ACCT 2102 1st Edition Lecture 11 Outline of Last Lecture:I. Refining the Allocation of MOHII. Departmental Overhead RatesOutline of Current Lecture:III. Departmental Overhead Rates ContinuedIV. Analysis of Jobs Sadie and TomV. Cost DistortionVI. Activity-Based Costing (ABC)Current Lecture: Activity-Based Costing (ABC) (Chapter 4)III. Departmental Overhead Rates ContinuedLast 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 IndustriesSelected job information for the month follows. All DL is paid at a $20/ hr rate (wage rate): DM cost Machining Department Assembly DepartmentJob Sadie $100 2 machine hrs and 1 DL hour 10 DL hrsJob Tom $100 5 machine hrs and 1 DL hour 10 DL hrs• Traditional Costing System . . . Plant-wide Overhead RateThese 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 Refined (Departmental) Costing SystemPOHR 1 = $1,000,000 = $80/DL hr 12,500 DL hrsPOHR 1 (machine) = $700,000 = $175/m hr 4,000 m hrsPOHR 2 (assembly) = $300,000 = $30/DL hr 10,000 DL hrs.Job SadieDM $100DL ($20 x 11 hrs) $220MOH ($80 x 11 hrs) $880Total job cost $1,200DM $100DL ($20 x 11 hrs) $220MOH 1 ($175 x 2 hrs) $350 2 ($30 x 10 hrs) $300Total job cost $970$1,200 - $970 = $230 overcostedJob TomDM $100DL ($20 x 11 hrs) $220MOH ($80 x 11 hrs) $880Total job cost $1,200DM $100DL ($20 x 11 hrs) $220MOH 1 ($175 x 5 hrs) $875 2 ($30 x 10 hrs) $300Total job cost $1,495$1,200 - $1,495 = $295 undercostedIV. 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 bothjobs.- 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 causethe 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 consumptiono 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 Tomo Why does it matter? It affects where we are at in the market and how many customers will return or begin coming- 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.VI. 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