30007 MANAGERIAL ACCOUNTING: 1st partial summary, Appunti di Cost Accounting

Scarica 30007 MANAGERIAL ACCOUNTING: 1st partial summary e più Appunti in PDF di Cost Accounting solo su Docsity! Managerial Accounting – 1st Partial Introduction Definitions Financial Accounting Financial accounting focuses on reporting to external stakeholders, measures and records business transactions, and provides financial statements based on generally accepted accounting principles. Management Accounting Management accounting measures and reports financial and non-financial information that helps managers make decisions to fulfil the goals of an organization. Cost Accounting Cost accounting provides information for both management accounting and financial accounting. It measures and reports financial and non-financial data that relates to the cost of acquiring or consuming resources by an organization. Cost Management Cost management describes the actions of managers in short-run and long-run planning and control of costs that increase the value for customers and lower the costs of products and services. It entails the continuous reduction of costs, and it is a key part of general management strategies and their implementation. Accounting Information System An accounting information system is the process of gathering, organizing, and communicating financial information. Planning and Control Accounting information helps managers plan and control the organization’s operations. • Planning à Setting objectives and outlining how the objectives will be obtained. • Control à Implementing plans and using feedback to evaluate the achievement of objectives. Major Purposes of Accounting Systems • Internal non-routine reporting à it covers information for decisions that occur irregularly or even without precedent. o Formulating overall strategies and long-range plans. o Performance measurement and evaluation of people. • Internal routine reporting à it covers information provided for decisions that occur with some regularity. o Resource allocation decisions, for example, product and customer emphasis and pricing. o Cost planning and cost control of operations and activities. • External reporting à it covers information provided to investors, government authorities and other outside company stakeholders on the organization's financial position, operations and related activities. o Meeting external regulatory and legal reporting requirements. Different Types of Firms • Manufacturing-sector companies purchase materials and components and convert them into finished products. At the end of an accounting period, stock can include direct materials, work in progress and finished goods. • Merchandising-sector companies purchase and then sell tangible products without changing their basic form. Merchandise purchased from suppliers but not sold at the end of an accounting period is held as stock. • Service-sector companies provide services (intangible products) like legal advice or audits. These companies do not have any stock of intangible products at the end of an accounting period. Types of Inventories • Direct materials are resources in-stock and available for use. • Work-in-process (or progress) are products started but not yet completed, often abbreviated as WIP. • Finished goods are products completed and ready for sale. Costs Cost Terminology A cost is a resource sacrificed or foregone to achieve a specific objective, which is usually considered as the monetary amount that must be paid to acquire goods and services. • An actual cost is a historical cost. • A budgeted cost is a future cost. Cost Object A cost object is anything for which a separate measurement of costs is desired: a product, a service, a department, a customer… Cost pool à a grouping of individual cost items. There are two basic stages of accounting for costs: 1. Cost accumulation à it is the collection of cost data in some organized way by means of an accounting system. 