Cost Accounting
Sixteenth Edition, Global Edition
Chapter 5
Activity-Based Costing
And Activity-Based
Management
Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved.
Learning Objectives (1 of 2)
5.1 Explain how broad averaging undercosts and
overcosts products or services
5.2 Present three guidelines for refining a costing
system
5.3 Distinguish between simple and activity-based
costing systems
5.4 Describe a four-part cost hierarchy
5.5 Cost products or services using activity-based
costing
Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved.
Learning Objectives (2 of 2)
5.6 Evaluate the benefits and costs of
implementing activity-based costing systems
5.7 Explain how managers use activity-based
costing systems in activity-based management
5.8 Compare activity-based costing systems and
department costing systems
Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved.
Undercosting and
Overcosting Example
Jose, Roberta, and Nancy order
separate items for lunch.
Jose’s order amounts to
$14
Roberta consumed
30
Nancy’s order is
16
Total
$60
What is the average cost per lunch?
Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved.
$60 ÷ 3 = $20
Jose and Nancy
are overcosted.
Roberta is
undercosted.
Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved.
Background
Recall that plant overhead is applied to production
in a rational systematic manner, using some type of
averaging. There are a variety of methods to
accomplish this goal.
These methods often involve trade-offs between
simplicity and realism.
Simple Methods
Can be Inaccurate
↔
Complex Methods
Usually more accurate
Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved.
Plantwide Overhead Calculations
Plantwide Overhead Rate:
Total Estimated Overhead ** / Total Estimated Base ***
** Obtain total of all overhead costs to be allocated.
*** Determine the best “base” – direct labor hours,
machine hours, etc.
This rate is used to allocate overhead costs to all products
Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved.
Broad Averaging
• Historically, firms produced a limited variety of goods and
at the same time, their indirect costs were relatively small.
• Allocating overhead costs was simple: use broad averages
to allocate costs uniformly regardless of how they are
actually incurred.
– Generally known as “Peanut-butter costing” (perhaps
because it is spread evenly??)
• The end-result:
– Products using fewer resources are overcosted and
products using more resources are undercosted.
Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved.
Over And Undercosting - Defined
• OVERCOSTING occurs when a product
consumes a low level of resources but is allocated
high costs per unit.
• UNDERCOSTING occurs when a product
consumes a high level of resources but is
allocated low costs per unit.
Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved.
Product Cost
Cross-Subsidization (1 of 4)
• If a company undercosts one of its products,
it will overcost at least one of its other
products.
• The overcosted product absorbs too much
cost, making it seem less profitable than it
really is.
• The undercosted product is left with too little
cost, making it seem more profitable than it
really is.
Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved.
Product Cost
Cross-Subsidization (2 of 4)
CONSIDER THIS:
• If you were using cost to determine price,
what effect would this have?
• If you were looking at product profitability to
determine marketing focus, what result?
• Managers use product costs everyday to
make decisions. If the cost is wrong, so will
be the decision.
Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved.
An Example: Plastim
EXHIBIT 5.1 Overview of Plastim’s Simple Costing System
Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved.
Plastim And Simple Costing
EXHIBIT 5.2 Plastim’s Product Costs Using the Simple Costing System
Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved.
Reasons For Refining A Costing
System
Three principal reasons have accelerated the
demand for refinements to the costing system.
1. Increase in product diversity
2. Increase in indirect costs with different cost
drivers
3. Competition in product markets
Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved.
Guidelines For Refining A Costing
System
There are three main guidelines for refining a
costing system:
1. Direct-cost tracing
2. Indirect-cost pools
3. Cost-allocation bases
Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved.
Cost Hierarchies
(1 of 2)
A cost hierarchy categorizes various activity cost
pools on the basis of the different types of cost
drivers, cost-allocation bases, or different degrees
of difficulty in determining cause-and-effect
relationships.
ABC systems commonly use a cost hierarchy with
four levels to identify cost-allocation bases that are
cost drivers of the activity cost pools.
Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved.
Cost Hierarchies (2 of 2)
The four levels in the cost hierarchy are:
Output unit-level costs (related to the individual
units of a product or service)
Batch-level costs (related to a group of units)
Product (or service)-sustaining costs (related to
support a particular product or service without
regard to the number of units or batches)
Facility-sustaining costs (related to costs of
activities that cannot be traced to individual
products or services)
Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved.
Plastim and ABC Illustrated
EXHIBT 5.3 Overview of Plastim’s Activity-Based Costing System
Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved.
Plastim And ABC Rate Calculation
EXHIBIT 5.4 Activity-Cost Rates for Indirect-Cost Pools
Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved.
Plastim and ABC Product Costs
EXHIBIT 5.5 Plastim’s Product Costs Using Activity-Based Costing System
Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved.
Plastim: Simple and ABC Compared
EXHIBIT 5.6 Comparing Alternative Costing Systems
Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved.
Conclusions
• Each method is mathematically correct
• Each method is acceptable
• Each method yields a different cost figure, which will lead
to different Gross Margin calculations
• Only Overhead is involved. Total Costs for the entire firm
remain the same – they are just allocated to different cost
objects within the firm
• Selection of the appropriate method and drivers should be
based on experience, industry practices, as well as a costbenefit analysis of each option under consideration
Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved.
ABC Vs. Simple Costing (1 of 2)
• ABC is generally perceived to produce superior
costing figures due to the use of multiple drivers
across multiple levels.
• ABC is only as good as the drivers selected, and
their actual relationship to costs. Poorly chosen
drivers will produce inaccurate costs, even with
ABC.
• Using ABC does not guarantee more accurate
costs!
Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved.
ABC Vs. Simple Costing (2 of 2)
• ABC is an alternate way to allocate costs. It is generally
considered to be more accurate and more costly to implement.
• A company should consider refining their cost system when
evidence begins to suggest that their existing system is flawed.
For Plastim, that occurred when they were in danger of losing
business due to their higher price.
• Because a number of critical decisions, such as pricing, whether
or not one product should be “pushed” over another, whether or
not a product should be dropped, etc. will be made using cost
information, best efforts should be used to arrive at a cost that is
fair and reasonable for each product. The goal isn’t to attain a
cost that serves the current purposes.
• This is an imprecise science and differences of opinion are likely
to occur.
Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved.
Signals that suggest that ABC
Implementation could help a Firm: (1 of 2)
1. Significant amounts of indirect costs are
allocated using only one or two cost pools.
2. All or most indirect costs are identified as output
unit-level costs.
3. Products make diverse demands on resources
because of volume, process steps, batch size or
complexity.
Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved.
Signals that suggest that ABC
Implementation could help a Firm: (2 of 2)
4. Products that a company is well-suited to make
show small profits whereas products that a
company is less suited to make show large
profits.
5. Operations staff has substantial disagreement
with the reported costs of manufacturing and
marketing products or services
Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved.
Activity-based Management
A method of management decision-making
that uses ABC information to improve
customer satisfaction and profitability.
We define ABM broadly to include decisions
about pricing and product mix, cost reduction,
process improvement and product and
process design.
Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved.
ABC and Service/Merchandising Firms
ABC implementation is widespread in a
variety of applications outside manufacturing,
including:
• Health Care
• Banking
• Telecommunications
• Retailing
• Transportation
Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved.
Terms to Learn (1 of 2)
TERMS TO LEARN
PAGE NUMBER
REFERENCE
Activity
178
Activity Based Costing (ABC)
178
Activity Based Management (ABM)
189
Batch-level costs
181
Cost Hierarchy
181
Facility-Sustaining Costs
181
Output Unit-Level Costs
181
Product-Cost Cross-Subsidization
172
Product overcosting
172
Product-sustaining costs
181
Product undercosting
172
Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved.
Terms to Learn (2 of 2)
TERMS TO LEARN
PAGE NUMBER
REFERENCE
Refined Costing System
177
Service-Sustaining Costs
181
Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved.
Cost Accounting
Sixteenth Edition, Global Edition
Chapter 6
Master Budget
and
Responsibility Accounting
Copyright © 2015 Pearson Education
6-1
LEARNING OBJECTIVES
1. Describe the master budget and explain its benefits
2. Describe the advantages of budgets
3. Prepare the operating budget and its supporting
schedules
4. Use computer-based financial planning models for
sensitivity analysis
5. Describe responsibility centers and responsibility
accounting
Copyright © 2015 Pearson Education
6-2
Chapter 6 learning objectives, concluded
6. Recognize the human aspects of budgeting
7. Appreciate the special challenges of budgeting in
multinational companies
Copyright © 2015 Pearson Education
6-3
Budget Defined
• A budget is the quantitative expression of a
proposed plan of action by management for a
specified period.
• A budget is an aid to coordinating what needs to
be done to implement that plan.
A budget generally includes both the plan’s
financial and nonfinancial aspects and serves as a
blueprint for the company to follow in an
upcoming period.
Copyright © 2015 Pearson Education
6-4
Budgets help managers….
• Communicate directions and goals to different
departments of a company to help them coordinate
the actions they must pursue to satisfy customers
and succeed in the marketplace.
• Judge performance by measuring financial results
against planned objectives, activities, and timelines
to learn about potential problems.
• Motivate employees to achieve their goals.
Copyright © 2015 Pearson Education
6-5
Strategic plans and operating plans
To develop successful strategies, managers must
consider questions such as the following:
1.What are our objectives?
2.How do we create value for our customers while
distinguishing ourselves from our competitors?
3.Are the markets for our products local, regional,
national or global?
4.What trends affect our markets?
5.What organizational and financial structures serve us
best?
6.What are risks and opportunities of alternative
strategies and what are our contingency plans if our
preferred plan fails?
Copyright © 2015 Pearson Education
6-6
Budgeting cycle:
1. Before the start of a fiscal year, managers at all
levels take into account past performance,
market feedback, anticipated future changes and
other indicators to initiate plans for the next
period.
2. Senior managers give subordinate managers a
frame of reference against which they will
compare actual results.
3. Managers and management accountants
investigate any deviations from the plan.
Copyright © 2015 Pearson Education
6-7
Working document: Master Budget
The master budget is at the core of the budgeting
process. It expresses management’s operating and
financial plans for a specified period:
• Operating decisions deal with how to best use
the limited resources of an organization. (the
operating budget)
• Financial decisions deal with how to obtain the
funds to acquire those resources. (the financial
budget)
Copyright © 2015 Pearson Education
6-8
Advantages of Budgets
• Promotes coordination and communication among
subunits within the company.
• Provides a framework for judging performance and
facilitating learning.
• Motivates managers and other employees.
Copyright © 2015 Pearson Education
6-9
Challenges in administering a budget
• Top managers want lower-level managers to
participate in the budgeting process because they
have more specialized knowledge of day-to-day
management, however…
• The budgeting process is time-consuming, and
• Upper-level management’s support is crucial
Copyright © 2015 Pearson Education
6-10
Time coverage of budgets
The timeline for a budget is dependent on the
motive for creating the budget.
The most frequently used budget period is 1 year.
Businesses may also use a rolling budget. This
budget is always available for a specified future
period, by continually adding a month, quarter, or
year to the period just ended.
Copyright © 2015 Pearson Education
6-11
The master budget
Sales
budget
Closing
stock
budget
Production
budget
Selling and
administrative
budget
Direct
materials
budget
Direct
labour
budget
Manufacturing
overhead
budget
Cash
budget
Copyright © 2015 Pearson Education
The sales budget
Detailed schedule showing expected sales for the
coming periods expressed in units and monetary
value.
Copyright © 2015 Pearson Education
Budgeting example
Royal Company is preparing budgets for the quarter ending June
30.
Budgeted sales for the next five months are:
April
May
June
July
August
20,000 units
50,000 units
30,000 units
25,000 units
15,000 units.
The selling price is £10 per unit.
