12 - 1 ©2008 prentice hall business publishing, introduction to management accounting 14/e,...

12 - 1©2008 Prentice Hall Business Publishing, ©2008 Prentice Hall Business Publishing, Introduction to Management AccountingIntroduction to Management Accounting 14/e,14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 12 Horngren/Sundem/Stratton/Schatzberg/Burgstahler 12 - - 11

Introduction to Management AccountingIntroduction to Management Accounting


Cost AllocationCost Allocation

Introduction to Management AccountingIntroduction to Management Accounting

Chapter Chapter 1212


General Framework for Cost General Framework for Cost AllocationAllocation

Four types of cost objectives:Four types of cost objectives:Service departmentsService departments

Producing departmentsProducing departmentsProducts/services, and Products/services, and

Customers.Customers.

LearningLearningObjective 1Objective 1

Cost allocation methods comprise an important Cost allocation methods comprise an important part of a company’s cost management system.part of a company’s cost management system.


General Framework for Cost AllocationGeneral Framework for Cost Allocation

Service departments exist only to Service departments exist only to support other departments or customers.support other departments or customers.

Producing departments are where employeesProducing departments are where employeesWork on the organization’s products or services.Work on the organization’s products or services.



Indirect costs must be allocated. Indirect costs must be allocated.

Direct costs can be physically traced to each department.Direct costs can be physically traced to each department.

Many companies develop Many companies develop allocation methods to assign allocation methods to assign

service department costs to the service department costs to the producing departments.producing departments.



Increasingly, companies measure and manage Increasingly, companies measure and manage the costs and profitability of their customers.the costs and profitability of their customers.

All organizations accumulate costs for their All organizations accumulate costs for their products or services for financial reporting purposes.products or services for financial reporting purposes.

Customer related costs include:Customer related costs include:Order processingOrder processing

Customer service sales Customer service sales commissionscommissions

Dedicated customer supportDedicated customer support



A cost driver that has a logical, cause-effect relationship A cost driver that has a logical, cause-effect relationship to the cost will be used as a cost-allocation baseto the cost will be used as a cost-allocation base

An accounting system will assign to a department’s outputAn accounting system will assign to a department’s outputall its direct costs plus all the indirect costs allocated to it.all its direct costs plus all the indirect costs allocated to it.


Allocation of Service Department Allocation of Service Department CostsCosts

Establish the details regardingEstablish the details regardingcost allocation in advance.cost allocation in advance.

Allocate variable- and fixed-Allocate variable- and fixed-cost pools separately.cost pools separately.

Evaluate performance using budgets forEvaluate performance using budgets foreach production and service department.each production and service department.



Service Department ExampleService Department Example

Computer DepartmentComputer Department

5-year lease5-year lease

School of BusinessSchool of Business School of Engineering School of Engineering



Suppose there are two majorSuppose there are two majorpurposes for the allocation:purposes for the allocation:

Predicting economic effectsPredicting economic effectsof the use of the computerof the use of the computer

Motivating departments andMotivating departments andindividuals to use itsindividuals to use its

capabilities more fullycapabilities more fully



The primary activity performedThe primary activity performedis computer processing.is computer processing.

Resources consumed includeResources consumed include1. Processing time 1. Processing time 2. Operator time2. Operator time3. Consulting time 3. Consulting time 4. Energy4. Energy5. Materials5. Materials6. Building space6. Building space

The budget formula for theThe budget formula for theforthcoming year is $100,000forthcoming year is $100,000monthly fixed cost plus $200monthly fixed cost plus $200

variable cost per hour ofvariable cost per hour ofcomputer time used.computer time used.


Variable-Cost PoolVariable-Cost Pool

The cost driver for the variable-cost pool is The cost driver for the variable-cost pool is Actual hours of computer time used.Actual hours of computer time used.

Therefore, variable costs shouldTherefore, variable costs shouldbe allocated as follows:be allocated as follows:

Budgeted unit rate XBudgeted unit rate X Actual Actual hours of computer time usedhours of computer time used



Consider the allocation of variableConsider the allocation of variablecosts to a department that usescosts to a department that uses

600 hours of computer time.600 hours of computer time.

