Question
Answered

PLEASE COMPLETE NO LATER THAN 10/14 @3:30PM

Each question(1,2,& 3) must be a minimum of 200 words. Please EXPLAIN answers in FULL detail and make answers knowledgeable based off the attached reading, also using outside scholarly sources.

ARE YOU ABLE TO COMPLETE THIS FOR ME? 20.00

ATC 5-1 (Pg. 246)

(Using ABC to improve product pricing) Answer the four questions posed in the case. Include in your answer the basic differences between volume based (traditional) overhead application procedures and the ABC method.

Describe the production characteristics (for example, high-volume, specialty, etc.) of the three products manufactured by Drilling Innovations, Inc. in our case study.

Describe the characteristics of products which would suggest it would be better to use ABC as an indirect cost allocation method over a traditional method such as direct labor hours.


This discussion must be a minimum of 100 words:

Define and discuss the difference between indirect and direct cost. Provide an example of each. In your initial response, please do not use citations to convey your understanding. Based on your reading, please communicate your own understanding of the requirements. Students are allowed to use one citation in each response to their peers.

1 Attachment
-MBA_524-Unit_5-read.pdf
edm10890_ch04_150-201.indd Page 150 7/10/10 5:21 PM user-f497 /Volumes/105/PHS00142/work/indd CHAPTER 4 Cost Accumulation,
Tracing, and Allocation
LEARNING OBJECTIVES W
I
L
S
O
N
, After you have mastered the material in this chapter, you will be able to: 1
2
3
4
5
6
7
8
9 Q
U
Distinguish direct costs from indirect costs.
A
Allocate indirect costs to cost objects.
S
Select appropriate cost drivers for allocating indirect costs.
H
Allocate costs to solve timing problems.
E
Explain the benefits and detriments of allocating pooled costs.
Identify cost objects and cost drivers. Allocate joint product costs. 1
9
Allocate service department costs to operating departments (Appendix).
9
7
B
CHAPTER OPENING
U
Recognize the effects of cost allocation on employee motivation. What does it cost? This is one of the questions most frequently asked by business managers. Managers must
have reliable cost estimates to price products, evaluate performance, control operations, and prepare financial
statements. As this discussion implies, managers need to know the cost of many different things. The things we are
trying to determine the cost of are commonly called cost objects. For example, if we are trying to determine the cost
of operating a department, that department is the cost object. Cost objects may be products, processes, departments, services, activities, and so on. This chapter explains techniques managerial accountants use to determine
the cost of a variety of cost objects. 150 edm10890_ch04_150-201.indd Page 151 7/10/10 5:21 PM user-f497 /Volumes/105/PHS00142/work/indd The Curious Accountant
A former patient of a California hospital complained
about being charged $7 for a single aspirin tablet.
After all, an entire bottle of 100 aspirins can be purchased at the local pharmacy store for around $2.
Can you think of any reasons, other than shameless profiteering, that a hospital would need to
charge $7 for an aspirin? Remember that the hospital
is not just selling the aspirin; it is also delivering it to
the patient. (Answer on page 159.) W
I
L
S
O
N
,
Q
U
A
S
H
E
1
9
9
7
B
U 151 edm10890_ch04_150-201.indd Page 152 152 7/10/10 5:21 PM user-f497 /Volumes/105/PHS00142/work/indd Chapter 4 DETERMINE THE COST OF COST OBJECTS
LO 1
Identify cost objects and cost drivers. Accountants use cost accumulation to determine the cost of a particular object. Suppose the Atlanta Braves advertising manager wants to promote a Tuesday night ball
game by offering free baseball caps to all children who attend. What would be the promotion cost? The team’s accountant must accumulate many individual
costs and add them together. For simplicity consider only three cost components: (1) the cost of the caps, (2) the cost of advertising the promotion, and (3) the cost of an employee to work on the promotion.
Cost accumulation begins with identifying the cost objects. The
primary cost object is the cost of the promotion. Three secondary cost
objects are (1) the cost of caps, (2) the cost of advertising, and (3) the
cost of labor. The costs of the secondary cost objects are combined to
determine the cost of the primary cost object.
