Class Meeting 05

VOLUME-BASED COSTING
(VBC)

RIWAYADI
 2 kinds of Costing
approach
Traditional costing  volume based
costing / VBC, unit-based costing or
functional based costing / FBC or
peanut-butter costing
Contemporary costing  activity based
costing / ABC or refined costing
 VBC
DIRECT RMC FOH Cost
DLC
(direct cost) (indirect cost)
(direct cost)
FBC

COST POOL
PLANT/PRODUCING
DEPT.

Pool cost is assigned to

products using
volume/unit
PRODUCTS basis/driver: DLH,
MH, RMC, LC, units
produced)
 Why do we call “unit
basis / driver”?
Because it is assumed that there is
correlation between FOH and units
produced.
Unit basis/driver:
No of units mendrive MH
mendrive FOH
produced DLH
+
+ RM cost
DL cost
+
 2 kinds of FOH rates
Single rate (plant-wide rate):
budgeted FOH for year
FOH rate: --------------------------------------
normal capacity of unit driver
FOH rate: Rp ? / MH
Rp ? / DLH
Rp ? / unit
? % of RM cost
? % of DL cost
 Departmental rates (multi-rates):
Budgeted Departmental FOH for year
FOH rate: -----------------------------------------------------
normal capacity of unit driver
Producing Dept. A rate: Rp ? / MH
Producing Dept. B rate : Rp ? /DLH
Producing Dept. C rate : Rp ? /MH
 COST ALLOCATION
Sometime called cost assignment, cost
distribution or cost apportionments
Cost allocation is needed for indirect
cost (common cost).
Needed for the company that
manufactures more than one product or
service through more than one
department so each product or service
and department can receive a fair cost
application
COST ALLOCATION (continuing)

For example, allocating costs of service

departments to producing departments,
and then applying costs of producing
departments to products; allocating
hospital’s personnel and equipment
costs to patient care centers; allocating
colleges’ administrative costs to
graduate and undergraduate programs
 CAPACITY CONCEPTS

Theoretical capacity
 Maximum or ideal capacity (100% of plant
capacity). This capacity is not used as
application basis because it is difficult to
achieve.
Practical capacity
 Theoretical capacity – internal interruptions
(set-up, time lost for repairs, vacations,
breakdowns and strikes). This capacity is
also not used as application basis because
it is still difficult to achieve.
CAPACITY CONCEPTS (Continuing)

Normal capacity
 Practical capacity – external
interruptions (national holiday, lack of
customer orders, strike, etc.). This
capacity is also consider the cyclical
changes, so it is a more appropriate
basis for applying overhead cost.
CAPACITY CONCEPTS (Continuing)

Expected actual capacity

 Short-range concept  Capacity that
will achieve for next period (year). 
does not attempt to even out the
cyclical changes in sales demand.
This capacity is not used for FOH
application basis.
 DEPARTMENTALIZTION

Departmentalization means
dividing the plant into
segments, called departments,
to which overhead costs are
charged.
 DEPARTMENTALIZATION
(Continuing)
For accounting purposes, dividing a
plant into separate departments
provides improved product costing
(different departments will have
different overhead rates) and promotes
responsible control of overhead costs
(supervisors or managers are
responsible for the cost of their
departments)
 DIVISION OF FACTORY

A producing department
manufactures the product by changing
the form or nature of material or by
assembling parts. Cutting, Assembly,
Mixing, Refining, Bottling, Canning, and
Finishing Departments are the
examples of producing departments
 DIVISION OF FACTORY
(continuing)
A service department renders a
service that contributes in an indirect
way to the manufacture of the product
but does not change the form,
assembly, or nature of the material.
Cafetaria, Maintenance, Power, Material
Handling, Inspection, Storage, and
Receiving Departments are the
examples of service departments.
 Steps to calculate the
product cost using VBC
1. Identify the producing dept and service dept
as well as the cost driver
2. Identify the resources and cost of resources
used by each department as well as the
cost driver for indirect cost of dept.
3. Collection of cost driver consumption /
capacity in the beginning of period (year) to
Data will be used for allocation basis and
application basis
4. Preparing FOH budget for all producing
departments and service departments.
5. Allocating service departments’ cost to
producing dept.
6. Calculating the FOH departmental
rates
7. Assigning the producing department’s
cost to products
 Step 1: Identify the producing and
service departments