Suppose inefficiencies in theSuppose inefficiencies in thecomputer department caused thecomputer department caused the

variable costs to be $140,000variable costs to be $140,000instead of $120,000.instead of $120,000.

600 hours × $200 = $120,000600 hours × $200 = $120,000



A good cost-allocation scheme would allocateA good cost-allocation scheme would allocateonly the $120,000 to the consuming departmentonly the $120,000 to the consuming department

and would let the $20,000 remain as anand would let the $20,000 remain as anunallocated unfavorable budget varianceunallocated unfavorable budget variance

of the computer department.of the computer department.

This scheme holds computer department This scheme holds computer department managers responsible for the $20,000 managers responsible for the $20,000 and reduces the resentment of user and reduces the resentment of user

managers.managers.


Fixed-Cost PoolFixed-Cost Pool

The cost driver for the fixed-cost pool isThe cost driver for the fixed-cost pool isthe amount of capacity required whenthe amount of capacity required whenthe computer facilities were acquired.the computer facilities were acquired.

Fixed costs should be allocated as follows:Fixed costs should be allocated as follows:

Budgeted percent of capacityBudgeted percent of capacity available for useavailable for use× Total budgeted fixed costs× Total budgeted fixed costs



Suppose the deans had originally predicted the Suppose the deans had originally predicted the long-run average monthly usage as follows:long-run average monthly usage as follows:

School of Business: 210 hoursSchool of Business: 210 hoursSchool of Engineering: 490 hoursSchool of Engineering: 490 hours

How is the fixed-cost pool allocated?How is the fixed-cost pool allocated?

Business:Business:210 ÷ 700 = 30% 210 ÷ 700 = 30%

$100,000 X .3 = $30,000$100,000 X .3 = $30,000

Engineering:Engineering:490 ÷ 700 = 70% 490 ÷ 700 = 70%

$100,000 X .7 = $70,000$100,000 X .7 = $70,000



This predetermined lump-sum approachThis predetermined lump-sum approachis based on the long-run capacityis based on the long-run capacity

available to the user, regardless ofavailable to the user, regardless ofactual usage from month to month.actual usage from month to month.

A major strength of using capacity available ratherA major strength of using capacity available ratherthan capacity used when allocating budgeted fixedthan capacity used when allocating budgeted fixed

costs is that actual usage by user departments does not costs is that actual usage by user departments does not affect the short-run allocations to other user departments.affect the short-run allocations to other user departments.


Reciprocal ServicesReciprocal Services

Service departments often supportService departments often supportother service departments in additionother service departments in addition

to production departments.to production departments.

There are two popular methods forThere are two popular methods forallocating service department costs:allocating service department costs:

The direct methodThe direct method

The step-down methodThe step-down method


Direct and Step-Down MethodsDirect and Step-Down Methods

The direct method ignores other serviceThe direct method ignores other servicedepartments when any given servicedepartments when any given service

department’s costs are allocateddepartment’s costs are allocatedto the revenue-producingto the revenue-producing(operating) departments.(operating) departments.

The step-down method recognizes that someThe step-down method recognizes that someservice departments support the activitiesservice departments support the activities

in other service departments as well asin other service departments as well asthose in production departments.those in production departments.



Direct and Step-Down MethodsDirect and Step-Down Methods

Facilities management cost = $1,260,000Facilities management cost = $1,260,000

Human resources cost = $240,000Human resources cost = $240,000

Total square footage in production departments:Total square footage in production departments:15,000 processing + 3,000 assembly = 18,00015,000 processing + 3,000 assembly = 18,000

Total employees in production departmentsTotal employees in production departments16 processing + 64 assembly = 8016 processing + 64 assembly = 80

Square footage in human resources = 9,000Square footage in human resources = 9,000


Direct MethodDirect Method

Facilities management costFacilities management costallocated to processing =allocated to processing =

(15,000 ÷ 18,000) × $1,260,000 = $1,050,000(15,000 ÷ 18,000) × $1,260,000 = $1,050,000

Facilities management costFacilities management costallocated to assembly =allocated to assembly =

