11CHAPTER 82USE OF 1 PLANT-WIDE PREDETERMINED O/H RATE3• In Chapter 3, we assumed: 1 Predetermined O/H Rate24• 1 Plant-Wide Application Rate may not be very accurate– E.g. goods are different• If you apply MO/H inaccurately Inaccurate costing5• Consequences of inaccurate costing– May go after wrong business– Inaccurate pricing– Wrong product line6• Having > 1 cost pool might increase accuracy– Allows you to differentiate between products37Departmental MO/H Application Rates8• Each department can have a different Predetermined O/H rate• Each department can have a different cost driver9• Example: Company Makes Standard & Custom Trophies• 2 production departments– Design Department– Manufacturing Department410OH Costs Design Manufacturing TotalRent $20K $ 80K $100KDepreciation ---- 200K 200KSupervisors 50K 50K 100KMaintenance 20K 80K 100KTotal $90K $410K $500K11Department Direct Labor Hours Design 10KManufacturing 90K Total $100K12• Job 1 unique product design– 20 DLHs in Design– 20 DLHs in Manufacturing • Job 2 standard model– No Design services– 20 DLHs in Manufacturing513• Plant-Wide Application Rate: $500,000 / 100,000 = $5/DLH• Job 1: 40 hours x $5 = $200• Job 2: 20 hours x $5 = $10014Job 1 Job 2Direct Materials $200 $200Direct Labor 400 200MO/H 200 100Total Cost $800 $500Profit $160 $100Price Bid $960 $60015• Job 2 bid rejected by client – Said we charged too much• Job 1 bid accepted–Said we had best prices in town616• Departmental Application Rates:Design:$90K/10K = $9/DLHManufacturing:$410K/90K = $4.55/DLH17Job 1 Job 2Design20x$9 = $180Man.20x$4.55 = $91 20x$4.55 = $91Total $271 $9118Job 1 Job 2DM $200.00 $200.00DL 400.00 200.00MO/H 271.00 91.00Total $871.00 $491.00Profit 174.20 98.20Bid $1055.20 $589.20719Job 1 Job 2Plant-Wide Rate $ 960.00 $600.00Departmental Rates 1055.20 589.20Difference -$95.20 $10.8020Plant-Wide Rate $5.00Design Rate $9.00Manufacturing Rate $4.5521ACTIVITY BASED COSTING822Activity-Based Costing (ABC)• Cost pools based on activities• Activities are not sub-divisions of departments.23• Possible manufacturing activities:–Perform Engineering Work;–Plan Production;–Purchase Materials;–Receive and Handle Materials;–Manage Production;–Setup Machinery;–Store Final Product; &–Ship Final Product.24• With ABC,– Calculate separate application rate for each activity – Use appropriate cost drivers for each activity– Apply MO/H by activity925• Disadvantage of ABC– More record keeping– Institutional resistance26• Advantage of ABC – Accurate cost information– Provides insight into cost control• Activity-Based Management (ABM)27• DLCs can be included in ABC• DL and MO/H are combined– Called “Conversion Costs”1028ABC Example29• Example: Company produces three products:–Quality, Superior & Superb• Currently applies Conversion Costs using 1 Plant-Wide Application Rate (DLHs as Driver)– Considering using ABC30Activity Area Budget Cost DriverMat. Handling $ 258.4K # partsProd. Scheduling 114K # prod. ordersSetups 160K # prod. setupsMach. Maint. 3,510K Machine hoursFinishing 1,092K DLHsPackg & Shipng 190K # orders shippedTotal $5,324.4K1131Cost Driver Q Spr SpbUnits planned 10K 5K 800# of parts per unit 30 50 120Production orders 300 70 200Production setups 100 50 50MHs. per unit 7 7 15DLHs. per unit 2 5 12Orders shipped 1K 2K 800• Estimates it will have 54,600 DLHs next year32Material Handling40¢/part$258,400/[(30 x10,000)+(50 x 5,000)+(120x 800)]Production Scheduling $200/ production order$114,000 / [300 + 70 + 200]Setups$800/ production setup$160,000 / [100 + 50 + 50]Machinery$30/ machine hour$3,510,000/[(7 x 10,000)+(7 x 5,000)+15(800)]Finishing $20/ DLH$1,092,000/[(2 x 10,000)+(5 x 5,000)+(12 x 800)]Packing & Shipping$50/ order shipped$190,000 / [1,000+2,000+800]33• 1 Plant-Wide Application Rate (using DLHs):Est Conversion Cost=$5,324,400=$97.52 (rounded)Estimated DLHs 54,6001234Activity QualityMat Hand ((30x10,000) x .40)$120,000Prod Sch (300 x $200) 60,000Setups (100 x $800) 80,000Machinery ((7 x 10,000) x $30) 2,100KFinishing ((2 x 10,000) x $20) 400,000Pck & Shp (1,000 x $50) 50,000Ttl Conv. $2,810,000Conv./Unit ($2,810,000/ 10,000) $281.0035Activity SuperiorMat Hand (50x5,000)x $.40) $100,000Prod Sch (70 x $200) 14,000Setups (50 x $800) 40,000Machinery ((7 x 5,000) x $30) 1,050,000Finishing ((5 x 5,000) x $20) 500,000Pck & Shp (2,000 x $50) 100,000Ttl Conv. $1,804,000Conv./Unit ($1,804,000/ 5,000) $360.8036Activity SuperbMat Hand ((120 x 800) x $.40) $38,400Prod Sch (200 x $200) 40,000Setups (50 x $800) 40,000Machinery ((15 x 800) x $30) 360,000Finishing ((12 x 800) x $20) 192,000Pck & Shp (800 x $50) 40,000Ttl Conv. $710,400Conv./Unit ($710,400/ 800) $888.001337Quality Superior SuperbPlant-Wide $195.04 $487.60 $1,170.24(2 x $97.52) (5 x $97.52) (12 x $97.52)ABC 281.00 360.80 888.00Difference -$85.96 $126.80 $282.2438REAL LIFE ABC EXAMPLES39Laporte Industries, Ltd.• Produced cleaning chemicals • Sales force focus–Big customers–Ignored small customers• O/H allocation system –Big customers were more profitable1440• ABC allocated O/H accurately–Profit margins higher for smaller customer • Smaller customers did not generate O/H costs.–Placed orders by telephone–Required little contact with sales force41• Larger customers generated high O/H costs:–Constant contact with sales force–24-hour technical support–Loans of equipment at no charge–Other concessions.42• After ABC–New cost structure–Change in sales mixes & prices bid–Operating Profits increased1543ExxonMobil• Lubricants Division• ABC –Accuracy in Costing–Understood Cost Behavior• ABC resulted in:–Cut # of products–Cut # of suppliers–Profit increased44The Boeing Company• Boeing tested ABM in two operations at its Wichita plant.45• ABC analysis showed:–Boeing outsourced when it shouldn’t–This is Relevant Costing1646• ABC analysis showed:–No standard for when rework required–Established rework standard •Cut costs by
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