Determining the costs of the secondary cost objects requires identifying what drives those costs. A cost driver has a cause-and-effect relationW
ship with a cost object. For example, the number of caps (cost driver) has
an effect on the cost of caps (cost object). The number of advertisements is
I
a cost driver for the advertising cost (cost object); the number of labor
hours worked is a L driver for the labor cost (cost object). Using the folcost
lowing assumptions about unit costs and cost drivers, the accumulated
S
cost of the primary cost object (cost of the cap promotion) is:
Cost Object
Cost of caps
Cost of advertising
Cost of labor
Cost of cap promotion O
N
Cost Per Unit
,
$2.50
$100.00
$8.00 3 Cost Driver 5 Total Cost of Object 3
3
3 4,000 Caps
50 Advertisements
100 Hours 5
5
5 $10,000
5,000
800
$15,800 Q
U
A
The Atlanta Braves should run the promotion if management expects it to produce
S
additional revenues exceeding $15,800.
H
Estimated versus Actual Cost
E The accumulated cost of the promotion—$15,800—is an estimate. Management cannot
know actual costs and revenues until after running the promotion. While actual information is more accurate, it is not relevant for deciding whether to run the promotion
1
because the decision must be made before the actual cost is known. Managers must ac9
cept a degree of inaccuracy in exchange for the relevance of timely information. Many
business decisions are based on9
estimated rather than actual costs.
Managers use cost estimates to set prices, bid on contracts, evaluate proposals,
7
distribute resources, plan production, and set goals. Certain circumstances, however,
require actual cost data. For B
example, published financial reports and managerial
performance evaluations use actual cost data. Managers frequently accumulate both
U
estimated and actual cost data for the same cost object. For example, companies use
cost estimates to establish goals and use actual costs to evaluate management performance in meeting those goals. The following discussion provides a number of business
examples that use estimated data, actual data, or a combination of both. ASSIGNMENT OF COSTS TO OBJECTS
IN A RETAIL BUSINESS
Exhibit 4.1 displays the January income statement for In Style, Inc. (ISI), a retail
clothing store. ISI subdivides its operations into women’s, men’s, and children’s departments. To encourage the departmental managers to maximize sales, ISI began edm10890_ch04_150-201.indd Page 153 7/10/10 5:21 PM user-f497 /Volumes/105/PHS00142/work/indd Cost Accumulation, Tracing, and Allocation 153 paying the manager of each department a bonus based on a percentage of departmental sales revenue.
Although the bonus incentive increased sales revenue, it also provoked negative
consequences. The departmental managers began to argue over floor space; each
manager wanted more space to display merchandise. The managers reduced prices;
they increased sales commissions. In the drive to maximize sales, the managers ignored
the need to control costs. To improve the situation, the store manager decided to
base future bonuses on each department’s contribution to profitability rather than its
sales revenue. IDENTIFYING DIRECT AND INDIRECT COSTS
The new bonus strategy requires determining the cost of operating each department.
LO 2
Each department is a separate cost object. Assigning costs to the departments (cost
objects) requires cost tracing and cost allocation. Direct costs can be easily traced to a
cost object. Indirect costs cannot be easily traced to a cost object. Whether or not a cost Distinguish direct costs from
W
is easily traceable requires cost/benefit analysis.
indirect costs.
I
Some of ISI’s costs can be easily traced to the cost
EXHIBIT 4.1
L
objects (specific departments). The cost of goods sold is an
example of an easily traced cost. Price tags on merchandise
S
Income Statement
can be coded so cash register scanners capture the departO
mental code for each sale. The cost of goods sold is not only
IN STYLE, INC.
easily traceable but also very useful information. Companies
N
Income Statement
need cost of goods sold information for financial reporting
,
(income statement and balance sheet) and for management
For the Month Ended January 31
decisions (determining inventory reorder points, pricing
Sales
$360,000
strategies, and cost control). Because the cost of tracing cost
Cost of goods sold
(216,000)
Q
of goods sold is small relative to the benefits obtained, cost
Gross margin
144,000