Copyright © 2015 Pearson Education
The sales budget
April
Budgeted
sales (units)
20,000
Selling price
per unit
£
10
Total sales
£ 200,000
May
June
50,000
30,000
100,000
£
10
£ 500,000
£
10
£ 300,000
£
10
£ 1,000,000
Copyright © 2015 Pearson Education
Quarter
Use this as a
template for all sales
budgets
The production budget
Sales
Budget
Production
Budget
Production must be adequate to meet
budgeted sales and provide for sufficient
ending stock.
Copyright © 2015 Pearson Education
The production budget
Royal Company wants closing stock to be equal to 20% of
the following month’s budgeted sales in units.
On March 31st, 4,000 units were on hand.
Let’s prepare the production budget.
Copyright © 2015 Pearson Education
The production budget
Budgeted sales
Add desired
closing stock
Total needed
Less opening stock
Required production
April
20,000
10,000
30,000
4,000
26,000
Use this as a
template for all
production budgets
May
50,000
June
30,000
Budgeted May sales
Desired percent
Desired stock
Copyright © 2015 Pearson Education
Quarter
100,000
50,000
20%
10,000
The production budget
April
20,000
May
50,000
Add desired
closing stock
Total needed
Less opening stock
10,000
30,000
4,000
6,000
56,000
Required production
26,000
Budgeted sales
Copyright © 2015 Pearson Education
June
30,000
Quarter
100,000
The production budget
April
20,000
May
50,000
Add desired
closing stock
Total needed
Less opening stock
10,000
30,000
4,000
6,000
56,000
10,000
Required production
26,000
46,000
Budgeted sales
Copyright © 2015 Pearson Education
June
30,000
Quarter
100,000
The production budget
Be careful with
your total column
April
20,000
May
50,000
June
30,000
Quarter
100,000
Add desired closing
stock
Total needed
Less opening stock
10,000
30,000
4,000
6,000
56,000
10,000
5,000
35,000
6,000
5,000
105,000
4,000
Required production
26,000
46,000
29,000
101,000
Budgeted sales
20% of July sales
25,000
Copyright © 2015 Pearson Education
The direct materials budget
• At Royal Company, 5 lbs of material are required
per unit of product.
• Management wants materials on hand at the end
of each month equal to 10% of the following
month’s production.
• On March 31st, 13,000 lbs of material are on
hand. Materials cost £0.40 per pound.
• Let’s prepare the direct materials budget….
…
Copyright © 2015 Pearson Education
The direct materials budget
Production
Materials per unit
Production needs
April
26,000
May
46,000
June
29,000
Quarter
101,000
Add desired
closing stock
Total needed
Less
opening stock
Materials to be
purchased
Use this as a
template for all raw
mat purch budgets
Copyright © 2015 Pearson Education
Starting point - from
production
budget
The direct materials budget
Production
Materials per unit
Production needs
April
26,000
5
130,000
May
46,000
5
230,000
Add desired
closing stock
Total needed
Less
opening stock
Materials to be
purchased
Copyright © 2015 Pearson Education
June
29,000
5
145,000
Quarter
101,000
5
505,000
The direct materials budget
Production
Materials per unit
Production needs
Add desired
closing stock
Total needed
Less
opening stock
Materials to be
purchased
April
26,000
5
130,000
May
46,000
5
230,000
23,000
153,000
10% of the following
month’s production
Copyright © 2015 Pearson Education
June
29,000
5
145,000
Quarter
101,000
5
505,000
The direct materials budget
Production
Materials per unit
Production needs
Add desired
closing stock
Total needed
Less
opening stock
Materials to be
purchased
April
26,000
5
130,000
May
46,000
5
230,000
23,000
153,000
13,000
140,000
March 31
stock
Copyright © 2015 Pearson Education
June
29,000
5
145,000
Quarter
101,000
5
505,000
The direct materials budget
Production
Materials per unit
Production needs
Add desired
closing stock
Total needed
Less
opening stock
Materials to be
purchased
April
26,000
5
130,000
May
46,000
5
230,000
June
29,000
5
145,000
Quarter
101,000
5
505,000
23,000
153,000
14,500
244,500
11,500
156,500
11,500
516,500
13,000
23,000
14,500
13,000
140,000
221,500
142,000
503,500
Copyright © 2015 Pearson Education
The direct materials budget
Production
Materials per unit
Production needs
April
26,000
5
130,000
May
46,000
5
230,000
Add desired
ending stock
23,000
14,500
Total needed
153,000
244,500
July Production and Stock
Less beginning
Sales in units
25,000
inventory
13,000
23,000
Add desired ending stock
3,000
Materials to be
Total units needed
28,000
purchased
140,000
221,500
Less beginning stock
5,000
Production in units
23,000
Pounds per unit
5
Total pounds
115,000
Desired percent
10%
Desired ending stock Copyright © 2015 Pearson
11,500
Education
June
29,000
5
145,000
Quarter
101,000
5
505,000
11,500
156,500
11,500
516,500
14,500
13,000
142,000
503,500
The direct materials budget
April
Production
May
June
Be careful with your total
column
Quarter
26,000
46,000
29,000
101,000
Materials per unit
5
5
5
5
Production needs
130,000
230,000
145,000
505,000
23,000
14,500
11,500
11,500
153,000
244,500
156,500
516,500
13,000
23,000
14,500
13,000
140,000
221,500
142,000
503,500
$0.4
$0.4
$0.4
$88,600
$56,800
$201,400
Add desired ending
stock
Total needed
Less
beginning inventory
Materials to
be purchased
cost per pounds of
Direct Material
total Cost of Direct
material
$0.4
$56,000
Copyright © 2015 Pearson Education
29
The direct labour budget
• At Royal, each unit of product requires 0.05 hours of
direct labour.
• The company has a ‘no layoff’ policy so all 10
employees will be paid for 37.5 hours of work each
week (Assume each month has 4 weeks)
• In exchange for the ‘no layoff’ policy, workers agreed
to a wage rate of £10 per hour regardless of the hours
worked (no overtime pay).
Copyright © 2015 Pearson Education
The direct labour budget
Production
Direct labour hours
Labour hours required
April
26,000
May
46,000
June
29,000
Quarter
101,000
Guaranteed labour hours
Labour hours paid
Wage rate
Total direct labour cost
Starting point - from
production
Copyright © 2015 Pearson Education
budget
The direct labour budget
Production
Direct labour hours
Labour hours required
April
26,000
0.05
1,300
May
46,000
0.05
2,300
Guaranteed labour hours
Labour hours paid
Wage rate
Total direct labour cost
Copyright © 2015 Pearson Education
June
29,000
0.05
1,450
Quarter
101,000
0.05
5,050
The direct labour budget
Production
Direct labour hours
Labour hours required
Guaranteed labour hours
Labour hours paid
Wage rate
Total direct labour cost
37.5 x 10 x 4
April
26,000
0.05
1,300
May
46,000
0.05
2,300
June
29,000
0.05
1,450
Quarter
101,000
0.05
5,050
1,500
1,500
1,500
2,300
1,500
1,500
5,300
Higher of labour hours required
or labour hours guaranteed.
Copyright © 2015 Pearson Education
The direct labour budget
April
26,000
0.05
1,300
May
46,000
0.05
2,300
June
29,000
0.05
1,450
Quarter
101,000
0.05
5,050
Guaranteed labour hours
1,500
Labour hours paid
1,500
Wage rate
£
10
Total direct labour cost
£ 15,000
1,500
2,300
£
10
£ 23,000
1,500
1,500
£
10
£ 15,000
5,300
£
10
£ 53,000
Production
Direct labour hours
Labour hours required
Copyright © 2015 Pearson Education
Manufacturing overhead budget
Royal Company uses a variable manufacturing overhead
rate of £1 per unit produced.
Fixed manufacturing overhead is £50,000 per month and
includes £20,000 of non cash costs (primarily
depreciation of plant assets).
Let’s prepare the manufacturing overhead budget…
Copyright © 2015 Pearson Education
Manufacturing overhead budget
April
Production in units
26,000
Variable mfg. OH rate £
1
Variable mfg. OH costs £ 26,000
Fixed mfg. OH costs
Total mfg. OH costs
Less noncash costs
May
46,000
£
1
£ 46,000
June
29,000
£
1
£ 29,000
Quarter
101,000
£
1
£ 101,000
Cash disbursements
for manufacturing OH
Starting point - from production
budget
Copyright © 2015 Pearson Education
Manufacturing overhead budget
April
Production in units
26,000
Variable mfg. OH rate £
1
Variable mfg. OH costs £ 26,000
Fixed mfg. OH costs
50,000
Total mfg. OH costs
76,000
May
46,000
£
1
£ 46,000
50,000
96,000
Copyright © 2015 Pearson Education
June
29,000
£
1
£ 29,000
50,000
79,000
Quarter
101,000
£
1
£ 101,000
150,000
251,000
Adj as workings for cash budget
April
Production in units
26,000
Variable mfg. OH rate £
1
Variable mfg. OH costs £ 26,000
Fixed mfg. OH costs
50,000
Total mfg. OH costs
76,000
Less noncash costs
May
46,000
£
1
£ 46,000
50,000
96,000
Cash disbursements
for manufacturing OH
Copyright © 2015 Pearson Education
June
29,000
£
1
£ 29,000
50,000
79,000
Quarter
101,000
£
1
£ 101,000
150,000
251,000
Manufacturing overhead budget
April
Production in units
26,000
Variable mfg. OH rate £
1
Variable mfg. OH costs £ 26,000
Fixed mfg. OH costs
50,000
Total mfg. OH costs
76,000
Less non-cash costs
20,000
May
46,000
£
1
£ 46,000
50,000
96,000
20,000
June
29,000
£
1
£ 29,000
50,000
79,000
20,000
Quarter
101,000
£
1
£ 101,000
150,000
251,000
60,000
Cash disbursements
for manufacturing OH £ 56,000
£ 76,000
£ 59,000
£ 191,000
Depreciation is a non-cash charge.
Copyright © 2015 Pearson Education
Selling and administrative expense
budget
• At Royal, variable selling and administrative expenses
are £0.50 per unit sold.
• Fixed selling and administrative expenses are £70,000
per month.
• The fixed selling and administrative expenses include
£10,000 in costs – primarily depreciation – that are
not cash outflows of the current month.
Let’s prepare the company’s selling and
administrative expense budget…
Copyright © 2015 Pearson Education
Selling and administrative expense
budget
April
20,000
Budgeted sales
Variable selling
and admin. rate £ 0.50
Variable expense £ 10,000
Fixed selling and
admin. expense
70,000
Total expense
80,000
May
50,000
June
30,000
Quarter
100,000
£ 0.50
£ 25,000
£ 0.50
£ 15,000
£
0.50
£ 50,000
70,000
95,000
70,000
85,000
210,000
260,000
Copyright © 2015 Pearson Education
Selling and administrative expense
budget
April
20,000
Adj for cash
budget
workings –
take off
depreciation
- it’s not a
cash flow
Budgeted sales
Variable selling
and admin. rate £ 0.50
Variable expense £ 10,000
Fixed selling and
admin. expense
70,000
Total expense
80,000
Less non-cash
expenses
Cash disbursements for
selling & admin.