2. Cost assignment to various cost objects à it is a general term that includes the tracing accumulated costs to a cost object and allocating accumulated costs to a cost object. Direct and Indirect Costs • Direct Costs à those that are related to a given cost object and that can be traced to it in an economically feasible (cost-effective) way. Cost-tracing describes the assignment of direct costs to the particular cost object. • Indirect Costs à are those that are related to the particular cost object but that cannot be traced to it in an economically feasible (cost-effective) way. Cost allocation describes the assigning of indirect costs to the particular cost object. Costs are not direct or indirect in isolation. A cost object (such as a product, service, or project) must be specified. Consider a supervisor’s salary in a maintenance department of a telephone company. If the cost object is the department, the salary is a direct cost. If the cost object is a telephone call by a customer, the salary is an indirect cost. Several factors affect the classification of a cost as direct or indirect. • The materiality of the cost in question • Underlying operations à the adoption of dedicated production lines • Available information-gathering technology à the use of barcodes and optical scanners • Design of operations • Contractual arrangements Classifications of Manufacturing Costs • Direct material costs are acquisition costs of all materials that will become part of the cost object and that can be traced to that cost object in an economically feasible way. They include freight-in (inward delivery) charges, sales taxes, and customs duties. • Direct labor costs are compensation of all manufacturing labor that can be traced to the cost object and that can be traced to the cost object in an economically feasible way. They include wages and fringe benefits paid to machine operators and assembly-line workers. • Indirect manufacturing costs are factory costs that are not traceable to the product in an economically feasible way. They include lubricants, indirect manufacturing labor, utilities, and supplies, plant rent and insurance, power supplies… Prime Costs and Conversion Costs • Prime cost are all direct manufacturing costs. In the two-part classification of manufacturing costs, prime costs would comprise direct materials costs. In the three-part classification, prime costs would comprise direct materials costs and direct manufacturing labor costs. • Conversion cost are all manufacturing costs other than direct materials costs. NORMAL COSTING Normal costing is a method of job costing that allocates indirect costs based on the budgeted indirect-cost rate times the actual quantity of the cost allocation base. Example: HP HP budgets 60,000€ for total manufacturing overhead costs and 2,400 machine hours. • Step 3: Identify the indirect costs. o Budgeted manufacturing overhead costs = 60,000€ • Step 5: Compute the rate per unit. o Budgeted indirect cost rate is 60,000€ / 2,400 = 25€ per machine hour. • Step 6.1: Compute the indirect costs allocated to the job. o 25€ per machine hour x 500 hours = 12,500€ • Step 6.2: Compute the total cost of Job 100. o 45,000€ (Direct material costs) + 14,000€ (Direct labor costs) + 12,500€ (Manufacturing overhead costs) = 71,500€ Budgeted indirect-cost rates can be assigned to individual jobs on an ongoing and timely basis. However, budgeted rates are based on estimates made up to 12 months before actual costs are incurred and you may need to make adjustments at the end of the year. End-of-Period Adjustments • Underallocated indirect costs (also underapplied or underabsorbed) à the allocated amount of indirect costs is less than the actual amount incurred. • Overallocated indirect costs (also overapplied or overabsorbed) à the allocated amount of indirect costs is greater than the actual amount incurred. à Under or overallocated indirect costs = Actual indirect costs – Allocated indirect costs End-of-Period Adjustments - Example: HP Assume the following annual data for HP: • Actual manufacturing overhead control = 65,100€ • Allocated manufacturing overhead applied = 2,480 actual machine hours x 25€ budgeted rate = 62,000€ • 65,100€ - 62,000€ = 3,100€ (underallocated) Reasons for the underallocated amount: • Different indirect costs à Actual manufacturing overhead costs of 65,100€ are more than the budgeted amount of 60,000€. • Different quantity of allocation base à Actual machine hours of 2,480 are more than the budgeted amount of 2,400 hours Approaches to disposing underallocated or overallocated overhead 1. Adjusted Allocation Rate Approach It restates all entries in the general and subsidiary ledgers by using actual cost rates rather than budgeted cost rates. Actual indirect-cost rate is computed at the end of the year. Every job to which indirect costs were allocated during the year has its amount recomputed. This is why this approach provides the most accurate record of individual job costs. • Actual manufacturing overhead (65,100€) exceeds manufacturing overhead allocated (62,000€) by 5%. (65,100 – 62,000)/62,000 = 3,100 / 62,000 = 5% • Actual manufacturing overhead rate (26.25€) exceeds the budgeted manufacturing overhead rate (25€) by 5% (26.25 – 25)/25 = 5% • HP could increase the manufacturing overhead allocated to each job by 5%. Manufacturing overhead allocated to Job 100 under normal costing is 12,500€. 