Transcript Slide 1

Chapter 21
COST ALLOCATION AND
PERFORMANCE MEASUREMENT
PowerPoint Authors:
Susan Coomer Galbreath, Ph.D., CPA
Charles W. Caldwell, D.B.A., CMA
Jon A. Booker, Ph.D., CPA, CIA
Cynthia J. Rooney, Ph.D., CPA
McGraw-Hill/Irwin
Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.
21 - 2
ALLOCATING COSTS FOR
PRODUCT COSTING
One of the most
difficult tasks in
computing accurate
unit costs lies in
determining the
proper amount of
overhead cost to
assign to each job.
Assigning
overhead is
difficult.
I agree!
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P1
TWO-STAGE COST ALLOCATION
Service
Dept. 1
Service
Dept. 2
Service
Dept. 3
Operating
Dept.1
Operating
Dept. 2
Operating
Dept. 3
Stage One:
Costs assigned
to departments
Stage Two:
Costs applied
to jobs
Direct
Labor
Hours
Machine
Hours
Raw
Materials
Cost
Jobs
Departmental Allocation Bases
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P1
ILLUSTRATION OF TWO-STAGE
COST ALLOCATION
Ames Company manufactures hammers in regular and
deluxe models. Overhead is assigned on the basis of
direct labor hours. Budgeted overhead for the current
year is $2,000,000. Other information includes:
First, determine the unit cost of each model
using traditional costing methods.
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P1
ILLUSTRATION OF TWO-STAGE
COST ALLOCATION
Overhead = Estimated overhead costs
Rate
Estimated activity
Overhead
$2,000,000
=
Rate
40,000 DLH
= $50 per DLH
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P1
ILLUSTRATION OF TWO-STAGE
COST ALLOCATION
ABC will result in different
overhead cost per unit.
Direct Material
Direct Labor
Manufacturing Overhead
$50 per hour × 1.6 hours
$50 per hour × 0.8 hours
Total Unit Cost
Deluxe
Model
$ 150
16
Regular
Model
$ 112
8
80
$
246
$
40
160
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P2
ACTIVITY-BASED COST ALLOCATION
A
A
C
B
B C
With the Activity-Based
Costing (ABC) method,
we recognize that many
activities within a
department drive
overhead costs.
Identify activities and assign indirect costs to those activities.
Central idea . . .
Products require activities.
Activities consume resources.
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P2
ACTIVITY-BASED COSTING BENEFITS
 More detailed measures of costs.
 Better understanding of activities.
 More accurate product costs for . . .
 Pricing decisions.
 Product elimination decisions.
 Managing activities that cause costs.
 Benefits should always be compared
to costs of implementation.
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P2
ACTIVITY-BASED COSTING STEPS
 Identify activities that consume resources.
 Assign costs to a cost pool for each activity.
 Identify cost drivers associated with each activity.
 Compute overhead rate for each cost pool:
Rate =
Estimated overhead costs in activity cost pool
Estimated number of activity units
 Assign costs to products:
Overhead
Rate
×
Actual
Activity
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P2
ILLUSTRATION OF
ACTIVITY-BASED COSTING
Ames Company plans to adopt activity-based costing.
Using the following activity center data, determine the
unit cost of the two products using activity-based costing.
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P2
ILLUSTRATION OF
ACTIVITY-BASED COSTING
Total units of activity for both products.
Activity
Center
Purchasing
Scrap Rework
Testing
Machine Related
Total Overhead
Cost
Driver
Orders
Orders
Tests
Hours
Overhead
Cost for
Activity
$
84,000
216,000
450,000
1,250,000
$ 2,000,000
Units
of
Activity
1,200
900
15,000
50,000
Rate = Overhead Cost for Activity ÷ Units of Activity
Rate
$ 70 per order
$240 per order
$ 30 per test
$ 25 per hour
P2
ILLUSTRATION OF
ACTIVITY-BASED COSTING
Total overhead = $720,000 + $1,280,000 = $2,000,000
Recall that $2,000,000 was the original amount of overhead
assigned to the products using traditional overhead costing.
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P2
ILLUSTRATION OF
ACTIVITY-BASED COSTING
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P2
COMPARISON OF TWO-STAGE
AND ABC ALLOCATION
Traditional Costing
Deluxe
Regular
Model
Model
Direct labor
$
150
$
112
Direct material
16
8
Overhead
80
40
Total cost
$
246
$
160
ABC
Deluxe
Regular
Model
Model
$
150
$
112
16
8
144
32
$
310
$
152
This result is not uncommon when activity-based costing
is used. Many companies have found that low-volume,
specialized products have greater overhead costs than
previously realized.
