Part Three Cost Accumulation, Tracing, and Allocation

Part Three

Cost Accumulation, Tracing, and Allocation

Introduction Did costs increase or decrease

from last year?

Who isresponsible?

Were actual costsconsistent withexpected costs?

Is our selling pricesufficient to cover costs

and provide foradequate profitability?

Who shouldbe rewarded?

How can improvementbe accomplished?

What is our costof goods sold?

What is ourinventory cost?

Using Cost Drivers to Accumulate Costs

Machinehours

Labourhours

Unitsproduced

Kilometresdriven

A cost driver is anyfactor that causes or “drives”

an activity’s costs

Using Cost Drivers to Accumulate Costs

Accumulated Minutes Rate per Cost Talked Minute

Minutes Talked

Tot

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Dis

tanc

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elep

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Bill

=

Minutes talked isthe cost driver.

Estimated Versus Actual Cost

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.


Relevant

PotentialInaccuracies

Timely

Estimated CostsManagers use estimated costs tomake decisions about the future.


Estimated CostsMay be used to set prices, make bids,

evaluate proposals, distribute resources, plan production, and set goals.

Relevant

PotentialInaccuracies

Timely

Assigning Cost to Objects in a Retail Business

Women's Men's Children's Total

Sales 190,000$ 110,000$ 60,000$ 360,000$

Department

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.



Sales 190,000$ 110,000$ 60,000$ 360,000$

Department

The first step in the development of the new bonusstrategy is to determine the costs of each department.

Costs that are easily traced todepartments are called direct costs.

Costs that cannot be easily traced todepartments are called 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.

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.

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


$18,400 ÷ 23,000 square metres = $0.80 per square metre

$0.80 × 12,000 Women’s square metres = $9,600

$0.80 × 7,000 Men’s square metres = $5,600

$0.80 × 4,000 Children’s square metres = $3,200


$2,300 ÷ 23,000 square metres = $0.10 per square metre

$0.10 × 12,000 Women’s square metres = $1,200

$0.10 × 7,000 Men’s square metres = $700

$0.10 × 4,000 Children’s square metres = $400


$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


$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



Now let’s combine thecosts and revenues andsee how departmental

profitability looks.



Sales 190,000$ 110,000$ 60,000$ 360,000$

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

Amortization 7,000 5,000 4,000 16,000

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 Behaviour on Cost Driver SelectionDoes this mean that I

should use different costdrivers for variable and

fixed overhead?

Using Volume Measures to Allocate Variable Manufacturing Overhead

Increases 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

LabourHours

MaterialsUsed


Filmier Furniture CompanyProduction and Cost Information

Use the two-step process to allocate indirect materialscost using the three volume measures as cost drivers.

Chairs Tables Total

Units of Production 4,000 1,000 5,000

Direct Labour Hours 3,500 2,500 6,000

Direct Materials Cost 1,000,000$ 500,000$ 1,500,000$

Indirect Materials Cost 60,000

Chairs Tables Total


Direct Labor Hours 3,500 2,500 6,000


Indirect Materials Cost Chairs Tables 60,000$

Allocation of Indirect Materials Cost Based on:

Units of Production 48,000$ 12,000$ 60,000$

Direct Labour 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 tables = $12,000


Chairs Tables Total








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


Chairs Tables Total








Direct Materials Cost 40,000 20,000 60,000

Product $60,000 ÷ $1,500,000 of material = $0.04 per $

$0.04 per $ × $1,000,000 = $40,000

$0.04 per $ × $500,000 = $20,000

Selecting the Best Cost Driver

So which volume measure should

I use?

Selecting the Best Cost Driver

Judgement 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.


Lednicky Bottling Company Information

Units Produced 2,000,000

Units Sold 1,800,000

Units in Ending Inventory 200,000

Fixed Rental Cost 28,000$

Use the two-step process to allocate the rentalcost to units sold and to units in ending inventory.


$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.

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.




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?


Now let’s allocate the $36,000 budget based

on the number of faculty in each department.





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 -


$36,000 ÷ 72 faculty = $500 per faculty member

$500 × 29 faculty members = $14,500





Now let’s allocate the $36,000 budget based

on the number of students in each

department.





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 -


$36,000 ÷ 1,200 students = $30 per student

$30 per student × 330 students = $9,900




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 numberof 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.



Consider the following example of an oil

refinery.We will assume only

two products,gasoline and oil.


JointInput

CommonProduction

Process

FinalSale

FinalSale

Split-OffPoint

JointCosts Oil

Gasoline SeparateProcessing

SeparateProcessing Costs

SeparateProcessing

SeparateProcessing Costs


Net realizablevalue method

Joint Cost Allocation Methods

Joint costs are allocated based on a

relative measure (weight, volume, etc.) of

the products atthe split-off point.

Physicalquantities method

Joint costs areallocated based onthe relative valuesof the products at

the split-off point.

Relative Sales Value Method

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 litres

360,000 litres

Joint material

cost = $275,000

Joint conversioncost = $225,000




$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


$200,000sales value atsplit-off point

$600,000sales value atsplit-off point



$225,000 joint conversion cost plus$275,000 joint material cost


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.

Thanks for Your Attention

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Part Three Cost Accumulation, Tracing, and Allocation