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Managerial Accounting CH5.docx

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ACCT 2301
Ed Dinan

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Anna Wang Managerial Accounting 5 Chapter 5 Cost Management in anAutomated Business EnvironmentABC,ABM, & TQM Development of a Single Companywide Cost Driver In the past, manufacturing process was labor intensive with minor overhead cost. It was rational to use labor hour as the allocation base.Although it wasn’t perfect, misallocation of overhead cost was not a big deal because it was overhead cost was so minor. Automation/machines changed the process. Labor hours is no longer an effective allocation base and overhead cost is much greater. Misallocation will create large distortions on the cost of cost objects. Effects of Automation on Selecting a Cost Driver Ex – new machinery increased overhead from $120 to $420. Before After New machinery shorted the hours for Job 2. Job1- 2hr Job1- 2hr Job 1 remains the same. Job2- 6hr Job2- 1hr Allocation of Overhead Using Labor Hour asAllocation Base Product Before After This creates a distortion. More overhead costs should have been Job1 $30 $280 allocated to Job 2 b/c automating the production of Job 2 caused Job2 $90 $140 costs to increase. Total $120 $420 One way to solve the problem is to use machine hours as cost driver. Automated production processes often generate costs with no cause-and-effect relationship with volume based cost drivers. Use activity-based cost drivers instead. Activity-Based Cost Drivers - Startup/Setup Costs – cost of activities performed to prepare to make a different product, such as resetting machines, changing production configurations, conducting inspections, etc Ex – a company that makes diff soups need to clean equipment and change settings btw each type of soup Vegetable Tomato Total #Cans 954,000 234,000 1,188,000 #Setups 180 180 360 1 Anna Wang Managerial Accounting 5 Each setup costs $264. Total setup costs is $95,040 Using # of Cans as theAllocation Base $0.80/can Vegetable  $76,320 Tomato  $18,720 It doesn’t make sense to allocate more costs to the vegetable b/c both product require the same # of setups. Abetter way to allocate setup costs is to use an activity-based cost driver. Using # of Setups as theAllocation Base $264/setup Vegetable  $47,520 Tomato  $47,520 Activity-Based Cost Drivers Enhances Relevance Better allocation b/c it distributes relevant costs to appropriate products Ex – if the company stops making vegetable soup, it wouldn’t avoid $76,320, but only $47,520 Ex – if an outside company offered to provide 180 tomato soup setup for $40,000, managers relying on the volume-based cost driver would’ve rejected it when in fact they should accept it. Activity-Based Costing Companies using ABC follow a 2 stage approach Step 1 – costs are assigned to pools based on the activities that cause the cost to be incurred - identify essential activities and the cost of performing them Step 2 – costs in activities cost pools are allocated using a variety of cost drivers Identifying Activity Centers Activity Center – cost centers composed of operating activities w/ similar characteristics - reduces record-keeping costs by allowing allocation based on a common cost driver for each center - # used by a company depends on cost/benefit analysis ComparingABC with Traditional CostAllocation 2 Anna Wang Managerial Accounting 5 Traditional allocation system pools costs by dept, then allocates dept cost pools using volume- based cost drivers ABC pools costs by activity centers, then allocates activity center cost pools using volume- and activity-based cost drivers Types of Production Activities - improve cost tracing by organizing activities into 4 hierarchal categories Unit-level Batch-level Overhead costs in each category are pooled Product-level and allocated to products based on how the products benefited from the activities Facility-level Ex – Company makes 2 products: dress shirts and casual shirts - expect to incur $5,730,000 of overhead costs - Cost/Shirt = $22.16 makes 680,000 dress shirts and 120,000 casual shirts - Sales Price = $31 Current allocation base is # shirts  $7.16/shirt - Gross Margin = Direct material cost - $8.20/shirt - $8.84 Direct labor cost - $6.80/shirt Company decides to change allocation method by usingABC Unit-Level Activity Center - Unit-level activities occur each time a unit of product is made - Machine related costs, cost of supplies, etc - Cost increases with volume - Some costs behave so much like unit-level costs that they may be accounted for as unit level, even though they may not be Step 1 Machine-RelatedUtilities 300,000 MachineMaintenance 50,000 Indirect Labor & Material 450,000 Inspection& QualtiyControl 200,000 Miscellaneous 296,000 TotalUnit-LevelCosts 1,296,000 Step 2 Need to allocate $1,296,000 btw the 2 products. Because unit-level costs are incurred each time a unit is produced, allocation base should correlate to production levels, such as direct hours Dress shirts  272,000 hr  $1,101,600 Casual shirts  48,000 hr  $194,000 3 Anna Wang Managerial Accounting 5 Batch-LevelActivity Center - Batch-level activities are related to producing groups of products - Costs are fixed regardless of #units produced in a single batch Ex – setting up machinery, first item testing, etc - Material
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