Chapter 21

1. Chapter 21 Cost Allocation and Performance Measurement

2. Conceptual Learning Objectives C1: Explain departmentalization and the role of departmental accounting C2: Distinguish between direct and indirect expenses C3: Identify bases for allocating indirect expenses to departments C4: Explain controllable costs and responsibility accounting C5:Appendix 21A: Describe allocation of joint costs across products

3. Analytical Learning Objectives A1: Analyze investment centers using return on total assets P1: Assign overhead costs using two-stage cost allocation P2: Assign overhead costs using activity-based costing P3: Prepare departmental income statements P4: Prepare departmental contribution reports

4. Assigning overhead is difficult. I agree! Overhead Cost Allocation Methods P1 One of the most difficult tasks in computing accurate unit costs lies in determining the proper amount of overhead cost to assign to each job.

5. Finishing Department Painting Department Shipping Department Two-Stage Cost Allocation P1 A two-stage process may be used because different departments may have different allocation bases.

6. Two-Stage Cost Allocation P1 Indirect Labor Indirect Materials Other Overhead Stage One: Costs assigned to departments Department 1 Department 2 Department 3

7. Two-Stage Cost Allocation P1 Indirect Labor Indirect Materials Other Overhead Stage One: Costs assigned to departments Department 1 Department 2 Department 3

8. Two-Stage Cost Allocation P1 Indirect Labor Indirect Materials Other Overhead Stage One: Costs assigned to departments Department 1 Department 2 Department 3

9. Two-Stage Cost Allocation P1 Indirect Labor Indirect Materials Other Overhead Stage One: Costs assigned to departments Department 1 Department 2 Department 3 Stage Two: Costs applied to jobs Jobs

10. Two-Stage Cost Allocation P1 Indirect Labor Indirect Materials Other Overhead Stage One: Costs assigned to departments Department 1 Department 2 Department 3 Direct Labor Hours Machine Hours Raw Materials Cost Stage Two: Costs applied to jobs Jobs Departmental Allocation Bases

11. Activity-Based Cost Allocation P2 Activity Based Costing Departmental Overhead Rates Level of Complexity Plantwide Overhead Rate Overhead Allocation

12. A A C B B C Activity-Based Cost Allocation P2 In the ABC method, we recognize that many activities within a department drive overhead costs.

13. A A C B B C Activity-Based Costing P2 Identify activities and assign indirect costs to those activities. Central idea . . . • Products require activities. • Activities consume resources.

14. Activity-Based Costing Benefits P2 • More detailed measures of costs. • Better understanding of activities. • More accurate product costs for . . . • Pricing decisions. • Product elimination decisions. • Managing activities that cause costs. • Benefits should always be comparedto costs of implementation.

15. Identifying Cost Drivers P2 Most cost driversare related to either volume or complexity of production. • Examples: machine time, machine setups, purchase orders, production orders. Three factors are considered in choosing a cost driver: • Causal relationship. • Benefits received. • Reasonableness.

16. Estimated overhead costs in activity cost pool Estimated number of activity units Rate = Overhead Actual Rate Activity × Activity-Based Costing Procedures P2 • 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:

17. Activity-Based Costing P2 Let’s look at anexample comparingtraditional costingwith ABC. We will start withtraditional costing.

18. Traditional Costing vs. ABCExample P2 Pear Company manufactures a product in regular and deluxe models. Overhead is assigned on the basis of direct labor hours. Budgeted overhead for the current year is $2,000,000. Other information: First, determine the unit cost of each model usingtraditional costingmethods.

19. Overhead Estimated overhead costs Rate Estimated activity = Overhead $2,000,000 Rate 40,000 DLH = = $50 per DLH P2 Traditional Costing

20. ABC will have differentoverhead per unit. P2 Traditional Costing

21. Activity-Based Costing P2 Pear Company plans to adopt activity-based costing. Using the following activity center data, determine the unit cost of the two products using activity-based costing.

22. Activity-Based Costing P2 400 deluxe + 800 regular = 1,200 total

23. Activity-Based Costing P2

24. Activity-Based Costing P2

25. Activity-Based Costing P2 Let’s completethe table.

26. Activity-Based Costing P2

27. Activity-Based Costing P2 Total overhead = $720,000 + $1,280,000 = $2,000,000Recall that $2,000,000 was the original amount of overhead assigned to the products using traditional overhead costing.

