Chapter Eleven Cost Accounting: Actual Cost, Job Order and Process BASICS For financial accounting, the purpose of cost accounting is to determine the cost of a product or service. There are two basic cost accounting systems: 1. Job Order—Costs are accumulated by specific job or lot. 2. Process—Costs are accumulated by department or productive process and allocated to the units processed based upon a cost flow assumption (generally weighted average or FIFO). (Standard cost can be applied to either system.) The cost system used by an enterprise will be determined by the type of operations performed. A job order costing system is appropriate when custom made or unique goods or services are produced, such that direct costs can be identified with the specific units of production. Job order costing is often used in industries such as printing, construction, auto repair, furniture and machinery manufacture, and professional services. A process costing system is appropriate when the operation continuously mass produces like units, one unit being indistinguishable from another. Process costing is often used in industries such as chemicals, food processing, petroleum, mining, and in the manufacturing of other standard products. Basic cost elements of production: Direct (raw) materials: Cost of materials that become part of the finished product and are directly traceable to the finished product. Examples: the cost of paper used in printing books and wood used in making desks. Direct labor: Cost of labor which works directly on the product, converting raw materials to a finished product, and is directly traceable to the finished product. Examples: wages of a printing press operator, or worker who assembles desks. Overhead: All other manufacturing costs. These costs are indirectly related to production of the finished product. Other terms that are synonymous with overhead include: manufacturing or factory overhead, burden, indirect costs, and applied manufacturing expense. Examples include indirect materials (oil for machines), indirect labor (supervisor's wages), utilities and property taxes on the manufacturing facility. Cost Classifications: Prime cost: Direct material cost plus direct labor cost. Conversion cost: Direct labor cost plus overhead cost. Product cost: The sum of direct material, direct labor and overhead costs which comprise the inventoriable costs. Period cost: Non-inventoriable cost which is expensed in the current period as incurred. Variable cost: Costs which vary in total directly with changes in the level of activity. The cost per unit is constant at different levels of activity. Fixed costs: Costs which remain constant in total, regardless of changes in the level of activity. Therefore, the per unit cost changes with changes in the level of operations. Relevant range: The limits within which the level of activity may vary and the above variable and fixed costvolume relationships will remain valid.

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Basic cost accounting cost expiration computations: Cost of Materials Used: Beginning Inventory Material Purchases Total Less: Ending Inventory Material Cost of Materials Used

$ 12,000 280,000 $292,000 15,000 $277,000

Cost of Goods Manufactured: Beginning Work-in-Process Inventory Direct Material Direct Labor Overhead Total Less: Ending Work-in-Process Inventory Cost of Goods Manufactured

$ 16,000 277,000 204,000 306,000 $803,000 23,000 $780,000

Cost of Goods Sold: Beginning Finished Goods Inventory Cost of Goods Manufactured Goods Available for Sale Less: Ending Finished Goods Inventory Cost of Goods Sold

$ 81,000 780,000 $861,000 96,000 $765,000

JOB ORDER COST Accumulation of Costs

a. Costs for each job or lot are accumulated on Job Cost sheets. Job cost sheets show cost of material and labor charged to the job based on actual cost. Overhead, however, cannot be charged to the job at actual—a predetermined rate must be used. A job cost sheet might appear as follows: Job 525 Direct Material—18 lbs. @ $4.50 Direct Labor—24 hrs. @ $4.25 Mfg. Overhead—$3 per labor hour Cost of job charged to work-in-process

$ 81.00 102.00 72.00 $255.00

b. An upward accumulation of job and departmental costs is maintained in plant or factory ledgers. c. Control accounts are maintained in the General Ledger.

Activity Base Computation—Predetermined Rates

While actual direct material and direct labor costs can be readily obtained, the books must be closed to assign actual overhead costs to specific jobs. Jobs must be continually costed for billing and control purposes and such procedures could not be delayed until actual overhead is determined. Therefore, the predetermined overhead rate is used. The overhead rate chosen will vary with the type of manufacturing operation, but generally will be computed as follows: Budget Estimated Manufacturing Expense Budget Estimated Activity Base