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C1
DEPARTMENTAL ACCOUNTING
Primary
goals
Provide information
for managers to use
in performance
evaluation.
Assign costs to
managers who are
responsible for
controlling the costs.
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MOTIVATION FOR
C1
DEPARTMENTALIZATION
Large complex businesses are
divided into departments
enabling managers to have a
smaller effective span of control.
Departments are established for specialized functions.
Production
Sales
Service
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C1
DEPARTMENTAL EVALUATION
The accounting system provides information about
resources used and outputs achieved. Managers use this
information to control operations, appraise performance,
allocate resources, and plan strategy. The type of
accounting information provided depends on whether the
department is a . . .
Cost
center
Profit
center
Investment
center
Evaluated on
ability to
control costs.
Evaluated on ability
to generate revenues
in excess of expenses.
Evaluated on ability
to generate return on
investment in assets.
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C1
DEPARTMENTAL EXPENSE
ALLOCATION
Direct expenses are
incurred for the sole
benefit of a specific
department.
Indirect expenses
benefit more than one
department and are
allocated among
departments benefited.
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C1
ILLUSTRATION OF INDIRECT
EXPENSE ALLOCATION
Classic Jewelry pays its janitorial service $300
per month to clean its store. Management
allocates this cost to its three departments
according to the floor space each occupies.
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C1
ALLOCATION OF INDIRECT EXPENSES
Indirect expenses can be allocated to departments
using a number of allocation bases. Some common indirect
expenses and their allocation bases are:
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C1
SERVICE DEPARTMENT EXPENSES
Service department costs are shared, indirect
expenses that support the activities of two or
more production departments.
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P3
DEPARTMENTAL INCOME STATEMENTS
Let’s prepare departmental income
statements using the following steps:
1. Direct expense accumulation.
2. Indirect expense allocation.
3. Service department expense
allocation.
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P3
STEP 1: DIRECT EXPENSE
ACCUMULATION
Direct expenses are traced to each
department without allocation.
Service
Dept. One
Operating
Dept. One
Service
Dept. Two
Operating
Dept. Two
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STEP 2: INDIRECT
EXPENSE ALLOCATION
P3
Indirect expenses are allocated to all departments
using appropriate allocation bases.
Allocation
Operating
Dept. One
Allocation
Allocation
Service
Dept. One
Service
Dept. Two
Allocation
Operating
Dept. Two
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P3
STEP 3: SERVICE DEPARTMENT
EXPENSE ALLOCATION
Service department total expenses (original direct
expenses + allocated indirect expenses) are
allocated to operating departments.
Operating
Dept. One
Service
Dept. One
Service
Dept. Two
Allocation
Allocation
Operating
Dept. Two
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P3
DEPARTMENTAL EXPENSE
ALLOCATION SPREADSHEET
Allocation
Base
Direct expenses
Salaries
Supplies
Expense Allocation to Departments
Sales
Service Service Sales
Dept.
Dept.
Dept.
Dept.
Total
Two
One
Two
Expense One
$ 20,000 $ 1,000 $ 2,000 $ 6,000 $ 11,000
Payroll
700
400
300
100
1,500
Requisitions
Step 1: Direct expenses are traced to service
departments and sales departments without
allocation.
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P3
DEPARTMENTAL EXPENSE
ALLOCATION SPREADSHEET
Expense Allocation to Departments
Sales
Service Service Sales
Dept.
Dept.
Dept.
Dept.
Total
Allocation
2,000 square
feet, theOne
service
Two
One
Twodepartments
Expense
Base
Of a total of
expenses200 square feet each, sales department one
Direct
occupy
$ 11,000
$ 2,000 $ 6,000two
$ 1,000 department
$ 20,000
Payroll feet,
Salaries
occupies 600 square
and sales
700
400
300
100
1,500
Requisitions
Supplies
occupies 1,000 square feet.
Indirect expenses
Rent
Utilities
Total dept. expenses
Floor space
Floor space
5,000
3,000
1,000
1,000
10,000
500
300
100
100
1,000
$ 32,500 $ 2,200 $ 3,400 $ 9,700 $ 17,200
Step 2: Indirect expenses are allocated to both the
service and the sales departments based on floor space
occupied.
