- 1. Cost Allocation Introduction to Management Accounting
Chapter 12
2. General Framework for Cost Allocation Four types of cost
objectives: Service departments Producing departments
Products/services, andCustomers. Learning Objective 1 Cost
allocation methods comprise an importantpart of a companys cost
management system. 3. General Framework for Cost Allocation Service
departments exist only tosupport other departments or customers.
Producing departments are where employees Work on the organizations
products or services. 4. General Framework for Cost Allocation
Indirect costs must be allocated.Direct costs can be physically
traced to each department. Many companies develop allocation
methods to assign service department costs to the producing
departments. 5. General Framework for Cost Allocation Increasingly,
companies measure and managethe costs and profitability of their
customers. All organizations accumulate costs for theirproducts or
services for financial reporting purposes. Customer related costs
include: Order processing Customer service sales commissions
Dedicated customer support 6. General Framework for Cost Allocation
A cost driver that has a logical, cause-effect relationshipto the
cost will be used as a cost-allocation base An accounting system
will assign to a departments output all its direct costs plus all
the indirect costs allocated to it. 7. Allocation of Service
Department Costs Learning Objective 2 Establish the details
regarding cost allocation in advance. 1 Allocate variable- and
fixed- cost pools separately. 2 Evaluate performance using budgets
for each production and service department. 3 8. Service Department
Example Computer Department 5-year lease School of Business School
of Engineering 9. Service Department Example Suppose there are two
major purposes for the allocation: Predicting economic effects of
the use of the computer Motivating departments and individuals to
use its capabilities more fully 10. Service Department Example The
primary activity performed is computer processing. Resources
consumed include 1. Processing time2. Operator time 3. Consulting
time4. Energy 5.Materials 6. Building space The budget formula for
the forthcoming year is $100,000 monthly fixed cost plus $200
variable cost per hour of computer time used. 11. Variable-Cost
Pool The cost driver for the variable-cost pool isActual hours of
computer time used. Therefore, variable costs should be allocated
as follows: Budgeted unit rate X Actualhours of computer time used
12. Variable-Cost Pool Consider the allocation of variable costs to
a department that uses 600 hours of computer time. Suppose
inefficiencies in the computer department caused the variable costs
to be $140,000 instead of $120,000. 600 hours $200 = $120,000 13.
Variable-Cost Pool A good cost-allocation scheme would allocate
only the $120,000 to the consuming department and would let the
$20,000 remain as an unallocated unfavorable budget variance of the
computer department. This scheme holds computer department managers
responsible for the $20,000 and reduces the resentment of user
managers. 14. Fixed-Cost Pool The cost driver for the fixed-cost
pool is the amount of capacity required when the computer
facilities were acquired. Fixed costs should be allocated as
follows: Budgeted percent of capacity available for use Total
budgeted fixed costs 15. Fixed-Cost Pool Suppose the deans had
originally predicted thelong-run average monthly usage as follows:
School of Business:210 hours School of Engineering: 490 hours How
is the fixed-cost pool allocated? Business: 210 700 = 30%$100,000 X
.3 = $30,000 Engineering: 490 700 = 70%$100,000 X .7 = $70,000 16.
Fixed-Cost Pool This predetermined lump-sum approach is based on
the long-run capacity available to the user, regardless of actual
usage from month to month. A major strength of using capacity
available rather than capacity used when allocating budgeted fixed
costs is that actual usage by user departments does notaffect the
short-run allocations to other user departments. 17. Reciprocal
Services Service departments often support other service
departments in addition to production departments. There are two
popular methods for allocating service department costs: The direct
method The step-down method 18. Direct and Step-Down Methods The
direct method ignores other service departments when any given
service departments costs are allocated to the revenue-producing
(operating) departments. The step-down method recognizes that some
service departments support the activities in other service
departments as well as those in production departments. Learning
Objective 3 19. Direct and Step-Down Methods Facilities management
cost = $1,260,000 Human resources cost = $240,000 Total square
footage in production departments: 15,000 processing + 3,000
assembly = 18,000 Total employees in production departments 16
processing + 64 assembly = 80 Square footage in human resources =
9,000 20. DirectMethod Facilities management cost allocated to
processing = (15,000 18,000) $1,260,000 = $1,050,000 Facilities
management cost allocated to assembly = (3,000 18,000) $1,260,000 =
$210,000 21. DirectMethod Human resources cost allocated to
processing = (16 80) $240,000 = $48,000 Human resources cost
allocated to assembly = (64 80) $240,000 = $192,000 22. Step-Down
Method Facilities management allocation: To assembly: (3 27)
$1,260,000 = $140,000 To human resources:(9 27) $1,260,000 =
$420,000 To processing: (15 27) $1,260,000 = $700,000 23. Step-Down
Method Human resources allocation: To assembly: (64 80) $660,000 =
$528,000 $240,000 + $420,000 = $660,000 To processing: (16 80)
$660,000 = $132,000 24. Step-Down Method Processing department
DirectStep-Down Direct department costs $1,000,000 $1,000,000From
facilities management 1,050,00 700,000 From Personnel 48,000
132,000Total costs $2,098,000 $1,832,000 25. Step-Down Method
Assembly department Direct Step-Down Direct department costs
$1,600,000 $1,600,000From facilities management 210,000 140,000From
personnel 192,000 528,000Total costs $2,002,000 $2,268,000 26.
