my house – house # 1 house # 2 your house –house # 3
TRANSCRIPT
MY HOUSE – HOUSE # 1
HOUSE # 2
YOUR HOUSE –HOUSE # 3
HOUSE COSTS
HOUSE #1 HOUSE #2 HOUSE #3
Direct
Material $140,000 $70,000 $90,000
Direct
Labor 210,000 130,000 60,000
Overhead* ? ? ?
*Total indirect costs such as supervisory salaries and indirect materials amount to $84,000
Cost Object
• The builder wants to determine the cost for each house
• The house is the COST OBJECT
HOUSE COSTS
HOUSE #1 HOUSE #2 HOUSE #3
Overhead* 28,000 28,000 28,000
*Total indirect costs such as supervisory salaries and indirect materials amount to $84,000
• There are three houses & each should have the same amount of overhead.
• Do you agree?
Use of Cost Drivers to Accumulate Costs
Machinehours
Milesdriven
Laborhours
Unitsproduced
A cost driver is anyfactor that causes or “drives”
an activity’s costs
How should the costs be allocated?House 1 House 2 House 3
Ttl Direct Costs 350,000 200,000 150,000
Total Direct Costs for All Houses = $700,000
What cost needs to be allocated?
$84,000
1st – Find Allocation Rate
= $84,000 / $700,000 = 0.12
COST DRIVER
Overhead Cost Allocation
• House 1 : $0.12 * 350,000 = 42,000
• House 2 : $0.12 * 200,000 = 24,000
• House 3 : $0.12 * 150,000 = 18,000
HOUSE #1 HOUSE #2 HOUSE #3
Direct
Material $140,000 $70,000 $90,000
Direct
Labor 210,000 130,000 60,000
Overhead* ? ? ?
*Total indirect costs such as supervisory salaries and indirect materials amount to $84,000
Assume the $84,000 of total overhead cost consists of $63,000 of indirect materials and $21,000 of employee benefits.
Let’s start w/ $63,000 of Indirect Materials• What should we use to allocate the
indirect materials?
• Direct Material
• Total Direct Materials = $300,000
• Amount to Allocate = $63,000
• Allocation Base = $300,000
• House 1:
(63,000 / 300,000) * 140,000 = 29,400
COST DRIVER
ALLOCATION RATE
What about the $21,000 Employee Benefits?
What is the cost driver?Direct Labor
What is the allocation base?$400,000
What amount needs to be allocated?$21,000
What is the allocation rate?$21,000 / $400,000 = 0.0525
Allocation of Benefits
House 1: 0.0525 * 210,000 = 11,025
House 2: 0.0525 * 130,000 = 6,825
House 3: 0.0525 * 60,000 = 3,150
The Builder also incurred the following expenses:
• Electric - $4,000
• Gas - $2,000
• Water - $1,000
• Telephone - $500
• Is it cost effective to allocate each of these expenses individually?– NO!
COST POOL
Cost Pool Total = $7,500Cost Pool = Utilities
WATER $1,000
ELECTRICITY
$4,000
GAS $2000
TELE
PHO
NE
$500
Cost Pool Allocation
What should be use to allocate the utilities?
What about square footage?
House 1 = 5,000 sq ft
House 2 = 3,000 sq ft
House 3 = 1,000 sq ft
Total Square Footage = 9,000
COST DRIVER ALLOCATION BASE
Allocation of Utilities
Allocation Rate: $7,500 / 9,000 = $0.833
House 1: $0.833 * 5,000 = 4,167
House 2: $0.833 * 3,000 = 2,500
House 3: $0.833 * 1,000 = 833
Estimated Versus Actual Cost
Estimated CostsManagers use estimated costs tomake decisions about the future.
Estimated CostsManagers use estimated costs tomake decisions about the future.
Actual CostsKnowledge of actual costs, after the fact, may
not be useful for planning and decision making.
Actual CostsKnowledge of actual costs, after the fact, may
not be useful for planning and decision making.
Estimated Versus Actual Cost
PotentialInaccuracies
Timely Relevant
Estimated CostsManagers use estimated costs tomake decisions about the future.
Estimated CostsManagers use estimated costs tomake decisions about the future.
Estimated Versus Actual Cost
Estimated CostsMay be used to set prices, make bids,
evaluate proposals, distribute resources, plan production, and set goals.
Estimated CostsMay be used to set prices, make bids,
evaluate proposals, distribute resources, plan production, and set goals.
PotentialInaccuracies
Timely Relevant
Women's Men's Children's Total
Sales 190,000$ 110,000$ 60,000$ 360,000$
Department
In Style, Inc. Department Store pays a bonus to eachdepartment manager based on departmental sales.
The incentive has increased departmental sales, but departmental profits have not increased accordingly.
