its
own unique production process. The
rationale is products consume activities;
activities consume resources
Activity Centers or cost pools (ordering matls.;
inspection; setting up machines; assembling.
Cost driver or cost pools (# of purchase orders; #
of setups; batch-level activities
 Activity-Based
Activity-Based Costing
Costing Method
Method
Activity-based costing changes the way
overhead costs are allocated.
When identifying specific activities,
inefficiencies may be discovered and
eliminated, reducing the products cost.
Traditional cost accounting undercosts complex
products and overstates their profit margins.
ABC may be used for decision making but not
necessarily for inventory valuation.
 Multiple
Multiple Production
Production Department
Department
Factory
Factory Overhead
Overhead versus
versus ABC
ABC
Production Department Production Department
Factory Overhead Factory Overhead

Production Department Rates

Products

Continued
Continued
 Multiple
Multiple Production
Production Department
Department
Factory
Factory Overhead
Overhead versus
versus ABC
ABC
Activity
Activity Activity
Activity Activity
Activity Activity
Activity

Activity Rates

Products
 Activity-Based
Activity-Based Costing
Costing Method
Method
Activity Amount Activity Rate
Fabrication $ 530,000
Assembly 70,000
Setup 480,000
Quality control 312,000
Engineering 208,000
Total $1,600,000
 Activity-Based
Activity-Based Costing
Costing Method
Method
Activity Amount Activity Rate
Fabrication $ 530,000 10,000 dlh = $53
Assembly 70,000 10,000 dlh = $7
Setup 480,000 120 setups = $4,000
Quality control 312,000 104 inspts. = $3,000
Engineering 208,000 16 changes = $13,000
Total $1,600,000

Fabrication: DL Hours Rate Total

Cost
Cost Drivers
Drivers
Snowmobile 8,000 $53 $424,000
Lawnmower 2,000 53 106,000
Total 10,000 $530,000
 Activity-Based
Activity-Based Costing
Costing Method
Method
Activity Amount Activity Rate
Fabrication $ 530,000 10,000 dlh = $53
Assembly 70,000 10,000 dlh = $7
Setup 480,000 120 setups = $4,000
Quality control 312,000 104 inspts. = $3,000
Engineering 208,000 16 changes = $13,000
Total $1,600,000

Assembly: DL Hours Rate Total

Snowmobile 2,000 $7 $14,000
Lawnmower 8,000 7 56,000
Total 10,000 $70,000
 Activity-Based
Activity-Based Costing
Costing Method
Method
Activity Amount Activity Rate
Fabrication $ 530,000 10,000 dlh = $53
Assembly 70,000 10,000 dlh = $7
Setup 480,000 120 setups = $4,000
Quality control 312,000 104 inspts. = $3,000
Engineering 208,000 16 changes = $13,000
Total $1,600,000

Setup: Setups Rate Total

Snowmobile 100 $4,000 $400,000
Lawnmower 20 4,000 80,000
Total 120 $480,000
 Activity-Based
Activity-Based Costing
Costing Method
Method
Activity Amount Activity Rate
Fabrication $ 530,000 10,000 dlh = $53
Assembly 70,000 10,000 dlh = $7
Setup 480,000 120 setups = $4,000
Quality control 312,000 104 inspts. = $3,000
Engineering 208,000 16 changes = $13,000
Total $1,600,000

Quality Control: Inspts. Rate Total

Snowmobile 100 $3,000 $300,000
Lawnmower 4 3,000 12,000
Total 104 $312,000
 Activity-Based
Activity-Based Costing
Costing Method
Method
Activity Amount Activity Rate
Fabrication $ 530,000 10,000 dlh = $53
Assembly 70,000 10,000 dlh = $7
Setup 480,000 120 setups = $4,000
Quality control 312,000 104 inspts. = $3,000
Engineering 208,000 16 changes = $13,000
Total $1,600,000

Engineering: Changes Rate Total

Snowmobile 12 $13,000 $156,000
Lawnmower 4 13,000 52,000
Total 16 $208,000
 Activity-Based
Activity-Based Costing
Costing Method
Method
Cost Allocation Summary:
Activity Snowmobile Mower Total
Fabrication $ 424,000 $106,000 $ 530,000
Assembly 14,000 56,000 70,000
Setup 400,000 80,000 480,000
Quality control 300,000 12,000 312,000
Engineering 156,000 52,000 208,000
Total $1,294,000 $306,000 $1,600,000
Budgeted units 1,000 1,000
Cost per unit $1,294 $306
 Activity-Based
Activity-Based Costing
Costing Method
MethodRuiz
Ruiz Company
Company

Quality
Assembl Engineering
Fabrication Setup Control
y Change
Activity Activity Inspectio
Activity Activity
$530,000 $480,000 n Activity
$70,000 $208,000
$312,000

$53 per $7 per $4,000 $3,000 per $13,000 per

dlh dlh per setup inspection engineering
change

$1,294 per unit $306 per unit

Activity-Based Costing for Selling
and Administrative Activities
Selling and administrative activities may include:
1. Post-sale technical support
2. Order writing
3. Promotional support
4. Order entry
5. Customer return processing
6. Shipping document preparation
7. Shipping and handling
8. Field service
Activity-Based
Activity-Based Costing
Costing in
in Service
Service Businesses
Businesses
Hopewell HospitalActivity-Based Costing
Admitting $180 per admission

Radiological P
$320 per image
Testing A
T
Operating $200 per operating I
Room room hour
E
N
Pathological
$120 per specimen T
Testing
S
Dietary and
$150 per day
Laundry
Activity-Based
Activity-Based Costing
Costing in
in Service
Service Businesses
Businesses
Hopewell HospitalActivity-Based Costing
Admitting $180 per admission

Radiological P
$320 per image
Testing A
T
Operating
Radiological $200 per
Testing operating
Activity Rate: I
CostRoom
Budget room$960,000
hour
E
= = $320
Estimated Activity
Pathological 3,000 images N
$120 per specimen T
Testing
S
Dietary and
$150 per day
Laundry
Chapter 25

The
The End
End