May
50,000
June
30,000
Quarter
100,000
£ 0.50
£ 25,000
£ 0.50
£ 15,000
£
0.50
£ 50,000
70,000
95,000
70,000
85,000
210,000
260,000
Copyright © 2015 Pearson Education
Selling and administrative expense
budget
April
20,000
Budgeted sales
Variable selling
and admin. rate £ 0.50
Variable expense £ 10,000
Fixed selling and
admin. expense
70,000
Total expense
80,000
Less non-cash
expenses
10,000
Cash disbursements for
selling & admin. £ 70,000
May
50,000
June
30,000
Quarter
100,000
£ 0.50
£ 25,000
£ 0.50
£ 15,000
£
0.50
£ 50,000
70,000
95,000
70,000
85,000
210,000
260,000
10,000
10,000
30,000
£ 85,000
£ 75,000
£ 230,000
Copyright © 2015 Pearson Education
Cash Budget
• Finally everything thing pulls together into an overall cash budget
• First, get the template for the cash budget straight in your
head………
• Then complete the workings for the different elements of the cash
budget
• Expected cash collections
• From sales
• Expected cash payments
•
For raw materials, direct labour, production o/h, selling
& admin expenses, perhaps some capital purchases
• Remember the depreciation adjustment on the o/h budgets
Copyright © 2015 Pearson Education
The Cash budget
Opening Cash Bal
Month Month Month Total
€/SAR €/SAR €/SAR €/SAR
-
Cash Receipts
Total cash receipts
-
-
-
-
Cash payments/ disbursements
Total cash disbursements-
-
-
-
Net Cashflow
-
-
-
-
Closing Cash balance -
-
-
-
Copyright © 2015 Pearson Education
Use as a template…
Expected cash collections
• All sales are on account.
• Royal’s collection pattern is:
70% collected in the month of sale
25% collected in the month following sale
5% is uncollectible
• The March 31 debtors/receivables balance of £30,000
will be collected in full in April.
Copyright © 2015 Pearson Education
Expected cash collections
Accounts rec. - 3/31
April
£ 30,000
Total cash collections
Copyright © 2015 Pearson Education
May
June
Quarter
£ 30,000
Expected cash collections
Remember
you’re
getting this
£200,000
from your
sales budget
Accounts rec. - 3/31
April sales
70% x £200,000
25% x £200,000
April
£ 30,000
May
140,000
£ 50,000
Total cash collections £ 170,000
Copyright © 2015 Pearson Education
June
Quarter
£ 30,000
140,000
50,000
Expected cash collections
Accounts rec. - 3/31
April sales
70% x £200,000
25% x £200,000
May sales
70% x £500,000
25% x £500,000
April
£ 30,000
May
June
140,000
Total cash collections £ 170,000
140,000
50,000
£ 50,000
350,000
£ 125,000
£ 400,000
Copyright © 2015 Pearson Education
Quarter
£ 30,000
350,000
125,000
Expected cash collections
April
£ 30,000
Accounts rec. - 3/31
April sales
70% x £200,000
140,000
25% x £200,000
May sales
70% x £500,000
25% x £500,000
June sales
70% x £300,000
Total cash collections £ 170,000
May
June
140,000
50,000
£ 50,000
350,000
£ 400,000
Copyright © 2015 Pearson Education
Quarter
£ 30,000
£ 125,000
350,000
125,000
210,000
£ 335,000
210,000
£ 905,000
Expected cash payments for
materials
• Royal pays £0.40 per pound for its materials.
• One half of a month’s purchases are paid for in the
month of purchase; the other half is paid in the
following month.
• The March 31 creditors/payables balance is £12,000.
Let’s calculate expected cash disbursements…
Copyright © 2015 Pearson Education
Expected cash payments for
materials
Accounts pay. 3/31
April purchases
April
£ 12,000
May
May purchases
June purchases
Total cash
disbursements
Copyright © 2015 Pearson Education
June
Quarter
£ 12,000
Expected cash payments for
materials
Accounts pay. 3/31
April purchases
50% x £56,000
50% x £56,000
May purchases
April
£ 12,000
May
28,000
£ 28,000
June purchases
Total cash
disbursements
£ 40,000
140,000kgs × £.40/kg = £56,000
Copyright © 2015 Pearson Education
June
Quarter
£ 12,000
28,000
28,000
Expected cash payments for
materials
Accounts pay. 3/31
April purchases
50% x £56,000
50% x £56,000
May purchases
50% x £88,600
50% x £88,600
June purchases
Total cash
disbursements
April
£ 12,000
May
June
28,000
28,000
28,000
£ 28,000
44,300
£ 44,300
£ 40,000
£ 72,300
Copyright © 2015 Pearson Education
Quarter
£ 12,000
44,300
44,300
Expected cash payments for
materials
Accounts pay. 3/31
April purchases
50% x £56,000
50% x £56,000
May purchases
50% x £88,600
50% x £88,600
June purchases
50% x £56,800
Total cash
disbursements
April
£ 12,000
May
June
28,000
28,000
28,000
£ 28,000
44,300
£ 40,000
£ 72,300
Copyright © 2015 Pearson Education
Quarter
£ 12,000
£ 44,300
44,300
44,300
28,400
28,400
£ 72,700
£ 185,000
The cash budget
This means that
every month the
co is free to
borrow whatever
it needs in order
to ensure that it
has a closing cash
balance of 30k per
month
Royal:
• maintains a 16% (interest rate) open line of credit for
£75,000.
• Maintains a minimum cash balance of £30,000.
• borrows on the first day of the month and repays
loans on the last day of the month.
• pays a cash dividend of £49,000 in April.
• purchases £143,700 of equipment in May and
£48,300 in June- paid in cash.
• has an April 1 cash balance of £40,000.
Of course they must pay that back and you must build this into
Copyright © 2015 Pearson Education
your cash budget
The cash budget
April
£ 40,000
170,000
210,000
May
June
Quarter
Beginning cash balance
Add cash collections
Total cash available
Less disbursements
Materials
40,000
Direct labour
Mfg. overhead
Schedule of expected
Selling and admin.
cash disbursements
Equipment purchase
Dividends
Total disbursements Schedule of expected
Excess (deficiency) of
cash collections
cash available over
disbursements
Copyright © 2015 Pearson Education
The cash budget
Beginning cash balance
Add cash collections
Total cash available
Less disbursements
Materials
Direct labour
Mfg. overhead
Selling and admin.
Equipment purchase
Dividends
Total disbursements
Excess (deficiency) of
cash available over
disbursements
April
£ 40,000
170,000
210,000
May
June
Quarter
Direct labour
budget
40,000
15,000
56,000
70,000
Manufacturing
overhead budget
Selling and administrative
expense budget
Copyright © 2015 Pearson Education
The cash budget
Beginning cash balance
Add cash collections
Total cash available
Less disbursements
Materials
Direct labour
Mfg. overhead
Selling and admin.
Equipment purchase
Dividends
Total disbursements
Excess (deficiency) of
cash available over
disbursements
April
£ 40,000
170,000
210,000
40,000
15,000
56,000
70,000
49,000
230,000
May
June
Quarter
Because Royal maintains
a cash balance of £30,000,
the company must
borrow on its
line-of-credit
-£ 20,000
Copyright © 2015 Pearson Education
Financing and repayment
April
Excess (deficiency)
of cash available
over disbursements -£ 20,000
Financing:
Borrowing
50,000
Repayments
Interest
Total financing
50,000
Ending cash balance £ 30,000
May
£
30,000
Ending cash balance for April
is the beginning May balance.
Copyright © 2015 Pearson Education
June
£
Quarter
-
£
-
The cash budget
April
£ 40,000
170,000
210,000
Beginning cash balance
Add cash collections
Total cash available
Less disbursements
Materials
40,000
Direct labour
15,000
Mfg. overhead
56,000
Selling and admin.
70,000
Equipment purchase
Dividends
49,000
Total disbursements
230,000
Excess (deficiency) of
cash available over
disbursements
-£ 20,000
Copyright © 2015 Pearson Education
May
£ 30,000
400,000
430,000
72,300
23,000
76,000
85,000
143,700
400,000
£ 30,000
June
Quarter
Financing and repayment
April
Excess (deficiency)
of cash available
over disbursements -£ 20,000
Financing:
Borrowing
50,000
Repayments
Interest
Total financing
50,000
Ending cash balance £ 30,000
May
£
30,000
£
30,000
June
Because the ending cash balance is
exactly £30,000, Royal will not repay
the loan this month.
Copyright © 2015 Pearson Education
Quarter
The cash budget
April
£ 40,000
170,000
210,000
Beginning cash balance
Add cash collections
Total cash available
Less disbursements
Materials
40,000
Direct labour
15,000
Mfg. overhead
56,000
Selling and admin.
70,000
Equipment purchase
Dividends
49,000
Total disbursements
230,000
Excess (deficiency) of
cash available over
disbursements
-£ 20,000
May
£ 30,000
400,000
430,000
June
£ 30,000
335,000
365,000
Quarter
£ 40,000
905,000
945,000
72,300
23,000
76,000
85,000
143,700
400,000
72,700
15,000
59,000
75,000
48,300
270,000
185,000
53,000
191,000
230,000
192,000
49,000
900,000
£ 30,000
£ 95,000
£ 45,000
+ 50,000 loan
Copyright © 2015 Pearson Education
no loan needed
The cash budget
April
£ 40,000
170,000
210,000
May
£ 30,000
400,000
430,000
June
£ 30,000
335,000
365,000
Quarter
£ 40,000
905,000
945,000
Beginning cash balance
Add cash collections
Total cash available
Less disbursements
Materials
40,000
72,300
72,700
185,000
Direct labour
15,000
23,000
15,000
53,000
Mfg. overhead
56,000
76,000
59,000
191,000
Selling and admin.
70,000
85,000
75,000
230,000
At
the
end
of
June,
Royal
has
enough
cash
Equipment purchase
143,700
48,300
192,000
to repay49,000
the £50,000 loan
plus interest
at49,000
16%.
Dividends
Total disbursements
230,000
400,000
270,000
900,000
Excess (deficiency) of
cash available over
disbursements
-£ 20,000
£ 30,000
£ 95,000
£ 45,000
Copyright © 2015 Pearson Education
Financing and repayment
April
Excess (deficiency)
of cash available
over disbursements -£ 20,000
Financing:
Borrowing
50,000
Repayments
Interest
Total financing
50,000
Ending cash balance £ 30,000
May
£
30,000
£
30,000
£50,000 × 16% × 3/12 = £2,000
Borrowings on April 1 and
repayment of June 30.
Copyright © 2015 Pearson Education
June
£
95,000
£
(50,000)
(2,000)
(52,000)
43,000
Quarter
£
45,000
£
50,000
(50,000)
(2,000)
(2,000)
43,000
Budgeted profit statement
Cash
budget
Budgeted
profit
Statement and
balance sheet
After we complete the cash budget, it is
possible to go on and prepare the
budgeted profit statement and budgeted
balance sheet for Royal
Copyright © 2015 Pearson Education
Cost Accounting
Sixteenth Edition, Global Edition
Chapter 7
Flexible Budgets,
Direct-Cost Variances,
and
Management Control
Copyright © 2015 Pearson Education
Chapter 7 learning objectives
1. Understand static budgets and static-budget
variances
2. Examine the concept of a flexible budget and
learn how to develop it
3. Calculate flexible-budget variances and salesvolume variances
4. Explain why standard costs are often used in
variance analysis
Copyright © 2015 Pearson Education
7-2
Chapter 7 learning objectives, concluded
5. Compute price variances and efficiency variances
for direct-cost categories.
6. Understand how managers use variances
7. Describe benchmarking and explain its role in
cost management
Copyright © 2015 Pearson Education
7-3
Basic Concepts
• Variance—difference between actual results and
expected (budgeted) performance.
• Management by exception—the practice of
focusing attention on areas not operating as
expected (budgeted).
• Static (master) budget is based on the output
planned at the start of the budget period.