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The Activity Base ideally should be an activity or quantity that is closely related to changes in overhead cost. In this way an increase in the activity base will measure the resulting increase in overhead. Activity bases frequently used are: 1. Units 4. Prime Cost (D.M. + D.L.) 2. Material Cost 5. Machine Hours 3. Labor Cost 6. Labor Hours Illustrative Problem—Computation of Predetermined Rate The Jigsaw Company has three departments—Molding, Fabrication and Finishing. Budgeted costs and production data for the three departments are as follows: Material Cost $12,000 6,000 3,000

Department Molding Fabrication Finishing

Labor Cost $6,000 4,000 4,500

BUDGETED

Labor Hours 1,200 800 900

Manufacturing Expense $18,000 8,000 9,000

Compute overhead rates for each of the departments assuming management has selected overhead activity bases as follows: (1) Molding—Material Cost (2) Fabrication—Labor Cost (3) Finishing—Labor Hours (1) $18,000 12,000

= 150%

(2) $8,000 4,000

= 200%

(3) $9,000 900

= $10

Assume that Job #120 accumulated costs and labor hour data as follows: Material $80 $30 $25

Molding Fabrication Finishing

Labor 7 hrs. @ $5 3 hrs. @ $6 2 hrs. @ $5.50

Determine the cost of Job #120 which is to be charged to Work in Process. Material Labor Overhead Total

Molding $ 80 35 (1) 120 $235

Fabrication $30 18 (2) 36 $84

Finishing $25 11 (3) 20 $56

Total $135 64 176 $375

(1) 150% × $80 (2) 200% × $18 (3) 2 × $10 In Job #120 we notice that work-in-process is charged with a total of $375 and upon completion finished goods will be charged likewise.

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Allocation of Service Department Costs

While Direct Material and Labor are at actual, the use of a predetermined rate for overhead will necessitate comparison with actual and, if done properly, can furnish management with some useful information, which we will consider later. Actual overhead costs are accumulated in the Manufacturing Expense Control Account to be compared with the overhead applied (predetermined rate) to the product. The accumulation of actual overhead costs is a relatively simple accounting matter in total; however, since these costs are indirect, they must be allocated to departments on some basis. Overhead costs that are directly attributable to a department or activity are, of course, assigned to that department or activity which is called a "cost center." Costs that are accumulated in service departments must ultimately be reallocated to the producing departments. The producing departments must ultimately bear all costs. Illustrative Problem (Allocation of Service Department Costs) The Edelweiss Co. has three producing departments, D, E and F. Costs are also accumulated in the Building Service, Power Plant, Maintenance and Personnel Departments. At the end of the period, overhead costs have been accumulated in these departments as follows: Costs $ 22,420 28,760 39,880 13,000 16,000 19,000 4,000 $143,060

Department D Department E Department F Building Service Power Plant Maintenance Personnel Total Costs Other data is also given concerning these departments: D Number of employees 16 Floor space 1,200 Power used—Kilowatt Hours12,000 Machine Hours 3,600

E 22 1,800 16,000 2,400

F 32 3,000 18,000 4,000

Departments B/S P/P 4 12 — 1,600 — — — —

M 18 1,400 4,000 —

P 6 1,000 — —

Total 110 10,000 50,000 10,000

If we use the step method, we can close out the departments one by one. There are no rules except common sense in determining the basis of allocation. The above shows an obvious relationship. In some situations considerable judgment may be required and the allocation basis can be quite complex. When a service department's costs are allocated, no reallocation of costs is made to that department. Solution: 1. Allocate building service costs to all departments. (Floor Space) 2. Allocate personnel costs to all other departments. (Number of Employees) 3. Allocate power plant costs to the producing departments and maintenance. (Power Used) 4. Allocate maintenance costs to the producing departments. (Machine Hours)

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Allocation of Costs D $22,420 1,560

Producing Departments E F $28,760 $39,880 2,340 3,900

848

1,166

1,696

4,490

5,990

6,736

8,378 $37,696

5,586 $43,842

9,310 $61,522

B/S $13,000 ($13,000)

P/P $16,000 2,080 636 18,716 ($18,716)

M $19,000 1,820 954

P $4,000 1,300 5,300 ($5,300)

1,500 23,274 ($23,274)

Total $143,060

______ $143,060

Note: This is not the only possible solution to the problem. As no basis of allocation was specified, any systematic and rational allocation can be used. There are other methods of allocating departmental overhead costs such as the direct method, where costs of nonproducing departments are allocated directly to producing departments. Another more complicated method can be used where service departments perform services for each other such as the above problem in that the Personnel and Building Service Departments perform services for each other. Solving this type of problem, giving recognition to this fact requires the use of simultaneous equations. While more accurate than the step method, it is not widely used in practice, because the difference in results is usually not significant.

