Question

Explain job order costing and activity-based costing income statements in general terms. Prepare income statement in both job order costing and activity-based costing formats for a hypothetical case. Your example should include at least three activities and at least two products. If you do both correctly the operating income in both statements should be identical. Explain the initial assumptions and the calculations in detail. 

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Answer 1

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Job Order Costing Job Order Costing is a method of assignment cost to each independent job In Job order costing each job has an independent identity based on customer requirements A job cost sheet is maintained to assign the material issued and labor hour spent Overheads are usually applied based on pre-determined overhead rate decided at the beginning of the year Job Order Income statement can be prepared for each job once it is sold to customers Examples of Job order costing Furniture making Aircraft industry Activity Based Costing Activity Based Costing is a method of costing where overheads are applied based on activities consumed In ABC Costing Cost pool is arrived based on activities and then activity driver rate is determined This activity driver rate is applied based on activities consumed to each product ABC Costing gives accurate costing of product since it is based on activities consumed Under both the method Direct Material, Direct Labor and Variable Overhead will remain the same Only the method of allocation of Fixed overheads will vary Hypothetical example 2 products are manufactured by Company Product A and B Given below further information Product A Product B Sales units 500 1000 Selling price 250 300 Direct Material Direct Labor 2 hours 3 hours Total Direct Labor hours 1,000 3,000 25 Direct Labor rate @ 20 per hour Variable Overhead @ 20 per hour Fixed Overhead $120,000 Fixed Overhead is absorbed based on Direct Labor hours Fixed Overhead absorption rate Fixed Overhead $120,000 Direct Labor hours 4,000 $30.00 Fixed Overhead @ $30 per hour Income Statement- Job Order Costing Product A Product B Total Sales $125,000 $300,000 $425,000 Direct Material Direct Labor Variable Overhead Fixed Overhead Total Cost $12,500 $35,000 $47,500 $20,000 $60,000 $80,000 $20,000 $60,000 $80,000 $30,000 $90,000 $120,000 $82,500 $245,000 $327,500 Net Profit $42,500 $55,000 $97,500 Activity Based Costing Assumed Fixed Overheads is classified into below Cost pools Activity Cost Pool Purchase Orders Set up Machining Total Overheads Total Activities Activity Activity Product A Product B Cost pool Driver $45,000 15 Number of Purchase Orders $60,000 15 Number of Set ups $15,000 100 50 Machine hours $120,000 Overhead allocated Activity Cost Pool Product Product B Purchase Orders Set up Machining Total Overheads Activity Total Cost pool Activities $45,000 $60,000 20 $15,000 Activity Rate $1,800 $3,000 $100 150 $18,000 $15,000 $10,000 $43,000 $27,000 $45,000 $5,000 $77,000 Income Statement- Activity Costing Method Product A Product B Total Sales $125,000 $300,000 $425,000 $12,500 $20,000 $20,000 $35,000 $60,000 $60,000 $47,500 $80,000 $80,000 Direct Material Direct Labor Variable Overhead Fixed Overhead Purchase Orders Set up Machining Total Cost $18,000 $27,000 $45,000 $15,000 $45,000 $60,000 $10,000 $5,000 $15,000 $95,500 $232,000 $327,500 Net Profit $29,500 $68,000 $97,500 From the above example it is clear profit under both methods of costing will be same at overall level At product level the profit will be different due to the way overheads is allocated