12,500 + (5% * 12,500) = 13,125€ which equals actual manufacturing overhead. 2. Proration Approach Proration is the spreading of underallocated or overallocated overhead among ending Work-in-Progress, Finished Goods and Cost of Goods Sold. Indirect cost-allocated components provide the most accurate stock and cost of goods sold figures. Proration approaches do not make any adjustment to individual job-cost records. Basis to prorate underallocated or overallocated overhead: a. Proration approach A à Proration based on the total amount of indirect costs allocated (before proration) in the closing balances of work in progress, finished goods and cost of goods sold. WORK IN PROGRESS FINISHED GOODS COST OF GOOD SOLD 23,500€ * 26,000€ 12,500€ Total: 62,000€ 23,500€/62,000€ = 38% 26,000€/62,000€ = 42% 12,500€/62,000€ = 20% 3,100€ x 38% = 1,178€ 3,100€ x 42% = 1,302€ 3,100€ x 20% = 620€ 30,000€ + 1,178€ = 31,178€ 32,500€ + 1,302€ = 33,802€ 71,500€ + 620€ = 72,120€ à Year end balances after proration WORK IN PROGRESS FINISHED GOODS COST OF GOOD SOLD 940 h * 1040 h 500 h Total: 2,480 h 940 h /2,480 h = 38% 1040 h/2,480 h = 42% 500 h/2,480 h= 20% 3,100€ x 38% = 1,178€ 3,100€ x 42% = 1,302€ 3,100€ x 20% = 620€ 30,000€ + 1,178€ = 31,178€ 32,500€ + 1,302€ = 33,802€ 71,500€ + 620€ = 72,120€ à Year end balances after proration * 940h : 2,480h = 23,500€ : 62,000€ b. Proration approach B à Proration based on total closing balances (before proration) in work in progress, finished goods and cost of goods sold. WORK IN PROGRESS FINISHED GOODS COST OF GOOD SOLD Ending balance: 30,000€ Ending balance: 32,500€ Ending balance: 71,500€ Total Ending balance: 134,000€ 30,000€/134,000€ = 22% 32,500€/134,000€ = 24% 71,500€/134,000€ = 54% 3,100€ x 22% = 682€ 3,100€x 24% = 744€ 3,100€ x 54% = 1,674€ 30,000€ + 682€ = 30,682€ 32,500€ + 744€ = 33,244€ 71,500€ + 1,674€ = 73,174€ à Year end balances after proration 3. Immediate Write-Off to COGS Approach Immediate write-off approach is the simplest. 3,100€ × 100% = 3,100€ to Cost Of Goods Sold Year-end balances after proration: o Cost of goods sold: 71,500€ + 3,100€ = 74,600€ Process Costing The cost object is masses of identical or similar units or a product or service. It accumulates costs for a period and divides them by quantities produced during the period to get average unit costs. The journal entries in process costing are like those made in job-costing systems. The main difference is that, in process costing, there is often more than one work-in-progress account – one for each process. Equivalent Units Equivalent units are the number of completed units that the department could have produced from the inputs applied. Examples: • A printer 100% finished versus 4x printers 25% finished. • A 2-liter bottle of cola versus 2x 1-liter bottles of cola. • A 3m rope versus 3x 1m ropes. Process-Costing Cost Categories Process-costing systems separate costs into cost categories according to when costs are introduced into the process. 1. Direct materials are usually added at the beginning of the production process, or at the start of work in a subsequent department down the assembly line. 2. Conversion costs are usually added equally along the production process (i.e. labor, energy, maintenance). 3. Transferred-In Costs (or previous department costs) o They are costs incurred in previous departments that are carried forward as the product’s cost when it moves to a subsequent process in the production cycle. o Journal entries are made to mirror the progress in production from department to department. o There are two reasons why the accountant should distinguish between transferred in costs and additional direct materials costs for a particular department: a. All direct materials may not be added at the beginning of the department process. b. The control methods and responsibilities may be different for transferred-in items and materials added in this department. o They are treated as if they are a separate type of direct material added at the beginning of the process à add another column Steps of Process Costing 1. Summarize the flow of physical units of output. 2. Compute output in terms of equivalent units. 3. Summarize total costs to account for. 4. Compute equivalent unit costs. 