my house – house # 1 house # 2 your house –house # 3

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


Overhead* 28,000 28,000 28,000


• 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


Direct

Material $140,000 $70,000 $90,000

Direct

Labor 210,000 130,000 60,000

Overhead* ? ? ?


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



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.


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.


PotentialInaccuracies

Timely Relevant




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.



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

Department

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.

In Style, Inc. chosethese cost drivers:


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 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


$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


$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$

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




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








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 Desks Total








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


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.


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$


$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.


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


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


$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.

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.




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




End of Chapter Five

my house – house # 1 house # 2 your house –house # 3

Documents