Wild FAP 19th Edition Chapter 21COST ALLOCATION AND PERFORMANCE MEASUREMENT
Chapter 21
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Central idea . . .
Part I.
With the Activity Based Costing (ABC) method, we recognize that many activities within a department drive overhead costs.
Part II.
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Better understanding of activities.
Pricing decisions.
to costs of implementation.
More detailed measures of costs.
Better understanding of activities.
Pricing decisions.
Benefits should always be compared to costs of implementation.
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Assign costs to a cost pool for each activity.
Identify cost drivers associated with each activity.
Compute overhead rate for each cost pool:
Assign costs to products:
Estimated number of activity units
The procedures that we generally follow when implementing activity-based costing are:
Identify activities that consume resources.
Assign costs to a cost pool for each activity.
Identify cost drivers associated with each activity.
Compute overhead rate for each cost pool.
Assign costs to products.
controlling the costs.
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McGraw-Hill/Irwin
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McGraw-Hill/Irwin
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Large complex businesses are divided into departments enabling managers to have a smaller effective span of control.
MOTIVATION FOR DEPARTMENTALIZATION
Part I.
Even the best managers can only do so much. It is necessary to divide businesses into smaller departments so a manager’s span of control is not too large.
Part II.
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The accounting system provides information about resources used and outputs achieved. Managers use this information to control operations, appraise performance, allocate resources, and plan strategy. The type of accounting information provided depends on whether the department is a . . .
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Evaluated on
ability to
control costs.
Part I.
All departments, whether production, sales, or service, use resources to achieve a desired output. If our departmental accounting system is properly designed and implemented, we can control operations, appraise performance, allocate resources, and plan strategy. One of top management’s objectives for this type of system is to be able to allocate more resources to those departments who are performing at the highest level.
Part II.
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C 2
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Is not a function of arbitrary allocations of indirect expenses.
Departmental revenue
– Direct expenses
= Departmental contribution
DEPARTMENTAL CONTRIBUTION
TO OVERHEAD
A department may be a candidate for elimination when its departmental contribution is negative.
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Departmental contribution is an important concept for managers. We subtract departmental direct expenses from departmental revenue to get departmental contribution. It is the amount that a department contributes to covering indirect expenses of the company. If the total of all the departments’ contribution is not sufficient to cover indirect costs, the company’s net income will be negative. If an individual department’s contribution is negative, it contributes nothing toward covering indirect costs and should be a candidate for elimination.
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INVESTMENT CENTER RETURN ON TOTAL ASSETS (ROI)
LCD Division earned more dollars of income, but it was less
efficient in using its assets to generate income compared
to S-Phone Division.
Part I.
Investment center managers are responsible for generating profit and for the investment of assets. They will be evaluated based on their ability to generate enough operating income to justify the investment in assets used to generate the operating income. An investment center’s performance is often evaluating using a measure called return on investment (ROI). ROI is defined as operating income divided by invested assets.
Part II.
Data for LCD and S-Phone Divisions indicate that That the ROI for LCD is 21 percent, while the ROI for S-Phone is 23 percent.
Part III.
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LCD
S-Phone
Part I.
Residual income is the difference between the investment center net income and target investment center net income. The target investment center net income is the minimum rate of return on investment center invested assets.
Part II.
The target net income for the LCD and S-Phone Divisions is 8 percent. When we compute the target investment center net income for each division and subtract it from net income we see that the LCD division has a higher residual income.
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Customer Perspective
A 1
A balanced scorecard consists of an integrated set of performance measures that are derived from and support a company’s vision and strategy. The balanced scorecard enables top management to translate its vision and strategy into four groups of performance measures – customer perspective, innovation and learning, internal business processes, and financial perspective.
In the balanced scorecard approach, we continually develop measurements that help us analyze or answer questions such as how do we appear to our owners; how do we appear to our customers; what kind of continual innovation and learning; and which processes within the organization are excellent and which need improvement?
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CONTROLLABLE VERSUS DIRECT COSTS
Costs are controllable if the manager has the power to determine, or strongly influence, the amounts incurred. A manager’s performance evaluation should be based on controllable costs.
Direct costs are traced to departments, but may not be controllable by the department manager.
Example: Department managers usually
C 4
Managers should be evaluated on how well they manage controllable costs. A cost is controllable by a manager if the manager has the power to determine, or strongly influence, the amounts incurred. For example, production managers are generally considered to be responsible for the amount of material used in their departments, but not for the cost of insurance on the building in which the departments are located.
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responsibilities of
individual managers.
To evaluate
managers on
controllable items.
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to level in organization.
RESPONSIBILITY ACCOUNTING
PERFORMANCE REPORTS
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Be timely.
RESPONSIBILITY ACCOUNTING
PERFORMANCE REPORTS
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LCDS-Phone
LCDS-Phone