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© Pearson Education Limited 2008 MANAGEMENT ACCOUNTING Cheryl S. McWatters, Jerold L. Zimmerman, Dale C. Morse Cheryl S. McWatters, Jerold L. Zimmerman,

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Presentation on theme: "© Pearson Education Limited 2008 MANAGEMENT ACCOUNTING Cheryl S. McWatters, Jerold L. Zimmerman, Dale C. Morse Cheryl S. McWatters, Jerold L. Zimmerman,"— Presentation transcript:

1 © Pearson Education Limited 2008 MANAGEMENT ACCOUNTING Cheryl S. McWatters, Jerold L. Zimmerman, Dale C. Morse Cheryl S. McWatters, Jerold L. Zimmerman, Dale C. Morse

2 © Pearson Education Limited Management Accounting McWatters, Zimmerman, Morse Management Accounting Cost allocations (Planning and control) Chapter 9

3 © Pearson Education Limited Management Accounting McWatters, Zimmerman, Morse Objectives Describe the relation among common resources, indirect costs and cost objects Explain the role of allocating indirect costs for external financial reports, income tax reports and cost reimbursement Identify reasons for cost allocation for planning purposes Identify reasons for cost allocation for control purposes Describe how the various reasons for cost allocation can create conflict within the organization Allocate indirect costs using the five basic steps Create segment reports for the organization

4 © Pearson Education Limited Management Accounting McWatters, Zimmerman, Morse Allocation involves the use of cost drivers Cost drivers are events causing indirect costs Allocating Indirect Costs Cost allocation is the process of assigning indirect costs to cost objects Cost Allocation Cost Object Indirect costs

5 © Pearson Education Limited Management Accounting McWatters, Zimmerman, Morse Cost Object Operating Departments Computer users Products made in the factory Departments requesting maintenance service Cost Object Operating Departments Computer users Products made in the factory Departments requesting maintenance service Cost Allocation Examples Indirect Cost Personnel Department Computer Center Factory building depreciation Maintenance Department Indirect Cost Personnel Department Computer Center Factory building depreciation Maintenance Department Allocating Indirect Costs Cost objects include products, activities, divisions, customers, suppliers, and time periods Indirect costs cant be traced to a single cost object. They are associated with multiple cost objects

6 © Pearson Education Limited Management Accounting McWatters, Zimmerman, Morse Satisfying external reporting requirements Planning purposes Control purposes Satisfying external reporting requirements Planning purposes Control purposes Reasons for Allocating Indirect Costs Benefits of indirect cost allocation

7 © Pearson Education Limited Management Accounting McWatters, Zimmerman, Morse Satisfying External Requirements Allocation methods that reduce income, reduce taxes Cost of Goods Sold (Income Statement) Allocation methods deferring indirect costs to inventory will increase profits in the current period Inventory (Balance Sheet) Manufacturing Costs

8 © Pearson Education Limited Management Accounting McWatters, Zimmerman, Morse Financial reports to shareholders Not all management accounting decisions are based on internal demand for information. Organizations have responsibility to provide information to outside parties such as: Satisfying External Requirements Reporting of taxable income Cost reimbursement contracts It is common to have separate accounting systems for internal and external purposes

9 © Pearson Education Limited Management Accounting McWatters, Zimmerman, Morse A sports ball manufacturer makes 2 types of balls. The company is considering 2 methods of allocating indirect costs Satisfying External Requirements 25% of the footballs are not yet sold so costs associated with them remain an asset There is no beginning inventory and the manufacturer makes 20,000 soccer balls and 40,000 footballs. Indirect manufacturing costs are £100,00. During the period all the soccer balls and 30,000 of the footballs are sold. The first method allocates £80,000 to soccer balls and £20,000 to footballs and the second allocates £40,000 to soccer balls and £60,000 to footballs

10 © Pearson Education Limited Management Accounting McWatters, Zimmerman, Morse A sports ball manufacturer makes 2 types of balls. The company is considering 2 methods of allocating indirect costs Satisfying External Requirements 25% of the footballs are not yet sold so costs associated with them remain an asset Under the first method 25% of the manufacturing overhead (£5,000) is not deducted from profits Under the second method 25% of £60,000 (£15,000) is not deducted The second method causes reported profits to be higher Under the first method 25% of the manufacturing overhead (£5,000) is not deducted from profits Under the second method 25% of £60,000 (£15,000) is not deducted The second method causes reported profits to be higher

11 © Pearson Education Limited Management Accounting McWatters, Zimmerman, Morse Product A Product B Product B is manufactured on a cost-plus contract Indirect Manufacturing Costs Cost Reimbursement Contracts Product A is sold in a competitive market Allocating more costs to Product B will result in more revenue from the cost-plus contract, thereby increasing profits Product B

