Cost Management ACCOUNTING AND CONTROL HANSEN & MOWEN

Allocating Costs of Support Departments and Joint Products CHAPTER 7 Allocating Costs of Support Departments and Joint Products

The cost objects must be determined, which are usually departments. OBJECTIVE 1 An Overview of Cost Allocation Allocation is dividing a pool of costs and assigning those costs to subunits. The cost objects must be determined, which are usually departments. Producing Support

Examples of Departmentalization for a Manufacturing Firm OBJECTIVE 1 An Overview of Cost Allocation Examples of Departmentalization for a Manufacturing Firm

Examples of Departmentalization for a Service Firm OBJECTIVE 1 An Overview of Cost Allocation Examples of Departmentalization for a Service Firm

1 An Overview of Cost Allocation OBJECTIVE 1 An Overview of Cost Allocation Steps in Allocating Support Department Costs to Producing Departments

1 An Overview of Cost Allocation OBJECTIVE 1 An Overview of Cost Allocation Examples of Possible Activity Drivers for Support Departments Allocating support department costs should be on the basis of appropriate causal factors (activity drivers).

Objectives of Allocation 1 An Overview of Cost Allocation Objectives of Allocation To obtain a mutually agreeable price To compute product-line profitability To predict the economic effects of planning and control To value inventory To motivate managers

2 Allocating One Department’s Cost to Another Department OBJECTIVE 2 Allocating One Department’s Cost to Another Department The costs of a support department are often allocated through the use of a charging rate. Major factors: Choice of single or dual rate Use of budgeted or actual support department costs.

Fixed costs + estimated variable costs estimated usage OBJECTIVE 2 Allocating One Department’s Cost to Another Department Fixed costs + estimated variable costs estimated usage Single rate: Dual rate: Fixed rate and a variable rate Development of fixed rate: Determine budgeted fixed costs. Compute allocation ratio Allocate Development of variable rate: Costs that change as the activity driver changes

2 Allocating One Department’s Cost to Another Department OBJECTIVE 2 Allocating One Department’s Cost to Another Department When allocating support department costs, should actual or budgeted costs be allocated? Answer: Budgeted – to prevent the transfer of efficiencies or inefficiencies from one department to another.

2 Allocating One Department’s Cost to Another Department OBJECTIVE 2 Allocating One Department’s Cost to Another Department Use of Budgeted Data for Products Costings: Comparison of Single- and Dual-Rate Methods

2 Allocating One Department’s Cost to Another Department OBJECTIVE 2 Allocating One Department’s Cost to Another Department Use of Actual Data for Performance Evaluation Pur- poses: Comparison of Single- and Dual-Rate Methods

Data for Illustrating Allocation Methods OBJECTIVE 3 Choosing A Support Department Cost Allocation Method Data for Illustrating Allocation Methods *For a producing department, direct costs refer only to overhead costs that are directly traceable to the department.

Direct Allocation Ilustrated OBJECTIVE 3 Choosing A Support Department Cost Allocation Method Direct Allocation Ilustrated

Sequential Allocation Ilustrated OBJECTIVE 3 Choosing A Support Department Cost Allocation Method Sequential Allocation Ilustrated

Data for Illustrating Reciprocal Method OBJECTIVE 3 Choosing A Support Department Cost Allocation Method Data for Illustrating Reciprocal Method

Reciprocal Method Illustrated OBJECTIVE 3 Choosing A Support Department Cost Allocation Method Reciprocal Method Illustrated a Power: 0.60  $271,429; Maintenance: 0.45  $214,286. b Power: 0.20  $271,429; Maintenance: 0.45  $214,286. *Rounded down.

3 Choosing A Support Department Cost Allocation Method OBJECTIVE 3 Choosing A Support Department Cost Allocation Method Comparison of Support Department Cost Allocations Using the Direct, Sequential, and Reciprocal Methods

4 Departmental Overhead Rates and Product Costing OBJECTIVE 4 Departmental Overhead Rates and Product Costing After allocating all support service costs to producing departments, an overhead rate is calculated for each department. Allocated service costs + Producing dept. overhead costs Measure of activity (direct labor hours, machine hours)

A product cost can now be determined. OBJECTIVE 4 Departmental Overhead Rates and Product Costing A product cost can now be determined. Materials + Labor + Overhead Product Cost

5 Accounting for Joint Production Processes OBJECTIVE 5 Accounting for Joint Production Processes Joint products are two or more products produced simultaneously by the same process up to a “split-off” point. The split-off point is the point at which the joint products become separate and identifiable. Separable costs are easily traced to individual products and offer no particular problem.

