14 CHAPTER COST ALLOCATION 14-1
Disagree. Cost accounting data plays a key role in many management planning and control decisions. The division president will be able to make better operating and strategy decisions by being involved in key decisions about cost pools and cost allocation bases.
14-2
The salary of a plant security guard would be a direct cost when the cost object is the security department or the plant. It would be an indirect cost when the cost object is a product. Exhibit 14-1 outlines four purposes for allocating costs: To provide information for economic decisions. To motivate managers and employees. To justify costs or compute reimbursement. To measure income and assets for meeting external reporting and legal regulatory obligations.
14-3
1. 2. 3. 4.
1. 2. 3. 4.
14-4
Exhibit 14-2 lists four criteria used to guide cost allocation decisions: Cause and effect. Benefits received. Fairness or equity. Ability to bear.
Either the cause-and-effect criterion or the benefits received criterion is the dominant one when the purpose of the allocation is related to the economic decision purpose or the motivation purpose.
14-5
1. 2. 3. 4. 5. 6.
Costs are allocated to divisions and departments in order to: Determine costs. Evaluate profit centres. Fix accountability. Allocate costs per usage. Promote more effective resource usage. Foster cost awareness.
14-6
Cost-benefit considerations can affect costing choices in several ways: (a) Classifying some immaterial costs as indirect when they could, at high cost, be traced to products, services or customers as direct costs. (b) 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. (c) 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.
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14-7
Three decisions managers face when designing the cost allocation component of an accounting system are: i. Which cost items should be included in the indirect cost pools? ii. How many indirect cost pools should be used? iii. Which allocation base should be used for each indirect cost pool?
14-8
Examples of bases used to allocate corporate cost pools to operating divisions are: Possible Allocation Bases Sales; assets employed; operating income Sales; assets employed; estimated time or usage Estimated time or usage; sales; assets employed Sales; number of sales personnel Number of employees; payroll dollars Number of employees; payroll dollars; number of new hires
Corporate Cost Pools Corporate executive dept. Treasury department Legal department Marketing department Payroll department Human resources department
14-9
The use of budgeted indirect cost allocation rates rather than actual indirect rates has several attractive features to the manager of a user department: a. The user knows the costs in advance and can factor them into ongoing operating choices. b. Inefficiencies at the department providing the service do not affect the costs allocated to the user department.
department managers means department managers can lower their cost allocations by deliberately underestimating their long-run use.
14-10 Disagree. Allocating costs on the basis of estimated long-run use by user
14-11 The three methods differ in how they recognize reciprocal services among support
departments: a. The direct allocation method ignores any services rendered by one support department to another; it allocates each support departments total costs directly to the operating departments. b. The step-down allocation method allows for partial recognition of support rendered by support departments to other support departments. c. The reciprocal allocation method allocates costs by explicitly recognizing the mutual services rendered among support departments.
recognizes the mutual services rendered among all departments, irrespective of whether those departments are operating or support departments.
14-12 The reciprocal method is theoretically the most defensible method because it explicitly
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14-13 The incremental common cost allocation method first allocates the common costs to the
primary user; the incremental party is allocated the incremental component of the common cost arising because there are two users and not just the primary user. The stand-alone common cost allocation method allocates the common cost on the basis of each users percentage of the total of the individual stand-alone costs.
14-14 The basis for the cost allocation should be clearly defined within the government
contract.
14-15 A dispute over allocation of revenues of a bundled product could be resolved by (a)
having an agreement that outlines the preferred method in the case of a dispute, or (b) having a third party (such as the company president or an independent arbitrator) make a decision.
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Chapter 14
14-16 (15-20 min.) Single-rate versus dual-rate cost allocation methods.
1. The total costs in the single-cost pool are fixed ($1,100,000) and variable ($2,200,000) = $3,300,000. The company could use one of two allocation bases (budgeted usage or actual usage) given the information provided. Allocation to Cambridge based on budgeted usage: (60/200) $3,300,000 = $990,000 Allocation to Cambridge based on actual usage: (120/240) $3,300,000 = $1,650,000 Using the dual-rate method (with separate fixed and variable cost pools), several combinations of the budgeted and actual usage allocation bases are possible: Fixed Cost Pool: Total costs of $1,100,000: Allocation to Cambridge based on budgeted usage: (60/200) $1,100,000 = $330,000 Allocation to Cambridge based on actual usage: (120/240) $1,100,000 = $550,000 Variable Cost Pool: Total costs of $2,200,000: Allocation to Cambridge based on budgeted usage: (60/200) $2,200,000 = $660,000 Allocation to Cambridge based on actual usage: (120/240) $2,200,000 = $1,100,000 The possible combinations are: Combination Fixed Cost Pool I Budgeted Usage II Budgeted Usage III Actual Usage IV Actual Usage
2.
Variable Cost Pool Budgeted Usage Actual Usage Budgeted Usage Actual Usage
Allocation Function = $330,000 + $660,000 = $990,000 = $330,000 + $1,100,000 = $1,430,000 = $550,000 + $660,000 = $1,210,000 = $550,000 + $1,100,000 = $1,650,000
Combinations I and IV give the same cost allocations as in requirement 1. Combination II is a frequently used dual-rate method. The fixed costs are allocated using budgeted usage on the rationale that it better captures the cost of providing capacity. The variable costs are allocated using actual usage on a cause-and-effect rationale. Combination III is rarely encountered in practice.
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14-17 (20 min.) Single-rate versus dual-rate methods, support department.
Bases available (kilowatt hours): Rockford Peoria Practical capacity 10,000 20,000 Expected monthly 8,000 9,000 usage Hammond Kankakee Total 12,000 8,000 50,000 7,000 6,000 30,000
1a. Single-rate method based on practical capacity: Total costs in pool = $6,000 + $9,000 = $15,000 Practical capacity = 50,000 kilowatt hours Allocation rate = $15,000 50,000 = $0.30 per hour of capacity Rockford Peoria Hammond Kankakee Total Practical capacity in hours 10,000 20,000 12,000 8,000 50,000 Costs allocated at $0.30 per $3,000 $6,000 $3,600 $2,400 $15,000 hour 1b. Single-rate method based on expected monthly usage: Total costs in pool = $6,000 + $9,000 = $15,000 Expected usage = 30,000 kilowatt hours Allocation rate = $15,000 30,000 = $0.50 per hour of expected usage Rockford Peoria Hammond Kankakee Total Expected monthly usage in hours 8,000 9,000 7,000 6,000 30,000 Costs allocated at $0.50 per hour $4,000 $4,500 $3,500 $3,000 $15,000 2. Variable-Cost Pool: Total costs in pool Expected usage Allocation rate Fixed-Cost Pool: Total costs in pool Practical capacity Allocation rate = = = $6,000 30,000 kilowatt hours $6,000 30,000 = $0.20 per hour of expected usage
= = =
$9,000 50,000 kilowatt hours $9,000 50,000 = $0.18 per hour of capacity
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14-17 (contd)
Rockford Variable-cost pool $0.20 8,000; 9,000; 7,000, 6,000 Fixed-cost pool $0.18 10,000; 20,000; 12,000, 8,000 Total $1,600 1,800 $3,400 Peoria $1,800 3,600 $5,400 Hammond Kankakee $1,400 2,160 $3,560 $1,200 1,440 $2,640 Total $ 6,000 9,000 $15,000
The dual-rate method permits a more refined allocation of the power department costs; it permits the use of different allocation bases for different cost pools. The fixed costs result from decisions most likely associated with the practical capacity level. The variable costs result from decisions most likely associated with monthly usage.
