If the costs are indirect, they are allocated to an indirect cost pool (there may be one or more). An appropriate portion of the indirect costs are then allocated from the cost pool(s) to the cost object(s). An example is the cost of the glue used to make each piece of furniture.
Cost Pool Homogeneity
Recalling the earlier calculation of the factory's indirect cost allocation to product X456 in the factory-wide rate system, we have the comparative results shown in Figure 4-10. For product X456, the allocated indirect costs decrease because relatively less of the more expensive resource is consumed.
Using Planned Capacity Cost
In the second step, the door is placed on a platform and a computer-controlled router creates the engraving on the door requested by the customer. In the third step, the door is treated with a finish specified by the customer and then packaged for shipment to the customer.
Reconciling Actual and Applied Capacity Costs
The simplest option is simply to charge the $500,000 of the cost of goods sold in the current period. Practical capacity is one of four commonly suggested activity levels used to calculate the cost driver rate. Those who advocate calculating the cost driver by dividing planned indirect costs by the planned level of the cost driver argue that this approach provides a practical attempt to allocate planned indirect costs and therefore provides a practical and appropriate basis for accurate product costing.
The problem with this approach is that, given capacity-related costs that are fixed, when the planned production level decreases, the cost driver rate will increase, causing product costs to increase. As the planned production level increases, the cost driver rate will decrease, causing product costs to decrease. Note that as expected demand decreases, the cost driver will increase, causing the cost-plus price to increase.
The increase in prices causes demand to decrease, which leads to further price increases as the cost-plus rate increases the cost-plus price. The main problem with this approach is that it sinks the cost of idle capacity into the cost of the product and does not provide a clear incentive for management to increase the use of idle capacity.
Job Order Costing
Estimating Practical Capacity
In each of these cases, the organization providing the product or service will typically allocate all direct material and labor costs to the job. Then, the organization will allocate overhead costs to the job using one of the indirect cost management methods we discussed earlier. The purpose of the job order costing system is to accumulate the cost of the job because, due to job differences, the cost will vary across jobs.
Each job will have a cost that is calculated by adding up the direct and indirect costs of each department or activity that was used to complete the job.
Process Costing
Roughing and Finishing – The silver bars are passed through a roughing mill and then through a finishing mill to produce silver strips the width of the coins that will be made. Blanking - The silver strips are run through a die cutting machine that punches out blank discs that will be used to create the coins. Rimming - The blank discs are fed through a rimming machine which places rims on the blank discs.
Cleaning—The discs are passed through a cleaning vat where they are mixed with water and abrasives to smooth and polish them. Coin Press - The discs are placed in a coin press where they are punched at the top and bottom simultaneously to create the coin. Each of these seven steps is a process required to create the collectible silver coins.
Exhibit 4-15 illustrates what this process cost system might look like to produce 100,000 one-ounce sterling silver collectible coins. In summary, the focus of process costing is to identify the cost that each process or activity used to make a product contributes to the total cost of the product.
Some Process Costing Wrinkles
10% complete based on the total work that needs to be done to turn the original block of wood into the finished product. Therefore, the work done on 1,000 blocks of wood in ending inventory is equivalent to the units of conversion work on completed units. To do this, we divide the total material cost by the equivalent material units and the total conversion cost by the equivalent conversion units.
Exhibit 4-20 provides important management information as it establishes the cost per unit produced for each of the major production activities. The calculation shows that the material cost per duck is $12 and the total manufacturing cost to convert the raw block of wood into the finished product is $70. The final step is to use equivalent costing to allocate total manufacturing costs to ending work in process and finished goods.
Exhibit 4-21 summarizes how costs will be allocated to ending work in process and finished goods.
Final Comments on Process Costing
Since the work in this department was labor intensive and labor driven, Enid decided that the costs in this department were driven by labor hours. Based on observing the workers preparing the prototype frame, Enid believed that a reasonable estimate of the time required to make the frame in this department was 0.20 hours. In this department, workers complete the framing by adding the portrait, backing, glass, base, and hardware.
Since the work in this department is labor intensive and labor driven, Enid decided that the costs in this department are driven by labor hours. From observing workers preparing the prototype frame, Enid believed that a reasonable estimate of the time required to complete the frame in this department is 0.30 hours. Enid estimated the total overhead costs in this division, which consist of labor and machine overhead, to be $150,000.
Since the work in the Packaging Division is machine driven, Enid decided that the costs in this department are driven by machine hours. For the sake of simplicity, in this appendix we will call departments that directly produce goods or services production departments.
Wellington Regional Hospital
Most organizations have so-called service departments that do not directly produce goods or services for customers, but instead provide services to the departments or activities that produce goods or services. The costs of the service departments are traditionally allocated to the production departments, where they are added to the production departments' own costs and allocated to the cost units. Most organizations also have so-called service departments that do not directly produce goods or services for customers, but instead provide services to the departments or activities that produce goods or services.
The service department costs are traditionally allocated to the production departments, where they are added to the production departments' own costs and allocated to the cost units. In what follows, remember that the goal then is to allocate all costs from the service department to the production departments. That service department ignores the services it provides to itself and allocates its costs to the other departments in proportion to the services provided to each department.
Once service department costs are assigned, they are removed from consideration and the process moves (steps) to the next department. This rate is then used to allocate the costs of the maintenance department to the remaining departments.
Approaches to Allocating Service Department Costs
This sequential method (also called the step-or-step-down method) of allocating service department costs partially addresses the complaint that the direct method ignores services provided by service departments by using the following approach. Begin by calculating the service rate ($171.43) for the Maintenance Department by dividing the total cost to be allocated by the total service units provided to the remaining departments (52,500). As you can see, the Maintenance Department allocates some of its costs to the Administration Department.
This cost is added to the direct costs of the Administration Department to result in a total of the Administration Department costs to be allocated. By following the same steps used by the Maintenance Department, you should be able to calculate the distribution of Administration Department costs in the above exhibit. In step 1, the cost analyst begins by developing a reciprocal cost equation for each service department.
In step 2, these reciprocal costs are used to allocate the service department costs to the production departments. These costs are allocated in proportion to each production department's use of the service department.
Summary
The company uses planned machine hours as a cost driver in determining the plant-wide cost driver rate. The overhead costs are assigned to each consultant task using a cost driver rate based on the consultant's labor costs. The company has used a factory-wide cost driver rate calculated by dividing plant-wide overhead costs by total factory-wide direct labor hours.
Determine departmental cost driver prices based on direct labor hours for assembly and machine hours for cutting. The department allocates conversion costs through a cost driver rate based on direct labor hours. The company uses a job costing system with a factory-wide cost driver rate calculated by dividing factory-wide overhead costs by the total factory-wide practical capacity direct labor hours.
Calculate these departmental cost driver rates and determine the cost of job 714 using these rates. Separate cost driver rates are set on the basis of machine hours for the casting department and on the basis of direct labor hours for the assembly department. The direct labor rate is $30 per hour. a) Calculate the plant-wide cost driver and use this rate to allocate overhead costs to products.
Recalculate the cost driver rate based on the new total direct labor hours remaining in the factory and use this rate to allocate overhead costs to the remaining three products.