of goods sold is a direct cost.
U
Sales commissions
(18,000)
In contrast, the cost of supplies (shopping bags, sales
Dept. managers’ salaries
(12,000)
A is
slips, pens, staples, price tags) used by each department
Store manager’s salary
(9,360)
much more difficult to trace. How could the number of S
staDepreciation
(16,000)
ples used to seal shopping bags be traced to any particular
Rental fee for store
(18,400)
department? The sales staff could count the number of H
staUtilities
(2,300)
ples used, but doing so would be silly for the benefitsE
obAdvertising
(7,200)
tained. Although tracing the cost of supplies to each
Supplies
(900)
department may be possible, it is not worth the effort of doNet income
$ 59,840
1
ing so. The cost of supplies is therefore an indirect cost. Indirect costs are also called overhead costs.
9
Direct and indirect costs can be described as follows: 9
7
Direct costs can be traced to cost objects in a cost-effective manner.
Indirect costs cannot be traced to objects in a cost-effective manner.
B
U By analyzing the accounting records, ISI’s accountant classified the costs from the
income statement in Exhibit 4.1 as direct or indirect, as shown in Exhibit 4.2. The next
paragraph explains the classifications.
All figures represent January costs. Items 1 though 4 are direct costs, traceable to the
cost objects in a cost-effective manner. Cost of goods sold is traced to departments at the
point of sale using cash register scanners. Sales commissions are based on a percentage
of departmental sales and are therefore easy to trace to the departments. Departmental
managers’ salaries are also easily traceable to the departments. Equipment, furniture,
and fixtures are tagged with department codes that permit tracing depreciation charges
directly to specific departments. Items 5 through 8 are incurred on behalf of the company as a whole and are therefore not directly traceable to a specific department. edm10890_ch04_150-201.indd Page 154 154 7/10/10 5:21 PM user-f497 /Volumes/105/PHS00142/work/indd Chapter 4 EXHIBIT 4.2
Income Statement Classification of Costs
Direct Costs
Cost Item
1. Cost of goods sold—$216,000
2. Sales commissions—$18,000
3. Dept. managers’ salaries—$12,000
4. Depreciation—$16,000
5. Store manager’s salary
6. Rental fee for store
7. Utilities
8. Advertising
9. Supplies
W
Totals Women’s Men’s Children’s $120,000
9,500
5,000
7,000 $58,000
5,500
4,200
5,000 Indirect
Costs $38,000
3,000
2,800
4,000 $141,500 $72,700 $47,800 $ 9,360
18,400
2,300
7,200
900
$38,160 I
L
S
Although Item 9 could be traced to specific departments, the cost of doing so would
exceed the benefits. The cost of O
supplies is therefore also classified as indirect.
N
Cost Classifications—Independent and Context Sensitive
, Whether a cost is direct or indirect is independent of whether it is fixed or variable. In
the ISI example, both cost of goods sold and the cost of supplies vary relative to sales
volume (both are variable costs), but cost of goods sold is direct and the cost of supQ
plies is indirect. Furthermore, the cost of rent and the cost of depreciation are both
U
fixed relative to sales volume, but the cost of rent is indirect and the cost of depreciation is direct. In fact, the very same cost can be classified as direct or indirect, dependA
ing on the cost object. The store manager’s salary is not directly traceable to a specific
department, but it is traceableS a particular store. As these examples demonstrate,
to
cost classification depends on the context in which the costs occur.
H LO 3
Allocate indirect costs to cost
objects. E
ALLOCATING INDIRECT COSTS TO OBJECTS
1
Common costs support multiple cost objects, but cannot be directly traced to any
specific object. In the case of In Style, Inc., the cost of renting the store (common cost)
9
supports the women’s, men’s, and children’s departments (cost objects). The depart9
mental managers may shirk responsibility for the rental cost by claiming that others
higher up the chain of command are responsible. Responsibility can be motivated at
7
the departmental level by assigning (allocating) a portion of the total rental cost to
B
each department.
To accomplish appropriateU
motivation, authority must accompany responsibility.
In other words, the departmental managers should be held responsible for a portion of
rental cost only if they are able to exercise some degree of control over that cost. For
example, if managers are assigned a certain amount of the rental cost for each square