(3,000 ÷ 18,000) × $1,260,000 = $210,000(3,000 ÷ 18,000) × $1,260,000 = $210,000


Direct MethodDirect Method

Human resources costHuman resources costallocated to processing =allocated to processing =

(16 ÷ 80) × $240,000 = $48,000(16 ÷ 80) × $240,000 = $48,000

Human resources costHuman resources costallocated to assembly =allocated to assembly =

(64 ÷ 80) × $240,000 = $192,000(64 ÷ 80) × $240,000 = $192,000


Step-Down MethodStep-Down Method

To assembly:To assembly:(3 ÷ 27) × $1,260,000 = $140,000(3 ÷ 27) × $1,260,000 = $140,000

To human resources: To human resources: (9 ÷ 27) × $1,260,000 = $420,000(9 ÷ 27) × $1,260,000 = $420,000

To processing:To processing:(15 ÷ 27) × $1,260,000 = $700,000(15 ÷ 27) × $1,260,000 = $700,000



To assembly:To assembly:(64 ÷ 80) × $660,000 = $528,000(64 ÷ 80) × $660,000 = $528,000

$240,000 + $420,000 = $660,000$240,000 + $420,000 = $660,000

To processing:To processing:(16 ÷ 80) × $660,000 = $132,000(16 ÷ 80) × $660,000 = $132,000



Processing departmentProcessing department

Direct Step-DownDirect Step-Down Direct department costsDirect department costs $1,000,000$1,000,000 $1,000,000 $1,000,000 From facilities managementFrom facilities management 1,050,00 1,050,00 700,000 700,000From PersonnelFrom Personnel 48,00048,000 132,000 132,000 Total costsTotal costs $2,098,000 $2,098,000 $1,832,000 $1,832,000



Assembly departmentAssembly department

DirectDirect Step-DownStep-DownDirect department costsDirect department costs $1,600,000$1,600,000 $1,600,000 $1,600,000 From facilities managementFrom facilities management 210,000 210,000 140,000 140,000 From personnelFrom personnel 192,000192,000 528,000 528,000 Total costsTotal costs $2,002,000$2,002,000 $2,268,000 $2,268,000


Costs Not Related to Cost DriversCosts Not Related to Cost Drivers

Identify additional cost drivers.Identify additional cost drivers.

Allocate all costs by the directAllocate all costs by the director step-down method usingor step-down method usingsquare footage as the cost-square footage as the cost-

allocation base.allocation base.


Traditional ApproachTraditional Approach

1. Divide the costs in each1. Divide the costs in eachproducing departments.producing departments.

2. Assign direct costs to the appropriate2. Assign direct costs to the appropriateproducts, services, or customers.products, services, or customers.

Direct costsDirect costs Indirect costsIndirect costs




3. Select one or more cost pools and related3. Select one or more cost pools and relatedcost drivers in each production department.cost drivers in each production department.

Indirect departmental costsIndirect departmental costs

CostCostpoolpool

CostCostpoolpool

CostCostpoolpool



4. Allocate costs4. Allocate costs

CostsCosts

ProductProductBB

ProductProductAA

ProductProductCC


Activity-Based CostingActivity-Based Costing

Determine the keyDetermine the keycomponents of the system.components of the system.

Step 1:Step 1:

Step 2:Step 2:

Develop the relationships amongDevelop the relationships amongresources, activities, and cost objectives.resources, activities, and cost objectives.


Activity-Based CostingActivity-Based Costing

Step 3:Step 3:

Collect relevant data concerning costsCollect relevant data concerning costsand the physical flow of the cost-driverand the physical flow of the cost-driverunits among resources and activities.units among resources and activities.

Step 4:Step 4:

Calculate and interpret the newCalculate and interpret the newactivity-based cost information.activity-based cost information.


Customer profitability depends on more than gross Customer profitability depends on more than gross margin, it depends on the costs incurred to fulfill margin, it depends on the costs incurred to fulfill

customer orders and to provide other customer services.customer orders and to provide other customer services.

Allocate costs associated with Allocate costs associated with customer actions to customers.customer actions to customers.

