Overheads

&
Activity Based Costing

Week 04 Topic
07

ACCT112: Management Accounting

Themin Suwardy, SMU 2005

Seminar Outline

1. Allocating OH to Products
2. Plant-Wide POR
3. Departmental POR

4. Activity-Based Costing (ABC)

Slide 2

1.1 Allocating OH to Products

All Costs Incurred
Manufacturing
Costs

Non-Manufacturing
Costs
Support
Dept

Direct
Trace
Product
Product A
A

Indirect

Supporting

Others

2
Financial
Statements

Product
Product B
B

Slide 3

2.1 Plant-Wide Pre-Determined Overhead Rate

The Algorithm:
(1) Estimate (Budget) the Overhead Costs for the period;
(2) Choose a driver and estimate the qty (level) for the period;
(3) Compute POR = (1) / (2)
(4) During operations in the period, Apply (allocate) OH based
on actual qty (level) of driver used.
(5) Deal with Over-Applied or Under-Applied OH at end of
period. (Will be dealt with in next topic)

Slide 4

2.2 Illustration of Plant-wide POR

(1)
(1) What
What are
are the
the OH
OH that
that the
the company
company
will
will incur
incur for
for the
the coming
coming year
year and
and what
what
is
is the
the budgeted
budgeted total
total manufacturing
manufacturing
OH?
OH?

Rent,
Rent, Utility,
Utility,
,, etc.,
etc., etc.,
etc.,
E.g.
E.g. Budgeted
Budgeted Total
Total == $640,000
$640,000

(2)
(2) What
What is
is aa reasonable
reasonable factor
factor (driver)
(driver)
that
that represent
represent usage
usage of
of OH
OH and
and what
what is
is
the
the budgeted
budgeted quantity
quantity (level)?
(level)?

E.g.
E.g. Direct
Direct Labour
Labour Hours
Hours LH);
LH);
E.g.
E.g. Budgeted
Budgeted Qty
Qty == 160,000
160,000 hrs
hrs

POR
POR == $640,000
$640,000 // 160,000
160,000
== $4
$4 per
per DLH
DLH

(3)
(3) Compute
Compute POR
POR == (1)
(1) // (2)
(2)

(4)
(4) So
So
If
If Job
Job xxx
xxx used
used 195
195 dlh?
dlh?

Applied
Applied OH
OH == $780
$780

Slide 5

2.3 Why dont we simply apply Actual Overheads?

3 Product Lines (or Jobs?)
A

Jan

Feb

Mar

Driver ?

Direct Labour Hour (DLH) ?

Actual O/H / mth

$150,000

Actual DLH

4,000 hr

1,500 hr

500 hr

Allocation =

$25
$100,000
per hr

$37,500

$12,500

Act DLH =

1,000 hr

1,500 hr

500 hr

Allocation =

$50
$50,000
per hr

$75,000

$25,000

Act O/H / mth =

Allocation =

$180,000
$60
$60,000
per hr

Mars Act DLH is the same as in Feb

Slide 6

$90,000

$30,000

2.4 Reasons for NOT applying Actual OH ?

1. It is NOT FAIR ?
(inequitable)
2. How do you know how well each
department is really doing?
3. How does the managers of the
various products (jobs) estimate
the costs of future jobs and thus
price their products?

This applies to
allocation of
Support
Departments costs
to Production
Departments too !

Some companies still allocate Actual OH ?

Slide 7

2.5 Will using Predetermined OH be better?

Plant Wide Rate
Driver ?
Budgeted O/H
Budgeted DLH
P.O.R.

3 Product Lines (or Jobs?)

A
B
C
Direct Labour Hour (DLH)
$150,000
4,000 hr
1,500 hr
500 hr
$25 per DLH

Jan

Actual DLH
Allocation =

4,000 hr
$100,000

1,500 hr
$37,500

500 hr
$12,500

Feb

If Act DLH =
Allocation =

1,000 hr
$25,000

1,500 hr
$37,500

500 hr
$12,500

Mar

If Act O/H =
Allocation =

$25,000

$180,000
$37,500

$12,500

Mars Act DLH is the same as in Feb

Slide 8

3.1 Departmental Rates

For example

F
Where different departments Costs
are driven by different factor?