foot of space they use, they should have the authority to establish the size of the space
used by their departments. Controllable costs are costs that can be influenced by a
manager’s decisions and actions. The controllability concept is discussed in more detail
in Chapter 9.
Cost allocation involves dividing a total cost into parts and assigning the parts to
designated cost objects. How should ISI allocate the $38,160 of indirect costs to each
of the three departments? First, identify a cost driver for each cost to be allocated.
For example, there is a cause-and-effect relationship between store size and rent cost; edm10890_ch04_150-201.indd Page 155 7/10/10 5:21 PM user-f497 /Volumes/105/PHS00142/work/indd Cost Accumulation, Tracing, and Allocation 155 REALITY BYTES
How does Southwest Airlines know the cost of flying a passenger from Houston, Texas, to Los Angeles, California? The
fact is that Southwest does not know the actual cost of flying
particular passengers anywhere. There are many indirect costs
associated with flying passengers. Some of these include the
cost of planes, fuel, pilots, office buildings, and ground personnel. Indeed, besides insignificant food and beverage costs,
there are few costs that could be traced directly to customers.
Southwest and other airlines are forced to use allocation and
averaging to determine the estimated cost of providing transportation services to customers. Estimated rather than actual
cost is used for decision-making purposes.
Consider that in its 2008 annual report Southwest reported
W
the average operating expenses of flying one passenger one
I
mile (called a passenger mile) were 10.2¢. However, this number was based on 103.3 billion “available passenger miles.” In
L
2008 Southwest operated at 71.2 percent of capacity, not 100 percent, so it was only able to charge passengers for 73.5 billion
S
passenger miles. Thus, its average operating expenses were closer to 14.4¢ for each mile for which they were able to charge.
Had they operated at a higher capacity, their average costs would have been lower.
O N
,
the larger the building, the higher the rent cost. This relationship suggests that the
more floor space a department occupies, the more rent cost that department should
Q
bear. To illustrate, assume ISI’s store capacity is 23,000 square feet and the women’s,
U
men’s, and children’s departments occupy 12,000, 7,000, and 4,000 square feet, reA
spectively. ISI can achieve a rational allocation of the rent cost using the following
two-step process.1
S
Step 1. Compute the allocation rate by dividing the total cost to be allocated ($18,400
H
rental fee) by the cost driver (23,000 square feet of store space). The cost driver
E
is also called the allocation base. This computation produces the allocation
rate, as follows: Total cost to be allocated 4 Cost driver (allocation base) 5 Allocation rate
1
$18,400 rental fee
Step 2. 23,000 square feet
9 5 9 $0.80 per
square foot Multiply the allocation rate by the weight of the cost driver (weight of the
7
base) to determine the allocation per cost object, as follows: Cost Object
Women’s department
Men’s department
Children’s department
Total 1 4 B
Number U
of Allocation
Rate 3 Square Feet 5 $0.80
0.80
0.80 3
3
3 12,000
7,000
4,000
23,000 5
5
5 Allocation per
Cost Object
$ 9,600
5,600
3,200
$18,400 Other mathematical approaches achieve the same result. This text consistently uses the two-step method
described here. Specifically, the text determines allocations by (1) computing a rate and (2) multiplying the
rate by the weight of the base (cost driver). edm10890_ch04_150-201.indd Page 156 156 7/10/10 5:21 PM user-f497 /Volumes/105/PHS00142/work/indd Chapter 4 It is also plausible to presume utilities cost is related to the amount of floor space a
department occupies. Larger departments will consume more heating, lighting, air conditioning, and so on than smaller departments. Floor space is a reasonable cost driver
for utility cost. Based on square footage, ISI can allocate utility cost to each department
as follows:
Step 1. Compute the allocation rate by dividing the total cost to be allocated ($2,300
utility cost) by the cost driver (23,000 square feet of store space):
Total cost to be allocated 4
$2,300 utility cost Step 2. Cost driver 5 Allocation rate 4 23,000 square feet 5 $0.10 per square foot Multiply the allocation rate by the weight of the cost driver to determine the
allocation per cost object: Cost Object