LearningLearningObjective 5Objective 5 Allocation of Customer CostsAllocation of Customer Costs


Small order quantitySmall order quantity Many order changesMany order changes Large amounts of pre-Large amounts of pre- and post-sales supportand post-sales support Expedited schedulingExpedited scheduling Special delivery requirementsSpecial delivery requirements Frequent returnsFrequent returns

Large order quantityLarge order quantity Few order changesFew order changes Little pre- and Little pre- and post-sales supportpost-sales support Regular schedulingRegular scheduling Standard deliveryStandard delivery Few returnsFew returns

Allocation of Customer CostsAllocation of Customer Costs

Customer Type 1Customer Type 1 Customer Customer Type 2 High Type 2 High

Cost to ServeCost to ServeLow Cost to Low Cost to

ServeServe



Customer Type 1Customer Type 1Low Cost to Low Cost to

ServeServe Buys a mix of Buys a mix of products that products that have high gross have high gross marginsmargins Has a low cost-to-Has a low cost-to-serve %serve % Has a high level of Has a high level of profitabilityprofitability

Buys a mix of Buys a mix of products that products that have lower gross have lower gross marginsmargins Has a high cost-Has a high cost-to-serve %to-serve % Has a low level of Has a low level of profitabilityprofitability

Customer Customer Type 2 High Type 2 High

Cost to ServeCost to Serve



Assume Cedar City Distributors Assume Cedar City Distributors (CCD), distributes many (CCD), distributes many

products to retail outlets.products to retail outlets.

The products are classified into just The products are classified into just two product groups – apparel and two product groups – apparel and

sports gear.sports gear.

CCD has two types of CCD has two types of customers:customers:

1.1. Small storeSmall store

2.2. Large storeLarge store



CCD uses a simple cost accounting CCD uses a simple cost accounting system to calculate both product system to calculate both product

and customer profitability.and customer profitability.The only direct costs The only direct costs

are costs of the are costs of the purchase of apparel purchase of apparel

and sports gear and sports gear products.products.

Indirect costs are Indirect costs are allocated to the allocated to the product groups product groups using a single using a single

indirect cost pool indirect cost pool for all indirect costs for all indirect costs

with “pounds of with “pounds of product” as the product” as the allocation base.allocation base.

CostsCosts


Small StoresSmall Stores Large StoresLarge Stores CasesCases Profit Margin TotalProfit Margin Total Cases Cases Profit Margin TotalProfit Margin Total

per case Profit Margin per case Profit Margin per case Profit Marginper case Profit MarginApparelApparel 600 600 $265.00 $265.00 $159,000 $159,000 800 800 $265.00 $265.00 $212,000 $212,000 Sports Gear 200Sports Gear 200 315.00 315.00 63,00063,000 800 800 315.00 315.00 252,000252,000

222,000222,000 464,000 464,000 Profit Margin PercentageProfit Margin Percentage 43.7% 43.7% 41.4% 41.4%

To determine customer profitability: To determine customer profitability: 1. Calculate the profit margin per case for each product 1. Calculate the profit margin per case for each product 2.2. Use the product mix ordered by each customer to calculate profitabilityUse the product mix ordered by each customer to calculate profitability



Allocation of Costs-to-ServeAllocation of Costs-to-Serve

Might number of customer orders Might number of customer orders be a more plausible cost-be a more plausible cost-

allocation base?allocation base?The cost of resources used for order The cost of resources used for order

processing and customer service processing and customer service activities should be included in a activities should be included in a

separate cost pool and allocated on separate cost pool and allocated on the basis of number of orders.the basis of number of orders.

This system gives managers at This system gives managers at CCD more insight into CCD more insight into

operations, and a tool to operations, and a tool to measure and manage customer measure and manage customer

profitability.profitability.


Allocation of Central CostsAllocation of Central Costs

Many managers believe it is desirableMany managers believe it is desirableto fully allocate all costs to the revenue-to fully allocate all costs to the revenue-

producing parts of the organization.producing parts of the organization.

Whenever possible, the preferredWhenever possible, the preferreddriver for central services is usage.driver for central services is usage.


