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Calculate Cost of Service with Multiple Cost Pools and Drivers

Calculate Cost of Service with Multiple Cost Pools and Drivers

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Calculate Cost of Service with Multiple Cost Pools and Drivers

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  1. Calculate Cost of Service with Multiple Cost Pools and Drivers Intermediate Cost Analysis and Management

  2. Why did this cost measurement method fail? Chez Paris Fillet and Lobster 35.00 Chicken Kiev 15.00 Top Sirloin 20.00 Caesar Salad 9.00 Coffee 2 @1.00 2.00 House Wine 4 @5.00 20.00 Champagne 24.00 Ice Cream 4.00 Chocolate Cheesecake 6.00 Sampler 10.00 Soup/Salad 8.00 Aperitif 7 .00 Total $160.00 Carol Alice Thank You Bob Ted

  3. Terminal Learning Objective • Task: Calculate Cost of Service with Multiple Cost Pools/Drivers • Condition: You are training to become an ACE with access to ICAM course handouts, readings, and spreadsheet tools and awareness of Operational Environment (OE)/Contemporary Operational Environment (COE) variables and actors • Standard: with at least 80% accuracy: • Identify 3 methods of distribution • Discuss relative merits of each • Describe need for homogeneity in pools/drivers • Describe need for correlation between pool and driver • Select suitable driver for cost pool 

  4. cost object Review: Managerial Costing cost pool raw accounting data managerial costing translation method of distribution = managerially useful information

  5. Review: Terminology • Method of distribution: • The mechanics of deriving management information from the cost pool • Example: • Determine unit cost by adding all input costs and dividing by number of units method of distribution

  6. Alternative Methods of Distribution • Managers can obtain the needed view of cost in several ways • Guessing: gut feel of cost distribution • Direct costing: detailed record keeping of all incurred cost transactions by every cost object • Allocation: distribution of cost pool in the same proportion as a cost driver

  7. Applications for Guessing • Simple situations where: • Cost of measurement error is small • Need for credibility is low • Ability to hold someone accountable is missing • Cost of cost measurement is high guessing and gut feel

  8. Detailed Record Keeping Applications • Labor cost can be accounted for by product through time and attendance reporting • Project costs can include supplies and services charged by job order • Product material costs can be determined through bill of materials detailed record keeping

  9. Examples of Detailed Record Keeping • Job order charges • Bill of materials system • Time and attendance reporting

  10. Why Not Use Detailed Record Keeping for All Cost? • May not be practical • Will be more expensive • May not be necessary • Probably less flexible • May not be possible • Joint costs and overhead costs often consumed by more than one cost object method of distribution

  11. An Extreme Example • Consider the accountant at Detailed Transaction Command • Changes pencils every time he writes a transaction for a different cost object • Writes a materials ticket for each pencil issued to each cost object • Maintains meticulous time records whenever he changes pencils • Wonders what to do about cost of pencil sharpener?

  12. Method of Distribution Comparison cost of method accuracy flexibility guessing cheap poor good direct very expensive good poor allocation reasonable reasonablereasonable

  13. Review: Allocation • Allocation: • A method of distribution that distributes cost pool to cost objects in the same proportion as cost driver • Example: • Distributing the cost of utilities to occupants in the same proportion as space occupied allocation based on cost driver

  14. detailed record keeping allocation based on cost driver cost object Most Systems Combine Methods cost pool

  15. Combining Methods Detailed Record Keeping Allocation Receptionist Materials Management Production Control Labor Accounting/ Payroll

  16. Choosing a Method of Distribution • Use guessing for simple decision making • Keep detailed records when accounting cost is low and high accuracy useful • Allocate overhead, support, and indirect costs when appropriate • Consider management’s needs for precision and timeliness

  17. Discussion: Telephone Charges • Should these be allocated or charged via detailed, call-by-call records? • Issues to consider • What does management need? • Is telephoning a core mission or support function? • Are detailed records available?

  18. Learning Check • Which method of distribution is the least expensive? • Which method is the most accurate?

  19. Facilities Case • An Army Installation has four Companies that occupy five buildings. Incurred costs of $100,000 include utilities, building maintenance, and miscellaneous facilities related expenditures. New policies require the Installation to charge its costs back to Companies. • Using the Allocation Worksheet and the following information, prepare a cost allocation: Company Company Company Company A B C D Number of Buildings 2 1 1 1

  20. Consider: • What are the cost objects? • What is the cost driver? • What is the rate per building? • What is each company’s proportion? • What assumptions are made in using number of buildings as a cost driver? • Is this a good method of distribution?

  21. Allocation Spreadsheet Enter the cost pool and cost objects After entering driver data the cost allocation calculates automatically

  22. What Difference Doesit Make? • Some of the buildings are small? • One of the building is the pentagon? ≠

  23. Company Company Company Company A B C D Square 20000 1000 9000 20000 Footage Facilities Case B • Not surprisingly, the Company Commanders were not pleased to hear about the Facilities assessment. However, the Company B brought up a valid point: Why should his organization, which occupies a small building, receive the same allocation as Company D, which occupies a substantially larger building? Taking this into consideration, the Facilities manager decided to re-allocate the $100,000 on the basis of Square Footage occupied by each organization.