Basic
Budgeted O/H

Special
$150,000

Dept 1 (D1)
Dept 2 (D2)

$60,000
$90,000

D1: Budgeted DLH

D2: Budgeted MH

4,000 hr
3,000 hr

POR (D1)
POR (D2)

1,500 hr
1,200 hr
= $10 / DLH
= $18 / MH

Slide 9

Deluxe

500 hr
800 hr

3.2 Illustration of applying OH using Dept POR

$10

D. Lab hr / U

4 hrs

5 hrs

5 hrs

Machine Hrs / U

3 hrs

4 hrs

8 hrs

D. Mat Costs
D. Lab Costs
D1: O/H
D2: O/H

$xxx
$xxx
$40
$54

$xxx
$xxx
$50
$72

$xxx
$xxx
$50
$144

Technology will drive changes in choice of

OH method and driver(s)?

Slide 10

$18

4.1 Activity Based Costing - The logic

What are the real drivers of costs?

Activities (i.e. doing something)

What can you really manage?

Activities

Slide 11

4.2 The Algorithm of ABC

(1) Identify & Classify
activities related to products

Definition of activities?

(2) Estimate Costs of EACH

activities in Step (1)

Identifying resources
used?

(3) Choose drivers for EACH

activity & Calculate rate(s)

May have more than 1

driver per Activity?

(4) Allocate costs to

products based on drivers
used?

This step is mechanical

Slide 12

4.3 The Various Levels (or Types) of ABC Driver

There
There are
are different
different level
level of
of Activities
Activities

(1) Unit Level

e.g. Inspection / Ind. Materials

(2) Batch Level

e.g. Set-up of Machines

(3) Product Level

e.g. Marketing / Agency Fees

(4) Customer Level

e.g. Design / Servicing

(5) Facility Level

e.g. Rent / Security / Cleaning

Examples are illustrative only
Slide 13

4.3a Two common types of Drivers (for all Levels)

Activity measures:
Transaction
driver

Duration
driver

Simple count
of the number of
times an activity
occurs.

A measure
of the amount
of time needed
for an activity.

Slide 14

4.4 An illustration of computing ABC rates

Activity
Level

Relevant
OH

Rel. Driver

OH Rates

Unit

$30,000

6,000 dlh

$5 / dlh

Batch

$60,000

40 batches $1,500 / b.

Product

$18,000

3 products

$6,000 / p.

Customer

$30,000

200 visits

$150 / v.

Facility *

$12,000

600 sq ft

$20 / sq ft

Total

$150,000

* Showroom

Details of Driver Quantities

Activity
Level

TOTAL

Dir Lab Hrs

4,000

1,500

500

6,000

# of
Batches

10

10

20

40

Product

# of Visits

---

100

100

200

Sq ft

---

150

450

600

Slide 15

4.5 Applying the ABC rates

Product Costing PER UNIT

Activity Drivers

A (1,000)

B (300)

C (100)

D. Lab hr / U
(Batch Size) # of B.
# of Product
# of Visits
Sq Ft (showroom)

4 hrs
(100) 10
1
-----

5 hrs
(30) 10
1
100
150

5 hrs
(5) 20
1
100
450

D. Mat Costs
D. Lab Costs

$xxx
$xxx

$xxx
$xxx

$xxx
$xxx

OH (unit)

$20

$25

$25

OH (batch)

$15

$50

$300

OH (Product)

$6

$20

$60

OH (Customer)

---

$50

$150

OH (Facility)

---

$10

$90

Slide 16

4.6 Some comments on ABC

ABC can be used to
evaluate the profitability of
services as well as
products.

ABC requires a change of

mindset and perhaps even
processes & structures, thus
needs the buy-in of (top)
management.

ABC requires resources and

efforts (i.e. NOT cheap),
thus NOT all companies
will benefit from ABC.
(CBA?)
Slide 17

Q&A

What are the problems with

allocating Actual Overheads?

Why dont all companies

adopt ABC?

Slide 18

Practice Question

Expected Production Quantity

Batch Size
Direct Material Costs per Unit
Direct Labour Hour per Unit
Costs per Direct Labour Hour
Total Manufacturing OH

P
5,000
200
$50
10
$6

PRODUCTS
Q
R
200
100
40
10
$90
$320
20
60
$10
$10
$1,200,000

(a) OH allocated to R using DLH as POR driver (Plant wide)

(b) Redo allocation to R using ABC if 50% of OH are
driven by batches, 30% by DL$; and 20% by DM$
Slide 19

Answer to (a)

Slide 20

Answer to (b)
PRODUCTS
Overhead Amount =
Expected Production Quantity

P
Q
R
Total of Driver
OH Rate
Allocated to R
Total Allocated to R

Slide 21

50%
Batch

30%
DL$

20%
DM$

25

$300,000

$250,000

$40,000

$18,000

10

$60,000

$32,000

40

$400,000

$300,000

Example of Exam/Test Question for Topic 07

2014-15-T1 - Test 1 - Qn 7

Slide 22