12 © Pearson Education Limited Management Accounting McWatters, Zimmerman, Morse Product A Product B Product B is manufactured on a cost-plus contract Indirect Manufacturing Costs Cost Reimbursement Contracts Product A is sold in a competitive market The US federal government established the Cost Accounting Standards Board to regulate cost allocations by suppliers of government agencies

13 © Pearson Education Limited Management Accounting McWatters, Zimmerman, Morse A web design firm has 2 types of clients. Those that request a cost-plus 20% contract and those that request a fixed fee of £20,000. The firm is considering 2 methods of cost allocation wishes to know which method provides a higher profit The firm completes 50 web designs of each type in the period. The average direct costs of each design are 10,000. Indirect costs are 500,000. The first method assigns 200,000 to cost plus designs and 300,000 to fixed-fee designs. The second method allocates 400,000 to cost-plus designs and 100,000 to fixed-fee designs Satisfying External Requirements Numerical Example

14 © Pearson Education Limited Management Accounting McWatters, Zimmerman, Morse Satisfying External Requirements Numerical Example Cost plus designs Direct costs (50 x 10,000)500,000 Indirect costs200,000 Total700,000 Total profit for both contracts Revenues Cost-plus (700,000 x 120%)840,000 Fixed fee (50 x 20,000)1,000,000 Total1,840,000 Costs Direct (100 x 10,000)1,000,000 Indirect500,000 Net profit340,000 Method 1 Method 2 Cost plus designs Direct costs (50 x 10,000)500,000 Indirect costs400,000 Total900,000 Total profit for both contracts Revenues Cost-plus (900,000 x 120%)1,080,000 Fixed fee (50 x 20,000)1,000,000 Total2,080,000 Costs Direct (100 x 10,000)1,000,000 Indirect500,000 Net profit580,000

15 © Pearson Education Limited Management Accounting McWatters, Zimmerman, Morse Different Accounting Systems for External and Internal Purposes Using the same cost allocation method for external financial, tax, and cost reimbursement reports can lead to conflicts Using a different accounting system for each purpose can... Increase reported financial income Reduce taxable income Increase revenues from cost reimbursements

16 © Pearson Education Limited Management Accounting McWatters, Zimmerman, Morse Cost Allocation for Planning Purposes Allocation of indirect costs... – can provide managers with information that allows them to make better decisions – serves as a communication mechanism to let managers know how their actions are affecting costs elsewhere in the organization

17 © Pearson Education Limited Management Accounting McWatters, Zimmerman, Morse Communication of Costs to Improve Planning Decisions Externalities result in costs and/or benefits imposed on others (external parties) without their consent For example, additional computing capacity is an externality

18 © Pearson Education Limited Management Accounting McWatters, Zimmerman, Morse Cost Allocation for Control Reasons The allocation of resources Cost allocations may control managers through The effect of cost allocations on performance measures

19 © Pearson Education Limited Management Accounting McWatters, Zimmerman, Morse Cost Allocations and the Allocation of Resources The allocation of costs in some organizations coincides with the allocation of resources The allocated costs are like a tax

20 © Pearson Education Limited Management Accounting McWatters, Zimmerman, Morse Responsibility centres are evaluated based on accounting numbers Cost Allocations and Performance Measures These accounting numbers are influenced by the allocation of indirect costs from resources used by multiple responsibility centres Performance measures should reveal the actions of the manager being evaluated Cost allocations change behaviour within organizations These accounting numbers are influenced by the allocation of indirect costs from resources used by multiple responsibility centres Performance measures should reveal the actions of the manager being evaluated Cost allocations change behaviour within organizations Organizations should continually evaluate their cost allocation methods

21 © Pearson Education Limited Management Accounting McWatters, Zimmerman, Morse Mutual Monitoring Incentives Mutual Monitoring results when cost allocations are made from one responsibility centre to another

22 © Pearson Education Limited Management Accounting McWatters, Zimmerman, Morse Basic Steps of Cost Allocation The steps for cost allocation are Defining the cost objects 2. Accumulating indirect costs into cost pools 3. Choosing an allocation base 4. Estimating an application rate 5. Allocating indirect costs based on use of the allocation base

23 © Pearson Education Limited Management Accounting McWatters, Zimmerman, Morse Defining the Cost Objects A cost object is chosen to... –Obtain cost information for planning purposes –Influence the decisions of managers for control purposes Cost objects include... –Departments and processes –Products and services –Customers and suppliers

24 © Pearson Education Limited Management Accounting McWatters, Zimmerman, Morse Accumulating the Indirect Costs in Cost Pools Costs caused by the common use of a resource are accumulated in cost pools Cost pools contain all costs of the resource, both direct costs and allocated indirect costs