Cost Driver
Producing Dept:
Raw Mill (machine intensive): Machine Hours
Kiln (machine intensive): Machine Hours
Cement Mill (machine intensive): Machine hours
Service Dept.:
Workshop: Repair hours
Material Handling: Raw material costs
 Step 2: Identify the resource and
cost of resource
Resources Cost of Resources DC/IC Cost Driver
Fact. Build Depr. Exp of FB IC Space
Square
Machine Dept. Exp of M DC -
Supervisor Salary Exp. IC No of workers
Electricity Electricity Exp. IC KWH
etc
 Step 3. Collecting cost driver cosumption
and capacity

KWH No. Of Estimated raw Floor Estimated Machine

worker material cost Size (in repair Hours
s m2) hours

Producing Dept.:
-Raw Mill 10.000 20 Rp 180.000.000 5.000 1.000 300.000
- Kiln 5.000 10 200.000.000 4.000 1.800 500.000
- Cement Mill 15.000 30 120.000.000 6.000 1.200 200.000
Supporting Dept:
-Material Handling 4.000 25 3.000 1.000
-Workshop 6.000 15 70.000.000 2.000

40.000 100 Rp 570.000.000 20.000 5,000 1.000.000

4. Preparing the departmental budget

Budget is prepared for both producing

department and service department.
FOH is classified by fixed cost and variable
cost as well as direct cost and indirect cost.
Direct cost is not allocated to other
departments because it can be easily and
accurately trace to each department
Indirect cost is allocated to other
departments using appropriate
allocation basis, such as floor size
for allocation of depreciation
expense of factory building. And
KWH for allocation of electricity
expense.
 PT SEMEN PADANG
FOH BUDGET
YEAR 200X (in Rp 000)
V Producing Dept.i Supporting Dept.
/ Raw Mill Kiln Cement Material Workshop
Total
F Mill Handling

Direct Dept. Cost.

Indirect labor…………………… V 5.000 8.000 7.000 6.000 4.000 30.000
Depreciation exp of machine…… F 12.000 15.000 13.000 3.000 7.000 50.000
Total .……. 17.000 23.000 20.000 9.000 11.000 80.000
Indirect dept. cost:
electricity (Rp 250 / KWH).. V 2.500 1.250 3.750 1.000 1.500 10.000
Deprec. Exp of fac. build.(Rp 750/m2) F 3.750 3.000 4.500 2.250 1.500 15.000
supervisor (Rp 80.000/worker) F 1.600 800 2.400 2.000 1.200 8.000
Total .…. 7.850 5.050 10.650 5.250 4.200 33.000
Total FOH 24.850 28.050 30.650 14.250 15.200 113.000
Total FOH V 7.500 9.250 10.750 7.000 5.500 40.000
Total FOH F 17.350 18.800 19.900 7.250 9.700 73.000
5. Allocation of Service Dept. Cost to
Producing Dept.

3 methods of service (supporting)

departmental cost allocation:
Direct allocation method
step allocation method or sequential
allocation method or non-reciprocal
method
algebraic method or simultaneous method
or reciprocal method
DIRECT ALLOCATION
METHOD
In this method, service dept. cost is directly
allocated to producing department.
This method assume that the service
dept. only provides services to
producing dept. and does not provide
services to other service department.
 Allocating budgeted service department costs – Direct Method
(In Rp 000)

Producing Department Service Dept.

Raw Kiln Cemen Mat. Maint.
Mill t Mill Hand. Total

Total overhead costs

before alloc. of serv. dept. 24.850 28.050 30.650 14.250 15.200 113.000
Alloc. of service dept. costs:
-Material Handling(2,85%
of material costs) 5.130 5.700 3.420 (14.250)
-Maintenance(Rp 3.800 /
labor hour) 3.800 6.840 4.560 (15.200)
Tot. S. Dep. Cost Allocated 8.930 12.540 7.980 (14.250) (15.200)

Total Overhead costs after

allocation 33.780 40.590 38.630 0 0 113.000
Fixed Overhead Costs 17.350 18.800 19.900
Variable Overhead Costs 16.430 21.790 18.730
 STEP METHOD (sequential
method/non-reciprocal method)

This method transfers the costs of service

departments by a sequence of steps; that is, in a
prescribed order by department.
Once cost is allocated from a service department,
no other service department’s cost is allocated
back to it in a subsequent step. To use this
method, a particular order must be decided on for
allocating the service departments’ costs because
the order of departments does make a difference
in the calculation.
 Step Method (continuing)

A partial recognition of interrelated benefits

among service departments is achieved with
this method. In the direct method, no such
interrelationships are recognized. However,
the step method is still only a partial
consideration of the service departments’
mutual benefits, because after distribution of
a service department’s costs, no further
distributions are made to that department.
 Step Method (continuing)
Service departments are usually
distributed in order of:
 the amount of service rendered and
received. On approach is to start with the
department serving the greatest number of
other departments and receiving service
from the smallest number of other service
departments.
 the costs of the service department that
provides the largest rupiah value of
services to other service departments can
be distributed first.
 Allocating budgeted service department costs – Step Method
(In Rp 000)

Producing Department Service Dept.