5. Assign total costs to units completed and transferred out and to units in closing work-in-progress. 6. Check that total costs to account for = total cost of completed and transferred out + total cost of closing work-in- progress FIFO METHOD The FIFO method assigns the cost of the prior accounting period’s equivalent units in opening work in progress stock to the first units completed and transferred out. This method assumes that the earliest equivalent units in the work in progress assembly account are completed first. An advantage of FIFO is that managers can judge the current performance independently from the performance in the preceding period. Example 4 Oakville Wooden Toys YEAR 2 o Opening WIP: 5,000 Physical units (100% finished for materials, 40% finished for conversion). o Completed and transferred out: 24,000 Physical units. o Closing WIP: 7,000 Physical units (100% finished for materials, 60% finished for conversion). o Direct material costs: 84,200€ o Conversion costs: 62,680€ à The firm uses the FIFO method. Step 1 and 2 Step 3 o Current direct material costs: 84,200€ o Current conversion costs: 62,680€ o Opening WIP direct material costs: 15,000€ à they come from the previous year closing work-in-progress o Opening WIP conversion costs: 5,000€ à they come from the previous year closing work-in-progress o Total costs to account for: 84,200€ + 62,680€ + 15,000€ + 5,000€ = 166,880€ Step 4 o Current equivalent unit costs direct material: 84,200€ / 26,000 equivalent units = 3.24€ o Current equivalent unit costs conversion: 62,680€ / 26,200 equivalent units = 2.4€ o Opening WIP equivalent unit costs direct material: 15,000€ / 5,000 equivalent units = 3€ o Opening WIP equivalent unit costs conversion: 5,000€ / 2,000 equivalent units = 2.4€ Step 5 o Completed and transferred out: 5,000 x 3€ + (24,000 – 5,000) x 3.24€ + 2,000 x 2.4€ + (24,000 – 2,000) x 2.4€ = 134,160€ o Closing work-in-progress: 7,000 x 3.24€ + 4,200 x 2.4€ = 32,760€ (22,680€ material costs, 10,080€ conversion costs) Step 6 à Total costs accounted for: 134,160€ + 32,760€ = 166,920€ (40€ rounding difference) Hybrid Costing Systems • Product costing systems do not always fall neatly into either job costing or process costing categories. • A hybrid costing system blends characteristics from both job costing and process costing systems. • The hybrid costing systems use process costing to account for the conversion costs and job costing for the material and customizable components. Operation-Costing Systems • An operation is a standardized method or technique that is performed repetitively resulting in different finished goods. • An operation-costing system is a hybrid-costing system applied to batches of similar, but not identical, products. • Within each operation, all product units are treated exactly alike, using identical amounts of the operation’s resources. • Managers find operation costing useful in cost management because operation costing focuses on control of physical processes or operations of a given production system. Activity-Based Costing ISSUES WITH TRADITIONAL COST ACCOUNTING SYSTEMS The traditional approach seeks to have one or a few indirect-cost pools, irrespective of the heterogeneity in the facility. Cost smoothing Cost smoothing describes a costing approach that uses broad averages uniformly to assign the cost of resources to cost objects when the individual products, services, or customers, in fact, use those resources in a non-uniform way. One way of determining if cost smoothing is occurring is to examine separately how individual products (services, customers, etc.) use the resources of the organization and to compare the results with the way the accounting system represents that usage. Undercosting and Overcosting Jane, Mercedes, and Cherie meet for lunch and each one orders separate items. Jane consumed 14£, Mercedes consumed 30£, Cherie consumed 16£, for a total of 60£. Assuming they divide the bill equally, what is the average cost per lunch? 60£ / 3 = 20£ Jane and Cherie are overcosted, while Mercedes is undercosted. Product undercosting à A product consumes a relatively high level of resources but is reported to have a relatively low total cost. Product overcosting à A product consumes a relatively low level of resources but is reported to have a relatively high total cost. If one product is undercosted then at least one other product must be overcosted. • The overcosted product absorbs too much cost, making it seem less profitable than it really is. • The undercosted product is left with too little cost, making it seem more profitable than it really is. REFINING A COSTING SYSTEM THROUGH THE ACTIVITY-BASED COSTING SYSTEM Guidelines for improving a costing system: 1. Direct-cost tracing à classify as many of the total costs as direct costs as is economically feasible. 