Application of Overhead to the Product—Overhead Over and Under Applied.

We have seen that Direct Costs, Material and Labor are applied to the product based on actual costs, but because costs must be assigned to the product before actual overhead can be determined and allocated, a predetermined rate is used for overhead. Later, when actual overhead is determined, the difference between actual and estimated results in an over or under application of overhead to the product, such as: a. If actual overhead exceeds the overhead applied by means of a rate, this results in overhead being underapplied. b. If actual overhead is less than the overhead applied to the product, this results in overhead being overapplied. The over- or under-applied overhead, if material, should be allocated to work-in-process, finished goods, and cost of goods sold to adjust these balances to full cost in accordance with GAAP. If immaterial, the over- or underapplied overhead is usually treated as an adjustment to the cost of goods sold. Actual overhead costs are accumulated in the Manufacturing Expense Control Account. Journal entries typically leading up to this situation are as follows: Stores Accounts Payable W in P—Direct Material Mfg. Exp. Control Stores Payroll Cash Sundry payroll tax credits

(1) (2)

(3)

Material is purchased for plant use. Materials are requisitioned for use in the plant, some as direct material. Material overhead costs are charged to Mfg. Exp. Control. Wages are paid.

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(4)

W in P—Direct Labor Mfg. Exp. Control Payroll

Wages are assigned to the product (direct) or charged to actual overhead (indirect).

(5)

Mfg. Exp. Control Sundry Credits Allowance for Depreciation W in P Overhead Dept. 1 W in P Overhead Dept. 2 W in P Overhead Dept. 3 Mfg. Overhead Applied Dept. 1 Mfg. Overhead Applied Dept. 2 Mfg. Overhead Applied Dept. 3 Mfg. Exp. Dept. 1 Mfg. Exp. Dept. 2 Mfg. Exp. Dept. 3 Mfg. Exp. Control

Overhead costs are charged to Mfg. Exp. Control such as rent, insurance, taxes and depreciation.

(6)

Overhead charged to product based on the predetermined rate is recorded. An alternate method would be to credit "Mfg. Exp." directly. If this is done entry 8 would be unnecessary.

(7)

Mfg. Exp. Control is closed out to the departments based on the company's method of allocating actual costs to the producing departments.

(8)

Mfg. Overhead Applied Dept. 1 Mfg. Overhead Applied Dept. 2 Mfg. Overhead Applied Dept. 3 Mfg. Exp. Dept. 1 Mfg. Exp. Dept. 2 Mfg. Exp. Dept. 3 Mfg. Exp. Dept. 1 Mfg. Exp. Dept. 2 Mfg. Exp. Dept. 3 Mfg. Exp. Over/Under Applied

Mfg. Overhead applied is closed out to Mfg. Expense. Differences result in Mfg. Exp. Over/Under Applied.

(9)

Difference between actual and applied overhead as indicated by the results of entry #8.

Flexible Budgets and Overhead Analysis

Flexible budgeting is a reporting system wherein the planned level of activity is adjusted to the actual level of activity before the budget to actual comparison report is prepared. It may appropriately be employed for any item which is affected by the level of activity. Assume that F Co. has a flexible budget as follows: Percent of Normal Fixed Cost Variable Direct labor hours

80% $10,000 12,000

90% $10,000 13,500

100% $10,000 15,000 $25,000

110% $10,000 16,500

16,000

18,000

20,000

22,000

Predetermined Rate—$1.25 per labor hour @ 100% ($.50 FC + $.75 VC) or ($25,000 ÷ 20,000 D.L. hrs.) During the period the plant operated at 92% of normal and incurred overhead costs of $23,960. For management information purposes the manufacturing expense over/under applied account can be analyzed and broken up into two variances—a budget variance and a volume or capacity variance.

