Kế toán, kiểm toán - Chapter 6: Cost allocation & activity - Based costing

Prepared by Debby Bloom-Hill CMA, CFMCHAPTER 6Cost Allocation &Activity-Based CostingPurposes of Cost AllocationTo provide information for decision makingTo reduce frivolous use of common resourcesTo encourage evaluation of servicesTo provide “full cost” informationSlide 6-3Learning objective 1: Explain why indirect costs are allocated, describe the cost allocation process, and discuss allocation of service department costs.Purposes of Cost AllocationSlide 6-4Learning objective 1: Explain why indirect costs are allocated, describe the cost allocation process, and discuss allocation of service department costs.Purposes of Cost AllocationTo provide information for decision makingWhen managers use a company resource they are receiving a charge for useAllocated cost should measure the opportunity cost of using a company resourceProvides a useful benchmarkThe closer to the opportunity cost of use, the better the allocationSlide 6-5Learning objective 1: Explain why indirect costs are allocated, describe the cost allocation process, and discuss allocation of service department costs.Purposes of Cost AllocationTo reduce frivolous use of common resourcesWhen managers are not charged for a service, they may tend to use it for frivolous or nonessential purposesFrivolous use may have hidden costs such as slower serviceAllocation provides incentive for departments to reduce frivolous useSlide 6-6Learning objective 1: Explain why indirect costs are allocated, describe the cost allocation process, and discuss allocation of service department costs.Purposes of Cost AllocationTo encourage evaluation of servicesIf costs are not allocated, there is no incentive to evaluate the services and look for lower cost alternativesWith cost allocation, there is a strong incentive to critically evaluate the efficiency and necessity of servicesUsers will certainly bring lower cost alternatives to the company’s attentionSlide 6-7Learning objective 1: Explain why indirect costs are allocated, describe the cost allocation process, and discuss allocation of service department costs.Purposes of Cost AllocationTo provide “full cost” informationGAAP requires full costing for external reporting purposesFull cost information is needed when the company has an agreement whereby revenue received depends upon cost incurredAlso called “cost-plus” contractsSlide 6-8Learning objective 1: Explain why indirect costs are allocated, describe the cost allocation process, and discuss allocation of service department costs.All of the following are reasons indirect costs are allocated to products, services and departments, except:To improve decision makingTo reduce frivolous use of resourcesTo provide information on variable and fixed costsTo encourage evaluation of servicesAnswer: c The allocation of indirect costs does not provide information on variable and fixed costsTest Your Knowledge 1Slide 6-9Learning objective 1: Explain why indirect costs are allocated, describe the cost allocation process, and discuss allocation of service department costs.Cost-Plus ContractsSlide 6-10Learning objective 1: Explain why indirect costs are allocated, describe the cost allocation process, and discuss allocation of service department costs.Process of Cost AllocationCost allocation is achieved by a three step processDetermining the cost objectiveForming cost poolsSelection of an allocation base to relate cost pools to the cost objectiveSlide 6-11Learning objective 1: Explain why indirect costs are allocated, describe the cost allocation process, and discuss allocation of service department costs.Slide 6-12Step 1 – determine the cost objectiveDetermine the product, service, or department that is to receive the allocationThe object of the allocation is referred to as the cost objectiveFor example, if computer costs are allocated to contracts worked on, the contracts are the cost objectivesProcess of Cost AllocationLearning objective 1: Explain why indirect costs are allocated, describe the cost allocation process, and discuss allocation of service department costs.Slide 6-13Process of Cost AllocationLearning objective 1: Explain why indirect costs are allocated, describe the cost allocation process, and discuss allocation of service department costs.In the cost allocation process, the cost objective is the:The allocation base used to allocate the costsA grouping of individual costs whose total is allocated using one allocation baseThe product, service or department that is to receive the allocationNone of the aboveAnswer: cThe product, service or department that is to receive the allocationSlide 6-14Test Your Knowledge 2Learning objective 1: Explain why indirect costs are allocated, describe the cost allocation process, and discuss allocation of service department costs.Step 2 – form cost poolsA cost pool is a grouping of individual costs whose total is allocated using one allocation baseCost pools can be organized along departmental lines or major activities, e.g. equipment