Week 4 Broadening Your Perspective
ACC/561
January 26, 2014
Sandra Welch
WEEK 4 BROADENING YOUR PERSPECTIVE / 1Week 4 Broadening Your Perspective
Ideal manufacturing company has supported the R&D department that deals with four different product lines: market analysis, product design, product development, and prototype testing. The company is using activity based costing. Activity based costing helps in allocating costs to the product according to the resources used by each activity. The cost of a product consists of direct material, direct labor, and overhead. Direct material and direct labor are easy to trace to a particular product, but the same cannot be said for overhead costs. There are more steps and information needed to determine overhead costs that can be traced to a particular product to determine the product cost.
For example, if a company pay $25,000 for a mortgage payment it cannot be traced to a particular product. That cost is assumed as an indirect cost to the product cost. One way it can be determined is by using a traditional method. If a company would manufacture 1000 designs, then the company would divide $25,000 by 1000 designs equals $25 per product, or if the company would make 2000 designs then $12.50 would be charged as mortgage to the product. This method is considered easy but also with the understanding that the number is not necessarily the exact amount of the resources used the by the product.
The following information was provided by the R&D department about the annual costs and the estimated total drivers.
Market Analysis $1,050,00015,000 hours
Product Design$2,350,0002,500 designs
Product Development$3,600,00090 products
Prototype Testing$1,400,000500 tests
The activity based overhead rate for each activity cost pool has been determined and is as follows:
Market Analysis $1,050,000 / 15,000 = $70 per hour
Product Design $2,350,000/ 2500 = $940 per design
Product Development $3,600,000/ 90 =$40,000 per product
Prototype Testing$1,400,000/ 500 =$2800 per test
The above rate is the actual amount of the cost related to its drivers. Now each activity rate is used to determine the R&D departments costs being charged to in-house departments is as follows:
Market Analysis 1800 * $70 =$126,000
Product Design280 * $940 =$263,200
Product Development 10 * $$40,000 =$400,000
Prototype Testing 92 * $2800=$257,000
Total charge to in-house manufacturing dept. $1,046,800
The cost that would serve as the basis for pricing an R & D bid with an outside company on a contract would be as follows:
Market Analysis800 * $70 =$56,000
Product Design178 * $940 =$167,320
Product Development 3 * $40,000 =$120,000
Prototype Testing70 * $2800=$196,000
Total charge to an outside company $539,320
Benefits to Ideal Manufacturing of applying activity-based costing to its R&D activity for both in-house and outside charging purposes
“Activity based costing works best in complex environments, where there are many machines and products, and tangled processes that are not easy to sort out” (“Accounting Tools”, 2014). With the company using the activity based costing instead of a traditional method, it shows the true selling price of the product. If activity based costing is not used, a customer may be charged low selling price for a product which should be charged high selling price and vice versa for another product. This mistake could potentially help the competitor to undertake advantage for selecting incorrect selling price for the product. According to Kimmel, Weygandt, and Kieso(2011) activity based costing leads to more cost pools being used to assign overhead costs to products, leads to enhanced control overhead costs and better management decisions.
If Ideal Manufacturing Company would use the traditional method, to compute overhead they would total the overhead costs and divide by the hours. For example, $8,400,000/15000 = $560. R&D costs for in house would be 1800 * $560 = $1,008,000. For the outside company it would be 800 * $560 = $448,000.
After going over the previous data, it is concluded that the activity based costing helps in allocating costs to each product according to the resources being used. It also helps in settling accurate selling price and makes the product competitive in the market. “Activity-based costing does not change the amount of overhead costs. What it does do is allocate those overhead costs in a more accurate manner. Furthermore, if the scorekeeping is more realistic and more accurate, managers should be able to better understand cost behavior and overall profitability” (Kimmel, 2011). Using the activity based costing method is a benefit to any business long as the steps are followed and all the information is used correctly.
References
Accounting Tools.(2014).Retrieved from
Costing
Kimmel, P. D., Weygandt, J. J., & Kieso, D. E. (2011). Accounting: Tools for business
decision making (4th ed.). NJ: John Wiley & Sons