| Introduction | Product Costing | ABC | Absorption & Variable Costing | Allocating Support Costs | Allocating Joint Costs | Part II | Part III |
Source:
Textbook: Managerial Accounting, Creating Value in a Dynamic Business Environment (Fifth edition), Ronald W. Hilton
Notes: Management Accounting A, 2003 Semester 1, University of Sydney
Web: http://www.mhhe.com/business/accounting/garrison/Student/olc/garrison9emgracct_s/index.htm
Cost allocation is important for several purposes,
Cost-based pricing and bidding
Provide decision making, e.g. product mix
Motivate managers and employees
Justify cost and compute cost reimbursement from outside parties, such as insurance co., valuation of inventory and determination of cost of goods sold
measure income and assets for reporting
Serve to make departmental managers aware of the costs incurred to produce services their departments use
Purpose of cost allocation will influence criteria used
cause and effect
benefits received
fairness or equity
ability to bear
Means of cost allocation
Plantwide - product / service
Two-stage, 1) divisions / departments / services, 2) Products
There are two specific types of cost allocation,
Service Department is a unit in an organization that is not involved directly in producing the organization's goods or services. However SD does provide a service that enables the organization's production process to take place.
Example (Manufacturing) : Maintenance department in an automobile plant
Example (Non-manufacturing): Hospital's personnel department - provide staff for medical care
Service Department Cost Allocation | top |
When two service departments provide services to each other, the two service departments exhibit reciprocal services.
Three methods of service department cost allocation
The proportion of each service department costs to be allocated to each production department is determined by the relative proportion of the service department 's output consumed by each production department.
Direct method ignores the provision of services by one service department to another service department.
The deficiency of the Direct method is overcome partially by the step-down method.
Under this method, the managerial accountant first chooses a sequence in which to allocate the service departments' costs. A common way to select the first service department in the sequence is to choose the one that serves the largest number of other service departments. The service departments are ordered in this manner, with the last service department being the one that serves the smallest number of other service departments.
First allocate to service department, then to production departments.
Reciprocal-services method (Page 789, 798-799, Problem 18.26, 18.33)
Both direct method and step-down method ignores the reciprocal services (Mutual provision of service).
Reciprocal-services overcome this deficiency because it fully accounts for the mutual provision of service.
Fixed versus Variable Costs (Page 790) | top |
Problem: Allocating common fixed costs using a variable activity allocation base
Result: When one department decreases activity to reduce allocations, all departments are penalized because of the charge per usage increases. (Total fixed costs do not change when activity changes)
Solution: Use Dual Cost Allocation
Dual Cost Allocation (Page 791) | top |
Dual cost allocation works with either direct method or step-down method.
Under dual cost allocation, the allocation of fixed cost and variable costs are done separately.
Variable costs are allocated on the basis of short-run usage of the service department's output.
Fixed costs are allocated on the basis of long-run average usage of the service department's output. In this approach, fixed costs are considered to be capacity-producing costs. When service departments are established, their size and scale usually are determined by the projected long-run needs of the using departments.
Dual Cost allocation prevents a change in the short-run activity of one using department from affecting the cost allocated to another using department.
Behavioral Problem with dual cost allocation
"The higher a manager's estimate of the department's long run average usage, the greater will be the department's allocation of fixed service department costs"
Incentive to behavior - underestimate the costs to reduce cost allocation
Solution - reward managers for making accurate estimates
Other Issues (Page 793, 794) | top |
New manufacturing environment - more accurate cost tracing means reducing need for allocation of direct costs
Rise of ABC - Allocation are to activities, not to departments