14-18 (2025 min.) Single-rate method, budgeted versus actual costs and quantities.
1a. Budgeted indirect costs = $115,000/50 trips = $2,300 per round-trip Budgeted trips Indirect costs allocated to Dark C. Division = $2,300 per round trip 30 budgeted round trips
Budgeted rate = = $69,000 Indirect costs allocated to Milk C. Division = $2,300 per round trip 20 budgeted round trips = $46,000 b. Budgeted rate = $2,300 per round-trip Indirect costs allocated to Dark C. Division = $2,300 per round trip 30 actual round trips = $69,000 Indirect costs allocated to Milk C. Division = $2,300 per round trip 15 actual round trips = $34,500
Actual indirect costs = $96,750/ 45 trips = $2,150 per round trip Actual trips Indirect costs allocated to Dark C. Division = $2,150 per round trip 30 actual round trips
c. Actual rate = = $64,500 Indirect costs allocated to Milk C. Division = $2,150 per round trip 15 actual round trips = $32,250
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14-18 (contd)
2. When budgeted rates/budgeted quantities are used, the Dark Chocolate and Milk Chocolate Divisions know at the start of 2009 that they will be charged a total of $69,000 and $46,000 respectively for transportation. In effect, the fleet resource becomes a fixed cost for each division. Then, each may be motivated to over-use the trucking fleet, knowing that their 2009 transportation costs will not change. When budgeted rates/actual quantities are used, the Dark Chocolate and Milk Chocolate Divisions know at the start of 2009 that they will be charged a rate of $2,300 per round trip, i.e., they know the price per unit of this resource. This enables them to make operating decisions knowing the rate they will have to pay for transportation. Each can still control its total transportation costs by minimizing the number of round trips it uses. Assuming that the budgeted rate was based on honest estimates of their annual usage, this method will also provide an estimate of the excess trucking capacity (the portion of fleet costs not charged to either division). In contrast, when actual costs/actual quantities are used, the two divisions must wait until year end to know their transportation charges. The use of actual costs/actual quantities makes the costs allocated to one division a function of the actual demand of other users. In 2009, the actual usage was 45 trips, which is 5 trips below the 50 trips budgeted. The Dark Chocolate Division used all the 30 trips it had budgeted. The Milk Chocolate Division used only 15 of the 20 trips budgeted. When costs are allocated based on actual costs and actual quantities, the same fixed costs are spread over fewer trips resulting in a higher rate than if the Milk Chocolate Division had used its budgeted 20 trips. As a result, the Dark Chocolate Division bears a proportionately higher share of the fixed costs. Using actual costs/actual rates also means that any efficiencies or inefficiencies of the trucking fleet get passed along to the user divisions. In general, this will have the effect of making the truck fleet less careful about its costs, although in 2009, it appears to have managed its costs well, leading to a lower actual cost per round trip relative to the budgeted cost per round trip. For the reasons stated above, of the three single-rate methods suggested in this problem, the budgeted rate and actual quantity may be the best one to use. (The management of Chocolat, Inc. would have to ensure that the managers of the Dark Chocolate and Milk Chocolate divisions do not systematically overestimate their budgeted use of the fleet division in an effort to drive down the budgeted rate).
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14-19 (20 min.) Dual-rate method, budgeted versus actual costs, and practical capacity versus actual quantities (continuation of 14-18).
1. Charges with dual rate method. Variable indirect cost rate = $1,500 per trip Fixed indirect cost rate = $40,000 budgeted costs/ 50 round trips budgeted = $800 per trip Dark Chocolate Division Variable indirect costs, $1,500 30 Fixed indirect costs, $800 30 Milk Chocolate Division Variable indirect costs, $1,500 15 Fixed indirect costs, $800 20
$45,000 24,000 $69,000
2.
$22,500 16,000 $38,500 The dual rate changes how the fixed indirect cost component is treated. By using budgeted trips made, the Dark Chocolate Division is unaffected by changes from its own budgeted usage or that of other divisions. When budgeted rates and actual trips are used for allocation (see requirement 1.b. of problem 14-18), the Dark Chocolate Division is assigned the same $24,000 for fixed costs as under the dual-rate method because it made the same number of trips as budgeted. However, note that the Milk Chocolate Division is allocated $16,000 in fixed trucking costs under the dual-rate system, compared to $800 15 actual trips = $12,000 when actual trips are used for allocation. As such, the Dark Chocolate Division is not made to appear disproportionately more expensive than the Milk Chocolate Division simply because the latter did not make the number of trips it budgeted at the start of the year.
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14-20 (30 min.) Support department cost allocation; direct and stepdown methods.
1. a. Direct method costs Alloc. of AS costs (40/75, 35/75) Alloc. of IS costs (30/90, 60/90) Step-down (AS first) costs Alloc. of AS costs (0.25, 0.40, 0.35) Alloc. of IS costs (30/90, 60/90) Step-down (IS first) costs Alloc. of IS costs (0.10, 0.30, 0.60) Alloc. of AS costs (40/75, 35/75) AS IS $600,000 $2,400,000 (600,000) (2,400,000) $ 0$ 0 $600,000 $2,400,000 (600,000) 150,000 GOVT
CORP
$ 320,000 800,000 $1,120,000
$ 280,000 1,600,000 $1,880,000
b.
$ 240,000 850,000 $1,090,000
$ 210,000 1,700,000 $1,910,000
c.
(2,550,000) $ 0$ 0 $600,000 $2,400,000 240,000 (2,400,000) (840,000) $ 0$
$ 720,000 448,000 $1,168,000 GOVT $1,120,000 1,090,000 1,168,000
$1,440,000 392,000 $1,832,000 CORP $1,880,000 1,910,000 1,832,000
0
2. Direct method Step-down (AS first) Step-down (IS first)
The direct method ignores any services to other support departments. The stepdown method partially recognizes services to other support departments. The information systems support group (with total budget of $2,400,000) provides 10% of its services to the AS group. The AS support group (with total budget of $600,000) provides 25% of its services to the information systems support group. When the AS group is allocated first, a total of $2,550,000 is then assigned out from the IS group. Given CORPs disproportionate (2:1) usage of the services of IS, this method then results in the highest overall allocation of costs to CORP. By contrast, GOVTs usage of the AS group exceeds that of CORP (by a ratio of 8:7), and so GOVT is assigned relatively more in support costs when AS costs are assigned second, after they have already been incremented by the AS share of IS costs as well.
