ACCT 2102 1st Edition Lecture 11 Outline of Last Lecture I Refining the Allocation of MOH II Departmental Overhead Rates Outline of Current Lecture III Departmental Overhead Rates Continued IV Analysis of Jobs Sadie and Tom V Cost Distortion VI Activity Based Costing ABC Current Lecture Activity Based Costing ABC Chapter 4 III Departmental Overhead Rates Continued Last class we talked about the difference between traditional and refined costing systems in terms of how we allocate MOH This class we will go further into our problem by showing how much we over or under costed our jobs and what role MOH and allocation bases play in this difference of costing Building upon the same example as before Mands Industries Selected job information for the month follows All DL is paid at a 20 hr rate wage rate DM cost Machining Department Assembly Department Job Sadie 100 2 machine hrs and 1 DL hour 10 DL hrs Job Tom 100 5 machine hrs and 1 DL hour 10 DL hrs Traditional Costing System Plant wide Overhead Rate These notes represent a detailed interpretation of the professor s lecture GradeBuddy is best used as a supplement to your own notes not as a substitute How much MOH would be assigned to Jobs Sadie and Tom using the plant wide overhead rate Does this allocation capture the reality of the manufacturing process Does this seem fair Refined Costing System Departmental Overhead Rate How much MOH would be assigned to Jobs Sadie and Tom using the departmental overhead rates Does this allocation capture the reality of the manufacturing process Does this seem fair Traditional Costing System POHR 1 1 000 000 12 500 DL hrs Refined Departmental Costing System 80 DL hr POHR 1 machine 700 000 175 m hr 4 000 m hrs POHR 2 assembly 300 000 30 DL hr 10 000 DL hrs Job Sadie DM 100 DM 100 DL 20 x 11 hrs 220 DL 20 x 11 hrs 220 MOH 80 x 11 hrs 880 MOH 1 175 x 2 hrs 350 2 30 x 10 hrs 300 Total job cost 1 200 Total job cost 970 100 DM 100 1 200 970 230 overcosted Job Tom DM DL 20 x 11 hrs 220 DL 20 x 11 hrs 220 MOH 80 x 11 hrs 880 MOH 1 175 x 5 hrs 875 2 30 x 10 hrs 300 Total job cost 1 200 Total job cost 1 495 1 200 1 495 295 undercosted IV Analysis of Jobs Sadie and Tom As we notice above DM and DL remain the same in both the Traditional and Refined Costing Methods for Job Sadie Is this a coincidence No DM and DL will not change because the materials used are still the same amount DM and the total amount of DL hours also remains the same for the entire job The same also holds true for Job Tom We also notice that DM and DL remain the same for Job Sadie and Job Tom Is this a coincidence Yes The numbers given to use just happen to be the same amount for both jobs Job Sadie o For our refined costing system MOH 1 is only 2 hours because we want only machine hours logged o For our refined costing system MOH 2 is only 10 hours not 11 hours because we want only the DL hours during assembly logged not total DL hours o Under the traditional system total estimated job cost is 1 200 under the refined system total estimated job cost is 970 which means that Job Sadie was overestimated overallocated overcosted 230 This overcosting will drive customers away and prevent new customers from coming Job Tom o For our refined costing system MOH 1 is only 5 hours because we want only machine hours logged o For our refined costing system MOH 2 is only 10 hours not 11 hours because we want only the DL hours during assembly logged not total DL hours o Under the traditional system total estimated job cost is 1 200 under the refined system total estimated job cost is 1 495 which means Job Tom was underestimated underallocated undercosted 295 This undercosting may cause the company to cost their jobs for lower than what they cost hence they would be losing money on each job Regardless of whether we used the Traditional or Departmental allocation systems how much DM and DL cost was traced to each job 100 DM and 220 DL Do we need to worry about the accuracy of these amounts No DM and DL will be the same so we are worried about MOH only in these problems V What is cost distortion o Cost distortion Over or under costing your job when running two systems traditional and refined simultaneously o What causes it Difference in resource consumption o If the company continues to use a traditional system rather than departmental overhead rates approximately how much cost distortion would occur on Jobs Sadie and Tom Cost distortion would be 230 for Sadie and 295 for Tom o Why does it matter It affects where we are at in the market and how many customers will return or begin coming VI What is the goal of ANY refined costing system Increase accuracy to get a true picture of what our costs are Can refined costing systems only be used to allocate MOH at manufacturers No Activity Based Costing ABC ABC goes a step farther in refining the way we allocate our indirect costs Instead of using DEPARTMENTS to define the indirect cost pools e g Machining Dept had an indirect cost pool of 700 000 to allocate Assembly had an indirect cost pool of 300 000 to allocate we use activities to define the indirect cost pools What are the key steps in implementing ABC 1 Identify the activities and estimate the total MOH costs associated with each activity These are called activity cost pools Unit Level activity we perform on all of our units example assembly Batch Level activity we perform on a group of units example machine set up Product Level activity we perform on an individual product line example advertising Facility Level activity we perform on everything else all other MOH costs also called General Factory 2 Choose an allocation base for each activity What should we consider when making this selection True cost driver 3 Calculate a POHR for each activity 4 Allocate the indirect costs Allocated MOH POHR x activity level