If a company does allocate the costs of If a company does allocate the costs of central services based on sales, although central services based on sales, although costs do not vary in proportion to sales, it costs do not vary in proportion to sales, it

should use budgeted, not actual, sales.should use budgeted, not actual, sales.


Allocation of Central CostsAllocation of Central Costs

UsageUsage

RevenueRevenue

Cost of goods soldCost of goods sold

Total assetsTotal assets

Total cost of each divisionTotal cost of each division

Not always economically viableNot always economically viable


Allocation of Joint Costs Allocation of Joint Costs LearningLearning

Objective 7Objective 7

Two conventional ways of allocatingTwo conventional ways of allocatingjoint costs to products are widely used:joint costs to products are widely used:

PhysicalPhysicalunitsunits

RelativeRelativesales valuessales values

Joint costs include all inputs of material, labor, and Joint costs include all inputs of material, labor, and overhead costs that are incurred before the split-off point.overhead costs that are incurred before the split-off point.


The physical-unitsThe physical-unitsmethod requires amethod requires acommon physicalcommon physicalunit for measuringunit for measuringthe output of eachthe output of each

product.product.

The joint costs areThe joint costs areallocated based onallocated based on

each product’seach product’spercentage of thepercentage of the

total physicaltotal physicalunits produced.units produced.

Allocation of Joint CostsAllocation of Joint Costs

Allocation of joint costs should Allocation of joint costs should not affect decisions about the not affect decisions about the

individual products.individual products.


Physical-Units MethodPhysical-Units Method

Dow Chemical produces two chemicals, X Dow Chemical produces two chemicals, X and Y. The joint cost is $100,000. X sells and Y. The joint cost is $100,000. X sells

for $.09 per liter and Y for $.06. for $.09 per liter and Y for $.06.

Allocation Sales Value atAllocation Sales Value at LitersLiters Weighting Weighting of Joint Costs Split-off Point of Joint Costs Split-off Point X 1,000,000 (10/15)X$100,000 $ 66,667 $ 90,000 X 1,000,000 (10/15)X$100,000 $ 66,667 $ 90,000 Y Y 500,000500,000 (5/15)X$100,000 (5/15)X$100,000 33,33333,333 30,00030,000 1,500,000 1,500,000 100,000 120,000 100,000 120,000


Relative-Sales-Value MethodRelative-Sales-Value Method

The joint costs are allocated based on eachThe joint costs are allocated based on eachproduct’s sales value as a percentageproduct’s sales value as a percentage

of the total sales value at split-off.of the total sales value at split-off.


Relative Sales Relative Sales Value at Value at Allocation Allocation Spit-off PointSpit-off Point Weighting Weighting of Joint Costsof Joint CostsX $ 90,000 (90/120)X$100,000 X $ 90,000 (90/120)X$100,000 $ 75,000 $ 75,000 Y 3Y 30,0000,000 (30/120X$100,000 (30/120X$100,000 25,00025,000 $120,000 $120,000 $100,000 $100,000

When weighting is based on the sales When weighting is based on the sales value of the individual products, the value of the individual products, the allocation of a cost to one product allocation of a cost to one product

depends upon the sales value of both depends upon the sales value of both products.products.

Relative-Sales-Value MethodRelative-Sales-Value Method


By-Product CostsBy-Product Costs

A by-product is not individuallyA by-product is not individuallyidentifiable until manufacturingidentifiable until manufacturing

reaches a split-off point.reaches a split-off point.

They have relatively insignificantThey have relatively insignificantsales value.sales value.


By-Product CostsBy-Product Costs

If an item is accounted for as aIf an item is accounted for as aby-product, only separableby-product, only separable

costs are allocated to it.costs are allocated to it.

All joint costs are allocatedAll joint costs are allocatedto the main products.to the main products.

Any revenues from by-products, lessAny revenues from by-products, lesstheir separable costs, are deductedtheir separable costs, are deductedfrom the cost of the main products.from the cost of the main products.


The EndThe End

End of Chapter 12End of Chapter 12

12 - 1 ©2008 prentice hall business publishing, introduction to management accounting 14/e,...

Documents