Task Team of FUNDAMENTAL ACCOUNTING School of Business Sun Yat-sen University Plant-wide Overhead Rate A single plant-wide overhead rate is relatively easy to use, but ay result in inaccurate product costs Two-stage Cost Allocation Two-stage cost allocation is more accurate method than Stage 1: Allocate service department costs to production departments. Service department costs are assigned to operating(or production) departments Stage 2: Allocate production department costs to cost objects. Costs accumulated within operating(or production)departments are assigned to cost object Activity-based Costing Activity-based costing attempts to better allocate costs to the desired cost objects by focusing on activities consumed by the cost objects. Many activities within a department drive overhead costs. Products require activities. Activities consume resources Activity-based Costing: Procedures The procedures include: (1)Identify activities that consume resources;(2)Assign costs to a cost pool for each activity; (3)Identify cost drivers associated with each activity;(4) Compute overhead rate for each cost pool, rate equals to estimated overhead costs in activity cost pool over to estimated number of activity units; (5) Allocate overhead cost, overhead rate times actual activity Activity-based Costing: Identifying Cost Drivers Most cost drivers are related to eit volume or complexity of production For example: purchasing, invoicing, quality inspection, product design Three factors must be considered in choosing a cost driver: (1) Causal relationship; (2) Benefits received; (3)Reasonableness The typical costs and cost drivers are listed as follows Cost driver Materials purchasing umber of purchase orders Materials handlin lumber of materials requisitions umber of employees uipment amortization Number of products produced or hours of use Quality inspection umber of units inspecte Indirect labour in setting unNumber of setups required Activity-based Costing: Benefits The benefits of activity-based costing include:(1) More detailed measures of costs; (2)Better understanding of activities; (3) More accurate product costs for pricing decisions, product elimination decisions, and managing activities that cause costs Certainly, benefits should al ways be compared with costs of implementation ABC Company acquired its factory building about 25 years ago. For a number of years, the company has rented out a small, unused part of the building The renter's lease will expire soonTask Team of FUNDAMENTAL ACCOUNTING School of Business, Sun Yat-sen University Plant-wide Overhead Rate A single plant-wide overhead rate is relatively easy to use, but may result in inaccurate product costs. Two-stage Cost Allocation Two-stage cost allocation is more accurate method than plant-wide. Stage 1: Allocate service department costs to production departments. Service department costs are assigned to operating (or production) departments. Stage 2: Allocate production department costs to cost objects. Costs accumulated within operating (or production) departments are assigned to cost objects. Activity-based Costing Activity-based costing attempts to better allocate costs to the desired cost objects by focusing on activities consumed by the cost objects. Many activities within a department drive overhead costs. Products require activities. Activities consume resources. Activity-based Costing: Procedures The procedures include: (1) Identify activities that consume resources; (2) Assign costs to a cost pool for each activity; (3) Identify cost drivers associated with each activity; (4) Compute overhead rate for each cost pool, rate equals to estimated overhead costs in activity cost pool over to estimated number of activity units; (5) Allocate overhead cost, overhead rate times actual activity.. Activity-based Costing: Identifying Cost Drivers Most cost drivers are related to either volume or complexity of production. For example: purchasing, invoicing, quality inspection, product design. Three factors must be considered in choosing a cost driver: (1) Causal relationship; (2) Benefits received; (3) Reasonableness. The typical costs and cost drivers are listed as follows: Cost Cost Driver Materials purchasing Number of purchase orders Materials handling Number of materials requisitions Personnel Number of employees Equipment amortization Number of products produced or hours of use Quality inspection Number of units inspected Indirect labour in setting up equipment Number of setups required Activity-based Costing: Benefits The benefits of activity-based costing include: (1) More detailed measures of costs; (2) Better understanding of activities; (3) More accurate product costs for pricing decisions, product elimination decisions, and managing activities that cause costs. Certainly, benefits should always be compared with costs of implementation Case Study ABC Company acquired its factory building about 25 years ago. For a number of years, the company has rented out a small, unused part of the building. The renter's lease will expire soon