Management has decided to base future bonuseson department profitability.
In Style, Inc. Department Store pays a bonus to eachdepartment manager based on departmental sales.
The incentive has increased departmental sales, but departmental profits have not increased accordingly.
Management has decided to base future bonuseson department profitability.
Identifying Direct Versus Indirect Costs
The first step in the development of the new bonusstrategy is to determine the costs of each department.
Costs that can be traced to departments in acost-effective manner are called direct costs.
Costs that cannot be traced to departments in acost-effective manner are called indirect costs.
The first step in the development of the new bonusstrategy is to determine the costs of each department.
Costs that can be traced to departments in acost-effective manner are called direct costs.
Costs that cannot be traced to departments in acost-effective manner are called indirect costs.
Identifying Direct Versus Indirect Costs
Women's Men's Children's Total
Sales 190,000$ 110,000$ 60,000$ 360,000$
Department
Identifying Direct Versus Indirect Costs
Direct and indirect costs may be either fixed or variable.
A cost can be either direct or indirectdepending on the cost object.
The store manager salary is indirect to any onedepartment, but is directly traceable to the store.
Identifying Direct Versus Indirect Costs
Allocating Indirect Costs to Departments
Identify the most appropriate costdriver for each indirect cost.
Indirect costs should be allocated to reflecthow the departments consume resources.
In Style, Inc. chosethese cost drivers:
Allocating Indirect Costs to Departments
Use a two-step process to allocate indirect costs:
Allocation rate = total cost ÷ cost driver activity.
Allocated cost = allocation rate × weight of the cost driver activity.
$9,360 ÷ 3 departments = $3,120 per department
$3,120 × 1 department = $3,120
Allocating Indirect Costs to Departments
$18,400 ÷ 23,000 square feet = $0.80 per square foot
$0.80 × 12,000 Women’s square feet = $9,600
$0.80 × 7,000 Men’s square feet = $5,600
$0.80 × 4,000 Children’s square feet = $3,200
Allocating Indirect Costs to Departments
$2,300 ÷ 23,000 square feet = $0.10 per square foot
$0.10 × 12,000 Women’s square feet = $1,200
$0.10 × 7,000 Men’s square feet = $700
$0.10 × 4,000 Children’s square feet = $400
Allocating Indirect Costs to Departments
$7,200 ÷ $360,000 sales = $0.02 per sales dollar
$0.02 × $190,000 Women’s sales = $3,800
$0.02 × $110,000 Men’s sales = $2,200
$0.02 × $60,000 Children’s sales = $1,200
Allocating Indirect Costs to Departments
$900 ÷ $360,000 sales = $0.0025 per sales dollar
$0.0025 × $190,000 Women’s sales = $475
$0.0025 × $110,000 Men’s sales = $275
$0.0025 × $60,000 Children’s sales = $150
Allocating Indirect Costs to Departments
Now let’s combine thecosts and revenues andsee how departmental
profitability looks.
Allocating Indirect Costs to Departments
Allocating Indirect Costs to Departments
Women's Men's Children's Total
Sales 190,000$ 110,000$ 60,000$ 360,000$
Direct Costs
Cost of Goods Sold 120,000 58,000 38,000 216,000
Sales Commissions 9,500 5,500 3,000 18,000
Supervisors' Salary 5,000 4,200 2,800 12,000
Depreciation 7,000 5,000 4,000 16,000
Indirect costs
Store Manager Salary 3,120 3,120 3,120 9,360
Store Rental 9,600 5,600 3,200 18,400
Utilities 1,200 700 400 2,300
Advertising 3,800 2,200 1,200 7,200
Supplies 475 275 150 900
Departmental Profit 30,305$ 25,405$ 4,130$ 59,840$
Department
The Effects of Cost Behavior on Cost Driver Selection
Does this mean that I should use different costdrivers for variable and
fixed overhead?
Using Volume Measures to Allocate Variable Overhead
CostsIncreases in the volume of production willcause variable overhead costs to increase.
Increases in the volume of production willcause variable overhead costs to increase.
Volume measuresserve as good cost drivers
for the allocation ofvariable overhead.
UnitsProduced
LaborHours
MaterialsUsed
Filmier Furniture CompanyProduction and Cost Information
Use the two-step process to allocate indirect materials
cost using the three volume measures as cost drivers.