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14-20 (contd)
3. Three criteria that could determine the sequence in the step-down method are: a. Allocate support departments on a ranking of the percentage of their total services provided to other support departments. 1. Administrative Services 25% 2. Information Systems 10% b. Allocate support departments on a ranking of the total dollar amount in the support departments. 1. Information Systems $2,400,000 2. Administrative Services $ 600,000 c. Allocate support departments on a ranking of the dollar amounts of service provided to other support departments 1. Information Systems (0.10 $2,400,000) = $240,000 2. Administrative Services (0.25 $600,000) = $150,000 The approach in (a) above typically better approximates the theoretically preferred reciprocal method. It results in a higher percentage of support-department costs provided to other support departments being incorporated into the step-down process than does (b) or (c), above.
14-21 (50 min.)
1a.
Support-department cost allocation, reciprocal method (continuation of 14-20).
Support Departments AS IS $600,000 $2,400,000 (861,538) 261,538 0 215,385 (2,615,385) $ 0 Operating Departments Govt. Corp.
Costs Alloc. of AS costs
(0.25, 0.40, 0.35) Alloc. of IS costs (0.10, 0.30, 0.60)
$ 344,615 784,616 $1,129,231
$ 301,538 1,569,231 $1,870,769
$
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14-21 (contd)
Reciprocal Method Computation AS = $600,000 + 0.10 IS IS = $2,400,000 + 0.25AS IS = $2,400,000 + 0.25 ($600,000 + 0.10 IS) = $2,400,000 + $150,000 + 0.025 IS 0.975IS = $2,550,000 IS = $2,550,000 0.975 = $2,615,385 AS = $600,000 + 0.10 ($2,615,385) = $600,000 + $261,538 = $861,538 Support Departments AS $600,000 (600,000) IS $2,400,000 150,000 2,550,000 (2,550,000) 63,750 (63,750) 1,594 Operating Departments Govt. Corp.
1b.
Costs
1st Allocation of AS (0.25, 0.40, 0.35) 1st Allocation of IS (0.10, 0.30, 0.60) nd Allocation of AS 2 (0.25, 0.40, 0.35) 2nd Allocation of IS (0.10, 0.30, 0.60) 3rd Allocation of AS (0.25, 0.40, 0.35) rd Allocation of IS 3 (0.10, 0.30, 0.60) th Allocation of AS 4 (0.25, 0.40, 0.35) th Allocation of IS 4 (0.10, 0.30, 0.60) 5th Allocation of AS (0.25, 0.40, 0.35) th Allocation of IS 5 (0.10, 0.30, 0.60) Total allocation
$ 240,000
$
210,000
255,000 (255,000) 6,375 (6,375)
765,000 102,000 19,125 2,550
1,530,000 89,250 38,250 2,231
160 (160) 4 (4) 0 0
(1,594) 40 (40) 1 (1 ) 0
478 64 12 2 0 $1,129,231
956 56 24 1 1 $1,870,769
$
$
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14-21 (contd)
2. a. b. c. d. e. Direct Step-down (AS first) Step-down (IS first) Reciprocal (linear equations) Reciprocal (repeated iterations) Govt. Consulting $1,120,000 1,090,000 1,168,000 1,129,231 1,129,231 Corp. Consulting $1,880,000 1,910,000 1,832,080 1,870,769 1,870,769
The four methods differ in the level of support department cost allocation across support departments. The level of reciprocal service by support departments is material. Administrative Services supplies 25% of its services to Information Systems. Information Systems supplies 10% of its services to Administrative Services. The Information Department has a budget of $2,400,000 that is 400% higher than Administrative Services. The reciprocal method recognizes all the interactions and is thus the most accurate. This is especially clear from looking at the repeated iterations calculations.
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14-22 (45 min.)
Allocating costs of support departments; step-down and direct methods.
Building and Grounds General Plant Admin. $ 26,090 700 210 $(27,000) Cafeteria Operating Loss $ 1,640 400 60 1,000 $(3,100)
Personnel $ 1,000 200 $(1,200)
Storeroom $ 2,670 700 30 1,000 100 $(4,500)
Machining $34,700 3,000 300 8,000 1,000 3,000 $50,000 5,000 $ 10
Assembly $48,900 5,000 600 17,000 2,000 1,500 $75,000 15,000 $ 5
1. Step-down Method: (1) Building & grounds at $0.10/sq. m. ($10,000 100,000) (2) Personnel at $6/employee ($1,200 200) (3) General plant administration at $1/labour-hour ($27,000 27,000) (4) Cafeteria at $20/employee ($3,100 155) (5) Storeroom at $1.50/requisition ($4,500 3,000) (6) Costs allocated to operating depts. (7) Divide (6) by dir. manuf. labour-hrs. (8) Overhead rate per direct manuf. labour-hour 2. Direct method: (1) Building and grounds, 30,000/80,000; 50,000/80,000 (2) Personnel, 50/150; 100/150 (3) General plant administration, 8,000/25,000; 17,000/25,000 (4) Cafeteria, 50/150; 100/150 (5) Storeroom: 2,000/3,000; 1,000/3,000 (6) Costs allocated to operating depts. (7) Divide (6) by direct manufacturing labour-hours (8) Overhead rate per direct manufacturing labour-hour
$ 10,000 $(10,000)
$10,000 (10,000)
$1,000
$26,090
$1,640
$2,670
$34,700 3,750 333
$48,900 6,250 667 17,741 1,093 890 $75,541 15,000 $ 5.036
(1,000) (26,090) (1,640) (2,670)
8,349 547 1,780 $49,459 5,000 $ 9.892
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14-22 (contd)
3. Comparison of methods: Step-down method: Job 88: Job 89: 18 $10 2$ 5 3 $10 17 $ 5 18 $9.892 2 $5.036 3 $9.892 17 $5.036 $180 10 $ 30 85 $178.06 10.07 $ 29.68 85.61
$190.00 115.00
Direct method:
Job 88: Job 89:
$188.13 115.29
4.
The manager of the Machining Department would prefer the direct method. The direct method results in a lower amount of support departments costs being allocated to the Machining Department than the step-down method. This is clear from a comparison of the overhead rate, per direct manufacturing labour-hour, for the Machining Department under the two methods.
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14-23 (20-25 mins.) Stand-alone revenue allocation
1. Allocation using ticket sales price Percentage of Total Price 0.333 0.500 0.167 Allocation % $90 $30 45 15 $90
Park Water Superhero Theme Animal Total 2.
Ticket Price $ 40 60 20 $120
Allocation using cost per entrant Cost Per Park Entrant Water $15 Superhero Theme 25 Animal 10 Total $50
Percentage of Total Cost 0.300 0.500 0.200
Allocation % $90 $27 45 18 $90
3.