Copyright © 2015 Pearson Education
7-4
Basic Concepts
• Static-budget variance—the difference between
the actual result and the corresponding static
budget amount
• Favorable variance (F)—has the effect of increasing
operating income relative to the budget amount
(actual revenues >budgeted revenues
actual costs < budgeted costs )
• Unfavorable variance (U)—has the effect of
decreasing operating income relative to the budget
amount
(actual revenues < budgeted revenues
actual costs > budgeted costs )
Copyright © 2015 Pearson Education
7-5
Copyright © 2015 Pearson Education
7-6
Assume that Pasadena Co. manufactures
and sells dress suits.
Budgeted variable costs per suit are as follows:
Direct materials cost
$ 65
Direct manufacturing labor
26
Variable manufacturing overhead
24
Total variable costs
$115
Copyright © 2015 Pearson Education
7-7
Static Budget Example
Budgeted selling price is $155 per suit.
Fixed manufacturing costs are expected
to be $286,000 within a relevant range
between 9,000 and 13,500 suits.
Variable and fixed period costs are ignored.
The static budget for year 2018 is based
on selling 13,000 suits.
What is the static-budget operating income?
Copyright © 2015 Pearson Education
7-8
Static Budget Example
Revenues (13,000 × $155)
Less Expenses:
Variable (13,000 × $115)
Fixed
Budgeted operating income
$2,015,000
1,495,000
286,000
$ 234,000
Assume that Pasadena Co. produced and sold
10,000 suits at $160 each with actual variable
costs of $120 per suit and fixed manufacturing
costs of $300,000.
Copyright © 2015 Pearson Education
7-9
Static Budget Example
What was the actual operating income?
Revenues (10,000 × $160)
Less Expenses:
Variable (10,000 × $120)
Fixed
Actual operating income
$1,600,000
1,200,000
300,000
$ 100,000
Copyright © 2015 Pearson Education
7-10
Static-Budget Variance Example
What is the static-budget variance of
operating income?
Actual operating income
Budgeted operating income
Static-budget variance of
operating income
$100,000
234,000
Copyright © 2015 Pearson Education
$134,000 U
7-11
Static-Budget Variance Example
Static-Budget Based Variance Analysis in (000)
Static Budget
Suits
Actual
13
10
$2,015
$1,600
Variable costs
1,495
1,200
Contribution margin
$520
$400
286
300
$234
$ 100
Revenue
Fixed costs
Operating income
Copyright © 2015 Pearson Education
7-12
Static-Budget Variance Example
Static-Budget Based Variance Analysis in (000)
Suits
Revenue
Variable costs
Contribution margin
Fixed costs
Operating income
Static Budget
13
$2,015
1,495
$ 520
286
$ 234
Copyright © 2015 Pearson Education
Actual
10
$1,600
1,200
$ 400
300
$ 100
Variance
3U
$415 U
296 F
$120 U
14 U
$134 U
7-13
Static Budgets and Performance Reports
• The relevant question is . . .
“How much of the favourable cost variance
is due to lower activity, and how much is
due to good cost control?”
• To answer the question,
we must
the budget to the actual level of activity.
Copyright © 2015 Pearson Education
7-14
Flexible Budgets
Show revenues and expenses
that should have occurred at the
actual level of activity.
May be prepared for any
activity level in the relevant
range.
Reveal variances due to good
cost control or lack of cost
control.
Improve performance evaluation.
Copyright © 2015 Pearson Education
7-15
Flexible Budgets
Central Concept
If you can tell me what your activity was
for the period, I will tell you what your costs and revenue
should have been.
Copyright © 2015 Pearson Education
7-16
Step 1:
Determine budgeted selling price,
variable cost per unit, and budgeted fixed cost.
Budgeted selling price is $155,
variable cost is $115 per suit, and
the budgeted fixed cost is $286,000.
Copyright © 2015 Pearson Education
7-17
Step 2:
Determine the actual quantity of output.
In the year 2018:
10,000 suits were produced and sold.
Step 3:
Determine the flexible budget for revenues.
$155 × 10,000 = $1,550,000
Copyright © 2015 Pearson Education
7-18
Step 4:
Determine the flexible budget for costs.
Variable costs: 10,000 × $115 = $1,150,000
Fixed costs
286,000
Total costs
$1,436,000
Copyright © 2015 Pearson Education
7-19
Flexible-Budget Variance
in (000)
Suits
Revenue
Variable cost
Contribution margin
Fixed costs
Operating income
Flexible
Budget
10
$1,550
1,150
$ 400
286
$ 114
Copyright © 2015 Pearson Education
Actual
10
$1,600
1,200
$ 400
300
$ 100
7-20
Flexible-Budget Variance
in (000)
Suits
Revenue
Variable costs
Contribution margin
Fixed costs
Operating income
Flexible
Budget
10
$1,550
1,150
$ 400
286
$ 114
Actual Variance
10
0
$1,600
$ 50 F
1,200
50 U
$ 400
$ 0
300
14 U
$ 100
$ 14 U
Copyright © 2015 Pearson Education
7-21
Flexible Budget Variance
What causes
the variable cost
variance?
There are two primary
reasons for unfavorable
variable cost variance
1. Spending too much for
resources.
2. Using the resources
inefficiently.
Copyright © 2015 Pearson Education
7-22
Sales-Volume Variance in (000)
Suits
Revenue
Variable costs
Contr. margin
Fixed costs
Operating income
Flexible
Budget
10
$1,550
1,150
$ 400
286
$ 114
Static
Budget
13
$2,015
1,495
$ 520
286
$ 234
Copyright © 2015 Pearson Education
Sales-Volume
Variance
3U
$465 U
295 F
$120 U
0
$120 U
7-23
VARIANCES, ANALYSIS
Some possible reasons we might incur an
unfavorable Sales-Volume Variance include:
1. Failure to execute the sales plan
2. Weaker than anticipated demand
3. Aggressive competitors taking market share
4. Unanticipated market preference away from the
product
5. Quality problems
Copyright © 2015 Pearson Education
7-24
Flexible Budget Variances
Level 3 variances provide even more information than we get
from level 2.
All product costs can have Level 3 variances. Direct materials
and direct labor will be discussed next. Overhead variances
are discussed in detail in a later chapter.
• Level 3 variances provide details of our level 2 flexible
budget variances. Instead of simply identifying the
difference between actual Material costs and (flexible)
budgeted costs, we can break that variance down into a
price variance component and an efficiency component.
Copyright © 2015 Pearson Education
7-25
Price and Efficiency variances
• Direct materials and direct labor both have
price and efficiency variances, and their
formulae are the same.
Copyright © 2015 Pearson Education
7-26
Variances
• Price variance formula:
Price
Variance
=
{
Actual Price
Of Input
-
Budgeted Price
Of Input
} X
Actual Quantity
Of Input
• Efficiency variance formula:
Efficiency
Variance
=
{
Actual Quantity
Of Input Used
-
Budgeted Quantity of Input
Allowed for Actual Output
}X
Budgeted Price
Of Input
Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall.
7-27
Actual Data
Direct materials purchased and used:
42,500 square yards at $15.95
Cost of direct materials = $677,875
Labor hours: 21,500 at $12.90
Cost of direct manufacturing labor = $277,350
Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall.
28
Budgeted Data
Direct materials purchase and use:
40,000 square yards at $16.25
Cost of direct materials = $650, 000
Labor hours: 20,000 at $13.00
Cost of direct manufacturing labor = $260,000
Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall.
29
Price Variance Example
Direct-material price variance
=
=
Actual price –
Budgeted price
×
Actual
quantity
($15.95 – $16.25) × 42,500 = $12,750 F
Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall.
30
Price Variance Example
Direct-labor price variance
=
=
Actual price –
Budgeted price
×
Actual
quantity
($12.90 – $13.00) × 21,500 = $2,150 F
Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall.
31
Efficiency Variance Example
Direct-material efficiency variance
=
=
Actual quantity –
budgeted quantity
×
Budgeted
price
(42,500 – 40,000) × $16.25 = $40,625 U
Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall.
32
Efficiency Variance Example
Direct-labor efficiency variance
=
=
Actual quantity –
Budgeted quantity
×
Budgeted
price
(21,500 – 20,000) × $13.00 = $19,500 U
Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall.
33
Obtaining budgeted input prices and input
quantities
Budgeted input prices and budgeted input
quantities can be obtained from a number of
sources including actual input data from past
periods, data from other companies that have
similar processes and standards developed by
the firm itself.
A standard is a carefully determined price, cost
or quantity that is used as a benchmark for
judging performance.
Copyright © 2015 Pearson Education
7-34
Standard Costing
• Targets or standards are established for direct
material and direct labor.
• The standard costs are recorded in the accounting
system.
• Actual price and usage amounts are compared to
the standard and variances are recorded.
Copyright © 2015 Pearson Education
7-35
Standard Costs can be a Useful Tool
• Price and efficiency variances provide feedback to
initiate corrective actions.
• Standards are used to control costs.
• Managers use variance analysis to evaluate
performance after decisions are implemented.
• Part of a continuous improvement program.
Copyright © 2015 Pearson Education
7-36
Benchmarking and Variances
Benchmarking refers to the continuous process of
measuring products, services, and activities
against the best levels of performance.
Variances can be extended to include
comparison to other entities
Copyright © 2015 Pearson Education
7-37
Cost Accounting
Sixteenth Edition, Global Edition
Flexible Budgets,
Overhead Cost Variances,
and
Management Control
Copyright © 2015 Pearson Education
Copyright © 2015 Pearson Education
Chapter 8 learning objectives
1. Explain the similarities and differences in planning
variable and fixed overhead costs
2. Develop budgeted variable and fixed overhead cost rates
3. Compute the variable overhead flexible-budget variance,
the variable overhead efficiency variance and the variable
overhead spending variance
4. Compute the fixed overhead flexible-budget variance, the
fixed overhead spending variance and the fixed overhead
production-volume variance
Copyright © 2015 Pearson Education
8-2
Chapter 8 learning objectives, concluded
5. Show how the 4-variance analysis approach reconciles the
actual overhead incurred with the overhead amounts
allocated during the period
6. Calculate variances in activity-based costing
7. Examine the use of overhead variances in
nonmanufacturing settings
Copyright © 2015 Pearson Education
8-3
Planning fixed and variable Overhead
• To effectively plan variable overhead costs,
managers should focus on activities that add value
and eliminate those that do not.
• Fixed overhead planning is similar ~ plan only for
essential activities and plan to be as efficient as
possible.
Copyright © 2015 Pearson Education
8-4
Standard Costing
…is a costing system that
Traces direct costs to output by multiplying
the standard prices or rate by the standard
quantities of inputs allowed for actual outputs
produced.
Allocates overhead costs on the basis of the
standard overhead-cost rates times the
standard quantities of the allocation bases
allowed for the actual outputs produced.
Copyright © 2015 Pearson Education
8-5
Developing Budgeted Variable
Overhead Cost Rates
1. Choose the period to be used for the budget.
2. Select the cost-allocation bases to use in
allocating variable overhead costs to output
produced.
3. Identify the variable overhead costs associated
with each cost-allocation base.
4. Compute the rate per unit of each costallocation base used to allocate variable
overhead costs to output produced.
Copyright © 2015 Pearson Education
8-6
The Details: Variable OH Variances
VARIABLE OVERHEAD FLEXIBLE-BUDGET
VARIANCE
• Variable overhead flexible-budget variance measures
the difference between actual variable overhead costs
incurred and flexible-budget variable overhead
amounts.
Variable Overhead
flexible-budget variance
=
Actual Costs
Incurred
-
Flexible-budget
amount
This variance can be further broken down into the
Variable Overhead Efficiency Variance and the
Variable Overhead Spending Variance.
8-7
Copyright © 2015 Pearson Education, Inc. All Rights Reserved
The Details: Variable OH Variances
VARIABLE OVERHEAD EFFICIENCY VARIANCE
Variable overhead efficiency variance is the difference
between the actual quantity of the variable overhead costallocation base used and the budgeted quantity of the
variable overhead cost-allocation base allowed for the
actual output X the budgeted variable overhead cost per
unit of the cost-allocation base.