Chairs Desks Total
Units of Production 4,000 1,000 5,000
Direct Labor Hours 3,500 2,500 6,000
Direct Materials Cost 1,000,000$ 500,000$ 1,500,000$
Indirect Materials Cost 60,000$
Product
Using Volume Measures to Allocate Variable Overhead
Costs
Chairs Desks Total
Units of Production 4,000 1,000 5,000
Direct Labor Hours 3,500 2,500 6,000
Direct Materials Cost 1,000,000$ 500,000$ 1,500,000$
Indirect Materials Cost Chairs Desks 60,000$
Allocation of Indirect Materials Cost Based on:
Units of Production 48,000$ 12,000$ 60,000$
Direct Labor Hours
Direct Materials Cost
Product $60,000 ÷ 5,000 units = $12 per unit
$12 per unit × 4,000 chairs = $48,000
$12 per unit × 1,000 desks = $12,000
Using Volume Measures to Allocate Variable Overhead Costs
Chairs Desks Total
Units of Production 4,000 1,000 5,000
Direct Labor Hours 3,500 2,500 6,000
Direct Materials Cost 1,000,000$ 500,000$ 1,500,000$
Indirect Materials Cost Chairs Desks 60,000$
Allocation of Indirect Materials Cost Based on:
Units of Production 48,000$ 12,000$ 60,000$
Direct Labor Hours 35,000 25,000 60,000
Direct Materials Cost
Product $60,000 ÷ 6,000 hours = $10 per hour
$10 per hour × 3,500 hours = $35,000
$10 per hour × 2,500 hours = $25,000
Using Volume Measures to Allocate Variable Overhead Costs
Chairs Desks Total
Units of Production 4,000 1,000 5,000
Direct Labor Hours 3,500 2,500 6,000
Direct Materials Cost 1,000,000$ 500,000$ 1,500,000$
Indirect Materials Cost Chairs Desks 60,000$
Allocation of Indirect Materials Cost Based on:
Units of Production 48,000$ 12,000$ 60,000$
Direct Labor Hours 35,000 25,000 60,000
Direct Materials Cost 40,000 20,000 60,000
Product $60,000 ÷ $1,500,000 of direct material = $0.04 per dollar of direct material
$0.04 per $ × $1,000,000 = $40,000
$0.04 per $ × $500,000 = $20,000
Using Volume Measures to Allocate Variable Overhead Costs
Selecting the Best Cost Driver
So which volume measure should
I use?
Judgment and reasoning are necessary.
Considerations
Relationship between cost driver activity and use of resources.
Availability of information.
Judgment and reasoning are necessary.
Considerations
Relationship between cost driver activity and use of resources.
Availability of information.
Allocating Fixed Overhead Costs
Objective
Distribute a fair share of theoverhead cost to each product.
There are novolume based cost
drivers forfixed overhead.
Allocating Fixed Overhead Costs
Belview Company Information
Use the two-step process to allocate the fixed rentalcost to units sold and to units in ending inventory.
Use the two-step process to allocate the fixed rentalcost to units sold and to units in ending inventory.
Units Produced 2,000,000
Units Sold 1,800,000
Units in Ending Inventory 200,000
Fixed Rental Cost 28,000$
Allocating Fixed Overhead Costs
$28,000 ÷ 2,000,000 units = $0.014 per unit
$0.014 per unit × 1,800,000 units = $25,200
$0.014 per unit × 200,000 units = $2,800
Units Produced 2,000,000
Units Sold 1,800,000
Units in Ending Inventory 200,000
Fixed Rental Cost 28,000$
Allocating Costs to Solve Timing Problems
Allocating fixed costs can be complicated when thevolume of production varies from month to month.
January February
Supervisor's Salary 3,000$ 3,000$
Units Produced 800 1,875
Salary Cost per Unit Produced 3.75$ 1.60$
If prices are based on these costs, units produced inJanuary will be higher than those produced in February.
Will customers think this is reasonable?
Allocating Costs to Solve Timing Problems
We solve this problem by using estimatedcosts and estimated production for the year toobtain a predetermined overhead rate (POHR).
Estimated overhead the year
Estimated allocation base for the yearPOHR =
$36,000
18,000 unitsPOHR = = $2.00 per unit
$2.00 allocated to each unit producedfor all months during the year.
Establishing Cost Pools
IndirectCost 1
IndirectCost 3
IndirectCost 2
IndirectCost 4
IndirectCost 5
Product3
Product1
Product2
This is the problem when we don’tuse cost pools to allocate costs.
This is the problem when we don’tuse cost pools to allocate costs.
15 allocations
Establishing Cost Pools
IndirectCost 1
IndirectCost 3
IndirectCost 2
IndirectCost 4
IndirectCost 5
CostPool
Product3
Product1
Product2
Threeallocations
Cost pools reduce the numberof cost allocation computations.Cost pools reduce the number
of cost allocation computations.
Contains indirect costs relatedto a common cost driver.
Contains indirect costs relatedto a common cost driver.
Allocating Joint Costs
Joint Costs
Product
Product
Product
Key terms
Joint products – products resulting from a process with a common input.
