1. Cost Accumulation, Tracing, and Allocation
Part Three
Cost Accumulation, Tracing, and Allocation

2. Introduction Did costs increase or decrease from last year?
Is our selling price sufficient to cover costs and provide for adequate profitability?
Were actual costs consistent with expected costs?
What is our cost of goods sold?
Who is responsible?
What is our inventory cost?
Who should be rewarded?
How can improvement be accomplished?

3. Using Cost Drivers to Accumulate Costs
Units produced
Machine hours
A cost driver is any factor that causes or “drives” an activity’s costs
Labour hours
Kilometres driven

4. Using Cost Drivers to Accumulate Costs
Accumulated Minutes Rate per Cost Talked Minute =
Total Long Distance Telephone Bill
Minutes talked is the cost driver.
Minutes Talked

5. Estimated Versus Actual Cost
Actual Costs Knowledge of actual costs, after the fact, may not be useful for planning and decision making.
Estimated Costs Managers use estimated costs to make decisions about the future.

6. Estimated Versus Actual Cost
Timely
Relevant
Potential Inaccuracies
Estimated Costs Managers use estimated costs to make decisions about the future.

7. Estimated Versus Actual Cost
Timely
Relevant
Potential Inaccuracies
Estimated Costs May be used to set prices, make bids, evaluate proposals, distribute resources, plan production, and set goals.

8. Assigning Cost to Objects in a Retail Business
Style, Inc. Department Store pays a bonus to each department manager based on departmental sales.
The incentive has increased departmental sales, but departmental profits have not increased accordingly.
Management has decided to base future bonuses on department profitability.

9. Assigning Cost to Objects in a Retail Business
The first step in the development of the new bonus strategy is to determine the costs of each department.
Costs that are easily traced to departments are called direct costs.
Costs that cannot be easily traced to departments are called indirect costs.

10. Assigning Cost to Objects in a Retail Business

11. Assigning Cost to Objects in a Retail Business
Direct and indirect costs may be either fixed or variable.
A cost can be either direct or indirect depending on the cost object.
The store manager salary is indirect to any one department, but is directly traceable to the store.

12. Allocating Indirect Costs to Departments
Identify the most appropriate cost driver for each indirect cost.
Indirect costs should be allocated to reflect how the departments consume resources.
Style, Inc. chose these cost drivers:

13. Allocating Indirect Costs to Departments
Use a two-step process to allocate indirect costs:
Allocation rate = total cost ÷ cost driver activity.
Allocated cost = allocation rate × weight of the cost driver activity.

14. Assigning Cost to Objects in a Retail Business
$9,360 ÷ 3 departments = $3,120 per department
$3,120 × 1 department = $3,120

15. Assigning Cost to Objects in a Retail Business
$18,400 ÷ 23,000 square metres = $0.80 per square metre
$0.80 × 12,000 Women’s square metres = $9,600
$0.80 × 7,000 Men’s square metres = $5,600
$0.80 × 4,000 Children’s square metres = $3,200

16. Assigning Cost to Objects in a Retail Business
$2,300 ÷ 23,000 square metres = $0.10 per square metre
$0.10 × 12,000 Women’s square metres = $1,200
$0.10 × 7,000 Men’s square metres = $700
$0.10 × 4,000 Children’s square metres = $400

17. Assigning Cost to Objects in a Retail Business
$7,200 ÷ $360,000 sales = $0.02 per sales dollar
$0.02 × $190,000 Women’s sales = $3,800
$0.02 × $110,000 Men’s sales = $2,200
$0.02 × $60,000 Children’s sales = $1,200

18. Assigning Cost to Objects in a Retail Business
$900 ÷ $360,000 sales = $ per sales dollar
$ × $190,000 Women’s sales = $475
$ × $110,000 Men’s sales = $275
$ × $60,000 Children’s sales = $150

19. Assigning Cost to Objects in a Retail Business

20. Assigning Cost to Objects in a Retail Business
Now let’s combine the costs and revenues and see how departmental profitability looks.

21. Assigning Cost to Objects in a Retail Business

22. The Effects of Cost Behaviour on Cost Driver Selection
Does this mean that I should use different cost drivers for variable and fixed overhead?

23. Using Volume Measures to Allocate Variable Manufacturing Overhead
Increases in the volume of production will cause variable overhead costs to increase.
Volume measures serve as good cost drivers for the allocation of variable overhead.
Units Produced
Labour Hours
Materials Used

24. Using Volume Measures to Allocate Variable Manufacturing Overhead
Filmier Furniture Company Production and Cost Information
Use the two-step process to allocate indirect materials cost using the three volume measures as cost drivers.

25. Using Volume Measures to Allocate Variable Manufacturing Overhead
$60,000 ÷ 5,000 units = $12 per unit
$12 per unit × 4,000 chairs = $48,000
$12 per unit × 1,000 tables = $12,000

26. Using Volume Measures to Allocate Variable Manufacturing Overhead
$60,000 ÷ 6,000 hours = $10 per hour
$10 per hour × 3,500 hours = $35,000
$10 per hour × 2,500 hours = $25,000

27. Using Volume Measures to Allocate Variable Manufacturing Overhead
$60,000 ÷ $1,500,000 of material = $0.04 per $
$0.04 per $ × $1,000,000 = $40,000
$0.04 per $ × $500,000 = $20,000

28. Selecting the Best Cost Driver
So which volume measure should I use?

29. Selecting the Best Cost Driver
Judgement and reasoning are necessary.
Considerations
Relationship between cost driver activity and use of resources.
Availability of information.