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Overhead Analysis

(Unfavorable) DR $23,960

Actual Overhead Budget Variance Budget at actual direct labor hours 92% × 20,000 hrs. = 18,400 hrs. FC (20,000 × .50) VC (18,400 × .75)

10,000 13,800

Volume or Capacity Variance Mfg. Overhead Applied FC 18,400 × .50 VC 18,400 × .75

9,200 13,800

Total Variance

$

(Favorable) CR

23,800

$160

23,000 960

*800 $960

*Caused by volume falling short of normal by 1,600 hours at .50 per hour (FC rate).

PROCESS COST Basics

In process cost a continuous flow of product is assumed and under ordinary conditions the cost per unit would not change significantly from period to period. Cost computations, admittedly oversimplified, can be expressed as follows: 4/1 4/30 PERIOD COSTS M, L & OH UNITS PRODUCED

= UNIT COST

Things get complicated, however, because of beginning and ending inventories of work-in-process and the assumptions under which costs are assigned. In process cost, we may compute costs using FIFO or weighted average. Where there is no beginning inventory, there is no difference in the two inventory methods. The basic steps in working process cost problems for both the FIFO and weighted average methods is shown in five steps. Note that step four is called a "cost of production report" which simply stated is the computation of inventory costs for finished product and the ending inventory of work-in-process. Step 5 is not usually a required step, but a check to determine if prior computations are correct. Treatment for spoiled units is covered after Process Cost Procedure.

Process Cost Procedure

1. Account for all units (do not use equivalents) Beginning Inventory + units started – transferred out – lost – ending inventory = zero

If one item is missing, for example, lost units, the number lost will be the number used to equal zero.

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2. Compute equivalent finished units (EFU) Finished Units +Ending Inventory1 +Abnormal Spoilage1 –Beginning Inventory2

FIFO OR

Average Finished +Ending Inv.1 +Abnormal Spoilage1

Beginning Inventory3 +Units started and finished4 +Abnormal Spoilage1 +Ending Inventory1

1Units × % complete 2Units × % complete at beginning of period 3Units × % completed during the current period (100% – the % complete at beginning of inventory 4Finished units – beginning inventory units (not equivalents) Separate EFU's may have to be computed for material, labor, overhead and prior department costs. 3. Compute unit costs. Set up a schedule as follows: Period Cost xxxx xxxx xxxx

Material Labor Overhead Departmental unit cost Prior dept. cost (if applicable) Total unit cost

Material Labor Overhead Departmental Unit Cost Prior Dept. Cost Total Unit Cost

÷

FIFO EFU xxx xxx xxx

xxxx

AVERAGE COST Beg. Inv. + Period xxxx xxxx xxxx xxxx xxxx xxxx xxxx

xxxx

=

xxxx

= Total xxxx xxxx xxxx

÷ EFU xxx xxx xxx

xxxx

xxxx

Unit Cost xx xx xx xx xx xx

= Unit Cost xx xx xx xx xx xx

4. Cost of Production Report—FIFO. In FIFO, the cost flow assumption is that the beginning inventory cost flows through first. Therefore, the first step is to complete the beginning inventory. Cost of units finished and transferred out Beginning inventory costs + Cost to complete (units × % completed this period × unit cost) Total cost of beginning inventory units + Cost of units started and finished (finished – beginning inventory) × total unit cost Cost of units finished and transferred out Cost of ending work-in-process inventory Units × % complete × unit cost Cost of abnormal spoilage (loss) Units × % complete × unit cost Total manufacturing costs accounted for

xxx (1) xxx (2) xxx xxx xxx xxx (3) xxx (3) xxx

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(1) Includes material, labor, overhead and, if applicable, prior department costs. (2) Separate computations may be required for material, labor, and overhead costs. NOTE: Prior department costs would not be applied as they are already included in the beginning inventory if applicable. (3) Separate computations may be required for material, labor, overhead and prior department costs. Cost of Production Report—Average. In average, costs and units are not isolated for the period, but instead, beginning inventory costs and units are merged as can be seen in the unit cost computation in Step 3. Cost of units finished and transferred out Units × total unit cost Cost of ending work-in-process inventory Units × % complete × unit cost Cost of abnormal spoilage (loss) Units × % complete × unit cost Total manufacturing costs accounted for

xxx xxx (1) xxx (1) xxx

(1) Separate computations may be required for material, labor, overhead and prior department costs. 5. Costs to be accounted for: Dr. Beginning inventory Period costs (M, L and OH) Prior dept. costs

Cr. Finished transferred Finished remaining Ending inventory Lost units (if computed separately)

Treatment of Spoiled Units (Lost, Defective, Spoiled, etc.)

