Cost Allocation and

Activity-Based
Costing
Edited by
Nazim Uddin
Lecturer, Northern University
Bangladesh

Learning Objective 1

Identify three
methods used for
allocating factory
overhead costs to
products.

Product Costing Allocation Methods

Most companies have accounting
systems that trace revenues to
individual product lines. In addition,
they need to subtract the cost of
manufacturing their products from
revenues in order to determine the
profit from sales. Determining the cost
of a product is termed product
costing.

Product Costing Allocation

Methods

Three methods of allocating factory

overhead costs are:
1. Single plantwide factory overhead
rate method
2. Multiple production department
factory overhead rate method
3. Activity-based costing method

Learning Objective 2

Use a single
plantwide factory
overhead rate for
product costing.

Single Plantwide Factory Overhead Rate

Method
Under the single plantwide factory
overhead rate method, all of the
factory overhead is allocated to all
products using only one rate.

Ruiz Company Illustration

Ruiz Company Illustration
Ruiz Company manufactures two products,
snowmobiles and riding mowers. Both products
are manufactured in a single factory. There is
$1,600,000 of factory overhead budgeted for the
period.

Ruiz Company Illustration

Each product is budgeted 10,000 direct labor
hours as shown below:

Ruiz Company Illustration

The plantwide rate is calculated as follows:
Total Budgeted Factory Overhead Costs
Total Budgeted Plantwide Allocation Base
$1,600,000
$80 per direct
=
labor hour
20,000 direct labor hours
(1,000 10 dlh) + (1,000 10 dlh)

Ruiz Company Illustration

Snowmobile:
$80 per dlh 10 direct labor hours =
$800
Riding Mower:
$80 per dlh 10 direct labor hours = $800
Factory
Factory
Overhead
Overhead
Cost
Costper
perUnit
Unit

Learning Objective 3

Use multiple
production
department factory
overhead rates for
product costing.

Multiple Production Department

Factory Overhead Rate Method
The multiple production department
factory overhead rate method uses
different rates for each production
department to allocate factory
overhead costs to products.

Department Overhead Rates

and Allocation
Fabrication Department Factory Overhead Rate:
$1,030,000
= $103 per dlh
10,000 direct labor hours
Assembly Department Factory Overhead Rate:
$570,000
= $57 per dlh
10,000 direct labor hours

Department Overhead Rates

and Allocation

Learning Objective 4

Use activitybased costing

for product
costing.

Activity-Based Costing Method

The activity-based costing method
provides an alternative approach for
allocating factory overhead that uses
multiple factory overhead rates based on
different activities.
Activities are the types of work, or
actions, involved in a manufacturing or
service process.

Activity-Based Costing Method

Budgeted
Cutting metal
Activity
Activity Cost
to
shape the
Manually
product
Fabrication
$ 530,000
assembling
Changing
tooling in
machined
Assembly
70,000
machines
in
Inspecting
the
piecesfor
preparation
Setup
480,000
product
for
making a new
An engineering
conformity
to
Quality-control inspections
312,000
product
change order
(ECO)
specifications
Engineering changes
208,000
initiates changing a
Total budgeted activity costs product or process.
$1,600,000

Activity Rates and Allocation

The budgeted activity costs are assigned
to products using factory overhead rates
for each activity. These rates are called
activity rates because they are related to
activities.
Budgeted Activity Cost
Activity Rate =
Total Activity Base
Usage
The term activity base, rather than
allocation base, is used because the
base is related to an activity.

Activity-Based Costing Method

Activity-Based Costing Method

Activity-Based Costing Method

Activity-Based Costing Method

Activity-Based Costing Method

Distortion of Product Costs

If Ruiz Company used the $800 factory
overhead cost allocation (single
plantwide rate) instead of activitybased costing, the following would
likely
1. The result:
snowmobile would be underpriced
because its factory overhead cost is
understated by $494 ($1,294 $800).
2. The riding mower would be overpriced
because its factory overhead cost is
overstated by $494 ($800 $306).

Learning Objective 5

Use activity-based
costing to allocate
selling and
administrative
expenses to products.

Activity-Based Costing for

Selling and Administrative
Expenses
Warranty Claim
Activity Rate

Budgeted Warranty
Claim Expenses
Estimated
Warranty Claims

Warranty Claim
Activity Rate

Warranty Claim
Activity Rate

= $1,500 per claim

$150,000
100 claims

Activity-Based Costing for

Selling and Administrative
Expenses
Assuming that Ipso had 10 warranty claims and
Facto had 90 warranty claims, the field service
activity expenses would be allocated as follows:
Ipso: $15,000 = 10 warranty claims x $1,500
per warranty claim
Facto: $135,000 = 90 warranty claims x $1,500
per warranty claim

Learning Objective 6

Use activitybased costing

in a service
business.

Activity-Based Costing in
Service Businesses
Hopewell
Hopewell Hospital
Hospital
Hopewell Hospital uses an activity-based costing
system to determine how hospital overhead is
allocated to patients.

Activity-Based Costing in
Service Businesses
Hopewell
Hopewell Hospital
Hospital
The budgeted costs for radiological testing are
$96,000, based on total estimated activity-base
usage of 3,000 images.
Activity Rate =
Radiological
Testing Activity =
Rate

Budgeted Activity Cost

Total Activity Base Usage
$960,000
3,000 images

= $320 per image

Activity-Based Costing in
Service Businesses
Hopewell
Hopewell Hospital
Hospital

6
Activity-Based
Costing in
Service Businesses
Hopewell
Hopewell Hospital
Hospital

Questions