30. Allocating Fixed Overhead Costs
Objective
Distribute a fair share of the overhead cost to each product.
There are no volume based cost drivers for fixed overhead.

31. Allocating Fixed Overhead Costs
Lednicky Bottling Company Information
Use the two-step process to allocate the rental cost to units sold and to units in ending inventory.

32. Allocating Fixed Overhead Costs
$28,000 ÷ 2,000,000 units = $0.014 per unit
$0.014 per unit × 1,800,000 units = $25,200
$0.014 per unit × 200,000 units = $2,800

33. Allocating Costs to Solve Timing Problems
Allocating fixed costs can be complicated when the volume of production varies from month to month.
If prices are based on these costs, units produced in January will be higher than those produced in February.
Will customers think this is reasonable?

34. Allocating Costs to Solve Timing Problems
We solve this problem by using estimated costs and estimated production for the year to obtain a predetermined overhead rate (POHR).
Estimated overhead the year
Estimated allocation base for the year
POHR =
$36,000
18,000 units
POHR = = $2.00 per unit
$2.00 allocated to each unit produced for all months during the year.

35. Cost Allocation: The Human Factor
Is it fair to divide the College of Business copy budget equally?
I think we consider the number of students.
I think we consider the number of faculty.

36. Cost Allocation: The Human Factor
Let’s see how the allocation of budgeted amounts will effect the different departments. We will begin by allocating equal amounts.

37. Cost Allocation: The Human Factor
Who is happy? Who is unhappy?

38. Cost Allocation: The Human Factor
Now let’s allocate the $36,000 budget based on the number of faculty in each department.

39. Cost Allocation: The Human Factor
$36,000 ÷ 72 faculty = $500 per faculty member
$500 × 29 faculty members = $14,500
$500 × 16 faculty members = $8,000
$500 × 12 faculty members = $6,000
$500 × 15 faculty members = $7,500
Cost Allocation: The Human Factor
Who is happy? Who is unhappy?

40. Cost Allocation: The Human Factor
Now let’s allocate the $36,000 budget based on the number of students in each department.

41. Cost Allocation: The Human Factor
$36,000 ÷ 1,200 students = $30 per student
$30 per student × 330 students = $9,900
$30 per student × 360 students = $10,800
$30 per student × 290 students = $8,700
$30 per student × 220 students = $6,600
Who is happy? Who is unhappy?

42. Establishing Cost Pools
This is the problem when we don’t use cost pools to allocate costs.
Indirect Cost 1
Product 1
Indirect Cost 2
Indirect Cost 3
Product 2
Indirect Cost 4
Product 3
Indirect Cost 5
15 allocations

43. Establishing Cost Pools
Cost pools reduce the number of cost allocation computations.
Indirect Cost 1
Product 1
Indirect Cost 2
Indirect Cost 3
Cost Pool
Product 2
Three allocations
Indirect Cost 4
Product 3
Indirect Cost 5
Contains indirect costs related to a common cost driver.

44. Allocating Joint Costs
Product
Joint Costs
Product
Product

45. Allocating Joint Costs
Key terms
Joint products – products resulting from a process with a common input.
Split-off point – the stage of processing where joint products are separated.
Joint cost – costs of processing joint products prior to the split-off point.

46. Allocating Joint Costs

47. Allocating Joint Costs
Consider the following example of an oil refinery.
We will assume only two products, gasoline and oil.

48. Allocating Joint Costs
Separate
Processing
Oil
Final
Sale
Common
Production
Process
Separate Processing Costs
Joint
Input
Separate
Processing
Gasoline
Final
Sale
Split-Off
Point
Separate Processing Costs

49. Joint Cost Allocation Methods
Joint costs are allocated based on a relative measure (weight, volume, etc.) of the products at the split-off point.
Physical quantities method
Net realizable value method
Joint costs are allocated based on the relative values of the products at the split-off point.
Relative Sales Value Method

50. Joint Cost Allocation Methods
Let’s look at an example illustrating the joint cost allocation methods.

51. Physical Quantities Method
Joint conversion cost = $225,000
Oil
240,000 litres
Common
Production
Process
Joint material
cost = $275,000
Gasoline
360,000 litres
Split-Off
Point

52. Physical Quantities Method

53. Physical Quantities Method

54. Physical Quantities Method
$225,000 joint conversion cost plus $275,000 joint material cost

55. Relative Sales Value Method
Joint conversion cost = $225,000
$200,000
sales value at
split-off point
Oil
Common
Production
Process
Joint material
cost = $275,000
$600,000
sales value at
split-off point
Gasoline
Split-Off
Point

56. Relative Sales Value Method

57. Relative Sales Value Method

58. Relative Sales Value Method
$225,000 joint conversion cost plus $275,000 joint material cost

59. Relatively low value relative to major products.
By-Products
Joint
Costs
Major Product
Joint
Production
Process
Joint
Input
Major Product
By-products
Relatively low value relative to major products.
Split-Off
Point

60. Joint Costs and the Issue of Relevance
The allocated portion of a joint cost is not relevant to a decision regarding further processing.
A product should be processed beyond the split-off point only if if the incremental revenue exceeds the incremental processing costs.

61. Thanks for Your Attention