Costs Not Related to Cost Drivers Guidelines: Identify additional
cost drivers. 1 Allocate all costs by the direct or step-down
method using square footage as the cost- allocation base. 2 27.
Traditional Approach 1. Divide the costs in each producing
departments. 2. Assign direct costs to the appropriate products,
services, or customers. Learning Objective 4 Direct costs Indirect
costs 28. Traditional Approach 3. Select one or more cost pools and
related cost drivers in each production department. Indirect
departmental costs Cost pool Cost pool Cost pool 29. Traditional
Approach 4. Allocate costs Costs Product B Product A Product C 30.
Activity-Based Costing Determine the key components of the system.
Step 1: Step 2: Develop the relationships among resources,
activities, and cost objectives. 31. Activity-Based Costing Step 3:
Collect relevant data concerning costs and the physical flow of the
cost-driver units among resources and activities. Step 4: Calculate
and interpret the new activity-based cost information. 32.
Allocation of Customer Costs Customer profitability depends on more
than grossmargin, it depends on the costs incurred to
fulfillcustomer orders and to provide other customer services.
Allocate costs associated withcustomer actions to customers.
Learning Objective 5 33. Allocation of Customer Costs
- Special delivery requirements
Customer Type 1 Customer Type 2 High Cost to Serve Low Cost to
Serve 34. Allocation of Customer Costs Customer Type 1 Low Cost to
Serve
- Buys a mix of products that
- Has a low cost-to-serve %
- Has a high level of profitability
- Buys a mix of products that
- Has a high cost-to-serve %
- Has a low level of profitability
Customer Type 2 High Cost to Serve 35. Allocation of Customer
Costs Assume Cedar City Distributors (CCD),distributes many
products to retail outlets. The products are classified into just
two product groups apparel and sports gear.
- CCD has two types of customers:
36. Allocation of Customer Costs CCD uses a simple cost
accounting system to calculate both product and customer
profitability. The only direct costs are costs of the purchase of
apparel and sports gear products. Indirect costs are allocated to
the product groups using a single indirect cost pool for all
indirect costs with pounds of product as the allocation base. Costs
37. Allocation of Customer Costs Small Stores Large Stores Cases
Profit MarginTotalCases Profit MarginTotal per caseProfit Marginper
caseProfit Margin Apparel 600$265.00$159,000800
$265.00$212,000Sports Gear200 315.0063,000 800315.00252,000 222,000
464,000Profit Margin Percentage 43.7%41.4%
- To determine customer profitability:
- 1.Calculate the profit margin per case for each product
- Use the product mix ordered by each customer to calculate
profitability
38. Allocation of Costs-to-Serve Might number of customer orders
be amore plausible cost-allocation base? The cost of resources used
for order processing and customer service activities should be
included in a separate cost pool and allocatedon the basis of
number of orders. This system gives managers at CCD more insight
into operations, and a tool to measure and manage customer
profitability. 39. Allocation of Central Costs Many managers
believe it is desirable to fully allocate all costs to the revenue-
producing parts of the organization. Whenever possible, the
preferred driver for central services is usage. Learning Objective
6 If a company does allocate the costs ofcentral services based on
sales, althoughcosts do not vary in proportion to sales, itshould
use budgeted, not actual, sales. 40. Allocation of Central Costs
Usage Revenue Cost of goods sold Total assets Total cost of each
division Not always economically viable 41. Allocation of Joint
CostsLearning Objective 7 Two conventional ways of allocating joint
costs to products are widely used: Physical units Relative sales
values Joint costs include all inputs of material, labor,
andoverhead costs that are incurred before the split-off point. 42.
Allocation of Joint Costs The physical-units method requires a
common physical unit for measuring the output of each product. The
joint costs are allocated based on each products percentage of the
total physical units produced. Allocation of joint costs should not
affect decisions about the individual products. 43. Physical-Units
Method Dow Chemical produces two chemicals, X and Y.The joint cost
is $100,000.X sells for $.09 per liter and Y for
$.06.AllocationSales Value at Liters Weightingof Joint
CostsSplit-off
PointX1,000,000(10/15)X$100,000$66,667$90,000Y500,000
(5/15)X$100,00033,333 30,000 1,500,000100,000120,000 44.
Relative-Sales-Value Method The joint costs are allocated based on
each products sales value as a percentage of the total sales value
at split-off. 45. Relative-Sales-Value Method Relative SalesValue
atAllocationSpit-off Point Weightingof Joint Costs
X$90,000(90/120)X$100,000$75,000Y3 0,000 (30/120X$100,00025,000
$120,000$100,000When weighting is based on the sales value of the
individual products, the allocation of a cost to one product
depends upon the sales value of both products. 46. By-Product Costs
A by-product is not individually identifiable until manufacturing
reaches a split-off point. They have relatively insignificant sales
value. 47. 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. 48. The End End of Chapter 12