Split-off point – the stage of processing where joint products are separated.
Joint cost – costs of processing joint products prior to the split-off point.
Key terms
Joint products – products resulting from a process with a common input.
Split-off point – the stage of processing where joint products are separated.
Joint cost – costs of processing joint products prior to the split-off point.
Allocating Joint Costs
Consider the following example of an oil
refinery.We will assume only
two products,gasoline and oil.
Allocating Joint Costs
JointInput
CommonProduction
Process
FinalSale
FinalSale
Split-OffPoint
JointCosts Oil
Gasoline SeparateProcessing
SeparateProcessing Costs
SeparateProcessing
SeparateProcessing Costs
Allocating Joint Costs
Joint Cost Allocation Methods
Physicalquantities method
Relative Sales Value Method
Joint costs are allocated based on a
relative measure (weight, volume, etc.) of
the products atthe split-off point.
Joint costs areallocated based onthe relative valuesof the products at
the split-off point.
Let’s look at anexample illustrating
the joint costallocation methods.
Joint Cost Allocation Methods
CommonProduction
Process
Split-OffPoint
Oil
Gasoline
Physical Quantities Method
240,000 gallons
360,000 gallons
Joint material
cost = $275,000
Joint conversioncost = $225,000
Physical Quantities Method
Physical Quantities Method
Physical Quantities Method
$225,000 joint conversion cost plus$275,000 joint material cost
Joint material
cost = $275,000
CommonProduction
Process
Split-OffPoint
Joint conversioncost = $225,000 Oil
Gasoline
Relative Sales Value Method
$200,000sales value atsplit-off point
$600,000sales value atsplit-off point
Relative Sales Value Method
Relative Sales Value Method
$225,000 joint conversion cost plus$275,000 joint material cost
Relative Sales Value Method
By-Products
JointInput
JointProduction
Process
Split-OffPoint
JointCosts
By-productsRelatively low
value relative tomajor products.
MajorProduct
MajorProduct
Joint Costs and the Issue of Relevance
The allocated portion of a joint cost is not relevant to a decision regarding further processing.
A product should be processed beyond the split-off point only if if the incremental revenue exceeds the incremental processing costs.
The allocated portion of a joint cost is not relevant to a decision regarding further processing.
A product should be processed beyond the split-off point only if if the incremental revenue exceeds the incremental processing costs.
Cost Allocation: The Human Factor Is it fair to divide
the College ofBusiness copy
budget equally?
I think weconsider the
number offaculty.
I think weconsider the
number ofstudents.
Cost Allocation: The Human Factor
Academic Departments
Number of Faculty
Number of Students
Actual Cost Prior Year
Management 29 330 12,000$ Accounting 16 360 10,000 Finance 12 290 8,000 Marketing 15 220 6,000 Totals 72 1,200 36,000
Let’s see how the allocation of budgeted amounts will effect the different departments.
We will begin by allocating equal amounts.
Let’s see how the allocation of budgeted amounts will effect the different departments.
We will begin by allocating equal amounts.
Cost Allocation: The Human Factor
Academic Departments
Actual Cost Prior Year
Allocation Difference
Management 12,000$ 9,000 (3,000)$ Accounting 10,000 9,000 (1,000) Finance 8,000 9,000 1,000 Marketing 6,000 9,000 3,000 Totals 36,000 36,000 -
Who is happy? Who is unhappy?
Cost Allocation: The Human Factor
Now let’s allocate the $36,000 budget based
on the number of faculty in each department.
Cost Allocation: The Human Factor
Academic Departments
Actual Cost Prior Year
Allocation Difference
Management 12,000$ 14,500 2,500$ Accounting 10,000 8,000 (2,000) Finance 8,000 6,000 (2,000) Marketing 6,000 7,500 1,500 Totals 36,000 36,000 -
Who is happy? Who is unhappy?
$36,000 ÷ 72 faculty = $500 per faculty member
$500 × 29 faculty members = $14,500
$500 × 16 faculty members = $8,000
$500 × 12 faculty members = $6,000
$500 × 15 faculty members = $7,500
Cost Allocation: The Human Factor
Now let’s allocate the $36,000 budget based
on the number of students in each
department.
Cost Allocation: The Human Factor
Academic Departments
Actual Cost Prior Year
Allocation Difference
Management 12,000$ 9,900 (2,100)$ Accounting 10,000 10,800 800 Finance 8,000 8,700 700 Marketing 6,000 6,600 600 Totals 36,000 36,000 -
Who is happy? Who is unhappy?
$36,000 ÷ 1,200 students = $30 per student
$30 per student × 330 students = $9,900
$30 per student × 360 students = $10,800
$30 per student × 290 students = $8,700
$30 per student × 220 students = $6,600
End of Chapter Five