Raw Kiln Cemen Mat. Worksh
Mill t Mill Hand. op Total

Total overhead costs

before alloc. of serv. dept. 24.850 28.050 30.650 14.250 15.200 113.000
Alloc. of service dept. costs:
-Workshop (Rp 3.040 /
labor hour) 3.040 5.472 3.648 3.040 (15.200)
-Material Handling(3,458%
of material costs) 6.224,4 6.916 4.149,6 (17.290)
Tot. S. Dep. Cost Allocated 9.264,4 12.388 7.797,6 (14.250) (15.200)

Total Overhead costs after

allocation 34.114,4 40.438 38.447,6 0 0 113.000
Fixed Overhead Costs 17.350 18.800 19.900
Variable Overhead Costs 16.764,4 21.638 18.547,6
 Class Meeting 06

VOLUME-BASED
COSTING (VBC)

RIWAYADI
 ALGEBRAIC METHOD
(SIMULTANEOUS
METHOD/RECIPROCAL METHOD)

The direct method and the step method fail to

measure the total cost of individual service
departments. This total cost information can
be useful for product costing and cost control.
The algebraic method considers completely
all interrelationships among all service
departments.
 Services Provided by Each
Service Department
Service Provided By:
Dept. Material %- Worksho %-
Handling tage p tage
Raw Mill 180.000.000 32 1.000 20
Kiln 200.000.000 35 1.800 36
Cemen Mill 120.000.000 21 1.200 24
Mat. Handl. 1.000 20
workshop 70.000.000 12
Total 570.000.000 100 5.000 100
 Equation
MH = M, workshop = W
M= 14.250.000 + 0,20 W
W = 15.200.000 + 0,12M

M=14.250.000+0,20(15.200.000+0,12M)
M= 14.250.000 +3.040.000 + 0,024M
0,976M =17.290.000
M= Rp 17.715.164
 
W = 15.200.000 + 0,12 (17.715.164)
W = Rp 17.325.820
 Allocating budgeted service department costs – Algebraic Method
(In Rp 000)

Producing Department Service Dept.

Raw Mill Kiln Cement Mat. workshop
Mill Hand. Total

Total overhead
costs before alloc. of 113.000
serv. dept.
24.850 28.050 30.650 14.250 15.200
Alloc. of service dept.
costs:
5.668,9 6.200,3 3.720,2 (17.715,2) 2.125,8
-Material Handling
3.465,1 6.237,3 4.158,2 3.465,2 (17.325,8)
-Workshop

Tot. S. Dep. Cost

Allocated 9.134 12.437,6 7.878,4 (14.250) (15.200)

Total Overhead costs

after allocation 33.984 40.487,6 38.528,4 0 0 113.000
Fixed Overhead
Costs (from budget) 17.350 18.800 19.900
4. Computing the factory overhead
application rate

The factory overhead application rate is only

computed for producing departments.
budgeted factory
overhead costs after allocation
Factory overhead = ____________________
application rate Normal Capacity of Unit Driver

Direct labor hours, machine hours, material

costs, direct labor costs are the examples of
application bases that can be used to
compute the factory overhead application rate
 Computing overhead application rate –
Algebraic method

Production Dept.

Raw Mill Kiln Cement Mill

Overh. cost after allocation (A 33.984.016 40.487.603 38.528.381

Fixed overhead costs B 17.350.000 18.800.000 19.900.000
Variable overhead costs C 16.634.016 21.687.603 18.628.381
Application bases to
products:
- Machine hours (normal 300.000 500.000 200.000
capacity)……….. D
Total overhead rate: A/D 113,28 80,98 192,64
Fixed overhead rate: B/D 57,83 37,60 99,50
Variable overhead rate: C/D 55,45 43,38 93,14
STEPS AT END OF PERIOD

At the end of period, actual overhead

costs are assembled in the same
manner as estimated costs at the
beginning of the period.
STEPS AT END OF PERIOD
(Continuing)
The steps are:
 Summarizing the actual direct
departmental overhead of producing
departments and service departments
and indirect departmental overhead
costs.
 Preparing a second survey of the actual
levels of allocation bases experienced
during the year.
STEPS AT END OF PERIOD
(continuing)
 Allocating actual indirect
departmental overhead based on the
results of the end-of-year survey
 Allocating actual service department
costs to benefiting departments
based on the end-of-year survey
STEPS AT END OF PERIOD
(continuing)
 Calculating actual overhead is
compared with applied, both for
the facility as a whole and for
each producing department, and
the over-or-underapplied factory
overhead.
 Accounting for factory
overhead costs

