Chapter 5 - Cost allocation Flashcards
Explain reciprocated costs
Complete reciprocated cost - the actual costs incurred by a support department plus a part of the costs of the other support departments that provide service to it (sometimes called the artificial costs of the support department), it is always larger than the actual costs
The excess costs is the total costs that are allocated among support departments
- Describe how a costing system can have multiple cost objects
A cost object is anything for which a separate measurement of costs is desired. Costing systems in organisations have multiple cost objects (departments, products, services and customers), meaning many individual costs are allocated and reallocated several times before becoming an indirect cost of a specific cost object.
- Outline four purposes for allocating costs to cost objects
1) To provide information for economic decisions
2) To motivate managers and employees
3) To justify costs or calculate reimbursement
4) To measure income and assets for reporting to external parties
The allocation of one particular cost does not have to satisfy all purposes simultaneously
- Discuss problems faced when collecting costs in indirect cost pools
A cost pool is a grouping of individual cost items. Two key decisions related to indirect cost pools are the number of indirect-cost pools and the allowability of individual cost items to be included in those cost pools.
Describe what a homogeneous cost pool is as well as the advantages and disadvantages
Homogeneous cost pool - one in which all the activities whose costs are included in the pool have the same or a similar cause-and-effect relationship or benefits-received relationship between the cost allocator and the costs of the activity
Using homogeneous indirect-cost pools enables more accurate product, service and customer costs to be obtained
A consequence of using a homogeneous cost pool is that the cost allocations using that pool will be the same as would be made if costs of each individual activity in that pool were allocated separately
The greater the degree of homogeneity, the fewer cost pools required to explain accurately the differences in how products use resources of the organisation
The combined rate per unit of the allocation base is the same as the sum of the rates if the individual cost pools were allocated separately
Describe the single-rate cost allocation method and the benefits of it
Single-rate cost-allocation method - pools all costs in one cost pool and allocates them to cost objects using the same rate per unit of the single allocation base. There is no distinction between costs in the cost pool in terms of cost variability (such as fixed costs versus variable costs)
Benefit - low cost of implementation, however, may lead divisions to take actions that appear to be in their own best interest but is not
Describe the dual-rate cost allocation method
Dual-rate cost-allocation method - first classifies costs in one cost pool into two subpools (typically into a variable-cost subpool and a fixed-cost subpool). Each subpool has a different allocation rate or a different allocation base
Benefit - signals to division managers how variable costs and fixed costs behave differently, important information which could lead managers to make decisions that benefit the corporation as well as each division
- Explain changes in risks at budgeted versus actual allocation rates
Budgeted rates let the user departments know the cost rates they will be charged in advance - users are then better equipped to determine the amount of the service to request and, if it is an option, whether to use the internal department source or an external supplier.
When actual rates are used, the user department will not know the rates charged until the end of the period
Describe the direct-method of cost allocation
Most widely used, the benefit is simplicity
Allocates support department costs to operating departments only
Here we ignore the mutual exchange between support departments and pretend that the entire resource consumption is used by the operating departments only.
Describe the step-down allocation method
Allocates support department costs to other support departments and to operating department.
- aka as sequential allocation
Allows a partial recognition of services rendered by support departments
Requires ranking the support departments (to determine the sequence)
- % of the support department’s total support provided to other support departments or
- On the total € amounts of service provided to other support departments
- of total service provided to other sup. deps.
The costs in the first-ranked support department are allocated to the other support departments and to the operating departments
The costs in the second-ranked departments are allocated to those support department not yet allocated and to the operating departments
This procedure is followed until the costs in the last-ranked support department have been allocated to the operating departments
Once a support department’s costs have been allocated, no subsequent support department costs are allocated or circulated back to it
Describe the reciprocal cost allocation method
Allocates costs by including the mutual services provided among all support departments.
Theoretically the most accurate
The reciprocal allocation method enables us to incorporate interdepartmental relationships fully into the support department cost allocations
Three steps:
- For the distribution of each sup. dep.’s costs an equation is formulated
- Calculate the complete reciprocated costs for each sup. dep.
- Allocate these complete reciprocated costs to all other departments (both operating and support)
Obstacles - difficult to understand for many managers and the numbers obtained differ little from those obtained in the other two methods
Explain common cost
Common cost - a cost of operating a facility, operation, activity or other cost object that is shared by two or more users
- See differences in incremental and stand-alone cost-allocation method
Stand-alone cost-allocation method - uses information pertaining to each cost object as a separate operating entity to determine the cost allocation weights
Fairness occurs because each employer bears a proportionate share of total costs in relation to their individual stand-alone costs
Incremental cost-allocation method - ranks the individual cost objects and then uses this ranking to allocate costs among those objects
The first ranked - primary party and is allocated costs up to its cost as a stand-alone entity
The second ranked - incremental party and is allocated the additional costs that arises from there being two users instead of only the primary user
5.8 Why is the distinction between labour-paced and machine-paced operations important when selecting indirect-cost allocation bases?
In labour-paced operations, worker dexterity and productivity determine the speed of production. Machines are tools that aid the production workers. Direct manufacturing labour costs or direct manufacturing labour-hours may still capture cause-and-effect relationships here, even if operations are highly automated
In machine-paced operations, machines conduct most or all phases of production, such as movement of materials to the production line, assembly and other activities on the production line and shipment of finished goods. Machine-hours will probably better capture cause-and-effect relationships
- Outline consequences of the inappropriate use of an allocation base
The use of an inappropriate cost allocation base can cause products to be manufactured less efficiently, management
to be misfocused and products to be mispriced in the marketplace.
Cost figures play a key role in many important decisions, if these figures result from allocation bases that fail to capture cause-and-effect relationships, managers may make decisions that conflict with maximising long-run company net income
Possible consequences:
o Provide incorrect information for decision making and distort the cost information
o Give a wrong basis for bonus payout etc.
o Provide the wrong basis for future prioritization of cost objects as well as incorrect prioritization regarding service departments’ functions
o In the worst case, provide the wrong information base for pricing and market strategies.
Contract disputes can often be reduced by making the cost assignment rules as explicit as possible.
These rules should include details such as cost item, cost-allocation base and how differences between budgeted and actual costs are to be handled.