Women’s department
Men’s department
Children’s department
Total Allocation
W
Rate I $0.10
0.10
L
0.10 S
O
N
, 3
3
3
3 Number of
Square Feet
12,000
7,000
4,000
23,000 5 Allocation per
Cost Object 5
5
5 $1,200
700
400
$2,300 CHECK YOURSELF 4.1
HealthCare, Inc., wants to estimateQ cost of operating the three departments (Dermatology,
the
Gynecology, and Pediatrics) that serve patients in its Health Center. Each department perU
formed the following number of patient treatments during the most recent year of operation:
A
Dermatology, 2,600; Gynecology, 3,500; and Pediatrics, 6,200. The annual salary of the Health
Center’s program administrator is $172,200. How much of the salary cost should HealthCare
S
allocate to the Pediatrics Department?
Answer
Step 1 H
E
Compute the allocation rate. Total cost to be allocated 4 Cost driver (patient treatments) 5 Allocation rate 1(2,600 1 3,500 1 6,200) 5 $14 per patient treatment
$172,200 salary cost 4
9
Step 2 Multiply the allocation rate by the weight of the cost driver (weight of the base) to
9
determine the allocation per cost object.
7
Allocation
No. of
Allocation per
B
Cost Object
Rate
3
Treatments
5
Cost Object
U
Pediatrics department
$14
3
6,200
5
$86,800 SELECTING A COST DRIVER
LO 4
Select appropriate cost drivers
for allocating indirect costs. Companies can frequently identify more than one cost driver for a particular indirect
cost. For example, ISI’s shopping bag cost is related to both the number of sales transactions and the volume of sales dollars. As either of these potential cost drivers increases,
shopping bag usage also increases. The most useful cost driver is the one with the strongest cause-and-effect relationship. edm10890_ch04_150-201.indd Page 157 7/10/10 5:21 PM user-f497 /Volumes/105/PHS00142/work/indd Cost Accumulation, Tracing, and Allocation Consider shopping bag usage for T-shirts sold in the children’s department versus
T-shirts sold in the men’s department. Assume ISI studied T-shirt sales during the first
week of June and found the following: Department Children’s Men’s 120
$1,440 92
$1,612 Number of sales transactions
Volume of sales dollars Given that every sales transaction uses a shopping bag, the children’s department uses far more shopping bags than the men’s department even though it has a
lower volume of sales dollars. A reasonable explanation for this circumstance is
that children’s T-shirts sell for less than men’s T-shirts. The number of sales transactions is the better cost driver because it has a stronger cause-and-effect relationship
W
with shopping bag usage than does the volume of sales dollars. Should ISI therefore
use the number of sales transactions to allocate supply cost to the departments?
I
Not necessarily.
L
The availability of information also influences cost driver selection. While the numS
ber of sales transactions is the more accurate cost driver, ISI could not use this allocation base unless it maintains records of the number of sales transactions per department.
O
If the store tracks the volume of sales dollars but not the number of transactions, it
N
must use dollar volume even if the number of transactions is the better cost driver. For
ISI, sales volume in dollars appears to be the best available cost driver for allocating
,
supply cost.
Assuming that sales volume for the women’s, men’s, and children’s departments was
$190,000, $110,000, and $60,000, respectively, ISI can allocate the supplies cost as follows:
Q
Step 1. Compute the allocation rate by dividing the total cost to be allocated ($900
U
supplies cost) by the cost driver ($360,000 total sales volume): A
5
Allocation rate
S
$900 supplies cost
4 $360,000 sales volume H $0.0025 per sales dollar
5
E
Multiply the allocation rate by the weight of the cost driver to determine the Total cost to be allocated 4 Step 2. Cost driver allocation per cost object: Cost Object
Women’s department
Men’s department
Children’s department
Total Allocation
Rate 3 $0.0025
0.0025
0.0025 3
3
3 1
Sales
9
Volume
9
$190,000
7
110,000
60,000
B
$360,000
U 5
5
5
5 Allocation per
Cost Object
$475
275
150
$900 ISI believes sales volume is also the appropriate allocation base for advertising cost.
The sales generated in each department were likely influenced by the general advertising
campaign. ISI can allocate advertising cost as follows:
Step 1. Compute the allocation rate by dividing the total cost to be allocated ($7,200