Suppose that the actual overhead

costs for Raw Mill are Rp 45
millions with 320.000 machine
hours, for Kiln are Rp 30 millions
with 400.000 machine hours, and
for Cement Mill are Rp 50 millions
with 250.000 machine hours.
 Accounting for factory overhead costs
(continuing)

To record the overhead costs applied to the product (overhead rates of

algebraic method are used)

WIP Inventory – Raw Mill

(320.000 x Rp 113,28)… 36.249.600
WIP Inventory – Kiln
(400.000 x Rp 80,98)… 32.392.000
WIP Inventory – Cement Mill
(250.000 x Rp 192,64) 48.160.000
Factory Overhead – Raw Mill 36.249.600
Factory Overhead – Kiln 32.392.000
Factory Overhead – Cmt Mill 48.160.000
 Accounting for factory overhead costs

(continuing)  
To record the actual overhead costs:
 
Factory Overhead – Raw Mill 45.000.000
Factory Overhead – Kiln…... 30.000.000
Factory Overhead – Cmt Mill 50.000.000
Any Accounts Credited 125.000.000
 
 Accounting for factory overhead costs

(continuing)  
To close the overhead costs:
 
Overhead Variance – Raw Mill 8.750.400
Factory Overhead Control – Kiln 2.392.000
Overhead Variance – Cmn Mill 1.840.000
Fact. Overhead Control – R. Mil 8.750.400
Overhead Variance – Kiln 2.392.000
Fact. Overhead Control – Cmt Mill 1.840.000
 Accounting for factory overhead costs

(continuing)  
Overhead Variance analysis
 
(1). Determining the over-or-under applied overhead
 
Raw Mill Kiln Cement Mill
Actual overhead 45.000.000 30.000.000 50.000.000
Applied overhead: 36.249.600 32.392.000 48.160.000
FOH Variance - Under
(over) applied 8.750.400UF (2.392.000)F 1.840.000 UF
debited credited Debited
 
 Accounting for factory overhead costs
(continuing)

(2). Analyzing Overhead Variances:

 
1. Spending Variance (budget variance)
is the variance that is caused by difference
between actual overhead cost and flexible
budget at actual capacity. Spending variance
can also be calculated by comparing the
actual variable overhead cost with budgeted
variable overhead cost at actual capacity.
Actual FOH xxx
Budgeted Fixed FOH
(Normal Capacity x Fixed FOH rate) (xxx)
Actual Variabel FOH xxx
Budgeted variable FOH
(Actual capacity x variable FOH rate) (xxx)
Spending variance xxx
 Accounting for factory overhead costs
(continuing)

SV = Total actual overhead – Flexible Budget at

the actual capacity
= Total actual overhead – { (Normal Capacity
x fixed rate)+(actual capacity x variable
rate)}
 
Actual overhead costs < Flexible budget at the
actual capacity = Favorable Variance
Actual overhead costs > Flexible budget at the
actual capacity = Unfaroable Variance
   Accounting for factory overhead costs

(continuing)

 
2. Capacity Variance
is associated with fixed overhead cost in
which normal capacity is different from actual
capacity. Over or excess capacity incurs
when actual capacity is greater than normal
capacity and other wise it is under or idle
capacity.
 Accounting for factory overhead costs
(continuing)

CV = (Normal Capacity – Actual Capacity)

Fixed Rate
 
Normal Capacity < Actual Capacity =
Favorable Variance (over or excess capacity)
Normal Capacity > Actual Capacity =
Unfavorable variance (under of idle capacity)
 Accounting for factory overhead costs
(continuing)

Raw Mill Kiln Cement Mill

Spending Variance:
Total actual overhead costs 45.000.000 30.000.000 50.000.000
Budgeted fixed overhead:
300.000 x Rp 57.83 (17.349.000)
500.000 x Rp 37,60 (18.800.000)
200.000 x Rp 99,50 (19.900.000)
---------------- ---------------- ------------------
Actual variable overhead 27.651.000 11.200.000 30.100.000
Budgeted variable overhead:
320.000 x Rp 55,45 (17.744.000)
400.000 x Rp 43,38 (17.352.000)
250.000 x Rp 93,14 (23.285.000)
---------------- --------------- -----------------
Spending Variance 9.907.000UF (6.152.000) F 6.815.000UF
---------------- --------------- ----------------
 Accounting for factory overhead costs
(continuing)