1. Abnormal spoilage should be computed as a separate cost and written off as a period loss. 2. Normal spoilage is included in production costs for the period as follows: a. Units lost during production are simply ignored in the computation of the EFU and their period costs will be absorbed by the units produced including both finished good units and ending inventory of work-in-process. Note: If the problem is silent as to when units are lost, assume loss at beginning of process. b. When units are transferred in from another department, it will be necessary to compute a new unit cost, such as: 18,000 units transferred from B to C at a cost of $36,000; 2,000 units were lost at the beginning of the process. The new unit cost becomes $36,000 ÷ 16,000, or $2.25. At times problems may ask for a lost unit adjustment computation. In the foregoing situation this would be computed as follows: Transferred-in Unit Cost $2.00 Lost unit adjustment 18,000 – 16,000 = 2,000 lost 2,000 × $2.00 = $4,000 ÷ 16,000 = .25 New unit cost $2.25 Note to Students: Cost accounting textbooks vary in their treatment of units normally lost in production. Some advocate computing a cost on the lost units and adding such cost to the good units. Others recommend ignoring the lost units, thus having the effect of spreading the cost over both the finished and ending inventory work in process. If you are instructed in a problem to compute a cost on lost units, you must include the lost units in the EFU to the extent such lost units were completed.

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Exercises

1. 20,000 units were started in the department, 8,000 were in process one-half complete at the end of the month, 27,000 were completed and 4,000 were found defective. How many units were in process at the beginning of the month? ____________ 2. 26,000 units were transferred into the department. Units in process at the beginning of the month, one-third complete, 18,000. At the end of the month 12,000 units were in process, three-fourths complete. 1,000 units were lost and 31,000 were finished and transferred. Compute the EFU for FIFO assuming that: a. Material is added as work in process ____________ b. Material is added at the beginning of processing ____________ c. Material is added at the end of the process ____________ Compute the EFU for average costing purposes assuming that d. Material is added when the process is one-half complete _____________ e. Material is added at the beginning of processing ____________ 3. 15,000 units were transferred in from the mixing department to cooking at a cost of $28,000. Beginning units totaled 6,000 at a cost of $13,000. One-thousand units were lost. Compute the transferred-in costs per unit for FIFO costing purposes. ___________ Make the same computation for average costing purposes. ____________ Solutions to Exercises 1. 19,000; 2. (a) 34,000, (b) 25,000, (c) 31,000, (d) 43,000, (e) 43,000; 3. $2.00, $2.05. Process Cost Illustrative Problem The Joy Manufacturing Co. manufactures a single product that passes through two departments: extruding and finishing-packing. The product is shipped at the end of the day that it is packed in the finishing-packing department. The production in the extruding and finishing-packing departments does not increase the number of units started. The cost and production data for the finishing-packing department for the month of January are as follows: FinishingPacking Dept.

Cost Data Work in process, January 1: Cost from preceding department Material Labor Overhead

$34,500 $14,750 15,800 6,230

Costs added during January: Cost from preceding department Material Labor Overhead

93,500 41,250 48,800 23,370

Percentage of completion of work in process January 1: Material Labor Overhead January 31: Material Labor Overhead

100% 60% 50% 100% 80% 70%

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January Production Statistics Units in process, January 1 Units in process, January 31 Units received from prior department Units completed and transferred or shipped

5,000 4,000 13,000 12,000

Required: Compute each of the following assuming the company uses A) FIFO and B) Weighted Average Process Cost: 1. Account for all units. 2. Compute the equivalent finished units for material, labor, overhead, and prior department costs. 3. Compute the unit cost. 4. Prepare a cost of production summary. 5. Show all the debits to the Work-in-Process account, all credits and reconcile the balance to the ending inventory of work-in-process computed in (4) above. Solution: A) FIFO Finishing-Packing 5,000 13,000 18,000

Step #1 In Process 1/1 Started Total units to account for Completed In Process 1/31 Lost in Production Total units accounted for

12,000 4,000 2,000 18,000

Step #2—EFU (FIFO) Finished + Ending Inv.

- Beginning Inv.

