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Chapter Twelve

Chapter Twelve. Cost Accumulation, Tracing, and Allocation. Learning Objective 1. Describe the relationships among cost objects, cost drivers, and cost accumulation. Chapter Opening. What does it cost?. Managers must have reliable cost estimates to: Price products. Evaluate performance.

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Chapter Twelve

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  1. Chapter Twelve Cost Accumulation,Tracing, and Allocation

  2. Learning Objective 1 • Describe the relationships among cost objects, cost drivers, and cost accumulation.

  3. Chapter Opening What does it cost? • Managers must have reliable cost estimates to: • Price products. • Evaluate performance. • Control operations. • Prepare financial statements.

  4. Use of Cost Drivers to Accumulate Costs Unitsproduced Machinehours Laborhours Milesdriven A cost driver is anyfactor that causes or “drives”an activity’s costs

  5. Use of Cost Drivers to Accumulate Costs Accumulated Minutes Rate per Cost Talked Minute ´ = Total Long DistanceTelephone Bill Minutes talked isthe cost driver. Minutes Talked

  6. Estimated Versus Actual Cost Actual CostsKnowledge of actual costs, after the fact, may not be useful for planning and decision making. Estimated CostsManagers use estimated costs tomake decisions about the future.

  7. Estimated Versus Actual Cost Timely Relevant PotentialInaccuracies Estimated CostsManagers use estimated costs tomake decisions about the future.

  8. Estimated Versus Actual Cost Timely Relevant PotentialInaccuracies Estimated CostsMay be used to set prices, make bids, evaluate proposals, distribute resources, plan production, and set goals.

  9. Learning Objective 2 • Distinguish direct costs from indirect costs.

  10. Identifying Direct Versus Indirect Costs In Style, Inc. (ISI) 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.

  11. 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.

  12. Identifying Direct Versus Indirect Costs

  13. Identifying Direct Versus 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.

  14. Learning Objective 3 • Use basic mathematics to compute indirect cost allocations.

  15. 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. InStyle, Inc. chosethese cost drivers:

  16. 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.

  17. Allocating Indirect Costs to Departments • $9,360 ÷ 3 departments = $3,120 per department • $3,120 × 1 department = $3,120

  18. Allocating Indirect Costs to Departments • $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

  19. Allocating Indirect Costs to Departments • $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

  20. Learning Objective 4 • Select appropriate cost drivers for allocating indirect costs in a variety of different circumstances.

  21. Allocating Indirect Costs to Departments • $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

  22. Allocating Indirect Costs to Departments • $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

  23. Allocating Indirect Costs to Departments Now let’s combine thecosts and revenues andsee how departmentalprofitability looks.

  24. Allocating Indirect Costs to Departments

  25. The Effects of Cost Behavior on Cost Driver Selection Does this mean that I should use different costdrivers for variable andfixed overhead?

  26. Using Volume Measures to Allocate Variable Overhead Costs UnitsProduced LaborHours MaterialsUsed Increases in the volume of production willcause variable overhead costs to increase. Volume measuresserve as good cost driversfor the allocation ofvariable overhead.

  27. Using Volume Measures to Allocate Variable Overhead Costs Filmier Furniture CompanyProduction and Cost Information Use the two-step process to allocate indirect materialscost using the three volume measures as cost drivers.

  28. Using Volume Measures to Allocate Variable Overhead Costs • $60,000 ÷ 5,000 units = $12 per unit • $12 per unit × 4,000 chairs = $48,000 $12 per unit × 1,000 desks = $12,000

  29. Using Volume Measures to Allocate Variable Overhead Costs • $60,000 ÷ 6,000 hours = $10 per hour • $10 per hour × 3,500 hours = $35,000 $10 per hour × 2,500 hours = $25,000

  30. Using Volume Measures to Allocate Variable Overhead Costs • $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

  31. Selecting the Best Cost Driver So which volume measure shouldI use? Judgment and reasoning are necessary. Considerations Relationship between cost driver activity and use of resources. Availability of information.

  32. Allocating Fixed Overhead Costs Objective Distribute a fair share of theoverhead cost to each product. There are novolume based costdrivers forfixed overhead.

  33. Allocating Fixed Overhead Costs Lednicky Company Information Use the two-step process to allocate the fixed rentalcost to units sold and to units in ending inventory.

  34. Allocating Fixed Overhead Costs • $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

  35. Learning Objective 5 • Use allocation to solve problems that emerge in the process of making cost-plus pricing decisions.

  36. Allocating Costs to Solve Timing Problems Allocating fixed costs can be complicated when thevolume of production varies from month to month. If prices are based on these costs, units produced inJanuary will be higher than those produced in February. Will customers think this is reasonable?

  37. Allocating Costs to Solve Timing Problems Estimated overhead the year POHR = Estimated allocation base for the year $36,000 POHR = = $2.00 per unit 18,000 units We solve this problem by using estimatedcosts and estimated production for the year toobtain a predetermined overhead rate (POHR). $2.00 allocated to each unit producedfor all months during the year.

  38. Learning Objective 6 • Explain why companies establish indirect cost pools.

  39. Establishing Cost Pools This is the problem when we don’tuse cost pools to allocate costs. IndirectCost 1 Product1 IndirectCost 2 Product2 IndirectCost 3 IndirectCost 4 Product3 IndirectCost 5 15 allocations

  40. Establishing Cost Pools Cost pools reduce the numberof cost allocation computations. IndirectCost 1 Product1 IndirectCost 2 CostPool Product2 IndirectCost 3 Threeallocations IndirectCost 4 Product3 IndirectCost 5 Contains indirect costs relatedto a common cost driver.

  41. Learning Objective 7 • Recognize human motivation as a key variable in the allocation process.

  42. Cost Allocation: The Human Factor Is it fair to dividethe College ofBusiness copybudget equally? I think weconsider the number ofstudents. I think weconsider the number offaculty.

  43. Cost Allocation: The Human Factor Let’s see how the allocation of budgeted amounts will effect the different departments.We will begin by allocating equal amounts.

  44. Cost Allocation: The Human Factor Who is happy? Who is unhappy?

  45. Cost Allocation: The Human Factor Now let’s allocate the $36,000 budget based on the number of faculty in each department.

  46. Cost Allocation: The Human Factor • $36,000 ÷ 72 faculty = $500 per faculty member • $500 × 29 faculty members = $14,500 $500 × 16 faculty members = $8,000 $500 × 12 faculty members = $6,000 $500 × 15 faculty members = $7,500 Who is happy? Who is unhappy?

  47. Cost Allocation: The Human Factor Now let’s allocate the $36,000 budget based on the number of students in each department.

  48. Cost Allocation: The Human Factor • $36,000 ÷ 1,200 students = $30 per student • $30 per student × 330 students = $9,900 $30 per student × 360 students = $10,800 $30 per student × 290 students = $8,700 $30 per student × 220 students = $6,600 Who is happy? Who is unhappy?

  49. End of Chapter Twelve

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