setups, inspections.Costs in the pool must be homogeneous (similar) to other costs in the poolSlide 6-15Process of Cost AllocationLearning objective 1: Explain why indirect costs are allocated, describe the cost allocation process, and discuss allocation of service department costs.Process of Cost AllocationSlide 6-16Learning objective 1: Explain why indirect costs are allocated, describe the cost allocation process, and discuss allocation of service department costs.Step 3 – select an allocation base that relates the cost pool to the cost objectivesThe base must be some characteristic that is common to all of the cost objectivesDeciding which base to use is not easyThe allocation should be based on a cause-and-effect relationshipEstablishing cause-and-effect relationships is not feasible when indirect costs are fixedAccountants use other methods which are shown on the next slideSlide 6-17Process of Cost AllocationLearning objective 1: Explain why indirect costs are allocated, describe the cost allocation process, and discuss allocation of service department costs.Fixed Indirect Costs – Other ApproachesRelative benefits approach to allocationMore costs allocated to those objectives that benefit most from incurring the costAbility to bear costsMore costs allocated to products, services or departments that are more profitableEquity approach to allocationBase results in allocations that are perceived to be fair or equitableSlide 6-18Learning objective 1: Explain why indirect costs are allocated, describe the cost allocation process, and discuss allocation of service department costs.Select an Allocation BaseTwo production departments: Assembly and FinishingBoth receive allocations of indirect costs from the maintenance departmentShould labor hours or machine hours be used as the allocation base?Slide 6-19Learning objective 1: Explain why indirect costs are allocated, describe the cost allocation process, and discuss allocation of service department costs.Selecting an Allocation BaseSlide 6-20Learning objective 1: Explain why indirect costs are allocated, describe the cost allocation process, and discuss allocation of service department costs.In the cost allocation process, an allocation base:Must be some characteristic that is common to all of the cost objectivesIdeally should result in cost being allocated based on a cause-and-effect relationshipBoth a and bNone of the aboveAnswer: c Both a and bSlide 6-21Test Your Knowledge 3Learning objective 1: Explain why indirect costs are allocated, describe the cost allocation process, and discuss allocation of service department costs.Allocating Service Department CostsOrganizational units of manufacturing firms classified as either:Production departmentsEngage in direct manufacturing activityService departmentsProvide indirect supportCost poolsFormed by service departmentsAllocated to production departmentsSlide 6-22Learning objective 1: Explain why indirect costs are allocated, describe the cost allocation process, and discuss allocation of service department costs.Direct Method – Mason FurnitureSlide 6-23Allocate janitorial cost of $100,000Allocation base: square feet Assembly department: 20,000 square feet Finishing department: 30,000 square feetCalculate the allocation rate: $100,000 / (20,000 + 30,000) = $2/sq ftAllocation to production departments: Assembly dept.:20,000 sq ft x $2 = $40,000 Finishing dept.: 30,000 sq ft x $2 = $60,000Learning objective 1: Explain why indirect costs are allocated, describe the cost allocation process, and discuss allocation of service department costs.Direct Method – Mason FurnitureSlide 6-24Allocate personnel cost of $200,000Allocation base: number of employees Assembly department: 60 employees Finishing department: 40 employeesCalculate the allocation rate: $200,000 / (60 + 40) = $2,000/employeeAllocation to Production DepartmentsAssembly dept: 60 x $2,000 = $120,000Finishing dept: 40 x $2,000 = $80,000Learning objective 1: Explain why indirect costs are allocated, describe the cost allocation process, and discuss allocation of service department costs.Direct Method of Allocating Service Department CostsService department costs allocated to production departments but not to other service departmentsSlide 6-25Learning objective 1: Explain why indirect costs are allocated, describe the cost allocation process, and discuss allocation of service department costs.The direct method of allocating costs:Allocates service department costs to other service departmentsAllocates only direct costsAllocates service department costs to production departments onlyBoth b and cAnswer: cAllocates service department costs to production departments onlySlide 6-26Test Your Knowledge 4Learning objective 1: Explain why indirect costs are allocated, describe the cost allocation process, and discuss allocation of service department costs.Direct Method – Mason FurnitureSlide 6-27Learning objective 1: Explain why indirect costs are allocated, describe the cost allocation process, and discuss allocation of service department costs. Slide 6-28Test