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CHAPTER 4

CHAPTER 4. Cost Accumulation, Tracing, and Allocation. Chapter Opening. What does it cost?. Managers must have reliable cost estimates to: Price products. Evaluate performance. Control operations. Prepare financial statements. Learning Objective.

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CHAPTER 4

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  1. CHAPTER 4 Cost Accumulation, Tracing, and Allocation

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

  3. Learning Objective To identify costobjects and cost drivers LO1

  4. Determine the Cost of Cost Objects A cost object is anyactivity, product, or serviceto which accountants wishto trace costs. • Cost accumulation begins with identifying: • Cost objects • Cost drivers

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

  6. 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

  7. 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.

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

  9. 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.

  10. Learning Objective To distinguishdirect costsfrom indirect costs LO2

  11. Identifying Direct andIndirect Costs 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.

  12. Identifying Direct andIndirect 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.

  13. Identifying Direct andIndirect Costs

  14. Identifying Direct andIndirect 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’s salary is indirect to any onedepartment, but is directly traceable to the store.

  15. Learning Objective To allocateindirect coststo cost objects LO3

  16. Allocating Indirect Coststo Departments Identify the most appropriate costdriver for each indirect cost. Indirect costs should be allocated to reflecthow the departments consume resources. The cost drivers of In Style, Inc. are:

  17. Allocating Indirect Coststo 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.

  18. Allocating Indirect Coststo Departments • $9,360 ÷ 3 departments = $3,120 per department • $3,120 × 1 department = $3,120

  19. Allocating Indirect Coststo 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

  20. Allocating Indirect Coststo 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

  21. Allocating Indirect Coststo 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 Coststo 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. Now let’s combine thecosts and revenues andsee how departmentalprofitability looks. Allocating Indirect Coststo Departments

  24. Allocating Indirect Coststo Departments

  25. Learning Objective To selectappropriate costdrivers for allocatingindirect costs LO4

  26. Selecting a Cost Driver An “Activity” isany task that an organization undertakes to make or deliver a good or service. Number ofprinters made byHP in a day A “cost driver” is an activity or event that causes costs to be incurred. Number offlights by Jet Blueeach day

  27. Performance evaluations may bebased on departmental profits. Department managers maymake decisions to enhancetheir performance evaluations. Behavioral Implications Cost allocations may affect departmental profits.

  28. Does this mean that I should use different costdrivers for variable andfixed overhead? Effects of Cost Behavior on Selecting a Cost Driver

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

  30. 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.

  31. 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

  32. 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

  33. 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

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

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

  36. Allocating FixedOverhead Costs Lednicky Bottling Company Information Use the two-step process to allocate the fixed rentalcost to units sold and to units in ending inventory.

  37. $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 Allocating FixedOverhead Costs

  38. Learning Objective To allocate coststo solve timingproblems LO5

  39. 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 priced higher than those produced in February. Will customers think this is reasonable?

  40. Estimated overhead for the year POHR = Estimated allocation base for the year $36,000 POHR = = $2.00 per unit 18,000 units 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). $2.00 allocated to each unit producedfor all months during the year.

  41. Learning Objective To allocate jointproduct costs LO6

  42. Allocating Joint Costs Product Joint Costs Product Product

  43. Allocating Joint Costs 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.

  44. Consider the following example of an oil refinery. We will assume only two products,gasoline and oil. Allocating Joint Costs

  45. Separate Processing Oil Separate Processing Gasoline Allocating Joint Costs Joint Costs Final Sale Common Production Process SeparateProcessing Costs Joint Input Final Sale Split-Off Point SeparateProcessing Costs

  46. Oil Gasoline Relative Sales Value Method Joint conversioncost = $225,000 $200,000 sales value at split-off point Common Production Process Joint material cost = $275,000 $600,000 sales value at split-off point Split-Off Point

  47. Relative Sales Value Method

  48. Relative Sales Value Method

  49. Relative Sales Value Method $225,000 joint conversion cost plus$275,000 joint material cost

  50. Learning Objective To recognize theeffects of costallocation onemployee motivation LO7

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