Variable
Overhead
Efficiency
Variance
=
{
Actual quantity of
variable overhead
cost-allocation base
used for actual output
-
Budgeted quantity of
variable overhead costallocation base allowed
for actual output
}X
Budgeted variable
overhead cost
per unit of
cost-allocation base
8-8
Copyright © 2015 Pearson Education, Inc. All Rights Reserved
The Details: Variable OH Variances
VARIABLE OVERHEAD SPENDING VARIANCE
• Variable overhead spending variance is the difference
between actual and budgeted variable overhead cost
per unit of the cost-allocation base, multiplied by the
actual quantity of variable overhead cost-allocation
base used.
=
{
Actual variable
overhead cost
per unit of
cost-allocation base
-
Budgeted variable
overhead cost
per unit of
cost-allocation base
}X
Actual quantity of
variable overhead
cost-allocation base
used
8-9
Copyright © 2015 Pearson Education, Inc. All Rights Reserved
EXAMPLE
• If the cost-allocation base were machine hours
Budgeted Data:
variable overhead cost per machine hour
$30
Machine hours per unit
0.40hr/unit
production
12000 units
Actual Data
machine hours
4500
variable overhead cost per machine hour $29
Production
10,000 units
10
Copyright © 2015 Pearson Education, Inc. All Rights Reserved
What is the variable overhead efficiency variance?
= (4500 x $30 ) – ( 0.4 x10,000x 30)
= 135,000 – 120,000 = 15,000 U
What is the variable overhead spending variance?
(29 – 30) x 4500 = $4500 F
What is the Flexible budget variance?
(4500 x29)-(.40 x10,000x 30)
= 130,500-120,000= 10,500 U
11
Copyright © 2015 Pearson Education, Inc. All Rights Reserved
Developing budgeted fixed overhead rates-intro
Fixed overhead costs are, by definition, a lump sum
of costs that remain unchanged for a given period
despite potentially wide changes in activity within
the relevant range.
These costs are fixed in the sense that, unlike
variable costs, fixed costs do not automatically
increase or decrease with the level of activity within
the relevant range.
Copyright © 2015 Pearson Education
8-12
Developing Budgeted Fixed Overhead
Cost Rates
1. Choose the period to be used for the budget.
2. Select the cost-allocation bases to use in
allocating fixed overhead costs to output
produced.
3. Identify the fixed overhead costs associated
with each cost-allocation base.
4. Compute the rate per unit of each costallocation base used to allocate fixed overhead
costs to output produced.
Copyright © 2015 Pearson Education
8-13
The Details: Fixed OH Variances
fixed overhead flexible-budget variance & fixed
overhead spending variance
Fixed overhead flexible-budget variance is the
difference between actual fixed overhead costs and
fixed overhead costs in the flexible budget.
The fixed overhead spending variance is the same
variance as the Fixed Overhead Flexible-Budget
Variance
Fixed Overhead
flexible-budget variance
=
Actual Costs
Incurred
-
Flexible-budget
amount
8-14
Copyright © 2015 Pearson Education, Inc. All Rights Reserved
The Details: Fixed OH Variances
production-volume variance
• Production-volume variance is the difference
between budgeted fixed overhead and fixed
overhead allocated on the basis of actual output
produced.
Production-Volume
Variance
=
Budgeted
Fixed Overhead
-
Fixed Overhead allocated
for actual output units
produced
8-15
Copyright © 2015 Pearson Education, Inc. All Rights Reserved
Production-Volume Variance
• Interpretation of this variance is difficult due to the
nature of the costs involved and how they are
budgeted.
• Fixed costs are by definition somewhat inflexible.
While market conditions may cause production to
flex up or down, the associated fixed costs remain
the same.
• Fixed costs may be set years in advance, and may be
difficult to change quickly.
• Contradiction: Despite this, examination of the fixed
overhead budget formulae reveals that it is
budgeted similar to a variable cost.
Copyright © 2015 Pearson Education
8-16
EXAMPLE
• Budgeted Data :
fixed overhead
Fixed overhead per unit
production
$276,000
$23
12000 units
• Actual results:
fixed overhead
Production
$285,000
10,000 units
Copyright © 2015 Pearson Education
8-17
What is the Fixed cost spending variance?
$285,000- $276,000 = $9,000 U
❖ remember spending variance is the same
variance as the Fixed Overhead Flexible-Budget
Variance
What is the production -Volume variance ?
= $276,000 – ($23/unit x 10000)
= $276,000 – 230,000= $46,000 U
Copyright © 2015 Pearson Education
8-18
4-variance analysis
4-VARIANCE
ANALYSIS
SPENDING
VARIANCE
EFFICIENCY
VARIANCE
PRODUCTIONVOLUME
VARIANCE
VARIABLE
OVERHEAD
YES
YES
NEVER A
VARIANCE
FIXED OVERHEAD
YES
NEVER A
VARIANCE
YES
Copyright © 2015 Pearson Education
8-19
Variance analysis and activity based
costing
• Activity-based costing systems focus on
individual activities as the fundamental cost
objects.
• Variances are calculated for each activity
Copyright © 2015 Pearson Education
8-20
Overhead variances in nonmanufacturing
settings
• Nonmanufacturing companies can benefit from
overhead variances just as manufacturing
companies can.
• Variance analysis can be used to examine
overhead costs and make decisions about
pricing, managing costs and the mix of
products.
• Output measures will be different and can be
passenger-miles flown, patient days provided,
rooms-days occupied, ton-miles of freight
hauled, etc.
Copyright © 2015 Pearson Education
8-21
Financial and Nonfinancial Performance
Measures
The overhead variances discussed in this chapter are
examples of financial performance measures.
Nonfinancial measures such as those related to
capacity utilization and physical measures of input
usage also provide useful information.
Both financial and nonfinancial performance
measures are used to evaluate the performance of
managers.
Copyright © 2015 Pearson Education
8-22
Cost Accounting
Sixteenth Edition, Global Edition
Chapter 9
Inventory Costing
and
Capacity Analysis
Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved.
Learning Objectives (1 of 2)
9.1 Identify what distinguishes variable costing from
absorption costing.
9.2 Compute income under absorption costing and
variable costing and explain the difference in income.
9.3 Understand how absorption costing can provide
undesirable incentives for managers to build up
inventory.
9.4 Differentiate throughput costing from variable costing
and absorption costing.
9.5 Describe the various capacity concepts that firms can
use in absorption costing.
Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved.
Learning Objectives (2 of 2)
9.6 Examine the key factors managers use to choose a
capacity level to compute the budgeted fixed
manufacturing cost rate.
9.7 Understand other issues that play an important role in
capacity planning and control.
Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved.
Chapter Overview
INVENTORY COSTING
The two most common methods of costing inventory in
manufacturing companies are VARIABLE costing and
ABSORPTION costing. The choice determines which
manufacturing costs are treated as inventoriable costs.
Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved.
Inventory Costing Choices:
Overview
• Variable costing is a method of inventory costing in which all
variable manufacturing costs (direct and indirect) are included as
inventoriable costs.
• Absorption costing is a method of inventory costing in which all
variable and fixed manufacturing costs are included as
inventoriablecosts.Youcansaythatinventory“absorbs”all
manufacturing costs.
• Throughput costing is a method of inventory costing in which only
direct materials are included as inventoriable costs. All other costs
are expensed.
Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved.
Inventory Costing: Differences in
Income
1. Operating income will differ between absorption and
variable costing if inventory levels change because of
the difference in accounting for fixed manufacturing
costs.
2. The amount of the difference represents the amount of
fixed manufacturing costs capitalized as inventory under
absorption costing and expensed as a period cost under
variable costing.
Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved.
EXAMPLE
units
Beginning inventory
0
Production
8,000
Sales
6,000
Ending inventory
2,000
Selling price
$1,000
Variable manufacturing cost per unit:
DM per unit
$ 110
DL per unit
$ 40
MOH per unit
$ 50
Total variable manufacturing cost per unit
= $ 200
Variable marketing costs per unit sold
$185
Fixed MOH costs
$ 1,080,000
Fixed marketing costs
$ 1,380,000
Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved.
Comparative Income Statements
Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved.
2017
Budgeted production
2018
2019
8,000
8,000
8,000
0
2,000
500
Actual production
8,000
5,000
10,000
Sales
6,000
6,500
7,500
Ending inventory
2,000
500
3,000
Example cont.
Beginning inventory
9-9
Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved.
Comparing income Statements for
Multiple Years
EXHIBIT 9.2 Comparison of Variable Costing and Absorption Costing for Stassen
Company: Telescope Product-Line Income Statements for 2017 and 2018
Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved.
9-11
Comparative Income Effects
Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved.
9-12
Comparative Income Effects
Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved.
Absorption Costing and Performance
Measurement (1 of 2)
Absorption costing is the required inventory method for
external financial reporting in most countries. Also preferred
because:
• It is cost-effective and less confusing.
• It can help prevent managers from taking actions that make
their performance measure look good but that hurt the
income they report to shareholders.
• It measures the cost of all manufacturing resources (variable
or fixed) necessary to produce inventory.
Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved.
Absorption Costing and Performance
Measurement (2 of 2)
• An important attribute of absorption costing is that it enables
a manager to increase margins and operating income by
producing more ending inventory.
• Producingforinventoryisjustifiedwhenafirm’smanagers
anticipate rapid growth in demand and want to produce and
store additional units to deal with possible production
shortages in the next year.
Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved.
Proposals for Revising Performance
Evaluation
• To reduce the undesirable effects of absorption costing,
management can:
• Focus on careful budgeting and inventory planning.
• Incorporate an internal carrying charge for inventory
• Change (lengthen) the period used to evaluate performance.
• Include nonfinancial as well as financial variables in the
measures to evaluate performance. (compare ratio of
ending/beginning inventory to ratio of units produced/sold)
Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved.
Extreme Variable Costing: Throughput
Costing
• Throughput costing (super-variable costing) is a method of
inventory costing in which only direct material costs are
included as inventory costs. All other product costs are
treated as period expenses.
• Throughput margin equals revenues minus all direct
material cost of the goods sold.
Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved.
Throughput Costing, Illustrated
EXHIBIT 9.5 Throughput Costing for Stassen Company: Telescope Product-Line Income
Statements for 2017 and 2018
Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved.
Costing Systems Compared
Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved.
Terms to Learn
TERMS TO LEARN
PAGE NUMBER
REFERENCE
Absorption costing
350
Direct costing
350
Downward demand spiral
367
Master-budget capacity utilization
364
Normal capacity utilization
364
Practical capacity
364
Super-variable costing
361
Theoretical capacity
364
Throughput costing
361
Variable costing
350
Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved.
5-21 Plant-wide, department, and ABC indirect cost rates. Automotive Products (AP) designs
and produces automotive parts. In 2017, actual variable manufacturing overhead is $308,600. AP’s
simple costing system allocates variable manufacturing overhead to its three customers based on
machine-hours and prices its contracts based on full costs. One of its customers has regularly
complained of being charged noncompetitive prices, so AP’s controller Devon Smith realizes that
it is time to examine the consumption of overhead resources more closely. He knows that there are
three main departments that consume overhead resources: design, production, and engineering.
Interviews with the department personnel and examination of time records yield the following
detailed information:
Required:
1. Compute the manufacturing overhead allocated to each customer in 2014 using the simple
costing system that uses machine-hours as the allocation base.
2. Compute the manufacturing overhead allocated to each customer in 2014 using
department-based manufacturing overhead rates.
3. Comment on your answers in requirements 1 and 2. Which customer do you think was
complaining about being overcharged in the simple system? If the new department-based
rates are used to price contracts, which customer(s) will be unhappy? How would you
respond to these concerns?