Your Knowledge 5Learning objective 1: Explain why indirect costs are allocated, describe the cost allocation process, and discuss allocation of service department costs.Taylor Bath has three production departments and allocates mailroom costs of $600,000 based on number of employeesShowers: 80 employeesBathtubs: 40 employeesVanities: 30 employeesUse the allocation rate of $4,000 per employee to allocate the mailroom costs to showers, bathtubs and vanitiesShowers 80 employees * $4,000 rate = $320,000Bathtubs 40 employees * $4,000 rate = $160,000Vanities 30 employees * $4,000 rate = $120,000Slide 6-29Test Your Knowledge 6Learning objective 1: Explain why indirect costs are allocated, describe the cost allocation process, and discuss allocation of service department costs.Allocating Budgeted and Actual Service Department CostsManagement should allocate based on budgeted rather than actual costsAllocation of actual amounts allows service department to pass on cost of inefficiencies and waste to production departmentsSlide 6-30Learning objective 1: Explain why indirect costs are allocated, describe the cost allocation process, and discuss allocation of service department costs.Problems with Cost AllocationPotential problems are brought about by:Allocations of costs that are not controllableArbitrary allocationsAllocation of fixed costs that make the fixed costs appear to be variable costsAllocations of manufacturing overhead to products using too few overhead cost poolsUse of only volume-related allocation basesSlide 6-31Learning objective 2: Identify potential problems with cost allocation, discuss activity-based costing (ABC) and cost drivers, and distinguish activity based costing (ABC) from activity-based management (ABM).Responsibility Accounting and Controllable CostsOne of the primary uses of managerial accounting is to evaluate the performance of managers and the operations under their controlEvaluation is facilitated by a system which traces revenues and costs to units with related responsibility for generating revenue and controlling costsThis system is referred to as a responsibility accounting systemSlide 6-32Learning objective 2: Identify potential problems with cost allocation, discuss activity-based costing (ABC) and cost drivers, and distinguish activity based costing (ABC) from activity-based management (ABM).Responsibility Accounting and Controllable CostsCost allocation is generally required in a responsibility accounting systemOne unit is often responsible for the costs incurred by another unitSome allocations are not consistent with a responsibility accounting systemManagers should be held responsible for controllable costs onlyControllable costs are affected by a manager’s decisionsSlide 6-33Learning objective 2: Identify potential problems with cost allocation, discuss activity-based costing (ABC) and cost drivers, and distinguish activity based costing (ABC) from activity-based management (ABM).Arbitrary AllocationsCost allocations are inherently arbitraryTypically there are numerous allocation bases that are equally justifiableIn almost all situations, determining the true allocation is impossibleManagers support the allocation which makes them look bestManagers reject allocations which cast an unfavorable light on their performanceSlide 6-34Learning objective 2: Identify potential problems with cost allocation, discuss activity-based costing (ABC) and cost drivers, and distinguish activity based costing (ABC) from activity-based management (ABM).Unitized Fixed CostsThe allocation process may make fixed costs appear to be variable costsThis happens when fixed costs are unitizedUnitized fixed costs are stated on a per unit basisWhen managers increase sales they also increase their allocated general and administrative costsThis could lead to decisions which could hurt the profitability of the companySlide 6-35Learning objective 2: Identify potential problems with cost allocation, discuss activity-based costing (ABC) and cost drivers, and distinguish activity based costing (ABC) from activity-based management (ABM).Lump Sum AllocationsAllocations of fixed costs must be made in such a way that they appear fixed to managersThis is achieved by lump-sum allocations of fixed costsA lump-sum allocation is not affected by changes in the activity level of the organizational unitLump-sum allocations generally should remain the same from year to yearSlide 6-36Learning objective 2: Identify potential problems with cost allocation, discuss activity-based costing (ABC) and cost drivers, and distinguish activity based costing (ABC) from activity-based management (ABM).When fixed costs are stated on a per unit basis:Fixed costs are said to be controllableFixed costs may appear to be variable to managers receiving allocationsA lump-sum allocation has been madeDivisions with high sales receive a low amount of allocated costsAnswer: bFixed costs may appear to be variable to managers receiving allocationsSlide 6-37Test Your Knowledge 7Learning objective 2: Identify potential problems with