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P3
DEPARTMENTAL EXPENSE
ALLOCATION SPREADSHEET
Expense
Allocation(original
to Departments
Step 3: Service department total
expenses
Service Service Sales
Sales
direct expenses
+ allocated
Allocation
Total indirect
Dept. expenses)
Dept.
Dept.are Dept.
allocated
departments.
Baseto sales
Expense
One
Two
One
Two
Direct expenses
Salaries
Payroll
$ 20,000 $ 1,000 $ 2,000 $ 6,000 $11,000
Supplies
Requisitions
300 and400
Sales department
one has 1,500
$40,000100in sales
sales 700
Indirect expenses
department two has $48,000 in sales.
Rent
Floor space
10,000
1,000
1,000
3,000
5,000
Utilities
Floor space
1,000
100
100
300
500
Total dept. expenses
$ 32,500 $ 2,200 $ 3,400 $ 9,700 $17,200
Service dept. expenses
Service Dept. One
Sales
(2,200)
1,000
1,200
Service Dept. Two
Employees
Total expenses
$ 32,500 $ 0
$ 3,400 $10,700 $18,400
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P3
DEPARTMENTAL EXPENSE
ALLOCATION SPREADSHEET
to Departments
Allocation (original
Expense
Step 3: Service department total
expenses
Sales
Service Service Sales
direct expenses
+
allocated
indirect
expenses)
are
Dept.
Dept.
Dept.
Dept.
Total
Allocation
allocated
Two
One
Two
One
Expensedepartments.
Base to sales
Direct expenses
$ 20,000 $ 1,000 $ 2,000 $ 6,000 $ 11,000
Payroll
Salaries
Sales department
one has1,500
28 employees
sales 700
300 and 400
100
Requisitions
Supplies
Indirect expenses
department two has 40 employees.
5,000
3,000
1,000
1,000
10,000
Floor space
Rent
500
300
100
100
1,000
Floor space
Utilities
$ 32,500 $ 2,200 $ 3,400 $ 9,700 $ 17,200
Total dept. expenses
Service dept. expenses
1,200
1,000
(2,200)
Sales
Service Dept. One
2,000
1,400
(3,400)
Service Dept. Two Employees
$ 12,100 $ 20,400
$ 0
$ 32,500 $ 0
Total expenses
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P3
DEPARTMENTAL
INCOME STATEMENTS
Combined
$ 88,000
38,000
$ 50,000
Sales
Cost of goods sold
Gross profit on sales
Operating expenses
Salaries
$
Supplies
Rent
Utilities
Service Department One
Service Department Two
Total operating expenses
$
Net income
$
17,000
1,100
8,000
800
2,200
3,400
32,500
17,500
Sales
Sales
Dept. One Dept. Two
$ 40,000 $ 48,000
20,000
18,000
$ 20,000 $ 30,000
$
6,000
400
3,000
300
1,000
1,400
$ 12,100
$ 7,900
$ 11,000
700
5,000
500
1,200
2,000
$ 20,400
$
9,600
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P3
DEPARTMENTAL CONTRIBUTION
TO OVERHEAD
Departmental revenue
– Direct expenses
= Departmental contribution
Departmental contribution . . .
 Is used to evaluate departmental performance.
 Is not a function of arbitrary allocations of indirect
expenses.
A department may be a candidate for elimination
when its departmental contribution is negative.
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P3
DEPARTMENTAL CONTRIBUTION
TO OVERHEAD
Departmental contributions to indirect expenses (overhead) are
emphasized. Departmental contributions are positive so neither
department is a candidate for elimination.
Net income for the company is still $17,500.
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INVESTMENT CENTER RETURN
ON TOTAL ASSETS (ROI)
A1
ROI =
Investment Center Net Income
Investment Center Average Invested Assets
Comparison of Return on Investment
for LCD and S-Phone Divisions
LCD
S-Phone
Net Income
$ 526,500
$ 417,600
Average Invested Assets
2,500,000
1,850,000
Return on Investment
21%
23%
LCD Division earned more dollars of income, but it was less
efficient in using its assets to generate income compared
to S-Phone Division.
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INVESTMENT CENTER
RESIDUAL INCOME
A1
Residual
Income
=
Investment Center
Net Income
–
Target Investment
Center Net Income
The target net income is 8% of divisional assets.
Residual Income Comparison
for LCD and S-Phone Divisions
LCD
S-Phone
Net Income
$ 526,500
$ 417,600
Less: Target Net Income:
8% of $2,500,000
200,000
8% of $1,850,000
148,000
Residual Income
$ 326,500
$ 269,600
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A1
BALANCED SCORECARD
Customer Perspective
How do our
customers see us?
