Chapter Nine- Activity-Based Costing

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And the overhead rate computation would be: Below is a summary comparison of the direct and step-down methods used in the examples. Reciprocal Method The reciprocal method is theoretically the best method because it allows for simultaneous intra-department services. Computationally it is more difficult; the method requires setting up simultaneous equations using the relative weights developed in the step method, assuming each service department goes first. Using the example of Kennesaw Cafeteria and B & G service departments, the equations would be: 8
Solve the last two equations first, then substitute these values (C = 34,435; B&G = 41,739) in the first two equations. The results are the total overhead for Assembly, $66,522, and the total overhead for Finishing, $103,478. The ease of using spreadsheets has resulted in use of the reciprocal method becoming more prevalent. A comparison of the methods follows: Joint Cost Allocation Two or more products of relatively equal value resulting from one common process are identified as joint products. If two or more products result from a process but one product is significantly more valuable than the other(s), the valuable one is called the main product and the other( s) is called the by-product. If the second product is worthless, it is called scrap. These definitions may change over time as tastes and/or technology change. For example, at one time old and outdated equipment was left to rust and deteriorate, but now it is either sold to third-world countries to be used in the manufacturing process or is recycled as scrap iron. The point at which the various products become identifiable is called the split-off point. All costs incurred prior to the split-off point are called joint costs; these costs are common to all the outputs. Think of processing poultry; if the bones were discarded, the cost to process the chicken would not decrease. In such a situation joint costs are unavoidable. Two questions arise with regard to joint costs: how should they appear in financial statements and how do they affect decisions. The relevant accounts for financial statements are Cost of Goods Sold on the Income Statement, and Inventory on the Balance Sheet. Poultry processing yields edible products, as well as feathers used for bedding and non-edible parts used for fertilizer. Assume that split off occurs when the poultry is disassembled; joint costs incurred before the split-off point are $1,200. At disassembly point (split-off) the poultry can be identified as 200 pounds of edible product (meat) and 400 pounds of bones (fertilizer). The feathers are considered a by-product. Assume that meat at the split-off point sells for $12 per pound and the bones for $1.50 per pound. Joint costs can be allocated using the physical quantity method or the net realizable value method (essentially, sales value at split off). 9
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Chapter Nine- Activity-Based Costing

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