chapter%206%20-%20ACCT%202332%20-%20spring%202010

# chapter%206%20-%20ACCT%202332%20-%20spring%202010 - CHAPTER...

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CHAPTER 6 CHAPTER 6 Cost Allocation and Activity- Cost Allocation and Activity- Based Costing Based Costing

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Purposes of Cost Allocation Purposes of Cost Allocation Assume that we have two departments where each is responsible for a certain product or process. Some of the fixed manufacturing overhead costs are for resources shared by both departments, for example: maintenance, lights, IT department. We should allocate these costs between the departments. What is the purpose of allocating this cost? How is it done? First lets look at an example:
A problem in cost allocation A problem in cost allocation The building maintenance department for Taylor Bath Manufacturing Company budgets annual costs of \$3,000,000 based on the expected operating level for the coming year. The costs are allocated to two production departments. Taylor Bath is considering two allocation bases for assignment of costs to departments: (1) square footage and (2) direct labor hours. The following data relate to the potential allocation bases: Production Dept. 1 Production Dept. 2 Square Footage 20,000 30,000 Direct Labor Hours 30,000 20,000 Calculate the costs allocated to the production departments using each allocation base. Comment on which allocation base is preferable.

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A problem in cost allocation: A problem in cost allocation: Analysis Analysis Square Footage as an Allocation Base Production Department 1 = (20,000/50,000) x \$3,000,000 = \$1,200,000 Production Department 2 = (30,000/50,000) x \$3,000,000 = \$1,800,000
A problem in cost allocation: A problem in cost allocation: Analysis Analysis Direct Labor Hours as an Allocation Base Production Department 1 = (30,000/50,000) x \$3,000,000 = \$1,800,000 Production Department 2 = (20,000/50,000) x \$3,000,000 = \$1,200,000

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A problem in cost allocation: A problem in cost allocation: Analysis Analysis Which allocation base is preferable? The choice of the allocation base greatly affects the cost allocated to each department. Department 1 would prefer to be allocated cost based on square footage and department 2 would prefer direct labor hours as the base. We should look for an allocation base that has cause and effect reasoning. If maintenance costs are mostly related to general building maintenance, then square footage is more likely to result in a cause and effect allocation. However, if maintenance costs are mostly due to employee activity, then labor hours might be a better allocation base.
Purposes of Cost Allocation Purposes of Cost Allocation

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Purposes of Cost Allocation Purposes of Cost Allocation To Provide Information for Decision Making Allocated cost should measure the opportunity cost of using a company resource. For example: a department is charged with maintenance cost relative to its floor space. What would it have to pay if it hired its own maintenance team? That should be the cost allocated to this department (in theory, as it is usually hard to measure) We should price products so that overhead will be covered (for example, the cost of prescription drugs is mostly overhead)
Purposes of Cost Allocation Purposes of Cost Allocation

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## This note was uploaded on 05/06/2010 for the course ACCT 2332 taught by Professor Howard during the Spring '10 term at University of Texas-Tyler.

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chapter%206%20-%20ACCT%202332%20-%20spring%202010 - CHAPTER...

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