Will's Notes

Cost - Volume - Profit

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Activity Based Costing

A Costing System

• The primary emphasis throughout creating a costing system is Cost-Benefit.
• The value of the information produced must always be greater than the cost to collect the data
• Beyond limiting complexity to practical need, a costing system should be derived from the company’s operations, not the other way around.
• Cost Pool
• A collection of cost items
• Typically used to accumulate indirect costs which will be later allocated to cost objects
• Cost-Allocation Base
• A cause-and-effect cost driver between a cost pool and a cost object.  This is the basis from which we will allocate the costs.
• Indirect-Cost Rate
• This is the rate per base unit when a cost pool is divided by its cost allocation base.  Typically annual time frames are used to calculate this rate since shorter time frame since:
• Season patterns or erratic cost behaviors may produce inappropriate rates
• Likewise, quantities of the cost allocation base may vary and cause inappropriate rates over a short time frame
• Source Documents help track and gather information throughout the costing system.  Many have been digitalized due to computers.
• A Job Cost Sheet relates to a specific job and accumulates all the costs from beginning to end.
• Materials Requisitions are required to order materials from storage.
• Labor Time Records track where the direct labor time is being spent

Job Costing

• The cost object is a job – which is a broad term referring to one object such as a motorcycle or a certain set of objects such as a set of trophies for a particular team.
• This is different from Process Costing, where identical units are produced and an average unit cost is calculated.
• Two  approaches that we will discuss: Actual Costing and Normal Costing
• Actual Costing
• Uses actual direct costs per unit times actual quantities
• Uses actual indirect cost rates time actual quantities used
• First, direct costs are accumulated for the cost object
• Second, a Cost Allocation Base is chosen base on the best cause-and-effect driver of the indirect costs
• Third, the indirect cost pool is divided by the Cost Allocation Base to determine an actual indirect-cost rate
• Fourth, the actual indirect-cost rate is multiplied by the amount of indirect cost driver used
• Finally, the total direct costs and total indirect costs are added together to get the total job cost
• Normal Costing
• Uses actual direct costs per unit times actual quantities
• Uses budgeted indirect cost rates time actual quantities used
• The budgeted indirect cost rates are calculated by dividing the annual estimated total indirect cost by the total allocation base estimated to be used over that year.
• There will inevitably be a discrepancy between the budgeted and actual; however, at least managers don’t have to wait until the end of the year.  It provides immediate feedback.

Journal Entries in a Job Costing System:

• When entries are made into the general ledger, many accounts have the word “Control” at the end.  This simply means that there is a detailed account in the subsidiary ledger.
• Manufacturing Overhead Control
• This account is a cost pool that accumulates the actual cost of the indirect overhead
• Each cost pool would have its own account
• Manufacturing Overhead Allocated
• This account accumulates all the overhead allocated to jobs, recall that with Normal Costing that we multiplied the budgeted indirect rate by the actual usage
• This is a CONTRA account to the Manufacturing Overhead Control
• Has a credit balance
• This account is increased to offset the Manufacturing Overhead Control and increases the Work-in-Process Control
• Underallocated/Underapplied Indirect Costs
• Manufacturing Overhead Allocated is less than Manufacturing Overhead Control
• Overallocated/Overapplied Indirect Costs
• Manufacturing Overhead Allocated is greater than Manufacturing Overhead Control
• Three ways to deal with Under/Over Allocation
• Adjusted Allocation-Rate Approach
• Once the actual indirect rate is calculated, all general ledger and subsidiary ledger amounts are restated using the actual indirect cost rate.
• This produces the same end of the year information as Actual Costing, but with the timeliness of information from Normal Costing
• Proration Approach
• The difference between actual and allocated overhead is prorated between work-in-progress, finished goods, and cost of goods sold.
• There are two primary ways to allocate the costs to these groups
• Use that group’s percentage of manufacturing overhead already allocated out of the Manufacturing Overhead Allocated and then multiply by the over or under allocated amount
• OR, use the account’s balance percentage of the total account total
• Write-off
• Cost-Benefit, if you aren’t going to use the more accurate information for each of the jobs come year end, just write-off any discrepancy between actual and budgeted to cost of goods sold and be done with it.
• Any of these methods are acceptable – we just have to close out the Manufacturing Overhead account each year.

Cost - Volume - Profit

Cost Accounting Home

Activity Based Costing