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Part Three Cost Accumulation, Tracing, and Allocation

Part Three Cost Accumulation, Tracing, and Allocation. Introduction. Did costs increase or decrease from last year?. Is our selling price sufficient to cover costs and provide for adequate profitability?. Were actual costs consistent with expected costs?. What is our cost of goods sold?.

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Part Three Cost Accumulation, Tracing, and Allocation

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  1. Part Three Cost Accumulation, Tracing, and Allocation

  2. Introduction Did costs increase or decrease from last year? Is our selling pricesufficient to cover costsand provide foradequate profitability? Were actual costsconsistent withexpected costs? What is our costof goods sold? Who isresponsible? What is ourinventory cost? Who shouldbe rewarded? How can improvementbe accomplished?

  3. Labourhours Using Cost Drivers to Accumulate Costs Unitsproduced Machinehours A cost driver is anyfactor that causes or “drives”an activity’s costs Kilometresdriven

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

  5. 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.

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

  7. 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.

  8. Assigning Cost to Objects in a Retail Business 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.

  9. Assigning Cost to Objects in a Retail Business 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.

  10. Assigning Cost to Objects in a Retail Business

  11. Assigning Cost to Objects in a Retail Business 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.

  12. 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:

  13. 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.

  14. Assigning Cost to Objects in a Retail Business • $9,360 ÷ 3 departments = $3,120 per department • $3,120 × 1 department = $3,120

  15. Assigning Cost to Objects in a Retail Business • $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

  16. Assigning Cost to Objects in a Retail Business • $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

  17. Assigning Cost to Objects in a Retail Business • $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

  18. Assigning Cost to Objects in a Retail Business • $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

  19. Assigning Cost to Objects in a Retail Business

  20. Now let’s combine thecosts and revenues andsee how departmentalprofitability looks. Assigning Cost to Objects in a Retail Business

  21. Assigning Cost to Objects in a Retail Business

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

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

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

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

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

  27. Using Volume Measures to Allocate Variable Manufacturing Overhead • $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

  28. So which volume measure shouldI use? Selecting the Best Cost Driver

  29. Selecting the Best Cost Driver Judgement and reasoning are necessary. Considerations Relationship between cost driver activity and use of resources. Availability of information.

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

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

  32. $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 Fixed Overhead Costs

  33. 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?

  34. Estimated overhead 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.

  35. 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.

  36. 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.

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

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

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

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

  41. 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?

  42. 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

  43. 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.

  44. Allocating Joint Costs Product Joint Costs Product Product

  45. 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.

  46. Allocating Joint Costs

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

  48. 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

  49. Relative Sales Value Method Physicalquantities 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. Joint Cost Allocation Methods Net realizablevalue method

  50. Joint Cost Allocation Methods Let’s look at anexample illustratingthe joint costallocation methods.

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