2. Indirect-cost pools à expand the number of cost pools until each of these pools is homogeneous. 3. Cost-allocation basis à identify the preferred cost allocation base for each indirect-cost pool. Activity-based costing systems refine costing systems by focusing on individual activities as the fundamental cost object. It calculates the costs of individual activities and assigns costs to cost objects such as products and services on the basis of the activities undertaken to produce each product or service. COST HIERARCHIES A cost hierarchy is a categorization of costs into different cost pools based on the different types of cost drivers (cost-allocation bases) or different degrees of difficulty in determining cause-and-effect relationships. Activity-based costing systems commonly use a four-part cost hierarchy to identify cost-allocation bases: 1. Output unit-level cost à resources sacrificed on activities performed on each individual unit of product or service. Examples are energy, machine depreciation, and repairs. 2. Batch level costs à resources sacrificed on activities that are related to a group of units of product(s) or service(s) rather than to each individual unit of product or service. Examples are set-up hours or procurement costs. 3. Product-sustaining costs à resources sacrificed on activities undertaken to support individual products or services. Examples are design costs and engineering costs. 4. Facility-sustaining costs à resources sacrificed on activities that cannot be traced to individual products or services but support the organization as a whole. Examples are general administration, rent and building security. Inventory valuation for financial reporting requires total or only some manufacturing costs (all levels of the hierarchy) to be expressed on a per output-unit basis. In contrast, for cost management purposes, the cost hierarchy need not be unitized as the cost driver is not uniformly allocated to units of output at each level in the hierarchy. TWO TYPES OF COST ALLOCATION 1. Cost allocation using direct manufacturing labor-hours à Single indirect-cost rate job costing system Oculus Ltd manufactures two types of lenses: Normal lenses (NL) and Complex lenses (CL). Normal lenses (NL) • N° of normal lenses: 80,000 • Direct materials: £1,520,000 • Direct mfg. labour: £800,000 • Tot direct costs: £1,520,000 + £800,000 = £2,320,000 • Direct cost per unit: £2,320,000 / 80,000 = £29 Complex lenses (CL) • N° of complex lenses: 20,000 • Direct materials: £920,000 • Direct mfg. labour: £260,000 • Tot direct costs: £920,000 + £260,000 = £1,180,000 • Direct cost per unit: £1,180,000 / 20,000 = £59 Indirect costs: £2,900,000 (grouped into a single overhead cost pool) Cost allocation base: 50,000 of direct manufacturing labour-hours (36,000 for NL and 14,000 for CL) The indirect cost rate: £2,900,000 / 50,000 = £58 How much indirect costs are allocated to each product? • NL: 36,000 x £58 = £2,088,000 • CL: 14,000 x £58 = £812,000 What is the total cost for each product? • NL: £2,320,000 (Direct costs) + £2,088,000 (Allocated costs) = £4,408,000 • CL: £1,180,000 (Direct costs) + £812,000 (Allocated costs) = £1,992,000 What is the cost per unit for each product? • NL: £4,408,000 / 80,000 = £55.10 • CL: £1,992,000 / 20,000 = £99.60 What’s the margin for each product? • If normal lenses sell for £60 each à (£60.00 - £55.10)/ £60.00 = 8.2% • If complex lenses sell for £142 each à (£142.00 - £99.60)/ £142.00 = 29.9% 2. Cost allocation using set up hours à Activity-Based System A cross-functional team at Oculus Corporation identified key activities: • Design products and processes • Set up moulding machine • Operate machines to manufacture lenses • Maintain and clean the moulds • Set up batches of finished lenses for shipment • Distribute lenses to customers • Administer and manage all processes at Oculus à Total set-up costs are £409,200 Cost allocation using direct manufacturing labor-hours (as we did before): Set-up cost per direct manufacturing labor hour: £409,200 / 50,000 = £8.184 • NL: £8.184 x 36,000 = £294,624 • CL: £8.184 × 14,000 = £114,576 • Total: £294,624 + £114,576 = £409,200 Cost allocation using set-up hours: Set-up