Practice Costing and Operation Control

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1 Note to student: Some of the following activities will require the student to use a calculator. Scenario: You are an accountant for Scrumptious, a large food manufacturing plant, and you work in the accounting division that supports the production activity of plant operations. The test kitchens have developed a new On-the-Go breakfast product that has been on the market for 3 months. The product sales are successful and doing well at the test locations along with the marketing and sampling displays. Your role as a cost accountant is to provide information and reports that enable management to make strategic business decisions about the cost of the product, research how well the product is doing in the market, and estimate the future outlook for production and sales. Activity: Product Costing Techniques Normal Costing Method Upper management at Scrumptious has directed a cost management strategy change to use the normal costing method in effort to more economically assign the indirect product costs. Currently the actual costing method is used. To determine the total overhead costs using the normal costing method, there are three are preliminary calculations that need to be completed first. The following tools are available to help you complete your computations: Normal Costing Method 1. Step1: Calculate predetermined variable and fixed overhead rates. 1. Predetermined variable overhead rate = variable budgeted factory overhead costs estimated cost drier activity level 2. Predetermined fixed overhead rate = fixed budgeted factory overhead costs estimated cost driver activity level 2. Step 2: Calculate variable and fixed overhead costs. 1. Variable overhead = (cost driver) x (predetermined variable overhead rate) 2. Fixed overhead = (allocation base) x (predetermined fixed overhead rate) 1

2 3. Step 3: Calculate total overhead cost. 1. Total overhead cost = Variable overhead + fixed overhead Scrumptious Overhead Budget For Quarter Ended June 30, 2005 APRIL MAY JUNE Quarter Total Total Direct Labor Hours 27,200 29,750 30,600 87,550 Var. Overhead Supplies $6,970 $7,140 $7,225 $21,335 Indirect labor $55,250 $56,950 $57,800 $170,000 Employee benefits $127,075 $128,775 $129,200 $385,050 Utilities $24,650 $27,625 $28,900 $81,175 Machine Maintenance $15,300 $16,575 $17,000 $48,875 TOTAL Var. Overhead $229,245 $237,065 $240,125 $706,435 Fix. Factory Overhead Depreciation $20,825 $20,825 $20,825 $62,475 Plant and Liability Insurance $1,020 $1,020 $1,020 $3,060 Workmen's Comp Insurance $807 $808 $808 $2,423 Plant Manager's salary $6,375 $6,375 $6,375 $19,125 Utilities $2,550 $2,550 $2,550 $7,650 Plant Maintenance $1,275 $1,275 $1,275 $3,825 TOTAL Fix. Overhead $32,852 $32,853 $32,853 $98,558 TOTAL Factory Overhead $262,097 $269,918 $272,978 $804,993 Question 1: Calculate pre-determined variable and fixed overhead rates. The correct answers are: $8.07 variable overhead rate per labor hour and $2.58 per machine hour. This is done by dividing the variable budgeted factory overhead costs by the estimated cost driver activity level. Scrumptious has determined the following data to be used in this first step calculation: 2

3 The variable factory overhead changes in relation to direct labor hours; machine hours are to be used as the allocation base; 38,250 machine hours are estimated for the quarter in the budget; at the end of the previous quarter the company experienced 110,500 direct labor hours and 38,250 machine hours Step 1a: Determine predetermined variable overhead rate using provided data: variable budgeted factory overhead costs for the quarter estimated cost driver activity level for the quarter $706,435 $87,550 = $8.07 variable overhead rate per labor hour Step1b: Determine pre-determined fixed overhead rate using provided data: fixed budgeted factory overhead costs estimated cost driver activity level of (the estimated machine hours for the quarter) $98,558 38,250 = $2.58 per machine hour It is indicated in the recent production analysis, that direct labor hours is the cost driver for the variable factory overhead and machine hours are used as the allocation base (used for the fixed overhead calculations) Note: The rates you determined in this step are used again in determining the variable and fixed overhead costs in the next calculations. Question 2: Calculate variable and fixed overhead costs. Step 2a: HINT: Multiply the cost driver (direct labor hours) by the predetermined labor/hour variable overhead rate. Note that Scrumptious experienced 110,500 direct labor hours and 38,250 machine hours at the end of the previous quarter. The correct answers are: $891,735 variable overhead costs and $98,685 fixed overhead costs. To calculate variable overhead costs: cost driver x pre-determined variable overhead rate 110,500 x $8.07 per labor hour = $891,735 variable overhead costs 3

4 To calculate fixed overhead costs: allocation base x pre-determined fixed overhead rate 38,250 machine hours x $2.58/machine hours pre-determined fixed overhead rate = $98,685 fixed overhead costs As indicated in the recent production analysis, direct labor hours is the cost driver for the variable factory overhead and machine hours are used as the allocation base. Note: The rates you determined in this step are also used in determining the variable and fixed overhead costs in the next calculations. Question 3: Calculate total overhead cost HINT: Use the calculated variable and fixed overhead rates and provided information to determine the variable and fixed overhead costs. The correct answer is: $990,420. To determine the total overhead cost: variable overhead cost + fixed overhead cost $891,735 + $98,685 = $990,420 Activity 2: Strategic Product Costing and Operation Control Question 4: True or False: Using the normal costing method will enable us to develop the master budget using actual costs for direct labor and machine hours and then estimated overhead costs. The correct answer is: True. Question 5: True or False: The main benefit of normal costing over actual costing is that the normal costing method enables determining product costs on a timely basis while actual costing uses numbers that are available at the end of a given period or quarter in this case. The correct answer is: True. 4

5 Activity 3: Variance Analysis As an accountant, you record, analyze, and compare actual product cost results to set standards. Recent quarterly reports for Scrumptious showed unfavorable variances in direct labor and direct materials in the flexible budget. Are the following variance considerations applicable for these unfavorable results? Question 3: The unfavorable variance in direct labor and direct materials means that the these actual costs were greater than the budgeted cost (a standard). The correct answer is A: applicable. In addition, the flexible budget is updated on a regular basis and compared to the standards (budgeted costs). Question 4: In conducting a variance analysis, you want to determine if the variances are due to price or usage. The correct answer is A: applicable. Variances in price can be the result of rate changes in the materials cost. A variance due to usage could be explained by an increase in volume. Question 5: The unfavorable variance will always result in corrective action being taken. The correct answer is B: not applicable. An unfavorable variance does not always require a reactive corrective action. Variances that recur on a regular basis do require corrective action. Question 6: In conducting the variance analyses, you want to ensure that you are comparing like processes otherwise the variance figures are 5

6 incorrect. The correct answer is A: applicable. It is important to evaluate unfavorable variances to ensure like processes are being compared. If the processes differ, then the variance calculations may be incorrect. Reference Blocher, E. J., Chen, K. H., Cokins, G., & Lin, T. W. (2005). Cost management: A strategic emphasis (3rd ed.). New York: McGraw- Hill/Irwin. End of activity. 6

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