cost allocation, discuss activity-based costing (ABC) and cost drivers, and distinguish activity based costing (ABC) from activity-based management (ABM).Too Few Cost PoolsSome companies assign overhead to products using only one or two overhead cost poolsAlthough simple, this may lead to distortion of cost allocationSome products will be overcostedSome products will be undercostedThis problem is solved by setting up separate cost pools for overheadSlide 6-38Learning objective 2: Identify potential problems with cost allocation, discuss activity-based costing (ABC) and cost drivers, and distinguish activity based costing (ABC) from activity-based management (ABM).Product costs will be more accurate when more overhead cost pools are usedDecisions that rely on product cost information will be improvedHowever, more cost pools equals more expensive record keepingMust analyze cost-benefit relationship of more cost poolsSlide 6-39Too Few Cost PoolsLearning objective 2: Identify potential problems with cost allocation, discuss activity-based costing (ABC) and cost drivers, and distinguish activity based costing (ABC) from activity-based management (ABM).Slide 6-40Too Few Cost PoolsLearning objective 2: Identify potential problems with cost allocation, discuss activity-based costing (ABC) and cost drivers, and distinguish activity based costing (ABC) from activity-based management (ABM).Using Only Volume-Related Allocation BasesSome firms allocate manufacturing overhead based on volume, using allocation bases likeDirect labor hours, or Machine hoursNot all overhead costs vary with volumeReferred to as the traditional approachSlide 6-41Learning objective 2: Identify potential problems with cost allocation, discuss activity-based costing (ABC) and cost drivers, and distinguish activity based costing (ABC) from activity-based management (ABM).Using Only Volume-Related Allocation BasesThe problem with the traditional approach is that it assumes that all overhead costs are proportional to production volumeMany overhead costs are not proportional to volumeThe cost of setting up equipment for a production runThe cost of inspecting raw materialsAmong othersSlide 6-42Learning objective 2: Identify potential problems with cost allocation, discuss activity-based costing (ABC) and cost drivers, and distinguish activity based costing (ABC) from activity-based management (ABM).Which of the following is not a volume-related cost driver?Direct labor hoursDirect labor costMachine timeTime to set up a production runAnswer: dA production run will take the same amount of time to set up no matter how many units are in the production runSlide 6-43Test Your Knowledge 8Learning objective 2: Identify potential problems with cost allocation, discuss activity-based costing (ABC) and cost drivers, and distinguish activity based costing (ABC) from activity-based management (ABM).Activity-Based Costing (ABC)Using the ABC approach, companies identify major activities that cause overhead costs to be incurredSome activities are related to production volume, some are notThe cost of resources consumed performing these activities are grouped into cost pools Costs are assigned to products using a measure of activity referred to as a cost driverSlide 6-44Learning objective 2: Identify potential problems with cost allocation, discuss activity-based costing (ABC) and cost drivers, and distinguish activity based costing (ABC) from activity-based management (ABM).The ABC ApproachSlide 6-45Learning objective 2: Identify potential problems with cost allocation, discuss activity-based costing (ABC) and cost drivers, and distinguish activity based costing (ABC) from activity-based management (ABM).Relating Cost Pools to Products Using Cost Drivers Slide 6-46Learning objective 2: Identify potential problems with cost allocation, discuss activity-based costing (ABC) and cost drivers, and distinguish activity based costing (ABC) from activity-based management (ABM).Common Activities and Associated Cost DriversSlide 6-47Learning objective 2: Identify potential problems with cost allocation, discuss activity-based costing (ABC) and cost drivers, and distinguish activity based costing (ABC) from activity-based management (ABM).McMaster Screen Technologies has two products and allocates overhead costs using a rate of $4 per dollar of labor.One product has a very low gross profit and the other has a very high gross profitThe CFO suspects that this may be due to problems with the costing systemThe CFO authorizes a study of how product costs will change if an ABC approach is takenSlide 6-48Activity Based Costing- McMaster Screen TechnologiesLearning objective 2: Identify potential problems with cost allocation, discuss activity-based costing (ABC) and cost drivers, and distinguish activity based costing (ABC) from activity-based management (ABM).The study finds that overhead cost is related to 7 drivers shown on the next slideThe ABC approach reveals that the high-volume product is very profitableHowever, the selling price does not come close to covering