  24. Allocation Spreadsheet Enter data for multiple drivers and select drivers from pull-down lists

  25. Consider: • What are the cost objects? • What is the cost driver? • What is the rate per square foot? • What is each company’s proportion? • Is this a better method of distribution? • Identify cross subsidizations and free goods created by the Case A method

  26. Facilities Case C • At this point, the manager of Company D protested. Yes, he did have a large building, but it was not air conditioned. By his estimates, which were reasonably accurate, forty percent of the facilities expenditures were air conditioning related. These expenses included the additional electricity, maintenance and repair needed to keep the air conditioning units running.

  27. Facilities Case C • Company D proposed dividing the Facilities Costs into two separate cost pools: one for Air-Conditioning related costs, and one for General Facilities costs. The General cost pool would be allocated on the basis of square footage, just as before. The Air Conditioning cost pool would be allocated on the basis of air conditioned square footage. Company Company Company Company A B C D Square 20000 1000 9000 20000 Footage 10000 1000 9000 0 A/C Square Footage

  28. A/C sqft sqft Company D’s Method Total Cost Pool $100K Air Conditioning Cost Pool $40K General Cost Pool $60K Company Facility Cost

  29. Allocation Spreadsheet Define activities and assign cost to activities Enter additional cost driver data

  30. Allocation Spreadsheet Select drivers for each activity View the total allocation for each Cost Object

  31. Consider: • What is the new rate per square foot? • What is the rate per air conditioned square foot? • Identify any cross subsidizations and free goods created by Case B’s method • Is this a better method of distribution? • Why might this method not reflect true cost?

  32. Good Method Test • Case A is a good method IF... • All buildings are the same • Case B is a good method IF... • All square feet are the same • Case C is a good method IF... • All general square feet are the same AND • All air conditioned square feet are the same

  33. Don’t Forget Behavioral Impacts • What undesired behavior is encouraged with allocation by number of buildings • Combining buildings one roof • Expanding buildings when new building might make more sense • Rejecting assignment to small building • In-fighting to occupy large air conditioned buildings

  34. Learning Check • What happens to an object’s overhead allocation as its proportion of cost driver increases? • If the unit of measure for the cost driver is dollars, what will be the unit of measure for the driver rate?

  35. Assumptions • Making assumptions is inescapable in managerial costing • There is simply too much to measure and too many ways to measure it • Reasonable assumptions simplify and facilitate the measurement process • Bad assumptions result in poor management decision making

  36. Homogeneity and Averaging • Allocation methods implicitly assume sameness or homogeneity • Allocating the dinner check based on number of eaters assumes that all eaters consume resources equally • Allocating facilities costs based on number of buildings assumes that all buildings consume facilities resources equally

  37. Homogeneity and Averaging • The homogeneity assumption allows the use of average cost • To simplify the allocation process • To minimize the cost of measurement • To avoid detailed record keeping for every cost object

  38. Cause and Effect Relationships • A cause and effect relationship means: • Increasing driver usage will cause more consumption of resources • Decreasing driver usage will cause less resource consumption • Allocating cost based on this driver will reflect the underlying economics of cost consumption and approximate true cost

  39. Cause and Effect Relationships • Give the cost manager another target for managing cost • Managing the driver usage will result in managing cost • Allow managers to make rational decisions based on knowledge of true cost • Instead of over-consuming goods and services that appear to be free or low-cost

  40. Common Examples of Cause - Effect Cost Drivers • Square footage Heating costs • Number of employees Personnel costs • Mileage Motor pool costs • Computer hours  Computer costs • Others?

  41. Learning Check • What is the underlying assumption when choosing a cost driver? • A cause-effect relationship means that when the driver usage is reduced, the will also decrease.

  42. Contracts Office Case • The contracts office at Fort Apache incurs annual costs of $1 million. These costs are currently distributed to companies A, B, and C on the basis of their number of soldiers • How much is each company allocated? Company Company Company A B C Number of Soldiers 250 300 450

  43. Contracts Case: Questions • What is the Cost Pool? • What is the Cost Object? • What is the Cost Driver? • What is the rate? • What is each Company’s proportion?

  44. Contracts Case: Results Company Company Company A B C Number of Soldiers 250 300 450

  45. Contracts Case:Discussion Questions • Is “number of soldiers” a good cost driver? • Will decreasing soldiers decrease consumption of contracts resources? • What undesired behaviors might be encouraged by this method of distribution?

  46. Contracts Office: Case B • Company C’s captain finds his allocation unacceptable. He rejects being charged $450K when he does not have any contracts and suggests using number of contracts as the cost driver. • How is cost allocated with this cost driver? Company Company Company A B C Number of Contracts 50 50 0

  47. Contracts Case B: Questions • What is the Cost Pool? • What is the Cost Object? • What is the Cost Driver? • What is the rate? • What is each Company’s proportion?

  48. Contracts Case B: Results Company Company Company A B C Number of Contracts 50 50 0

  49. Balloon Squeezing • Company A’s cost doubles • Company B’s cost increases 67% • Total cost remains unchanged • A change in distribution means: • If one command’s allocation goes DOWN by $1000 Then... • Someone else’s allocation has to go UP by $1000 • (Zero sum game requires support of top management in order to succeed)

  50. Contracts Case B: Discussion Questions • Is “number of contracts” a good cost driver? • Will decreasing number of contracts decrease consumption of contracts resources? • What undesired behaviors might be encouraged by this method?