12 - 1 ©2002 prentice hall business publishing, introduction to management accounting 12/e,...
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12 - 1©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton
Chapter 12
Cost Allocation
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©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton
Cost Allocation
Costs are linked with cost objectives by selectingappropriate cost drivers.
A cost driver is often called a cost-allocation base.
A cost pool is a grouping of individual cost itemsthat are allocated to cost objectives.
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Learning Objective 1
Explain the major reasons
for allocating costs.
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Purposes of Allocation
There are four major purposes for allocating costs:
1 To predict the economic effects of planning and control decisions
2 To obtain desired motivation3 To compute income and asset valuation4 To justify costs or obtain reimbursement
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Three Types of Cost Allocations
1 – Allocation to the appropriateorganizational unit
2 – Allocation from one organizationalunit to another
3 – Allocation to products or services
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Learning Objective 2
Allocate the variable and fixed
costs of service departments
to other organizational units.
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Allocation of Service Department Costs
Guidelines for allocatingservice department costs:
Establish the details regardingcost allocation in advance.
Allocate variable- and fixed-costpools separately.
Evaluate performance using budgets.
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Service Department Example
Computer Department
School of Business School of Engineering
5-year lease
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Service Department Example
Analyze the costs of the computerdepartment in detail.
The primary activity performedis computer processing.
Resources consumed includeprocessing time, operator time,consulting time, energy, materials,and building space.
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Service Department Example
Suppose there are two major purposes for the allocation:
1 Predicting economic effects of the use of the computer
2 Motivating departments and individuals to use its capabilities more fully
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Service Department Example
Assume that cost behavior analysis has been performed.
The budget formula for the forthcoming year is $100,000 monthly fixed cost plus $200 variable cost per hour of computer time used.
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Variable-Cost Pool
The cost driver for the variable-cost pool is hours of computer time used.
Therefore, variable costs should be allocated as follows:
Budgeted unit rate × Actual hours ofcomputer time used
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Variable-Cost Pool
Consider the allocation of variablecosts to a department that uses600 hours of computer time.
Assume that inefficiencies in thecomputer department caused thevariable costs to be $140,000instead of $120,000.
600 hours × $200 = $120,000
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Variable-Cost Pool
A good cost-allocation scheme would allocateonly the $120,000 to the consuming departmentand would let the $20,000 remain as anunallocated unfavorable budget variance of thecomputer department.
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Fixed-Cost Pool
The cost driver for the fixed-cost pool is the amount of capacity required when the computer facilities were acquired.
Therefore, fixed costs should be allocated as follows:
Budgeted % of capacity available for use× Total budgeted fixed costs
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Fixed-Cost Pool
Suppose the deans, in our university computer department example, had originally predicted the long-run average monthly usage as follows:
School of Business 210 hours
School of Engineering 490 hours
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Fixed-Cost Pool
How is the fixed-cost pool allocated?
Business:210 ÷ 700 × $100,000 = $30,000Engineering:490 ÷ 700 × $100,000 = $70,000
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Fixed-Cost Pool
This predetermined lump-sum approach is basedon the long-run capacity available to the user,regardless of actual usage from month to month.
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Learning Objective 3
Allocate the central costs
of an organization.
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Allocation of Central Costs
UsageUsage
RevenueRevenue
Cost of goods soldCost of goods sold
Total assetsTotal assets
Total cost of each divisionTotal cost of each division
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Learning Objective 4
Use the direct and step-down
methods to allocate service
department costs to user
departments.
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Reciprocal Services
Service departments often support other service departments in addition to producing departments.
There are two popular methods for allocating service department costs:
1 The direct method2 The step-down method
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Direct and Step-Down Methods
The direct method ignores other service departmentswhen any given service department’s costs areallocated to the revenue-producing (operating)departments.
The step-down method recognizes that some servicedepartments support the activities in other servicedepartments as well as those in productiondepartments.
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Direct and Step-Down Methods
Service Departments Production Departments
Facilities$126,000
$100,000Molding
Personnel$24,000
$160,000Finishing
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15
27
3
2720
42080
420
320
420
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Direct Method
Service Departments Production Departments
Facilities$126,000
$100,000Molding
Personnel$24,000
$160,000Finishing
0% 0%
$105,000
$19,200
$21,000
$4,800
320 ÷ 400 × $24,000
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Step-Down Method
Service Departments Production Departments
Facilities$126,000
$100,000Molding
Personnel$24,000 + $42,000
$160,000Finishing
$70,000
$52,800
$14,000
$13,2009
27
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Step-Down Method
Finishing DepartmentMolding Department
Direct costs $100,000From Fac. Mgt. 70,000From Personnel 13,200Total $183,200
Direct costs $160,000From Fac. Mgt. 14,000From Personnel 52,800Total $226,800
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Facility Management Example
Assume management wants to analyze facility management’s costs.
