13.3 Activity-Based Costing, Joint and By-Products, and Service Department Cost Allocation
Key Takeaways
ABC assigns overhead through activity cost pools and drivers at the unit, batch, product, and facility levels, correcting the overcosting of high-volume products under volume-based rates.
Joint costs are allocated by physical units, weighted units, relative sales value at split-off, or net realizable value (final sales value less separable costs).
Joint cost allocation is irrelevant to the decision to sell at split-off or process further, which compares incremental revenue with separable costs.
By-products are either recognized when sold (no joint cost allocated) or recognized at production at net realizable value deducted from joint costs.
The direct method ignores services among service departments, the step-down method recognizes them in one sequence, and the reciprocal method recognizes them fully with simultaneous equations.
Activity-Based Costing, Joint and By-Products, and Service Department Cost Allocation
The last three cost accounting topics in AFAR are about allocation: assigning overhead to products by activities (topic 13.5), dividing the cost of a joint process among products that emerge together (topic 13.6), and passing the costs of service departments on to producing departments (topic 13.7). Management Services revisits ABC for pricing decisions; here the focus is on computing product costs.
1. Activity-Based Costing (ABC) for Product Costing
Traditional costing uses one plantwide rate on a volume driver (direct labor hours or machine hours). ABC assigns overhead to activity cost pools and then to products using activity drivers:
| Activity Level | Varies With | Example Activities and Drivers |
|---|---|---|
| Unit-level | Each unit produced | Machine operation (machine hours), power |
| Batch-level | Each batch | Setups (number of setups), material handling (moves), inspection (inspections) |
| Product-level | Each product line | Engineering changes, product design |
| Facility-level | The plant as a whole | Plant management, building depreciation (often not assigned to products) |
Worked example. Overhead of PHP 1,000,000 is split into machining PHP 600,000 (driver: 20,000 machine hours) and setups PHP 400,000 (driver: 100 setups). Product Standard uses 16,000 machine hours and 20 setups for 10,000 units; product Custom uses 4,000 machine hours and 80 setups for 1,000 units.
| Product | Traditional (PHP 50 per machine hour) | ABC | Overhead per Unit (Traditional / ABC) |
|---|---|---|---|
| Standard | 16,000 x 50 = 800,000 | 16,000 x 30 + 20 x 4,000 = 560,000 | PHP 80 / PHP 56 |
| Custom | 4,000 x 50 = 200,000 | 4,000 x 30 + 80 x 4,000 = 440,000 | PHP 200 / PHP 440 |
The machining rate is 600,000 / 20,000 = PHP 30 per machine hour and the setup rate is 400,000 / 100 = PHP 4,000 per setup. The volume-based system overcosts the high-volume product and undercosts the low-volume, setup-intensive product.
2. Joint Products and the Split-Off Point
Joint products emerge from one process at the split-off point, and joint costs incurred up to that point cannot be traced to any one product. Costs incurred after split-off (separable costs) are traced to the product processed further. The main allocation methods are:
| Method | Allocation Base |
|---|---|
| Physical units (average units) | Units, weight, or volume at split-off |
| Weighted average | Units multiplied by weight factors (difficulty, time, size) |
| Market (sales) value at split-off | Relative sales values of the products at the split-off point |
| Hypothetical market value (net realizable value) method | Final sales value less separable costs, for products that are processed further |
Worked example. A joint process costs PHP 600,000 and yields 10,000 units of A, sold at split-off for PHP 50 each (PHP 500,000), and 20,000 units of B, which needs further processing costing PHP 150,000 before selling at PHP 42.50 each (PHP 850,000).
| Method | Product A | Product B |
|---|---|---|
| Physical units (10,000 : 20,000) | 200,000 | 400,000 |
| Relative NRV (A: 500,000; B: 850,000 - 150,000 = 700,000; total 1,200,000) | 250,000 | 350,000 |
Under the NRV method, B's total cost is 350,000 + 150,000 = PHP 500,000 for sales of PHP 850,000. The allocation of joint costs is irrelevant to a sell-or-process-further decision, which compares only incremental revenue with separable costs.
3. By-Products
A by-product has a relatively small sales value compared with the main products. Two broad approaches exist:
| Approach | Accounting |
|---|---|
| No joint cost allocated (recognized at sale) | By-product revenue (net of its separable costs) is reported as other income, a reduction of cost of sales, or an addition to sales; no inventory is carried at the split-off point |
| Joint cost allocated (recognized at production) | The by-product's net realizable value is deducted from the joint cost before the remainder is allocated to the main products; the by-product is carried in inventory at that NRV |
Example. If the joint process above also yields a by-product with an NRV of PHP 30,000, the production method allocates only PHP 570,000 to A and B (A: 570,000 x 500/1,200 = 237,500; B: 332,500).
4. Service Department Cost Allocation
Service departments (maintenance, power, cafeteria) support production departments. Their costs are allocated to producing departments before product overhead rates are computed. Data for the example:
| S1 Maintenance | S2 Power | P1 | P2 | |
|---|---|---|---|---|
| Direct costs | 100,000 | 60,000 | ||
| S1's services used by | 20% | 40% | 40% | |
| S2's services used by | 10% | 50% | 40% |
| Method | How It Works | P1 | P2 |
|---|---|---|---|
| Direct | Ignores services between service departments; S1 split 40:40 and S2 split 50:40 | 50,000 + 33,333 = 83,333 | 50,000 + 26,667 = 76,667 |
| Step-down (S1 first) | S1 allocated to S2, P1, and P2 (20,000; 40,000; 40,000); S2's new total of 80,000 then split 50:40 among producing departments only | 40,000 + 44,444 = 84,444 | 40,000 + 35,556 = 75,556 |
| Reciprocal (algebraic) | Solve S1 = 100,000 + 0.10 S2 and S2 = 60,000 + 0.20 S1: S1 = 108,163 and S2 = 81,633, then allocate each total to the producing departments | 84,082 | 75,918 |
Each method allocates the full PHP 160,000 to the producing departments; they differ only in how accurately they reflect services exchanged between service departments. In the step-down method, the department serving the most other departments (or with the highest cost) usually goes first, and once allocated, it receives no further allocations.
Joint costs of PHP 900,000 produce products X and Y. X sells at split-off for PHP 800,000. Y requires separable costs of PHP 200,000 and then sells for PHP 1,400,000. Using the net realizable value method, how much joint cost is allocated to Y?
PHP 540,000
PHP 360,000
PHP 573,000
PHP 450,000
Under activity-based costing, which activity is classified as batch-level?
Machine operation measured in machine hours
Machine setups measured by the number of setups
Designing a new product line
Depreciation of the factory building
Which service department cost allocation method fully recognizes the services that service departments provide to each other?
Direct method
Step-down method
Reciprocal method
Physical units method
Sections you finish are checked off in the contents.