cost per set-up hour: £409,200 / 2,640 = £155 • NL: £155 x 640 = £99,200 • CL: £155 x 2,000 = £310,000 • Total: £99,200 + £310,000 = £409,200 How should Oculus allocate set-up costs? Set-up costs should be allocated on the basis of set-up hours because there is a strong cause-and-effect relationship between setup related overhead costs and set-up hours. Department Costing and Cost Allocation PURPOSES OF COST ALLOCATION 1. Providing information for economic decisions • To decide whether to add a new product • To decide whether to manufacture a component part or to purchase it from another manufacturer • To decide on the selling price for a product 2. Motivating managers and employees • Managers and employees need to be encouraged to design products that are simpler to manufacture or less costly to service • Sales representatives need to be motivated to push high-margin products or services 3. Justifying the costs or calculate reimbursement • It is important to cost products at a “fair” price, especially in government defense contracts • A consulting firm that is paid a percentage of the cost savings resulting from the implementation of its recommendations needs to justify costs to compute reimbursement 4. Reporting to meet external regulatory obligations • Inventory costs must be determined for financial reporting and for reporting to tax authorities • Under GAAP, stock costs include manufacturing costs but exclude research and development, marketing, distribution and customer service costs Companies place great importance on the cost-benefit approach when designing and implementing their cost- allocation system. The costs of designing and implementing a system are highly visible, but the benefits from using a well-designed system are difficult to measure and are frequently less visible. Cost-benefit considerations can affect costing choices in several ways: • Classifying some immaterial costs as indirect when they could, at high cost, be traced to products, services or customers as direct costs. • Using a small number of indirect-cost pools when, at high cost, an increased number of indirect-cost pools would provide more homogeneous cost pools. • Using allocation bases that are readily available (or can be collected at low cost) when, at high cost, more appropriate cost-allocation bases could be developed. COST ALLOCATION WITHIN FIRM Costs incurred in different parts of an organization can be assigned, and then reassigned, when costing products, services, customers, or contracts. • Some companies allocate all corporate costs to divisions because it generates interest on the part of division managers regarding how corporate costs are planned and controlled. They also allocate all corporate costs to divisions to calculate the full costs of products. • Other companies do not allocate corporate costs to divisions. They maintain that division managers generally have no say or role in incurring these costs. • Other companies allocate only those costs for which there is widespread agreement, such as human resources. Example Sandy Corporation Sandy Corporation manufactures clothes washers and dryers in two international divisions: Paris and Prague. Sandy Corporation collects costs at the following levels in its organization: o Treasury costs: €600,000 interest on debt used to finance the construction of new assembly equipment which cost €4,000,000 in the Paris Division and €2,000,000 in the Prague Division. o Human resources costs: €1,200,000 in recruitment and ongoing employee training and development. o Corporate administration costs: €4,800,000 in executives’ salaries, rent and general administration. o Division costs: Direct costs, Paris: €2,200,000 Indirect costs, Paris: €1,980,000 Total costs, Paris: €4,180,000 Direct costs, Prague: €4,000,000 Indirect costs, Prague: €2,500,000 Total costs, Prague: €6,500,000 If Sandy Corporation allocates corporate costs to divisions, it should use the allocation basis that has the best cause-and-effect relationship with costs. Treasury costs Assume Sandy Corporation uses the cost of new assembly department equipment to allocate treasury costs o Treasury costs: €600,000 o Paris: €600,000 x (€4,000,000 / €6,000,000) = €400,000 o Prague: €600,000 x (€2,000,000 / €6,000,000) = €200,000 Corporate treasury costs are reallocated by the Paris and Prague Divisions to the Assembly Department Human resource costs Sandy Corporation analysis indicates that the demand for corporate human resource management costs for recruitment and training varies