the full cost of the low volume productThe CFO’s intuition that the traditional product costing might be providing misleading information is correctSlide 6-49Activity Based Costing- McMaster Screen TechnologiesLearning objective 2: Identify potential problems with cost allocation, discuss activity-based costing (ABC) and cost drivers, and distinguish activity based costing (ABC) from activity-based management (ABM).Activity Based Costing- McMaster Screen TechnologiesSlide 6-50Learning objective 2: Identify potential problems with cost allocation, discuss activity-based costing (ABC) and cost drivers, and distinguish activity based costing (ABC) from activity-based management (ABM).Power Electronics uses two cost poolsEquipment setupsTotal estimated cost $1,500,000Estimated setups 10,000InspectionsTotal estimated cost $3,000,000Estimated inspections 15,000Calculate the cost per driver unit for each poolEquipment setups $1,500,000 / 10,000 = $150 per setupInspections $3,000,000 / 15,000 = $200 per inspectionSlide 6-51Test Your Knowledge 9Learning objective 2: Identify potential problems with cost allocation, discuss activity-based costing (ABC) and cost drivers, and distinguish activity based costing (ABC) from activity-based management (ABM).Power Electronics has two products:EP15010 setups3 inspectionsEP17540 setups8 inspectionsCalculate the overhead applied to EP150Equipment setups 10 * $150 per setup = $1,500Inspections 3 * $200 per inspection = $600Total overhead $1,500 + $600 = $2,100Slide 6-52Test Your Knowledge 10Learning objective 2: Identify potential problems with cost allocation, discuss activity-based costing (ABC) and cost drivers, and distinguish activity based costing (ABC) from activity-based management (ABM).Power Electronics has two products:EP15010 setups3 inspectionsEP17540 setups8 inspectionsCalculate the overhead applied to EP175Equipment setups 40 * $150 per setup = $6,000Inspections 8 * $200 per inspection = $1,600Total overhead $6,000 + $1,600 = $7,600Slide 6-53Test Your Knowledge 11Learning objective 2: Identify potential problems with cost allocation, discuss activity-based costing (ABC) and cost drivers, and distinguish activity based costing (ABC) from activity-based management (ABM).Pros and Cons of ABCBenefitsLess likely to undercost complex low volume products and overcost simple high volume productsDrivers used in ABC are not always volume relatedABC may lead to improvements in cost controlCosts are not buried in one or two poolsSlide 6-54Learning objective 2: Identify potential problems with cost allocation, discuss activity-based costing (ABC) and cost drivers, and distinguish activity based costing (ABC) from activity-based management (ABM).Pros and Cons of ABCLimitationsMore costly to develop and maintain than a traditional costing systemAllocations are made from each cost pool to each productUsed to develop full cost of productsIncludes fixed costsLacks incremental information necessary for decision makingSlide 6-55Learning objective 2: Identify potential problems with cost allocation, discuss activity-based costing (ABC) and cost drivers, and distinguish activity based costing (ABC) from activity-based management (ABM).Fixed and Variable CostsSlide 6-56Learning objective 2: Identify potential problems with cost allocation, discuss activity-based costing (ABC) and cost drivers, and distinguish activity based costing (ABC) from activity-based management (ABM).Activity-Based ManagementA tool that involves analyzing and costing activities with the goal of improving efficiency and effectivenessABC focus is on measuring cost of products and servicesABM focus is on goal of managing the activities themselvesFor example, ABC would calculate the cost per equipment setupABM would focus on ways to improve the setup process and reduce setup costSlide 6-57Learning objective 2: Identify potential problems with cost allocation, discuss activity-based costing (ABC) and cost drivers, and distinguish activity based costing (ABC) from activity-based management (ABM).Activity-Based ManagementSlide 6-58Learning objective 2: Identify potential problems with cost allocation, discuss activity-based costing (ABC) and cost drivers, and distinguish activity based costing (ABC) from activity-based management (ABM).Activity Based ManagementSlide 6-59Learning objective 2: Identify potential problems with cost allocation, discuss activity-based costing (ABC) and cost drivers, and distinguish activity based costing (ABC) from activity-based management (ABM).AppendixThe steps in activity-based management are:Determine major activitiesIdentify resources used by each activityEvaluate the performance of the activitiesIdentify ways to improve the efficiency and/or effectiveness of the activitiesSlide 6-60Learning objective 2: Identify potential problems with cost allocation, discuss activity-based costing (ABC) and cost drivers, and distinguish activity based costing (ABC) from activity-based management (ABM).Copyright © 2016 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.Slide 6-61