Allocation using number of tickets received # of Tickets Percentage of Park Received Total Price Water 1 0.333 Superhero Theme 1 0.333 Animal 1 0.333 Total 3
Allocation % $90 $30 30 30 $90
4.
Sharing on the basis of revenue makes the most sense, especially if the ticket price is somewhat a surrogate for demand. One could argue that since each ticket gives the entrant one full day in each park, then an entrants willingness to pay more for a particular park reflects the additional value placed on that park. Also, it would be hard to justify the Animal park receiving almost its full ticket price using the cost basis and more than its ticket price using the number of tickets basis.
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14-24 (40 min.)
1.
Direct and step-down allocation.
Support Departments HR IS $72,700 $234,400 (72,700) (234,400) $ 0 $ 0 Operating Departments Corporate Consumer $ 998,270 $489,860 43,620 127,855 $1,169,745 29,080 106,545 $625,485 $1,795,230
Costs Incurred Alloc. of HR costs (42/70, 28/70) Alloc. of IS costs (1,920/3,520, 1,600/3,520)
Total $1,795,230
2.
Rank on percentage of services rendered to other support departments. Step 1: HR provides 23.077% of its services to Information Systems: 23.077%
21 21 = = 42 28 21 91 This 23.077% of $72,700 HR department costs is $16,777.
Step 2: Information Systems provides 8.333% of its services to HR:
320 320 = = 8.333% 1,920 1,600 320 3,840 This 8.333% of $234,400 Information Systems department costs is $19,533.
Support Departments Costs Incurred Alloc. of HR costs (21/91, 42/91, 28/91) Alloc. of IS costs (1,920/3,520, 1,600/3,520) HR $72,700 (72,700) $ 0 IS $234,400 16,777 251,177 (251,177) $ Operating Departments Corporate $ 998,270 33,554 Consumer $489,860 22,369 Total $1,795,230
137,006 0 $1,168,830
114,171 $626,400 $1,795,230
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14-24 (contd)
3. An alternative ranking is based on the dollar amount of services rendered to other support departments. Using numbers from requirement 2, this approach would use the following sequence: Step 1: Allocate Information Systems first ($19533 provided to HR). Step 2: Allocate HR second ($16777 provided to Information Systems).
14-25 (30 min.) Reciprocal cost allocation (continuation of 14-25).
1. The reciprocal allocation method explicitly includes the mutual services provided among all support departments. Interdepartmental relationships are fully incorporated into the support department cost allocations. HR IS HR
2.
= $72,700 + .08333IS = $234,400 + .23077HR = $72,700 + [.08333($234,400 + .23077HR)] = $72,700 + [$19,532.55 + 0.01923HR] 0.98077HR = $92,232.55 HR = $92,232.55 0.98077 = $94,041 IS = $234,400 + (0.23077 $94,041) = $256,102
Costs Incurred Alloc. of HR costs (21/91, 42/91, 28/91) Alloc. of IS costs (320/3,840, 1,920/3,840, 1,600/3,840) Support Depts. HR IS $72,700 $234,400 (94,041) 21,702 Operating Depts. Corporate Consumer Total $ 998,270 $489,860 $1,795,230 43,404 28,935
21,341 $ 0
(256,102) $ 0
128,051 $1,169,725
106,710 $625,505
$1,795,230
Solution Exhibit 14-25 presents the reciprocal method using repeated iterations.
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14-25 (contd)
SOLUTION EXHIBIT 14-25 Reciprocal Method of Allocating Support Department Costs for September 2010 at E-books Using Repeated Iterations Support Departments Operating Departments Human Information Corporate Consumer Resources Systems Sales Sales
Budgeted manufacturing overhead costs before any interdepartmental cost allocation 1st Allocation of HR (21/91, 42/91, 28/91)a 1st Allocation of Information Systems (320/3,840, 1,920/3,840, 1,600/3,840)b 2nd Allocation of HR (21/91, 42/91, 28/91)a 2nd Allocation of Information Systems (320/3,840, 1,920/3,840, 1,600/3,840)b 3rd Allocation of HR (21/91, 42/91, 28/91)a 3rd Allocation of Information Systems (320/3,840, 1,920/3,840, 1,600/3,840)b 4th Allocation of HR (21/91, 42/91, 28/91)a 4th Allocation of Information Systems: (320/3,840, 1,920/3,840, 1,600/3,840)b Total budgeted manufacturing overhead of operating departments $72,700 (72,700) $234,400 16,777 251,177 (251,177) $ 998,270 33,554 $489,860 22,369
Total
$1,795,230
20,931
125,589
104,657
(20,931)
4,830
9,661
6,440
402
(4,830)
2,415
2,013
(402) 8
93 (93)
185 46
124 39
(8)
2
4
2
0
(2)
1
1
$
0
$
0
$1,169,725
$625,505
$1,795,230
Total accounts allocated and reallocated (the numbers in parentheses in first two columns) HR $72,700 + $20,931 + $402 + $8 = $94,041 Information Systems $251,177 + $4,830 + $93 + $2 = $256,102
a b
Base is (21 + 42 + 28) or 91 employees Base is (320 + 1,920 + 1,600) or 3,840 minutes
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14-25 (contd)
3. The reciprocal method is more accurate than the direct and step-down methods when there are reciprocal relationships among support departments. A summary of the alternatives is:
Direct method Step-down method (HR first) Reciprocal method Corporate Sales $1,169,745 1,168,830 1,169,725
Consumer Sales $625,485 626,400 625,505
The reciprocal method is the preferred method, although for September 2010 the numbers do not appear materially different across the alternatives.
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14-26 (20 min.) Single-rate, dual-rate, and practical capacity allocation.
Budgeted number of gifts wrapped = 6,750 Budgeted fixed costs = $6,750 Fixed cost per gift based on budgeted volume = $6,750 6,750 = $1.00 Average budgeted variable cost per gift = 0.50 Total cost per gift wrapped $1.50 1.a. Allocation based on budgeted usage of gift-wrapping services: Womens Face Wash (2,475 $1.50) $ 3,712.50 Mens Face Wash (825 $1.50) 1,237.50 Fragrances (1,800 $1.50) 2,700.00 Body Wash (450 $1.50) 675.00 Hair Products (1,200 $1.50) 1,800.00 Total $10,125.00
1.b. Allocation based on actual usage of gift-wrapping services:
Womens Face Wash (2,100 $1.50) Mens Face Wash (750 $1.50) Fragrances (1,575 $1.50) Body Wash (525 $1.50) Hair Products (1,050 $1.50) Total
$3,150.00 1,125.00 2,362.50 787.50 1,575.00 $9,000.00
1.c. Practical gift-wrapping capacity = 7,500 Budgeted fixed costs = $6,750 Fixed cost per gift based on practical capacity = $6,750 7,500 = $0.90 Average budgeted variable cost per gift = 0.50 Total cost per gift wrapped $1.40
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14-26 (contd)
Allocation based on actual usage of gift-wrapping services: Womens Face Wash (2,100 $1.40) Mens Face Wash (750 $1.40) Fragrances (1,575 $1.40) Body Wash (525 $1.40) Hair Products (1,050 $1.40) Total 2. Budgeted rate for fixed costs = $2,940 1,050 2,205 735 1,470 $8,400
Budgeted costs fixed Practical capacity = $6,750 7,500 gifts = $0.90 per gift Fixed costs allocated on budgeted usage.