Innovation and Learning
How can we continually
improve and create value?
Performance
Measures
Financial Perspective
How do we look
to the firm’s owners?
Internal Business
Processes
In which activities
must we excel?
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C2
CONTROLLABLE VERSUS
DIRECT COSTS
Costs are controllable if the manager has the power
to determine, or strongly influence, the amounts
incurred. A manager’s performance evaluation
should be based on controllable costs.
Direct costs are traced to departments, but may not
be controllable by the department manager.
Example: Department managers usually
have no control over their own salaries.
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C2
RESPONSIBILITY ACCOUNTING SYSTEM
An accounting system that
provides information . . .
Relating to the
responsibilities of
individual managers.
To evaluate
managers on
controllable items.
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C2
Successful
implementation
of responsibility
Responsibility
Accounting
accounting may use organization charts with
clear lines of authority and clearly defined
levels of responsibility.
Board of Directors
President
Vice President
of Finance
Vice President
of Operations
Store Manager
Department Manager
Vice President
of Marketing
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C2
RESPONSIBILITY ACCOUNTING
PERFORMANCE REPORTS
Amount of detail varies according
to the level in the organization.
A department manager
receives detailed reports.
A store manager receives
summarized information
from each department.
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C2
RESPONSIBILITY ACCOUNTING
PERFORMANCE REPORTS
To be of maximum benefit, responsibility reports
should . . .
 Be timely.
 Be issued regularly.
 Be understandable.
 Compare budgeted
and actual amounts.
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GLOBAL VIEW
L’Oreal is an international cosmetics company incorporated in France.
With multiple brands and operations in over 100 countries, the
company uses concepts of departmental accounting and controllable
costs to evaluate performance. A recent annual report shows the
following for the major divisions in L’Oreal’s Cosmetics branch:
Division
Consumer Products
Professional Products
Luxury Products
Active Cosmetics
Other Cosmetics
Non-allocated costs
Cosmetics branch total
Operating Profit (€ millions)
€
1,578
519
766
259
(12)
€
3,110
(502)
€
2,608
L’Oreal’s non-allocated costs include costs that are not controllable by
division managers. Excluding noncontrollable costs enables L’Oreal to
prepare more meaningful division performance evaluations.
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A2
INVESTMENT CENTER PROFIT MARGIN
AND INVESTMENT TURNOVER
Return on
investment (ROI)
=
Profit
Margin
×
Investment
turnover
Investment center net income
Investment center sales
Investment center sales
Investment center average assets
International ROI = 2.56%
Domestic ROI = 16.64%
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C3
APPENDIX 21A: TRANSFER PRICING
A transfer price is the amount charged when one
division sells goods or services to another division.
LCD Displays
LCD Division
S-Phone Division
S-Phone can
purchase displays
for $80 from other
companies.
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C3
APPENDIX 21A: TRANSFER PRICING
LCD is producing and selling 100,000 units to outside customers.
(No excess capacity)
Transfer price = $80.
LCD Displays
LCD Division
S-Phone Division
With no excess capacity, the LCD manager will not accept a
transfer price less than $80 per monitor. The S-Phone manager
cannot buy monitors for less than $80 from outside suppliers, so
the $80 price is acceptable.
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C3
APPENDIX 21A: TRANSFER PRICING
LCD is producing and selling less than100,000 units to outside
customers. (Excess capacity)
Transfer price = $40 to $80.
LCD Displays
LCD Division
S-Phone Division
At a transfer price greater than $40, the LCD division receives
contribution margin. At a transfer price less than $80, the
S-Phone manager is pleased to buy from LCD, since that price
is below the market price of $80.
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C4
APPENDIX 21B: JOINT COSTS
AND THEIR ALLOCATION
Joint costs are costs incurred to produce or purchase two or more
products at the same time. Consider a sawmill company:
How should the joint costs be allocated to the different products?
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C4
APPENDIX 21B: JOINT COSTS
AND THEIR ALLOCATION
Physical Basis Allocation of Joint Cost
10,000 ÷ 100,000 = 10%
10% of $30,000 = $3,000
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C4
APPENDIX 21B: JOINT COSTS
AND THEIR ALLOCATION
Value Basis Allocation of Joint Cost
$12,000 ÷ $50,000 = 24%
24% of $30,000 = $7,200
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END OF CHAPTER 21