What are the possibilities?1 Divide costs into two or more different cost
pools and use a different cost driver to allocate the costs in each pool.
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Facility Management Example
2 Allocate variable costs using the direct or step-down method, but do not allocate the fixed costs.
3 Allocate all costs using square footage as the cost driver.
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Allocate usingCost Driver 2
Allocate usingCost Driver 3
Facility Management Example
Facilities Management Cost
Cost Pool Cost Pool Cost Pool
Allocate usingCost Driver 1
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Learning Objective 5
Describe the traditional
approach to allocating
costs to products or services.
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Traditional Approach
Operating orproductiondepartments
Step 1:Allocate production-related costs todepartments.
Step 2:Select one or morecost drivers.
Directlaborhours
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Traditional Approach
Step 3:Allocate coststo products orservices.
ProductA
ProductB
ProductC
Direct labor hours
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Fixedcosts
Variablecosts
Traditional Approach
One cost driver
If only one cost driver is used,two cost pools should be maintained
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Learning Objective 6
Use activity-based costing to
allocate costs in a modern
manufacturing environment
to products or services.
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Activity-Based Costing
ABC systems focus on accumulating costs into key activities.
If many costs are caused by non-volume-based cost drivers, activity-based costing (ABC) should be considered.
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Activity-Based Costing
Determine cost objective, key activitycenters, resources, and related cost drivers.
Step 1:
Step 2:
Develop a process-based map representingthe flow of activities, resources, and theirinterrelationships.
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Activity-Based Costing
Step 3:
Collect relevant data concerning costs andthe physical flow of the cost-driver unitsamong resources and activities.
Step 4:
Calculate and interpret the new activity-based information.
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Learning Objective 7
Use the physical-units and
relative-sales-value methods to
allocate joint costs to products.
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Meaning of Terms
Joint products Joint costs
Separable costs Split-off point
Main product By-product
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Joint Costs
Physical unitsRelative sales
values
Two conventional ways of allocatingjoint costs to products are widely used:
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The physical-unitsmethod requires acommon physicalunit for measuringthe output of eachproduct.
The joint costs areallocated based oneach product’spercentage of thetotal physicalunits produced.
Physical-Units Method
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Relative-Sales-Value Method
The joint costs are allocated based on each product’s sales value as a percentage of the total sales value at split-off.
Sales value at split-off method
Estimated net realizable value (NRV) method
Constant gross-margin percentage NRV method
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Why Allocate Joint Costs?
To determine inventory cost and cost of goods sold
To determine cost reimbursement under contracts
For conducting customer profitability analysis
For insurance settlement computations
For rate regulation
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No Allocation of Joint Costs
Some companies refuse to allocatejoint costs and instead carry theirinventories at estimated net realizablevalue minus a normal profit margin.
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By-Product Costs
If an item is accounted for as a by-product, only separable costs are allocated to it.
All joint costs are allocated to the main products.
Any revenues from by-products, less their separable costs, are deducted from the cost of the main products.
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Joint Costs Allocation Example
100 pounds Z-1Separable cost $300
400 pounds Z-2Separable cost $150
Joint costis $900.
Product A$800
Z-1 and Z-2are worthlessat split-off point.
Product B$800
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Physical Units Example
Joint Cost Allocated
To A:100 ÷ 500 × $900 = $180
To B:400 ÷ 500 × $900 = $720
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Physical Units Example
A B Total
Sales Value $800 $800 $1,600Separable Costs 300 150 450Allocation of Joint Cost 180 720 900Operating Profit (Loss) $320 $(70) $ 250
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Relative-Sales-Value Method Example
A B TotalSales Value $800 $800 $1,600Separable Costs 300 150 450Sales Value Imputedat Splitoff Point $500 $650 $1,150Allocation of Joint Cost500/1,150; 650/1,150 391 509 900Operating Profit (Loss) $109 $141 $ 250
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Learning Objective 8
Understand how cost allocation
is used in cost planning
and control.
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Cost Allocation in Planning and Control
Across the entire chain, managers need accurate cost information in order to effectively plan and control operations.
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End of Chapter 12