Rate for variable costs = $0.50 per item Variable costs based on actual usage. Allocation:
Department Womens Face Wash Mens Face Wash Fragrances Body Wash Hair Products Total 3.
Variable Costs Fixed Costs 2,100 $0.50 =$1,050.00 2,475 $0.90 = $2,227.50 750 $0.50 = 375.00 825 $0.90 = 742.50 1,575 $0.50 = 787.50 1,800 $0.90 = 1,620.00 525 $0.50 = 262.50 450 $0.90 = 405.00 1,050 $0.50 = 525.00 1,200 $0.90 = 1,080.00 $3,000.00 $6,075.00
Total $3,277.50 1,117.50 2,407.50 667.50 1,605.00 $9,075.00
The dual-rate method has three major advantages over the single-rate method: a. Fixed costs and variable costs can be allocated differentlyfixed costs based on rates calculated using practical capacity and budgeted usage, and variable costs based on budgeted rates and actual usage. b. Fixed costs are allocated proportionately to the departments causing the incurrence of those costs based on the capacity of each department. c. The costs allocated to a department are not affected by the usage by other departments.
Note: If capacity costs are the result of a long-term decision by top management, it may be desirable to allocate to each department the cost of capacity used based on actual usage. The users are then not allocated the costs of unused capacity.
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14-27 (15 min.) Allocating costs to divisions.
1. Allocations based on square metres.
Refrigerator 1. Square metres 2. % square metres (130,000; 90,000; 80,000; 10,000 400,000) 3. Allocated headquarters cost (Row 2 $14,255,000) 130,000 Stove 90,000 Dishwasher 80,000 Microwave Oven 100,000
Total 400,000
32.5% $4,632,875
22.5% $3,207,375
20% $2,851,000
25% $3,563,750
100% $14,255,000
Refrigerator Segment margin Less: Headquarters costs Division margin Division margin Revenues $5,200,000 4,632,875 $ 567,125 5.2%
Stove $8,400,000 3,207,375 $5,192,625 27.6%
Dishwasher $5,300,000 2,851,000 $2,449,000 21.3%
Microwave Oven $3,560,000 3,563,750 $ (3,750) (0.06)%
Total $22,460,000 14,255,000 $ 8,205,000 17.1%
Allocations based on segment margin.
Refrigerator 1. Segment margin 2. % segment margin $5,200,000; $8,400,000; $5,300,000; $3,560,000 $22,460,000 3. Allocated headquarters cost (Row 2 $14,255,000) $5,200,000 Stove $8,400,000 Dishwasher $5,300,000
Microwave Oven $3,560,000
Total $22,460,000
23.15% $3,300,033
37.40% $5,331,370
23.60% $3,364,180
15.85% $2,259,417 Microwave Oven $3,560,000 2,259,417 $1,300,583 19.2%
100% $14,255,000
Refrigerator Segment margin Less: Headquarters costs Division margin Division margin Revenues $5,200,000 3,300,033 $1,899,967 17.4%
Stove $8,400,000 5,331,370 $3,068,630 16.3%
Dishwasher $5,300,000 3,364,180 $1,935,820 16.8%
Total $22,460,000 14,255,000 $ 8,205,000 17.1%
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2. I prefer the allocation based on segment margins because a cause-and-effect relationship may exist between headquarters costs and division segment margin headquarters staff are likely to spend more time on divisions that have more revenues and segment margins. Segment margins can also be justified on the abilityto-bear principledivisions with higher margins can bear more of the headquarters costs. The physical size of the divisions probably has no cause-and-effect relationship with headquarters costs. None of the divisions should be dropped, since all four have positive segment margins before considering the headquarters cost allocation. As seen by these two options, the allocation of headquarters costs is arbitrary and should not serve as the basis for closing a division.
3.
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Chapter 14
14-28 (4060 min.) Support-department cost allocations; singledepartment cost pools; direct, step-down, and reciprocal methods.
All the following computations are in dollars. 1.
Direct method: A B Total To X 250/400 $100,000 = $62,500 100/500 $ 40,000 = 8,000 $70,500 To Y 150/400 $100,000
= $37,500 32,000 $69,500
400/500 $ 40,000 =
Step-down method, allocating A first: Costs to be allocated Allocate A: (100; 250; 150 500) Allocate B: (100; 400 500) Total A $100,000 (100,000) $ 0 B $40,000 20,000 (60,000) $ 0 B $ 40,000 (40,000) $ 0 X $50,000 12,000 $62,000 X $ 4,000 75,000 $79,000 Y $30,000 48,000 $78,000 Y $16,000 45,000 $61,000
Step-down method, allocating B first: A Costs to be allocated $100,000 Allocate B: (500; 100; 400 1,000) 20,000 Allocate A: (250/400, 150/400) (120,000) Total $ 0
Note that these methods produce significantly different results, so the choice of method may frequently make a difference in the budgeted department overhead rates.
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Reciprocal method: Stage 1: Let (1) (2) A B A B = = = = total costs of materials-handling department total costs of power-generating department $100,000 + 0.5B $ 40,000 + 0.2A A A 0.9A A = = = = = = $100,000 + 0.5($40,000 + 0.2A) $100,000 + $20,000 + 0.1A $120,000 $133,333
Stage 2: Substituting in (1):
Substituting in (2): B B Stage 3: Original amounts Allocation of A Allocation of B Totals accounted for
$40,000 + 0.2($133,333) $66,666 B X Y $40,000 26,666(20%) $66,667(50%) $40,000(30%) (66,666) 6,667(10%) 26,666(40%) $ 0 $73,334 $66,666
A $100,000 (133,333) 33,333(50%) $ 0
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SOLUTION EXHIBIT 14-28 Reciprocal Method of Allocating Support Department Costs for Manes Company Using Repeated Iterations. Support Departments A B
Budgeted manufacturing overhead costs before any interdepartmental cost allocations 1st Allocation of Dept. A: (2/10, 5/10, 3/10)a 1st Allocation of Dept. B (5/10, 1/10, 4/10)b 2nd Allocation of Dept. A (2/10, 5/10, 3/10)a 2nd Allocation of Dept B: (5/10, 1/10, 4/10)b 3rd Allocation of Dept A: (2/10, 5/10, 3/10)a 3rd Allocation of Dept. B: (5/10, 1/10, 4/10)b 4th Allocation of Dept. A (2/10, 5/10, 3/10)a 4th Allocation of Dept. B (5/10, 1/10, 4/10)b 5th Allocation of Dept A (2/10, 5/10, 3/10)a 5th Allocation of Dept B (5/10, 1/10, 4/10)b 6th Allocation of Dept A (2/10, 5/10, 3/10)a Total budgeted manufacturing overhead of operating departments
Operating Departments X Y
$100,000
$40,000
20 ,000 60 ,000
(100,000) 30,000 (30,000) 3,000 (3,000) 300 (300) 30 (30) 3 (3 ) $ 0 $
$50,000 6,000 15,000 600 1,500 60 150 6 15 1 2 $73,334
$30,000 24,000 9,000 2,400 900 240 90 24 9 2 1 $66,666
(60,000) 6,000 (6,000) 600 (600) 60 (60) 6 (6) 0 0
Total accounts allocated and reallocated (the numbers in parentheses in first two columns) Dept A; Materials Handling: $100,000 + $30,000 + $3,000 + $300 + $30 + $3 = $133,333 Dept B; Power Generation: $60,000 + $6,000 + $600 + $60 + $6 = $66,666
a
b
Base is (100 + 250 +150) or 500 labour-hours; 100 500 = 2/10, 250 500 = 5/10, 150 500 = 3/10. Base is (500 + 100 + 400) or 1,000 kWh ; 500 1,000 = 5/10, 100 1,000 = 1/10, 400 1,000 = 4/10.