EFU - FIFO Step #3—Unit Cost M L OH Transferred in costs

4000 × 100% 4000 × 80% 4000 × 70% 4000 × 100% 5000 × 100% 5000 × 60% 5000 × 50% 5000 × 100%

Material 12,000 4,000

16,000 (5,000)

11,000

Period Cost $41,250 48,800 23,370

EFU 11,000 12,200 12,300

$93,500

11,000

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Finishing-Packing Labor Overhead 12,000 12,000 3,200 15,200 (3,000) 12,200

2,800 14,800 (2,500) 12,300 Unit Cost $ 3.75 4.00 1.90 $ 9.65 8.50 $18.15

Prior Dept. 12,000

4,000 16,000

(5,000) 11,000

Step #4—Cost of Production Report Cost of Finished Units Opening WIP Costs 1/1 (34,500 + 14,750 + 15,800 + 6,230) Cost to Complete Material 5,000 × 0% × $3.75 Labor 5,000 × 40% × $4.00 Overhead 5,000 × 50% × $1.90 Prior Dept. 5,000 × 0% × 8.50 Cost of 5,000 complete units Add: Cost of units started and finished during January 7,000 × $18.15 Cost of 12,000 finished units Cost of WIP 1/31 Material 4,000 × 100% × $3.75 Labor 4,000 × 80% × $4.00 Overhead 4,000 × 70% × $1.90 Transferred in Costs 4,000 × 100% × $8.50

$ 71,280 — 8,000 4,750 — $ 84,030 127,050

$211,080

$ 15,000 12,800 5,320 $ 34,000

Total manufacturing cost accounted for

67,120 $278,200

Step #5—Costs To Be Accounted For Costs Beginning Inventory Period Costs

Finishing-Packing $ 71,280 206,920 $278,200

Transfers from WIP Ending Inventory WIP

$211,080 67,120 $278,200

Solution: B) Weighted Average Step #1

Finishing-Packing Department 5,000 13,000 18,000

Units in process, January 1 Units received from preceding department Total units to be accounted for Units completed and transferred or shipped Units in process, January 31 Units lost during January Total units accounted for

12,000 4,000 2,000 18,000

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Step #2—EFU (Weighted Average) Finished +Ending Inventory 4000 × 100% 4000 × 80% 4000 × 70% 4000 × 100% EFU Weighted Average

4,000

3,200

2,800

Prior Dept. 12,000

16,000

15,200

14,800

4,000 16,000

Beg. Inv. $14,750 15,800 6,230

Costs Period $41,250 48,800 23,370

Total $56,000 64,600 29,600

EFU 16,000 15,200 14,800

Unit Cost $3.50 4.25 2.00

$34,500

$93,500

128,000 $278,200

16,000

8.00 $17.75

Step #3—Unit Cost Finishing-Packing Dept. M L OH Preceding Dept. Costs Total manufacturing costs

Finishing-Packing Labor Overhead 12,000 12,000

Material 12,000

Step #4—Cost of Production Report Cost of Finished Units 12,000 units × $17.75 Cost of WIP 1/31 Material 4000 × 100% × $3.50 Labor 4000 × 80% × $4.25 Overhead 4000 × 70% × $2.00 Prior Dept. 4000 × 100% × $8.00 Total manufacturing costs accounted for

$213,000 $14,000 13,600 5,600 32,000

65,200 $278,200

ACTIVITY BASED COSTING: Activity Based Costing is a method of assigning costs to goods and services that assumes all costs are caused by the activities (cost drivers) used to produce those goods and services. ABC first relates costs to the activities that cause the costs (cost drivers), then assigns costs to products/services based upon their use of those activities (cost driver) in production. ABC results in the use of multiple predetermined rates for overhead costs as companies engage in many different activities that cause overhead cost (multiple cause/effect relationships exist within a company for overhead costs). As a result, ABC provides more detailed measures of cost than departmental or plantwide allocation methods. Advantages of ABC include: • Provide more insight into the causes of cost. Managers must know: 1) the activities that go into making the good/service and 2) the cost of those activities to employ ABC. • Stresses cost control results from control of activities. ABC is based on the concept that the production of goods and services consumes activities, and activities consume economic resources (costs). • Promotes improved quality/continuous improvement. Nonvalue-added activities (cost drivers), such as movement, storage, set up, inspection, defective rework are minimized or eliminated.

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