Raw Mill Kiln Cement Mill

Capacity Variance:
( 300.000 – 320.000) x Rp 57,83 1.156.600F
(500.000 – 400.000) x Rp 37,60 3.760.000UF
(200.000 – 250.000) x Rp 99,50 4.975.000F
----------------- --------------- ---------------
Total Overhead Variance 8.750.400UF 2.392.000F 1.840.000UF
----------------- --------------- -------------
 
   Accounting for factory overhead costs
(continuing)

(e). To record the overhead variances:

 
Spending Variance – Raw Mill 9.907.000
Capacity Variance – Kiln 3.760.000
Overhead Variance – Kiln… 2.392.000
Spending Variance – Cmt Mill 6.815.000
Capacity Variance – Raw Mill 1.156.600
Overhead Variance – Raw Mill 8.750.400
Spending Variance – Kiln…….. 6.152.000
Capacity Variance – Cement Mill 4.975.000
Overhead Variance – Cement Mill 1.840.000
 Accounting for factory overhead costs
(continuing)

(f). Closing the overhead variances:

 
If the overhead variance is insignificant, it can
directly be closed to cost of goods sold. But if
the overhead variance is significant, it should
be prorated to work in process inventory,
finished goods inventory, and cost of goods
sold.
   Accounting for factory overhead costs
(continuing)

Assuming the overhead variances are closed to cost of

goods sold, the entries are:
 
Cost of Goods Sold… 8.198.400
Capacity Variance – Raw Mill 1.156.600
Spending Variance – Kiln 6.152.000
Capacity Variance – Cmt Mill 4.975.000
Spending Variance – Raw Mill 9.907.000
Capacity Variance – Kiln……….. 3.760.000
Spending Variance – Cement Mill 6.815.000
 THE EFFECT OF AUTOMATION ON
VOLUME-BASED OVERHEAD
APPLICATION RATES

In today’s automated environment, applying

overhead on direct labor often distorts true
manufacturing cost performance and distracts
management attention from increasing
overhead, staff, and other indirect costs. A
direct labor application base may encourage
managers to monitor the absorption of
overhead, rather than to eliminate waste.
THE EFFECT OF AUTOMATION ON VOLUME-
BASED OVERHEAD APPLICATION RATES

For example, if the overhead rate is 600

percent of direct labor, the costing system
implies to product designers that direct labor
is very expensive. Thus, a design change
reducing direct labor cost by Rp 1 for a
product results in an apparent savings of Rp
6 in overhead. However, in reality, a design
change reducing labor usually results in
increased overhead because of engineering
change activities.
 Exercise 1
FOH rate Rp 1.000 (60% variable)
Normal Capacity 5.000 MH
Capacity variance Rp 500.000 (F)
Spending variance Rp 200.000 (UF)
Required:
a. Determine the actual FOH cost
b. Make journal entries
 Exercise 2
Cutting Assembly finishing
RM 500.000 - 100.000
DL 300.000 500.000 200.000
Actual FOH 700.000 600.000 500.000
Actual capc. 100 MH 300 DLH 200 MH
FOH rate Rp 5.000 Rp 2.500 Rp 3.000
Production 1.000 units.
1. Calculate product cost per unit.
2. If Variable FOH rate 40% of FOH rate and
normal capacity 120 MH for Cutting, 250 DLH
for Assembly, and 210 MH for finishing, make
FOH variance analysis.
3. Make journal entries needed related to FOH.
 ASSIGNMENT
Producing Department Service Department

A B X Y
Budgeted FOH 1.000.000 1.500.000 600.000 400.000
Service Provided By:
X 50% 40% 10%
Y 35% 45% 20%

Normal Capacity 1.000 MH 2.000 DLH

Actual Capacity 1.200 MH 1.700 DLH
Actual FOH 1.400.000 1.800.000

Required:
a.Calculate the FOH rate for each producing dept. using algebraic
method. Variable FOH rate is 40% of total FOH rate
b.Calculate the FOH variance and analyze this variance into
spending variance and capacity variance
c.Make journal entries needed
 exercise
Dept. I Dept. II
FOH rate (40% variable) Rp1.000/MH Rp500/MH
Normal capacity 5.000 MH 8.000 MH
Actual capacity 5.500 MH 7.000 MH
Actual FOH Rp5.200.000 Rp3.9 00.000
Required:
a.Determine FOH variance and anlyze into spending variance
and capacity variance
b.Make journal entries