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14-28 (contd)
Comparison of methods:
Method of Allocation
Direct method Step-down: A first Step-down: B first Reciprocal method
X
$70,500 62,000 79,000 73,334
Y
$69,500 78,000 61,000 66,666
Note that in this case the direct method produces answers that are the closest to the correct answers (that is, those from the reciprocal method), step-down allocating B first is next, and step-down allocating A first is least accurate. 2. At first glance, it appears that the cost of power is $40 per unit plus the material handling costs. If so, Manes would be better off by purchasing from the power company. However, the decision should be influenced by the effects of the interdependencies and the fixed costs. Note that the power needs would be less (students frequently miss this) if they were purchased from the outside: Outside Power Units Needed 100 400
X Y A (500 units minus 20% of 500 units, because there is no need to service the nonexistent power department) Total units Total costs, 900 $40 = $36,000
400 900
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14-28 (contd)
In contrast, the total costs that would be saved by not producing the power inside would depend on the effects of the decision on various costs: Avoidable Costs of 1,000 Units of Power Produced Inside Variable indirect labour and indirect material costs Supervision in power department Materials handling, 20% of $70,000* Probable minimum cost savings Possible additional savings: a. Can any supervision in materials handling be saved because of overseeing less volume? Minimum savings is probably zero; the maximum is probably 20% of $10,000 or $2,000. b. Is any depreciation a truly variable, wear-and-tear type of cost? Total savings by not producing 1,000 units of power $10,000 10,000 14,000 $34,000
?
? ______ $34,000 + ?
* Materials handling costs are higher because the power department uses 20% of materials handling. Therefore, materials-handling costs will decrease by 20%.
In the short run (at least until a capital investment in equipment is necessary), the data suggest continuing to produce internally because the costs eliminated would probably be less than the comparable purchase costs.
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14-29 (25 min.) Common costs.
1. Stand-alone cost-allocation method.
Wright, Inc.
=
(900 $40) (1,500 $32) (900 $40) (600 $40)
=
$36, 000 $48, 000 = $28,800 ($36, 000 $24, 000) (600 $40) (1,500 $32) (900 $40) (600 $40)
Brown, Inc.
=
=
$24, 000 $48, 000 = $19,200 ($36, 000 $24, 000)
2.
With Wright, Inc. as the primary party: Party Wright Brown Total Costs Allocated $36,000 12,000 ($48,000 $36,000) $48,000
Cumulative Costs Allocated $36,000 $48,000
With Brown, Inc. as the primary party (not required): Party Brown Wright Total Costs Allocated $24,000 24,000 ($48,000 $24,000) $48,000
Cumulative Costs Allocated $24,000 $48,000
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14-29 (contd)
3. The results of the three cost-allocation methods are shown below. Wright, Inc. $28,800 36,000 24,000 Brown, Inc. $19,200 12,000 24,000
Stand-alone method Incremental (Wright primary) Incremental (Brown primary)
The allocations are very sensitive to the method used. The stand-alone method is simple and fair since it allocates the common cost of the dyeing machine in proportion to the individual costs of leasing the machine. In this case, the standalone method is likely more acceptable. If they used the incremental cost-allocation method, Wright, Inc. and Brown, Inc. would probably have disputes over who is the primary party because the primary party gets allocated all of the primary partys costs.
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14-30 (25 min.) Cost allocation to divisions.
Percentages for various allocation bases (old and new):
Pulp (1) Division margin percentages $2,400,000; $7,100,000; $9,500,000 $19,000,000 (2) Share of employees $350; 250; 400 1,000 (3) Share of floor space 35,000; 24,000; 66,000 125,000 (4) Share of total division administrative costs $2,000,000; $1,800,000; $3,200,000 $7,000,000 1. (5) Division margin (6) Corporate overhead allocated on segment margins = (1) $9,000,000 1,136,842 3,363,158 4,500,000 9,000,000 (7) Operating margin with division margin$1,263,158 $ 3,736,842 $ 5,000,000 $10,000,000 based allocation = (5) (6) (8) Revenues $8,500,000 $17,500,000 $24,000,000 $50,000,000 Operating margin as a percentage of 14.9% 21.3% 20.8% 20.0% revenues Pulp Paper Fibres Total $2,400,000 $ 7,100,000 $ 9,500,000 $19,000,000 Paper Fibres Total
12.63157% 37.36843% 35.0 28.0 25.0 19.2
50.0% 40.0 52.8
100.0% 100.0 100.0
28.57142
25.71428
45.71428
100.0
2.