with direct labor costs. These costs are allocated to divisions on the basis of the total direct labor costs incurred in each division. Suppose direct labor costs in the Paris Division and the Prague Division are €1,200,000 and €1,800,000, respectively. How does Sandy Corporation allocate its €1,200,000 of human resources costs? o Human resources costs: €1,200,000 o Paris: €1,200,000 x (€1,200,000 / €3,000,000) = €480,000 o Prague: €1,200,000 x (€1,800,000 / €3,000,000) = €720,000 Corporate human resource management costs are reallocated by the divisions to the Department of Human Resources OPERATING AND SUPPORT DEPARTMENTS Organizations distinguish between: • An operating department (production department) adds value to a product or service. • A support department (service department) provides the services that assist other operating departments. Three methods are widely used to allocate the costs of support departments to operating departments: 1. Direct allocation method à Allocates support department costs to operating departments only, ignoring any services rendered by one support department to another. 1. Step-down method (sequential allocation) à Allocates support department costs to other support departments and to operating departments. 2. Reciprocal method (Equation method) à Allocates costs by including the mutual services provided among all support departments. Example: The Paris Division has two operating departments (Assembly and Finishing), and two support departments (Maintenance and Human Resources). • The maintenance department uses the square meter as allocation base. • The HR department uses the n° of employees as allocation base. 1. Direct Method • The allocation ratio for allocating Maintenance to Assembly is 110,000/220,000 x €300,000 = €150,000. • The allocation ratio for allocating Maintenance to Finishing is 110,000/220,000 x €300,000 = €150,000. • The allocation ratio for allocating Human Resources to Assembly is 48 / 72 x €2,160,000 = €1,440,000. • The allocation ratio for allocating Human Resources to Finishing is 24 / 72 x €2,160,000 = €720,000. 2. Step-Down Method a. Decide the order Which support department should be allocated first? The order of departments is important since the step-down method only allocates costs in one direction. The support department providing the greatest support to other support departments is allocated first. Services from Maintenance (using square m) to Human Resources: 30,000 / (30,000 + 110,000 + 110,000) = 0.12 à Maintenance provides 12% of its services to Human Resources. Services from Human Resources (using n° of employees) to Maintenance: 8 / (8 + 48 + 24) = 0.1 à Human Resources provide 10% of its services to Maintenance. Based on these % we select the following order of allocation: 1. Maintenance 2. Human Resources 3. Operating departments (Assembly and Finishing) Note that these % represent this amount of €… o 0.12 x €300,000 = €36,000 o 0.10 x €2,160,000 = €216,000 … and based on these amounts HR should come first, but management decides to use the order based on %. b. Reallocate the first support department (in this case Maintenance) Services from Maintenance (using square m) to Human Resources: 30,000 / (30,000 + 110,000 + 110,000) = 0.12 Services from Maintenance (using square m) to Assembly: 110,000 / (30,000 + 110,000 + 110,000) = 0.44 Services from Maintenance (using square m) to Finishing: 110,000/ (30,000 + 110,000 + 110,000) = 0.44 Allocation from Maintenance to Human Resources: 0.12 x €300,000 = €36,000 Allocation from Maintenance to Assembly: 0.44 x €300,000 = €132,000 Allocation from Maintenance to Finishing: 0.44 x €300,000 = €132,000 c. Reallocate the second support department (in this case HR) Services from Human Resources (using number of employees) to Assembly: 48 / (48 + 24) = 0.66 Services from Human Resources (using number of employees) to Finishing: 24 / (48 + 24) = 0.33 Allocation from Human Resources to Assembly: 0.66 x €2,196,000 = €1,449,360 (exact: €1,464,000) Allocation from Human Resources to Finishing: 0.33 x €2,196,000 = €724,680 (exact: €732,000) Consider an external supplier that charges an amount between €200 and €450 per hour. A division of Sandy that uses this supplier rather than the Central Computer Department may decrease its own division costs, but the overall costs to Sandy are increased. For example, suppose the Paris Division uses an external supplier that charges €360 per hour when the Central Computer Department has excess capacity. In the short run, Sandy