SOLUTION: Plant wide, department, and ABC indirect cost rates.
Actual plant wide variable MOH rate based on machine hours:
$308,600 ÷ 4,000 = $77.15 per machine hour
Simple costing system
1.
United Motors
Variable manufacturing
overhead, allocated
based on machine hours
Holden Motors
($77.15× 120)
$9,258
Leland Auto
($77.15 × 2,800)
$216,020
Total
($77.15 × 1,080)
$83,322
$308,600
Department-based manufacturing overhead rates (...…)
2.
Department
MOH in 2014
Total Driver Units
Rate
Design
Production
Engineering
$39,000
29,600
240,000
390
370
4,000
$100
$ 80
$ 60
Design-related overhead, allocated on CAD-design hours
Production-related overhead, allocated on engineering hours
Engineering-related overhead, allocated on machine hours
Total
per CAD-design hour
per engineering hour
per machine hour
United
Motors
Holden
Motors
Leland
Auto
110 × $100
200 × $100
80 × $100
$11,000
$ 20,000
$ 8,000
70 × $80
60 × $80
240 × $80
5,600
4,800
19,200
120 × $60
2,800 × $60
1,080 × $60
7,200
$23,800
168,000
$192,800
64,800
$92,000
Total
$ 39,000
29,600
240,000
$308,600
3.
United
Motors
Holden
Motors
Leland
Auto
a.Department rates(Requirement 2)
$23,800
$192,800
$92,000
b. Plant wide rate(Requirement 1)
$ 9,258
$216,020
$83,322
Ratio of (a) ÷ (b)
2.57
0.89
1.10
The manufacturing overhead allocated to United Motors increases by 157% under the department
rates, the overhead allocated to Holden decreases by about 11%, and the overhead allocated to
Leland increases by about 10%.
Holden Motors was probably complaining under the use of the simple system because its contract
was being over costed relative to its consumption of MOH resources. United and Leland, on the
other hand, were having their contracts undercoated and underpriced by the simple system.
5-26 Activity-based costing, manufacturing. Decorative Doors, Inc., produces two types of
doors, interior and exterior. The company’s simple costing system has two direct-cost categories
(materials and labor) and one indirect-cost pool. The simple costing system allocates indirect costs
on the basis of machine-hours. Recently, the owners of Decorative Doors have been concerned
about a decline in the market share for their interior doors, usually their biggest seller. Information
related to Decorative Doors production for the most recent year follows:
The owners have heard of other companies in the industry that are now using an activity-based
costing system and are curious how an ABC system would affect their product costing decisions.
After analyzing the indirect-cost pool for Decorative Doors, the owners identify six activities as
generating indirect costs: production scheduling, material handling, machine setup, assembly,
inspection, and marketing. Decorative Doors collected the following data related to the indirectcost activities:
Marketing costs were determined to be 3% of the sales revenue for each type of door.
Required
1. Calculate the cost of an interior door and an exterior door under the existing simple costing
system.
2. Calculate the cost of an interior door and an exterior door under an activity-based costing
system.
3. Compare the costs of the doors in requirements 1 and 2. Why do the simple and activity-based
costing systems differ in the cost of an interior door and an exterior door?
4. How might Decorative Doors, Inc., use the new cost information from its activity-based
costing system to address the declining market share for interior doors?
SOLUTION
(30 min.)
Activity-based costing, manufacturing.
1. Simple costing system:
Total indirect costs =
$95,000 + $45,000 + $25,000 + $60,000 + $8,000 + 3 %[($125 3,200) + ($200 1,800)]
= $255,800
Total machine-hours = 5,500 + 4,500 = 10,000
Indirect cost rate per machine-hour = $255,800 10,000
= $25.58 per machine-hour
Simple Costing System
Direct materialsa
Direct manufacturing laborb
Interior
$ 96,000
76,800
Exterior
$ 81,000
64,800
($25.58 × 5,500)
Indirect cost allocated to each job (machine hours)
Total costs
140,690
a
b
115,110
$313,490
($313,490 3,200)
Total cost per unit
($25.58 × 4,500)
$
$260,910
$260,910 1,800
97.97
($30 × 3,200 units =$96,000);( $45 1,800 units =$81,000)
($16 × 1.5 × 3,200 units =76,800 ); ($16 2.25 1,800 units =64,800)
$ 144.95
2.
Activity-based costing system
Total Cost of
Activity
(2)
Activity
(1)
Product scheduling
Material handling
Machine setup
Assembly
Inspection
Marketing
c
$95,000
$45,000
$25,000
$60,000
$ 8,000
40 + 85 = 125;
d
Cost Driver
Quantity
(4)
Cost Driver
(3)
125c
$760.00
240d
$187.50
e
200
$125.00
10,000
$ 6.00
400f
$ 20.00
3% Or $0.03
Production runs
Material moves
Machine setups
Machine hours
Inspections
Percentage of revenues
72 + 168 = 240;
e
f
45 + 155 = 200;
ABC System
Direct materials
Direct manufacturing labor
Indirect costs allocated:
Production scheduling
Allocation Rate
(5) = (2) (4)
per production run
per material move
per setup
per machine hour
per inspection
per dollar of sales
250 + 150 = 400
Interior
$ 96,000
76,800
($760 per run
Exterior
$ 81,000
64,800
40)
($760 per run
30,400
Material handling
( $187.50per move 72)
( $125 per setup
45 )
( $125 per setup
($6 per MH × 5,500)
($6 per MH × 4,500)
27,000
($20 per inspection × 250)
($20 per inspection × 150)
5,000
Marketing
Total costs
Total cost per unit
( $125
12,000
$272,325
3%
$272,325 ÷ 3,200 units
155)
19,375
33,000
Inspection
168)
31,500
5,625
Assembly
85)
( $187.50 per move
13,500
Machine setup
64,600
3,000
( $200
10,800
$302,075
3,200)
3%
$302,075 ÷ 1,800 units
$ 85.10
1,800)
$
167.82
3.
Cost per unit
Simple Costing System
Activity-based Costing System
Difference (Simple – ABC)
Interior
$97.97
$85.10
$12.87
Exterior
$144.95
$167.82
$ (22.87)
Relative to the ABC system, the simple costing system overcosts interior doors and undercosts
exterior doors.
Cost Accounting: A Managerial Emphasis, 16e (Horngren)
Chapter 5 Activity-Based Costing and Activity-Based Management
5.1 Objective 5.1
1) Which of the following statements is true of a peanut-butter costing system?
A) A peanut-butter costing system typically has more-homogeneous indirect cost pools.
B) A peanut-butter costing system broadly averages or spreads the cost of resources uniformly to cost
objects.
C) A peanut-butter costing system assumes that all costs are variable.
D) In a peanut-butter costing system, costs of activities are used to assign costs to other cost objects such
as products or services based on the activities the products or services consume.
Answer: B
Diff: 2
Objective: 1
AACSB: Analytical thinking
2) Overcosting a particular product may result in:
A) pricing the product too high
B) pricing the product too low
C) operating efficiencies
D) understating total product costs
Answer: A
Diff: 2
Objective: 1
AACSB: Analytical thinking
3) For a company with diverse products, undercosting overhead of a product will lead to product-cross subsidization which means that:
A) direct labor costs of the product are misallocated
B) direct material costs of the product are misallocated
C) indirect costs of another product are misallocated
D) direct costs of another product are misallocated
Answer: C
Diff: 2
Objective: 1
AACSB: Analytical thinking
1
Copyright © 2018 Pearson Education, Inc.
4) Aqua Company produces two products–Alpha and Beta. Alpha has a high market share and is
produced in bulk. Production of Beta is based on customer orders and is custom designed. Also, 55% of
Beta's cost is shared between design and setup costs, while Alpha's major portions of costs are direct
costs. Alpha is using a single cost pool to allocate indirect costs. Which of the following statements is true
of Aqua?
A) Aqua will overcost Beta's direct costs as it is using a single cost pool to allocate indirect costs.
B) Aqua will undercost Alpha's indirect costs because alpha has high direct costs.
C) Aqua will overcost Alpha's indirect costs as it is using a single cost pool to allocate indirect costs.
D) Aqua will overcost Beta's indirect costs because beta has high indirect costs.
Answer: C
Diff: 2
Objective: 1
AACSB: Analytical thinking
5) Product-cost cross-subsidization means that:
A) when one product is overcosted, it results in more than one other product being overcosted
B) when a company undercosts more than one of its products, it will overcost more than one of its other
products
C) when a company undercosts one of its products, it will overcost at least one of its other products
D) when one product is overcosted it results in all other products being overcosted
Answer: C
Diff: 2
Objective: 1
AACSB: Analytical thinking
6) Which of the following has accelerated need for refined cost systems?
A) global monopolies
B) rising prices
C) intense competition
D) a shift toward increased direct costs
Answer: C
Diff: 2
Objective: 1
AACSB: Analytical thinking
7) Uniformly assigning the costs of resources to cost objects when those resources are actually used in a
nonuniform way is called activity based costing.
Answer: FALSE
Explanation: Peanut butter costing occurs when costs are assigned uniformly amount multiple products
using average costs that do not take into account the nonuniform way the resources are consumed to
produce the different products.
Diff: 1
Objective: 1
AACSB: Analytical thinking
2
Copyright © 2018 Pearson Education, Inc.
8) Product-cost cross-subsidization is very common when costs are uniformly spread across various
products.
Answer: TRUE
Diff: 2
Objective: 1
AACSB: Analytical thinking
9) Companies that overcost products risk becoming less effective on pricing and losing market share
when competition utilizes more accurate cost systems.
Answer: TRUE
Diff: 1
Objective: 1
AACSB: Analytical thinking
10) If companies increase market share in a given product line because their reported costs are less than
their actual costs, they will become more profitable in the long run.
Answer: FALSE
Explanation: The actual costs will increase because of the additional sales and the other product lines
(which are subsidizing the undercosting of the growing product line) will suffer. The net result will be the
company having a lower operating income than it could have had.
Diff: 2
Objective: 1
AACSB: Analytical thinking
11) As product diversity and indirect costs increase, it is usually best to switch away from a broad
averaging system to an activity-based cost system.
Answer: TRUE
Diff: 1
Objective: 1
AACSB: Analytical thinking
12) The risk of peanut-butter costing rises when broad averages are used across multiple products
without managers considering the true amounts of resources consumed in the making of each product.
Answer: TRUE
Diff: 2
Objective: 1
AACSB: Analytical thinking
13) Explain how a top-selling product may actually result in losses for the company.
Answer: If indirect costs are not properly allocated to the products, a product may appear to cost less
than it actually does cost to produce. If the selling price is based on these lower costs, the selling price
may actually be lower than the costs needed to produce the product resulting in losses for the company.
This would make undercosted products appear more profitable and therefore making marketing efforts
to promote the undercosted product counter productive.
Diff: 2
Objective: 1
AACSB: Analytical thinking
3
Copyright © 2018 Pearson Education, Inc.
5.2 Objective 5.2
1) Refining a cost system involves which of the following?
A) classifying as many costs as indirect costs as is feasible
B) creating as many cost pools as possible to capture all costs
C) identifying the activities involved in a process and understanding how those activities consume
resources
D) Seeking an easier and more cost effective way to calculate average costs
Answer: C
Diff: 1
Objective: 2
AACSB: Analytical thinking
2) Which of the following is true of refinement of a costing system?
A) While refining a costing system, companies should identify as many indirect costs as is economically
feasible.
B) A homogeneous cost pool will use multiple cost drivers to allocate costs.
C) It reduces the use of broad averages for assigning the cost of resources to cost objects.
D) It is likely to yield the most decision-making benefits when direct costs are a high percentage of total
costs.