advertising cost) by the cost driver ($360,000 total sales volume): Total cost to be allocated 4 Cost driver 5 Allocation rate $7,200 advertising cost 4 $360,000 sales volume 5 $0.02 per sales dollar 157 edm10890_ch04_150-201.indd Page 158 158 7/10/10 5:21 PM user-f497 /Volumes/105/PHS00142/work/indd Chapter 4 Step 2. Multiply the allocation rate by the weight of the cost driver to determine the
allocation per cost object: Cost Object Allocation
Rate 3 $0.02
0.02
0.02 3
3
3 Women’s department
Men’s department
Children’s department
Total Sales
Volume
$190,000
110,000
60,000
$360,000 Allocation per
Cost Object 5 $3,800
2,200
1,200
$7,200 5
5
5 There is no strong cause-and-effect relationship between the store manager’s salary
and the departments. ISI pays the store manager the same salary regardless of sales
level, square footage of store space, number of labor hours, or any other identifiable
W
variable. Because no plausible cost driver exists, ISI must allocate the store manager’s
I
salary arbitrarily. Here the manager’s salary is simply divided equally among the departments as follows:
L
Step 1. S
Compute the allocation rate by dividing the total cost to be allocated
($9,360 manager’s monthly salary) by the allocation base (number of
O
departments):
N
, Total cost to be allocated 4 Cost driver 5 Allocation rate $9,360 store manager’s salary 4 3 departments 5 $3,120 per department
Step 2. Multiply the allocation rate by the weight of the cost driver to determine the
Q
allocation per cost object: Cost Object
Women’s department
Men’s department
Children’s department
Total U
A
Allocation
S
Rate
H
$3,120
E
3,120
3,120 3
3
3
3 Number of
Departments
1
1
1
3 5
5
5
5 Allocation per
Cost Object
$3,120
3,120
3,120
$9,360 1
9
9
As the allocation of the store manager’s salary demonstrates, many allocations
are arbitrary or based on a weak relationship between the allocated cost and the
7
allocation base (cost driver). Managers must use care when making decisions using
B
allocated costs.
U
Behavioral Implications
Using the indirect cost allocations just discussed, Exhibit 4.4 shows the profit each department generated in January. ISI paid the three departmental managers bonuses
based on each department’s contribution to profitability. The store manager noticed an
immediate change in the behavior of the departmental managers. For example, the
manager of the women’s department offered to give up 1,000 square feet of floor space
because she believed reducing the selection of available products would not reduce sales
significantly. Customers would simply buy different brands. Although sales would not
decline dramatically, rent and utility cost allocations to the women’s department would
decline, increasing the profitability of the department. edm10890_ch04_150-201.indd Page 159 7/10/10 5:21 PM user-f497 /Volumes/105/PHS00142/work/indd Cost Accumulation, Tracing, and Allocation 159 W
When we compare the cost that a hospital charges for an aspirin to the price Answers to The Curious Accountant we pay for an aspirin, we are probably
w
not considering the full cost that we incur to purchase aspirin. If someone asks you what you pay for an aspirin, you would probably take the price of a
bottle, say $2, and divide it by the number of pills in the bottle, say 100. This would suggest their cost is $0.02 each.
Now, consider what it cost to buy the aspirins when all costs are considered. First, there is your time to drive to
the store; what do you get paid per hour? Then, there is the cost of operating your automobile. You get the idea; in
reality, the cost of an aspirin, from a business perspective, is much more than just the cost of the pills themselves.
Exhibit 4.3 shows the income statement of Hospital Corporation of America (HCA) for three recent years. W
I
ated 271 facilities in 20 states and England. As you can see, while it generated over $28 billion in revenue, it...
See more...
Answer & Explanation
Verified Solved by verified expert
Rated

Done

pulvinar tortor nec facilisis. Pellentesque dapibus efficitur laoreet. Nam risus ante, dapibus a molestie consequat, ultrices ac magna. Fusce dui lectus, congue vel laoreet ac, dictum vitae odio. Donec aliquet. Lorem ipsum dolor sit amet, consectetur adipiscing elit. Nam lacinia pulvinar tortor nec facilisis. Pellentesque

Unlock full access to Course Hero

Explore over 16 million step-by-step answers from our library

Subscribe to view answer
1 Attachment
Drilling innovation case study Word Document (3).edited-2.docx
docx