28. Activity-Based Costing P2

29. Traditional Costing vs. ABC P2 This result is not uncommon when activity-based costing is used. Many companies have found that low-volume, specialized products have greater overhead costs than previously realized.

30. Costs and Cost Drivers inActivity-Based Costing P2 Exh. 21-6

31. Provide informationfor managers to usein performanceevaluation. Assign costs tomanagers who areresponsible forcontrolling the costs. Departmental Accounting C1 Primarygoals

32. Departmental Accounting C1 Large complex businesses are divided into departments enabling managers to have a smaller effective span of control.

33. Departmental Accounting C1 Departments areestablished forspecialized functions. Production Service Sales

34. Information forDepartmental Evaluation C1 The accounting system provides information about resources used and outputs achieved. Managers use this information to: • Control operations • Appraise performance • Allocate resources. • Plan strategy

35. Costcenter Profitcenter Evaluated on ability tocontrol costs. Evaluated on abilityto generate revenuesin excess of expenses. Information forDepartmental Evaluation C1 The type of accounting information provided depends on whether the department is a . . .

36. CustomerSatisfaction Quality CostEffectiveness Profitability Information forDepartmental Evaluation C1 Information must support these four pillars of any successful business

37. Departmental Expense Allocation C2 Direct expensesare incurred for the sole benefit of a specific department. Indirect expensesbenefit more than one department and are allocated among departments benefited.

38. Illustration of IndirectExpense Allocation C2 Exh. 21-7 Classic Jewelry pays its janitorial service $300 per month to clean its store. Management allocates this cost to its three departments according to the floor space each occupies.

39. Illustration of IndirectExpense Allocation C2 Exh. 21-7 Classic Jewelry pays its janitorial service $300 per month to clean its store. Management allocates this cost to its three departments according to the floor space each occupies.

40. Illustration of IndirectExpense Allocation C2 Exh. 21-7 Classic Jewelry pays its janitorial service $300 per month to clean its store. Management allocates this cost to its three departments according to the floor space each occupies.

41. Bases for AllocatingService Department Costs C3 Exh. 21-8 Service department costs are shared, indirect expenses that support the activities of two or more production departments.

42. Service Department CostsQuestion C3 ABCO allocates its $300,000 personnel cost to operating departments based on the number of employees in each department. The assembly department has 100 employees and the packing department has 150 employees. What amount of cost is allocated to assembly? a. $100,000 b. $120,000 c. $150,000 d. $180,000

43. Service Department CostsQuestion C3 ABCO allocates its $300,000 personnel cost to operating departments based on the number of employees in each department. The assembly department has 100 employees and the packing department has 150 employees. What amount of cost is allocated to assembly? a. $100,000 b. $120,000 c. $150,000 d. $180,000 Assembly percentage= 100 ÷ (100 + 150) = 40% 40% of $300,000 = $120,000

44. Preparing DepartmentalIncome Statements P3 • Let’s prepare departmental income statements using the following steps: • Direct expense accumulation. • Indirect expense allocation. • Service department expense allocation

45. Step 1: Direct Expense Accumulation P3 Direct expensesaretracedto eachdepartment without allocation. Service Dept. One Service Dept. Two Operating Dept. One Operating Dept. Two

46. Step 2: Indirect Expense Allocation P3 Indirect expensesareallocatedto all departmentsusing appropriate allocation bases. Allocation Allocation Allocation Allocation Service Dept. One Service Dept. Two Operating Dept. One Operating Dept. Two

47. Step 3: Service Department Expense Allocation P3 Service departmenttotal expenses(original direct expenses + allocated indirect expenses) areallocatedto operating departments. Service Dept. One Service Dept. Two Allocation Allocation Operating Dept. One Operating Dept. Two

48. Departmental ExpenseAllocation Spreadsheet P3 Let’s examine this three-step allocation procedure forOwl Company.

49. Departmental ExpenseAllocation Spreadsheet P3 Step 1:Direct expensesaretracedto service departments and sales departments without allocation.

50. Departmental ExpenseAllocation Spreadsheet P3 Of a total of 2,000 square feet, the service departments occupy 200 square feet each, sales department one occupies 600 square feet, and sales department two occupies 1,000 square feet. Step 2:Indirect expensesare allocatedto both the service and the sales departments based on floor space occupied.