(5) Division margin HRM costs (alloc. base: no. of employees) = (2) $1,800,000 Facility costs (alloc. base: floor space) = (3) $2,700,000 Corp. admin (alloc. base: div. admin costs) = (4) $4,500,000 Corp. overhead allocated to each division Operating margin with cause-and-effect allocation (8) Revenues Operating margin as a percentage of revenues Pulp Paper Fibres Total $2,400,000 $ 7,100,000 $ 9,500,000 $19,000,000 630 ,000 756,000 1,285,714 2,671,714 450,000 518,400 1,157,143 2,125,543 720,000 1,425,600 2,057,143 4,202,743 1,800,000 2,700,000 4,500,000 9,000,000
$ (271,714) $ 4,974,457 $ 5,297,257 $10,000,000 $8,500,000 $17,500,000 $24,000,000 $50,000,000 -3.2% 28.4% 22.1% 20.0 %
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14-30 (contd)
3. When corporate overhead is allocated to the divisions on the basis of division margins (requirement 1), each division is profitable (has positive operating margin) and the Paper division is the most profitable (has the highest operating margin percentage) by a slim margin, while the Pulp division is the least profitable. When Bardems suggested bases are used to allocate the different types of corporate overhead costs (requirement 2), we see that, in fact, the Pulp division is not profitable (it has a negative operating margin). Paper continues to be the most profitable and, in fact, it is significantly more profitable than the Fibres division. If division performance is linked to operating margin percentages, Pulp will resist this new way of allocating corporate costs, which causes its operating margin of nearly 15% (in the old scheme) to be transformed into a -3.2% operating margin. The new cost allocation methodology reveals that, if the allocation bases are reasonable, the Pulp division consumes a greater share of corporate resources than its share of segment margins would indicate. Pulp generates 12.6% of the segment margins, but consumes almost 29.7% ($2,671,714 $9,000,000) of corporate overhead resources. Paper will welcome the changeits operating margin percentage rises the most, and Fibres operating margin percentage remains practically the same. Note that in the old scheme, Paper was being penalized for its efficiency (smallest share of administrative costs), by being allocated a larger share of corporate overhead. In the new scheme, its efficiency in terms of administrative costs, employees, and square metres is being recognized. The new approach is preferable because it is based on cause-and-effect relationships between costs and their respective cost drivers in the long run. Human resource management costs are allocated using the number of employees in each division because the costs for recruitment, training, etc., are mostly related to the number of employees in each division. Facility costs are mostly incurred on the basis of space occupied by each division. Corporate administration costs are allocated on the basis of divisional administrative costs because these costs are incurred to provide support to divisional administrations. To overcome objections from the divisions, Bardem may initially choose not to allocate corporate overhead to divisions when evaluating performance. He could start by sharing the results with the divisions, and giving themparticularly the Pulp divisionadequate time to figure out how to reduce their share of cost drivers. He should also develop benchmarks by comparing the consumption of corporate resources to competitors and other industry standards.
4.
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14-31 (40 min.) Allocation of corporate costs to divisions.
1. The purposes for allocating central corporate costs to each division include the following (students may pick and discuss any two): a. To provide information for economic decisions. Allocations can signal to division managers that decisions to expand (contract) activities will likely require increases (decreases) in corporate costs that should be considered in the initial decision about expansion (contraction). When top management is allocating resources to divisions, analysis of relative division profitability should consider differential use of corporate services by divisions. Some allocation schemes can encourage the use of central services that would otherwise be underutilized. A common rationale related to this purpose is to remind profit centre managers that central corporate costs exist and that division earnings must be adequate to cover some share of those costs. b. Motivation. Allocations create incentives for division managers to control costs; for example, by reducing the number of employees at a division, a manager will save direct labour costs as well as central personnel and payroll costs allocated on the basis of number of employees. Allocation also creates incentives for division managers to monitor the effectiveness and efficiency with which central corporate costs are spent. c. Cost justification or reimbursement. Some lines of business of Richfield Oil may be regulated with cost data used in determining fair prices; allocations of central corporate costs will result in higher prices being set by a regulator. d. Income measurement for external parties. Richfield Oil may include allocations of central corporate costs in its external line-of-business reporting. Oil & Gas Chemical Copper Oil & Gas Upstream Downstream Products Mining $8,000 $16,000 $4,800 $3,200 Total $32,000
2. Revenues Percentage of revenues $8,000; $16,000; $4,800; $3,200 $32,000 (Dollar amounts in millions) Revenues Operating costs Operating income Corp. costs allocated on revenues (% of revs $3,228) Division operating income
25%
50%
15%
10%
100% Total $32,000 25,300 6,700 3,228 $ 3,472
Oil & Gas Oil & Gas Chemical Copper Upstream Downstream Products Mining $8,000 $16,000 $4,800 $3,200 3,000 15,000 3,800 3,500 5,000 1,000 1,000 (300) 807 $4,193 1,614 (614) 484 $ 516 323 $ (623)
$
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14-31 (contd)
3. First, calculate the share of each allocation base for each of the four corporate cost pools: Oil & Gas Oil & Gas Chemical Copper Upstream Downstream Products Mining Total $6,000 $3,000 $2,000 $25,000 Identifiable assets $14,000 (1)Percentage of total identifiable assets $14,000; $6,000; $3,000; $2,000 $25,000 56% 24% 12% 8% 100% $8,000 $16,000 $4,800 $3,200 $32,000
Division revenues (2) Percentage of total division revenues $8,000; $16,000; $4,800; $3,200 $32,000 Positive operating income (3) Percentage of total positive operating income $5,000; $1,000; $1,000; 0 $7,000
25% $5,000
50% $1,000
15% $1,000
10% NONE
100% $7,000
71.4%
14.3%
14.3%
0%
100%
12,000 6,000 3,000 30,000 Number of employees 9,000 (4) Percentage of total employees 9,000; 12,000; 6,000; 3,000 40% 20% 10% 100% 30,000 30% Using these allocation percentages and the allocation bases suggested by Rhodes, we can allocate the $3,228 M of corporate costs as shown below. Note that the costs in Cost Pool 2 total $800 M ($150 + $110 + $200 + $140 + $200).
(Dollar amounts in millions) Revenues Operating Costs Operating Income Cost Pool 1 Allocation ((1) $2,000) Cost Pool 2 Allocation ((2) $800) Cost Pool 3 Allocation ((3) $203) Cost Pool 4 Allocation ((4) $225) Division Income Oil & Gas Oil & Gas Chemical Upstream Downstream Products $16,000.00 $4,800.00 $8,000.00 3,000.00 15,000.00 3,800.00 5,000.00 1,000.00 1,000.00 1,120.00 480.00 240.00 200.00 400.00 120.00 145.00 29.00 29.00 67.50 90.00 45.00 $3,467.50 $ 1.00 $ 566.00 Copper Mining $3,200.00 3,500.00 (300.00) 160.00 80.00 0.00 22.50 $ (562.50) Total $32,000 25,300 6,700 2,000 800 203 225 $ 3,472
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14-31 (contd)
4. The table below compares the reported income of each division under the original revenue-based allocation scheme and the new four pool-based allocation scheme. Oil & Gas Upstream seems 17% less profitable than before ($3,467.5 $4,193 = 83%), and may resist the new allocation, but each of the other divisions seem more profitable (or less loss-making) than before and they will probably welcome it. In this setting, corporate costs are relatively large (about 13% of total operating costs), and division incomes are sensitive to the corporate cost allocation method.