incurs an extra €160 per hour because this external supplier is used (€360 external purchase price per hour minus the €200 internal variable costs per hour) instead of its own Central Computer Department. BUDGETED VERSUS ACTUAL RATES The decision of whether to use budgeted cost rates or actual cost rates affects the level of uncertainty user divisions face. Actual rate • When cost allocations are made using actual rates, managers do not know the rates to be used until the end of the budget period. Budgeted rate • When cost allocations are made using budgeted rates, user divisions will know in advance their allocated costs and they face no uncertainty about the rates to be used in that budget period. • The main justification given for the use of budgeted usage to allocate fixed costs relates to long-run planning. Organizations commit to infrastructure costs on the basis of a long-run planning horizon. • Budgeted rates help motivate the manager of the supplier department to improve efficiency. • During the budget period, the supplier department, not the user departments, bears the risk of any unfavorable cost variances. This happens because the user departments do not pay for any costs that exceed the budgeted rates. Example • Consider the budget of €300,000 fixed costs at the Central Computer Department of Sandy Corporation. Assume that actual and budgeted fixed costs are equal. • Assume also that the actual usage by the Paris Division is always equal to the budgeted usage. • The budgeted usage is 800 hours for the Paris Division and 400 hours for the Prague Division. We now look at the effect on allocating the €300 000 in total fixed costs when in the Prague Division: 1. Actual usage (400) = Budgeted usage (400) Paris: 800 / (800 + 400) x €300 000 = €200 000 Prague: 400 / (800 + 400) x €300 000 = €100 000 à fixed-cost allocation equals the expected amount 2. Actual usage (700) > Budgeted usage (400) Paris: 800 / (800 + 700) x €300 000 = €160 000 Prague: 700 / (800 + 700) x €300 000 = €140 000 à the fixed-cost allocation is €40,000 less to the Paris Division than expected (€160 000 vs €200 000) 3. Actual usage (200) < Budgeted usage (400) Paris: 800 / (800 + 200) x €300 000 = €240 000 Prague: 200 / (800 + 200) x €300 000 = €60 000 à the fixed-cost allocation is €40,000 more than expected (€240 000 vs €200 000) Why is there an increase of €40 000 even though the Paris Division’s actual and budgeted usage are exactly equal? Because the fixed costs are spread over fewer hours of usage. Variations in usage in the Prague Division will affect the fixed costs allocated to the Paris Division when fixed costs are allocated on the basis of actual usage. COMMON COSTS A common cost is a cost of operating a facility, activity or like cost object that is shared by two or more users. An auditor located in London wants to visit two clients: Client 1 is located in Berlin and Client 2 is located in Paris. • The round-trip London-Berlin-London costs 540€ • The round-trip London-Paris-London costs 360€ • The combined round-trip London-Berlin-Paris-London costs 760€ What does the auditor charge client 1 and client 2 for these visits? The two methods for allocating common costs are: 1. Stand-alone cost-allocation method It uses information pertaining to each user of a cost object as a separate entity to determine the cost-allocation weights. Client 1: o 360 / (360 + 540) = 0.40 o 0.40 x 760 = 304€ Client 2: o 540 / (360 + 540) = 0.60 o 0.60 x 760 = 456€ 2. Incremental cost-allocation method It ranks the individual users of a cost object and then uses this ranking to allocate costs among those users. The first-ranked user of the cost object is termed the primary party and is allocated costs up to the cost of it as a stand-alone user. The second-ranked user is termed the incremental party and is allocated the additional cost that arises from there being two users instead of only the primary user. Client 1: Primary party à 540€ Client 2: Incremental party à 760 - 540 = 220€ COST ALLOCATION AND CONTRACTS • Many commercial contracts include clauses that require the use of cost accounting information. • Contract disputes arise with some regularity, often with respect to cost allocation. • Contract disputes over amounts to be paid can often be reduced by making the cost assignment rules as explicit as possible and in writing. • These rules should include details such as the allowable cost item, the acceptable cost-allocation bases and how differences between budgeted and actual costs are to be handled.