Answer: C
Diff: 2
Objective: 2
AACSB: Analytical thinking
3) Which of the following is a reason that has accelerated the demand for refinements to the costing
system?
A) The declining demand for customized products has led managers to decrease the variety of products
and services their companies offer.
B) The use of product and process technology has led to an increase in indirect costs and a decrease in
direct costs.
C) The increased of automated processes has led to the increase in direct manufacturing cost leading to a
decrease in break even point.
D) The increasing competition in product markets has led to an increase in contribution margin resulting
in a decrease of break even point.
Answer: B
Diff: 3
Objective: 2
AACSB: Analytical thinking
4) Demand for refinements to the costing system has accelerated due to ________.
A) increase in direct costs
B) decrease in product diversity
C) decrease in indirect costs
D) competition in product markets
Answer: D
Diff: 1
Objective: 2
AACSB: Analytical thinking
4
Copyright © 2018 Pearson Education, Inc.
5) Johnson Superior Products Inc. produces hospital equipment and the setup requirements vary from
product to product. Johnson produces its products based on customer orders and uses ABC costing. In
one of its indirect cost pools, setup costs and distribution costs are pooled together. Costs in this pool are
allocated using number of customer orders for the easiness of costing operations. Based on the
information provided, which of the following arguments is valid?
A) Johnson has clearly failed to identify as many direct costs as is economically feasible.
B) All costs in a homogeneous cost pool have the same or a similar cause-and-effect relationship with the
single cost driver that is used as the cost-allocation base for Johnson.
C) Johnson has unnecessarily wasted resources by classifying setup and distribution costs as they could
have been considered as direct costs.
D) Johnson has failed to use the correct cost driver as the cost-allocation base for setup costs.
Answer: D
Diff: 1
Objective: 2
AACSB: Application of knowledge
6) Increased used of automation, computer integrated manufacturing, and utilization of robots have lead
to an increase in indirect costs relative to direct costs.
Answer: TRUE
Diff: 2
Objective: 2
AACSB: Analytical thinking
7) Modern manufacturing practices have helped reduce overhead costs relative to direct costs as the
reliance on support resources such as scheduling, design, and engineering has diminished.
Answer: FALSE
Explanation: Managing complex technology and producing diverse products require additional support
functions such as production scheduling, product and process design, and engineering.
Diff: 1
Objective: 2
AACSB: Analytical thinking
8) Indirect labor and distribution costs would most likely be in the same activity-cost pool.
Answer: FALSE
Explanation: Indirect labor and distribution costs would not be in the same activity-cost pool because
their cost drivers are very dissimilar. A cost driver of indirect labor would include direct labor hours,
while a cost driver of distribution costs would include, for example, cubic feet of cargo moved.
Diff: 2
Objective: 2
AACSB: Analytical thinking
9) Managers should look for evidence of cause-and-effect when choosing a cost driver with the driver
being the cause and the effect being the cost incurred.
Answer: TRUE
Diff: 1
Objective: 2
AACSB: Analytical thinking
5
Copyright © 2018 Pearson Education, Inc.
10) Identification of a cost-allocation base is not a critical element when using a strategy that will refine a
costing system.
Answer: FALSE
Explanation: Managers refine their cost systems by looking for effective cost=allocation basis (cost
driver) and seek evidence of cause-and-effect when choosing a cost driver with the driver being the cause
and the effect being the cost incurred.
Diff: 1
Objective: 2
AACSB: Analytical thinking
11) What are the factors that are causing many companies to refine their costing systems to obtain more
accurate measures of the costs of their products?
Answer: The first cause is increasing product diversity. Companies are producing many more products
than they used to, placing strains on more simple, older cost systems. A second cause is the overall
increased in indirect costs and the relative decline of direct costs. The indirect nature of these costs
requires allocation, and any inaccuracies in allocation of these costs become magnified as these indirect
costs increase. A third cause would be advances in information technology that makes complex allocation
of indirect costs less burdensome. Finally, increased competition from both national and international
competitors has resulted in more pressure to reduce costs, as well as increasing the need for and value of
information to support responses to these new threats.
Diff: 2
Objective: 2
AACSB: Analytical thinking
5.3 Objective 5.3
1) ABC systems create ________.
A) one large cost pool
B) homogeneous activity-related cost pools
C) activity-cost pools with a broad focus
D) activity-cost pools containing many direct costs
Answer: B
Diff: 1
Objective: 3
AACSB: Analytical thinking
2) Activity based costing system differs from traditional costing systems in the treatment of ________.
A) direct labor costs
B) direct material costs
C) prime costs
D) indirect costs
Answer: D
Diff: 1
Objective: 3
AACSB: Analytical thinking
6
Copyright © 2018 Pearson Education, Inc.
3) The fundamental cost objects of ABC are ________.
A) activities
B) cost drivers
C) products
D) services
Answer: A
Diff: 2
Objective: 3
AACSB: Analytical thinking
4) Which of the following statements is true of activity-based costing?
A) In activity-based costing, direct labor-hours is always the best allocation base to allocate all nonmanufacturing indirect costs.
B) Activity based costing is more suited to companies with high product diversity than companies with
single product line.
C) Activity based costing broadly averages or spreads the cost of resources uniformly to cost objects such
as products or services.
D) The main advantage of activity-based costing over peanut-butter costing is the accurate distribution of
all direct costs to the products.
Answer: B
Diff: 2
Objective: 3
AACSB: Analytical thinking
5) A single indirect-cost rate distorts product costs because ________.
A) there is an assumption that all support activities affect all products in a uniform way
B) it recognizes specific activities that are required to produce a product
C) competitive pricing is ignored
D) it assumes all costs are product costs
Answer: A
Diff: 2
Objective: 3
AACSB: Analytical thinking
7
Copyright © 2018 Pearson Education, Inc.
6) Extracts from cost information of Hebar Corp.:
Simple L3
Pack
Setup cost allocated using direct labor-hours $19,250
Setup cost allocated using setup-hours
$13,400
Total
Complex L7 Pack
$5,750
$25,000
$11,600
$25,000
Assuming that setup-hours is considered a more effective cost drive for allocating setup costs than direct
labor-hours. Which of the following statements is true of Hebar's setup costs under traditional costing?
A) L3 pack is undercosted by $5,850
B) L7 pack is undercosted by $5,750
C) L3 pack is overcosted by $5,850
D) L7 pack is overcosted by $5,850
Answer: C
Explanation: Setup cost allocated using direct labor-hours - Setup cost allocated using setup-hours
= $19,250 − $13,400 = $5,850
Diff: 2
Objective: 3
AACSB: Application of knowledge
7) Which of the following is true with activity based cost accounting?
A) Activity-based costing ignores the allocation of marketing and distribution costs.
B) Activity-based costing is more likely to result in major differences from traditional costing systems if
the firm manufactures only one product rather than multiple products.
C) The focus is on activities that account for a sizable fraction of indirect costs .
D) Chances of product-cost cross-subsidization are higher in activity-based costing compared to
traditional costing systems.
Answer: C
Diff: 2
Objective: 3
AACSB: Analytical thinking
8) Activity-based costing (ABC) can eliminate cost distortions because ABC systems ________.
A) establish a cause-and-effect relationship with the activities performed
B) use single cost pool for all overhead costs, thereby enabling simplicity
C) use a broad average to allocate all overhead costs
D) never consider interactions between different departments in assigning support costs
Answer: A
Diff: 2
Objective: 3
AACSB: Analytical thinking
8
Copyright © 2018 Pearson Education, Inc.
9) When "available time" (i.e., setup-hours) is used to calculate a cost of a resource and to allocate costs to
cost objects , the system is called:
A) job costing
B) process costing
C) hybrid costing
D) time-driven activity based costing
Answer: D
Diff: 2
Objective: 3
AACSB: Analytical thinking
10) Extreme Manufacturing Company provides the following ABC costing information:
Activities
Account inquiry
Account billing
Account verification accounts
Correspondence letters
Total costs
Total Costs
$320,000
$200,000
$173,250
$24,000
$717,250
Activity-cost drivers
16,000 hours
4,000,000 lines
70,000 accounts
4,000 letters
The above activities are used by Departments A and B as follows:
Account inquiry hours
Account billing lines
Account verification accounts
Correspondence letters
Department A
2,700 hours
900,000 lines
8,000 accounts
1,400 letters
Department B
4,200 hours
750,000 lines
6,000 accounts
1,800 letters
How much of the account inquiry cost will be assigned to Department A?
A) $54,000
B) $320,000
C) $160,000
D) $84,000
Answer: A
Explanation: Account inquiry costs - Department A = ($320,000 ÷ 16,000) × 2,700 = $54,000
Diff: 2
Objective: 3
AACSB: Application of knowledge
9
Copyright © 2018 Pearson Education, Inc.
11) Extreme Manufacturing Company provides the following ABC costing information:
Activities
Account inquiry
Account billing
Account verification accounts
Correspondence letters
Total costs
Total Costs
$320,000
$220,000
$182,000
$25,000
$747,000
Activity-cost drivers
16,000 hours
4,000,000 lines
80,000 accounts
4,000 letters
The above activities are used by Departments A and B as follows:
Account inquiry hours
Account billing lines
Account verification accounts
Correspondence letters
Department A
2,200 hours
600,000 lines
5,000 accounts
1,000 letters
Department B
3,700 hours
450,000 lines
3,000 accounts
1,400 letters
How much of the account billing cost will be assigned to Department B?
A) $220,000
B) $110,000
C) $24,750
D) $33,000
Answer: C
Explanation: Billing costs - Department B = ($220,000 ÷ 4,000,000) × 450,000 = $24,750
Diff: 2
Objective: 3
AACSB: Application of knowledge
10
Copyright © 2018 Pearson Education, Inc.
12) Extreme Manufacturing Company provides the following ABC costing information:
Activities
Account inquiry
Account billing
Account verification accounts
Correspondence letters
Total costs
Total Costs
$420,000
$225,000
$95,000
$46,000
$786,000
Activity-cost drivers
14,000 hours
5,000,000 lines
40,000 accounts
8,000 letters
The above activities are used by Departments A and B as follows:
Account inquiry hours
Account billing lines
Account verification accounts
Correspondence letters
Department A
2,900 hours
600,000 lines
12,000 accounts
1,800 letters
Department B
4,400 hours
450,000 lines
10,000 accounts
2,200 letters
How much of account verification costs will be assigned to Department A?
A) $23,750
B) $28,500
C) $95,000
D) $47,500
Answer: B
Explanation: Account verification costs - Department A = ($95,000/ 40,000) × 12,000 = $28,500
Diff: 2
Objective: 3
AACSB: Analytical thinking
11
Copyright © 2018 Pearson Education, Inc.
13) Extreme Manufacturing Company provides the following ABC costing information:
Activities
Account inquiry
Account billing
Account verification accounts
Correspondence letters
Total costs
Total Costs
$390,000
$275,000
$130,500
$22,000
$817,500
Activity-cost drivers
13,000 hours
5,000,000 lines
60,000 accounts
4,000 letters
The above activities are used by Departments A and B as follows:
Account inquiry hours
Account billing lines
Account verification accounts
Correspondence letters
Department A
2,500 hours
800,000 lines
9,000 accounts
2,000 letters
Department B
4,000 hours
650,000 lines
7,000 accounts
2,400 letters
How much of correspondence costs will be assigned to Department A?
A) $22,000
B) $49,500
C) $11,000
D) $11,242
Answer: C
Explanation: Correspondence costs - Department A = ($22,000 ÷ 4,000) × 2,000 = $11,000
Diff: 2
Objective: 3
AACSB: Application of knowledge
12
Copyright © 2018 Pearson Education, Inc.