Oil & Gas Upstream $5,000.00 Oil & Gas Chemical Downstream Products $1,000.00 Copper Mining Total $6,700
(Dollar amounts in millions) Operating income (before corp. cost allocation) Division income under revenuebased allocation of corporate costs Division income under 4-cost-pool allocation of corporate costs
$1,000.00 $(300.00)
$4,193.00 $3,467.50
$ (614.00) $ 1.00
$ 516.00 $(623.00) $ 566.00 $(562.50)
$3,472 $3,472
Strengths of Rhodes proposal relative to existing single-cost pool method: a. Better able to capture cause-and-effect relationships. Interest on debt is more likely caused by the financing of assets than by revenues. Personnel and payroll costs are more likely caused by the number of employees than by revenues. b. Relatively simple. No extra information need be collected beyond that already available. (Some students will list the extra costs of Rhodes proposal as a weakness. However, for a company with $30 billion in revenues, those extra costs are minimal.) Weaknesses of Rhodes proposal relative to existing single-cost pool method: a. May promote dysfunctional decision making. It may encourage division managers to lease or rent assets rather than to purchase assets, even where it is economical for Richfield Oil to purchase them. This off-balance sheet financing will reduce the identifiable assets of the division and thus will reduce the interest on debt costs allocated to the division. (Richfield Oil could counteract this problem by incorporating leased and rented assets in the identifiable assets base.)
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14-31 (contd)
Note: Some students criticized Rhodes proposal, even though agreeing that it is preferable to the existing single-cost pool method. These criticisms include: a. The proposal does not adequately capture cause-and-effect relationships for the legal and research and development cost pools. For these cost pools, specific identification of individual projects with an individual division can better capture cause-and-effect relationships. b. The proposal may give rise to disputes over the definition and valuation of identifiable assets. c. The use of actual rather than budgeted amounts in the allocation bases creates interdependencies between divisions. Moreover, use of actual amounts means that division managers do not know cost allocation consequences of their decisions until the end of each reporting period. d. A separate allocation of fixed and variable costs would result in more refined cost allocations. e. It is questionable that 100% of central corporate costs should be allocated. Many students argue that public affairs should not be allocated to any division, based on the notion that division managers may not control many of the individual expenditures in this cost pool.
14-32 Cost allocation to divisions.
1. Segment margin Allocated headquarters costs ($5,100,000 3) Operating income Bread $6,400,000 1,700,000 $4,700,000 Cake $1,300,000 1,700,000 $ (400,000) Doughnuts $6,150,000 1,700,000 $4,450,000 Total $13,850,000 5,100,000 $ 8,750,000
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14-32 (contd)
2. Segment margin Allocated headquarters costs, Human resources1 (50%; 12.5%; 37.5% $1,900,000) Accounting department2 (53.9%; 11.6%; 34.5% $1,400,000) Rent and depreciation3 (50%; 20%; 30% $1,200,000) 1 Other ( $600,000 ) 3 Total Operating income
1HR 2Accounting:
Bread $6,400,000
Cake $1,300,000
Doughnuts $6,150,000
Total $13,850,000
950,000 754,600 600,000 200,000 2,504,600 $3,895,400
237,500 162,400 240,000 200,000 839,900 $ 460,100
712,500 483,000 360,000 200,000 1,755,500 $4,394,500
1,900,000 1,400,000 1,200,000 600,000 5,100,000 $ 8,750,000
costs: 400 800 = 50%; 100 800 = 12.5%; 300 800 = 37.5% $20,900,000 $38,800,000 = 53.9%; $4,500,000 $38,800,000 = 11.6%; $13,400,000 $38,800,000 = 34.5% 3 Rent and depreciation: 10,000 20,000 = 50%; 4,000 20,000 = 20%; 6,000 20,000 = 30%
A cause-and-effect relationship may exist between Human Resources costs and the number of employees at each division. Rent and depreciation costs may be related to square metres, except that very expensive machines may require few square metres, which is inconsistent with this choice of allocation base. The Accounting Department costs are probably related to the revenues earned by each divisionhigher revenues mean more transactions and more accounting. Other overhead costs are allocated arbitrarily.
3.
The manager suggesting the new allocation bases probably works in the Cake Division. Under the old scheme, the Cake Division shows an operating loss after allocating headquarters costs because it is smaller, yet was charged an equal amount (a third) of headquarters costs. The new allocation scheme shows an operating profit in the Cake Division, even after allocating headquarters costs. The ABC method is a better way to allocate headquarters costs because it uses cost allocation bases that, by and large, represent cause-and-effect relationships between various categories of headquarters costs and the demands that different divisions place on these costs.
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14-33 Matrix algebra.
1.
2.
3.
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14-34 Matrix algebra.
1.
2.
3.
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14-35 (2025 min.) Revenue allocation, bundled products.
1.a. The stand-alone revenues (using unit selling prices) of the three components of the $1,000 package are: Lodging $400.00 2 = $ 800 Recreation $187.50 2 = 375 Food $100.00 2 = 200 $1,375 $800 Lodging $1,000 0.582 $1,000 $582 $1,375 $375 Recreation $1,000 0.273 $1,000 $273 $1,375 $200 Food $1,000 0.145 $1,000 $145 $1,375 b. Product Recreation Lodging Food Revenue Allocated $ 375 625 ($1,000 $375) 0 $1,000 Cumulative Revenue Allocated $ 375 $1,000 $1,000
2.
The pros of the stand-alone revenue-allocation method include the following: a. Each item in the bundle receives a positive weight, which means the resulting allocations are more likely to be accepted by all parties than a method allocating zero revenues to one or more products. b. It uses market-based evidence (unit selling prices) to decide the revenue allocationsunit prices are one indicator of benefits received. c. It is simple to implement. The cons of the stand-alone revenue-allocation method include: a. It ignores the relative importance of the individual components in attracting consumers to purchase the bundle. b. It ignores the opportunity cost of the individual components in the bundle. The golf course operates at 100% capacity. Getaway participants must reserve a golf booking one week in advance, or else they are not guaranteed playing time. A
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Instructors Solutions Manual for Cost Accounting, 5Ce
14-35 (contd)
getaway participant who does not use the golf option may not displace anyone. Thus, under the stand-alone method, the golf course may be paid twiceonce from the non-getaway person who does play and second from an allocation of the $1,000 package amount for the getaway person who does not play (either did not want to play, wanted to play but made a booking too late, or failed to show). The weight can be artificially inflated by individual product managers setting high list unit prices and then being willing to frequently discount these prices. The use of actual unit prices or actual revenues per product in the stand-alone formula will reduce this problem. The weights may change frequently if unit prices are constantly changing. This is not so much a criticism as a reflection that the marketplace may be highly competitive.
c.
d.
The pros of the incremental method include: a. It has the potential to reflect that some products in the bundle are more highly valued than others. Not all products in the bundle have a similar write-down from unit list prices. Ensuring this potential pro becomes an actual pro requires that the choice of the primary product be guided by reliable evidence on consumer preferences. This is not an easy task. b. Once the sequence is chosen, it is straightforward to implement.
The cons of the incremental method include: a. Obtaining the rankings can be highly contentious and place managers in a nowin acrimonious debate. The revenue allocations can be sensitive to the chosen rankings. b. Some products will have zero revenues assigned to them. Consider the Food division. It would incur the costs for the two dinners but receive no revenue.
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