25 © Pearson Education Limited Management Accounting McWatters, Zimmerman, Morse Two-Stage Allocation Procedure Service Dept 1 Service Dept 2 Service Dept 3 Mfg Dept A Mfg Dept B Mfg Dept C Mfg Dept D P r o d u c t s Multi-stage allocation occurs when costs are allocated through a series of cost pools

26 © Pearson Education Limited Management Accounting McWatters, Zimmerman, Morse Choosing an Allocation Base The allocation base is a measurement of a characteristic used to distribute indirect costs of a cost pool Each pool may have a different allocation base Cost drivers of the allocation bases that costs from overhead activity cost pools to different responsibility centres The choice of the allocation base depends on the organization goals The choice of allocation base is diverse to be associated with the indirect cost

27 © Pearson Education Limited Management Accounting McWatters, Zimmerman, Morse Fairness Consistency Simplicity Choosing an Allocation Base Key Objectives Of Allocation System

28 © Pearson Education Limited Management Accounting McWatters, Zimmerman, Morse Selection Criteria Causal Relation Benefits Received Reasonableness Choosing an Allocation Base Allocation Base

29 © Pearson Education Limited Management Accounting McWatters, Zimmerman, Morse Choosing an Allocation Base Allocation Base Examples

30 © Pearson Education Limited Management Accounting McWatters, Zimmerman, Morse Choosing an Allocation Base Allocation Base Examples

31 © Pearson Education Limited Management Accounting McWatters, Zimmerman, Morse Estimating an Application Rate The application rate for an allocation base is commonly estimated at the beginning of the year using the following ratio: Estimated Dollars in the Cost Pool Estimated Total Usage of the Allocation Base Application Rate =

32 © Pearson Education Limited Management Accounting McWatters, Zimmerman, Morse A motor pool allocates costs to other departments based on the number of kilometers driven in company vehicles The motor pool expects to incur annual fixed costs of £200,000 and variable costs of £0.20 per km. The motor pool expects company vehicles to be driven a total of 800,000 km Estimating an Application Rate Numerical Example £200,000 + (£0.20/km x 800,000km=£0.45/km 800,000 km The application rate is higher than the incremental cost of operating the vehicle (£0.20/km) and thus acts like a transfer price leading the managers to choose to use other means of transportation

33 © Pearson Education Limited Management Accounting McWatters, Zimmerman, Morse Problem When one department decreases activity to reduce allocations, all departments are penalized because the charge per use increases Remember, total fixed costs do not change as activity changes Estimating an Application Rate Pitfall Allocating indirect fixed costs using a variable activity allocation base Solutions Establish nominal per use charge so users are aware that service is not free, but not so large as to discourage legitimate use Charge a flat fee so that the per use charge declines with more uses, thereby encouraging more uses

34 © Pearson Education Limited Management Accounting McWatters, Zimmerman, Morse Based on estimates, and determined before the period begins Indirect costs applied = Activity Rate × Actual activity Actual amount of the allocation base, such as maintenance hours, incurred during the period Distributing Indirect Costs Based on Usage of the Allocation Base

35 © Pearson Education Limited Management Accounting McWatters, Zimmerman, Morse Segment Reporting Segment reporting is the process of developing accounting reports for the separate units of an organization Objectives To communicate information to managers of the different segments To motivate managers to better decisions consistent with the goals of the organization Objectives To communicate information to managers of the different segments To motivate managers to better decisions consistent with the goals of the organization

36 © Pearson Education Limited Management Accounting McWatters, Zimmerman, Morse The Green Corporation makes chemex and citrol. The corporation has 2 product lines with separate managers. Calculate the profit of the 2 divisions The Chemex Division sells 50 tonnes of chemex for £10,000 per tonne and 20 tonnes of chemex are transferred to the Citrol Division. The Citrol Division sells 100 tonnes of citrol for £20,000. The Chemex Division has variable costs of £8,000 per tonne and fixed costs of £200,000. The Citrol Division has variable costs of £8,000 per tonne (excluding the cost of chemex) and fixed costs of £400,000. Central administration allocates £100,000 of fixed costs to Chemex Division and £500,000 of fixed costs to Citrol Division Segment Reporting Numerical Example

37 © Pearson Education Limited Management Accounting McWatters, Zimmerman, Morse Estimating an Application Rate Numerical Example Chemex Division (£)Citrol Division (£) Revenues Open market sales500,0002,000,000 Internal sales Chemex200,000 Variable costs Internal purchase of chemex(200,000) Other variable costs(350,000)(800,000) Contribution margin350,0001,000,000 Fixed costs(200,000)(400,000) Profit before allocated costs150,000600,000 Allocated costs(100,000)(500,000) Divisional profit50,000100,000

38 © Pearson Education Limited Management Accounting McWatters, Zimmerman, Morse Management Accounting Cost allocations (Planning and control) End of Chapter 9


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