14) Extreme Manufacturing Company provides the following ABC costing information:
Activities
Account inquiry
Account billing
Account verification accounts
Correspondence letters
Total costs
Total Costs
$280,000
$350,000
$93,750
$29,000
$752,750
Activity-cost drivers
14,000 hours
7,000,000 lines
50,000 accounts
4,000 letters
The above activities are used by Departments A and B as follows:
Account inquiry hours
Account billing lines
Account verification accounts
Correspondence letters
Department A
2,100 hours
500,000 lines
7,000 accounts
1,200 letters
Department B
3,600 hours
350,000 lines
5,000 accounts
1,600 letters
How much of the total costs will be assigned to Department A?
A) $88,825
B) $118,825
C) $120,000
D) $85,075
Answer: A
Explanation: Account inquiry costs
= ($280,000 ÷ 14,000) × 2,100
Billing costs
= ($350,000 ÷ 7,000,000) × 500,000
= $25,000
Account verification costs
= ($93,750 ÷ 50,000) × 7,000
Correspondence costs
= ($29,000 ÷ 4,000)
× 1,200
= $8,700
$88,825
Diff: 3
Objective: 3
AACSB: Application of knowledge
13
Copyright © 2018 Pearson Education, Inc.
= $42,000
=
$13,125
15) Extreme Manufacturing Company provides the following ABC costing information:
Activities
Account inquiry
Account billing
Account verification accounts
Correspondence letters
Total costs
Total Costs
$750,000
$250,000
$173,250
$42,000
$1,215,250
Activity-cost drivers
15,000 hours
5,000,000 lines
70,000 accounts
7,000 letters
The above activities are used by Departments A and B as follows:
Account inquiry hours
Account billing lines
Account verification accounts
Correspondence letters
Department A
2,000 hours
900,000 lines
9,000 accounts
1,200 letters
Department B
3,500 hours
750,000 lines
7,000 accounts
1,600 letters
How much of the total costs will be assigned to Department B?
A) $282,460
B) $246,925
C) $239,425
D) $256,825
Answer: C
Explanation: Account inquiry costs
= ($750,000 ÷ 15,000) × 3,500
Billing costs
= ($250,000 ÷ 5,000,000)
× 750,000
= $37,500
Account verification costs = ($173,250 ÷ 70,000)
× 7,000
= $17,325
Correspondence costs
= ($42,000 ÷ 7,000)
× 1,600
= $9,600
$239,425
= $175,000
Diff: 3
Objective: 3
AACSB: Application of knowledge
16) Dalrymple Company produces a special spray nozzle. The budgeted indirect total cost of inserting the
spray nozzle is $68,750. The budgeted number of nozzles to be inserted is 11,000. What is the budgeted
indirect cost allocation rate for this activity?
A) $0.16
B) $0.32
C) $1.16
D) $6.25
Answer: D
Explanation: $68,750 / 11,000 = $6.25
Diff: 2
Objective: 3
AACSB: Application of knowledge
14
Copyright © 2018 Pearson Education, Inc.
17) Activity-based costing is most likely to yield benefits for companies ________.
A) with complex product design processes that vary significantly from product to product
B) with operations that remain fairly consistent across product lines
C) in a monopolistic market
D) having nominal percentage of indirect costs
Answer: A
Diff: 1
Objective: 3
AACSB: Analytical thinking
18) Which of the following statements is true of ABC systems?
A) ABC systems are time-driven cost systems.
B) ABC systems classify some direct costs as indirect costs and some indirect costs as direct costs.
C) ABC systems provide valuable information to managers beyond accurate product costs.
D) ABC systems assume all costs are variable costs.
Answer: C
Diff: 2
Objective: 2
AACSB: Analytical thinking
19) Columbus Company provides the following ABC costing information:
Activities
Labor
Gas
Invoices
Total costs
Total Costs
$392,000
$30,000
$180,000
$602,000
Activity-cost drivers
8,000 hours
5,000 gallons
7,500 invoices
The above activities used by their three departments are:
Labor
Gas
Invoices
Lawn Department
2,600 hours
1,800 gallons
1,600 invoices
Bush Department
1,300 hours
1,000 gallons
100 invoices
How much of the labor cost will be assigned to the Bush Department?
A) $127,400
B) $63,700
C) $200,900
D) $97,825
Answer: B
Explanation: Labor cost assigned = ($392,000 ÷ 8,000) × 1,300 = $63,700
Diff: 2
Objective: 3
AACSB: Analytical thinking
15
Copyright © 2018 Pearson Education, Inc.
Plowing Department
4,100 hours
2,200 gallons
5,800 invoices
20) Columbus Company provides the following ABC costing information:
Activities
Labor
Gas
Invoices
Total costs
Total Costs
$336,000
$84,000
$180,000
$600,000
Activity-cost drivers
8,000 hours
7,000 gallons
7,500 invoices
The above activities used by their three departments are:
Labor
Gas
Invoices
Lawn Department
3,100 hours
1,900 gallons
1,300 invoices
Bush Department
1,500 hours
900 gallons
400 invoices
Plowing Department
3,400 hours
4,200 gallons
5,800 invoices
If labor hours are used to allocate the non-labor, overhead costs, what is the overhead allocation rate?
A) $75.00 per hour
B) $26.67 per hour
C) $42.00 per hour
D) $33.00 per hour
Answer: D
Explanation: Overhead allocation rate = ($84,000 + $180,000) ÷ 8,000 = $33.00
Diff: 2
Objective: 3
AACSB: Application of knowledge
16
Copyright © 2018 Pearson Education, Inc.
21) Columbus Company provides the following ABC costing information:
Activities
Labor
Gas
Invoices
Total costs
Total Costs
$384,000
$36,000
$180,000
$600,000
Activity-cost drivers
8,000 hours
6,000 gallons
7,500 invoices
The above activities used by their three departments are:
Labor
Gas
Invoices
Lawn Department
2,500 hours
1,800 gallons
1,300 invoices
Bush Department
1,400 hours
1,000 gallons
300 invoices
How much of invoice cost will be assigned to the Bush Department?
A) $7,200
B) $141,600
C) $31,200
D) $180,000
Answer: A
Explanation: ($180,000 / 7,500 invoices) × 300 invoices = $7,200
Diff: 2
Objective: 3
AACSB: Application of knowledge
17
Copyright © 2018 Pearson Education, Inc.
Plowing Department
4,100 hours
3,200 gallons
5,900 invoices
22) Columbus Company provides the following ABC costing information:
Activities
Labor
Gas
Invoices
Total costs
Total Costs
$352,000
$8,000
$110,000
$470,000
Activity-cost drivers
8,000 hours
4,000 gallons
5,500 invoices
The above activities used by their three departments are:
Labor
Gas
Invoices
Lawn Department
3,200 hours
1,900 gallons
1,500 invoices
Bush Department
1,200 hours
900 gallons
300 invoices
How much of the gas cost will be assigned to the Lawn Department?
A) $1,800
B) $3,800
C) $2,400
D) $8,000
Answer: B
Explanation: Gas cost = ($8,000 ÷ 4,000 gallons) × 1,900 gallons = $3,800
Diff: 2
Objective: 3
AACSB: Application of knowledge
18
Copyright © 2018 Pearson Education, Inc.
Plowing Department
3,600 hours
1,200 gallons
3,700 invoices
23) Columbus Company provides the following ABC costing information:
Activities
Labor
Gas
Invoices
Total costs
Total Costs
$490,000
$18,000
$56,000
$564,000
Activity-cost drivers
10,000 hours
3,000 gallons
3,500 invoices
The above activities used by their three departments are:
Labor
Gas
Invoices
Lawn Department
2,800 hours
1,800 gallons
1,600 invoices
Bush Department
1,400 hours
900 gallons
300 invoices
How much of the total cost will be assigned to the Plowing Department?
A) $564,000
B) $311,600
C) $188,000
D) $173,600
Answer: B
Explanation: ($490,000 / 10,000)
× 5,800
= $284,200
($18,000 / 3,000)
× 300
= $1,800
($56,000 / 3,500)
× 1,600
= $25,600
$311,600
Diff: 3
Objective: 3
AACSB: Application of knowledge
19
Copyright © 2018 Pearson Education, Inc.
Plowing Department
5,800 hours
300 gallons
1,600 invoices
24) Columbus Company provides the following ABC costing information:
Activities
Labor
Gas
Invoices
Total costs
Total Costs
$384,000
$40,000
$40,000
$464,000
Activity-cost drivers
8,000 hours
4,000 gallons
2,500 invoices
The above activities used by their three departments are:
Labor
Gas
Invoices
Lawn Department
2,800 hours
1,800 gallons
1,400 invoices
Bush Department
1,500 hours
900 gallons
300 invoices
How much of the total costs will be assigned to the Lawn Department?
A) $192,000
B) $464,000
C) $174,800
D) $154,667
Answer: C
Diff: 3
Objective: 3
AACSB: Application of knowledge
20
Copyright © 2018 Pearson Education, Inc.
Plowing Department
3,700 hours
1,300 gallons
800 invoices
25) Milan Manufacturing Company has identified three cost pools to allocate overhead costs. The
following estimates are provided for the coming year:
Cost Pool
Supervision of direct labor
Machine maintenance
Facility rent
Total overhead costs
Overhead Costs
$539,000
$120,000
$215,000
$874,000
Cost driver
Direct labor-hours
Machine-hours
Square feet of area
Activity level
920,000
1,000,000
160,000
The accounting records show the Mossman Job consumed the following resources:
Cost driver
Direct labor-hours
Machine-hours
Square feet of area
Actual level
300
1,675
70
If direct labor-hours are considered the only overhead cost driver, what is the single cost driver rate for
Milan?
A) $1.05 per direct labor-hour
B) $0.59 per direct labor-hour
C) $0.95 per direct labor-hour
D) $1.71 per direct labor-hour
Answer: C
Explanation: Cost driver rate = $874,000 ÷ 920,000 = 0.95 per dlh
Diff: 2
Objective: 3
AACSB: Application of knowledge
21
Copyright © 2018 Pearson Education, Inc.
26) Milan Company has identified three cost pools to allocate overhead costs. The following estimates are
provided for the coming year:
Cost Pool
Supervision of direct labor
Machine maintenance
Facility rent
Total overhead costs
Overhead Costs
$624,000
$100,000
$216,000
$940,000
Cost driver
Direct labor-hours
Machine-hours
Square feet of area
Activity level
940,000
840,000
140,000
The accounting records show the Mossman Job consumed the following resources:
Cost driver
Direct labor-hours
Machine-hours
Square feet of area
Actual level
290
1,681.68
50
Under activity-based costing, what is the amount of machine maintenance costs allocated to the Mossman
Job? (Do not round any intermediary calculations.)
A) $1,881.88
B) $200.20
C) $1,681.68
D) $210.45
Answer: B
Explanation: Machine maintenance costs = 1,681.68 mh × ($100,000 ÷ 840,000) = $200.20
Diff: 2
Objective: 3
AACSB: Application of knowledge
22
Copyright © 2018 Pearson Education, Inc.
27) Velshi Printers has contracts to complete weekly supplements required by forty-six customers. For the
year 2018, manufacturing overhead cost estimates total $1,500,000 for an annual production capacity of 10
million pages.
For 2018 Velshi Printers has decided to evaluate the use of additional cost pools. After analyzing
manufacturing overhead costs, it was determined that number of design changes, setups, and inspections
are the primary manufacturing overhead cost drivers. The following information was gathered during
the analysis:
Cost pool
Manufacturing overhead costs
Design changes
$100,000
Setups
1,300,000
Inspections
100,000
Total manufacturing overhead costs
$1,500,000
Activity level
400 design changes
3,000 setups
10,000 inspections
During 2018, two customers, Money Managers and Hospita...
Purchase answer to see full
attachment