Joint Production Process OBJECTIVE 5 Accounting for Joint Production Processes Joint Production Process Hide Pork Meat Split-Off Point Material: Hog Processing

5 Accounting for Joint Production Processes OBJECTIVE 5 Accounting for Joint Production Processes Independent Multiple-Product Production Using the Same Material Processing Taurus Mustang Material: Steel

5 Accounting for Joint Production Processes OBJECTIVE 5 Accounting for Joint Production Processes The distinction between joint and by-products rests solely on the relative importance of their sales value. A by-product is a secondary product recovered in the course of manufacturing a primary product.

5 Accounting for Joint Production Processes OBJECTIVE 5 Accounting for Joint Production Processes The distinction between joint and by-products rests solely on the relative importance of their sales value. A by-product is a secondary product recovered in the course of manufacturing a primary product.

5 Accounting for Joint Production Processes OBJECTIVE 5 Accounting for Joint Production Processes Benefits-Received Approaches Physical Units Method Weighted Average Method Allocation Based on Relative Market Value Sales-Value-at-Split-Off-Method Net Realizable Value Method

5 Accounting for Joint Production Processes Physical Units Method OBJECTIVE 5 Accounting for Joint Production Processes Physical Units Method A sawmill processes logs into four grades of lumber totaling 3,000,000 board feet as follows: Percent of Joint Cost Grades Board Feet Units Allocation First and second 450,000 0.15 $ 27,900 No. 1 common 1,200,000 0.40 74,400 No. 2 common 600,000 0.20 37,200 No. 3 common 750,000 0.25 46,500 Totals 3,000,000 $186,000

Weighted Average Method OBJECTIVE 5 Accounting for Joint Production Processes Weighted Average Method A peach canning factory purchases $5,000 of peaches and grades and cans them by quality. The following data pertains to this operation: Number Weight Weighted Number Allocated Grades of Cases Factor of Cases Percent Joint Cost Fancy 100 1.30 130 0.21667 $1,083 Choice 120 1.10 132 0.22000 1,100 Standard 303 1.00 303 0.50500 2,525 Pie 70 0.50 35 0.05833 292 Totals 600 $5,000

Sales-Value-at-Split-Off Method OBJECTIVE 5 Accounting for Joint Production Processes Sales-Value-at-Split-Off Method Using the lumber mill example from earlier-- Price at Percent Quantity Split-Off Sales of Total Allocated Produced (per 1,000 Value at Market Joint Grades (board ft.) board ft.) Split-Off Value Cost First and second 450,000 $300 $135,000 0.2699 $ 50,201 No. 1 common 1,200,000 200 240,000 0.4799 89,261 No. 2 common 600,000 121 72,600 0.1452 27,007 No. 3 common 750,000 70 52,500 0.1050 19,530 Totals 3,000,000 $500,100 $185,999 * *Rounding error

Net Realizable Value Method OBJECTIVE 5 Accounting for Joint Production Processes Net Realizable Value Method A company manufactures two products, Alpha and Beta, from a joint process. One production run costs $5,750 and results in 1,000 gallons of Alpha and 3,000 gallons of Beta. Neither product is salable at the split-off point, but must be further processed. The separable cost for Alpha is $1 per gallon and for Beta is $2 per gallon. Further Hypothetical Hypothetical Allocated Market Processing Market Number Market Joint Price Cost Price of Units Value Cost Alpha $5 $1 $4 1,000 $ 4,000 $2,300 Beta 4 2 2 3,000 6,000 3,450 $10,000 $5,750

Constant Gross Margin Percentage Method OBJECTIVE 5 Accounting for Joint Production Processes Constant Gross Margin Percentage Method Percent Revenue ($5 x 1,000) + ($4 x 3,000) $17,000 100 % Costs [$5,750 + ($1 x 1,000) + ($2 x 3,000)] 12,750 75 % Gross margin $ 4,250 25 % Alpha Beta Eventual market value $ 5,000 $12,000 Less: Gross margin at 25% of market value 1,250 3,000 Cost of goods sold $ 3,750 $ 9,000 Less: Separable costs 1,000 6,000 Allocated joint costs $2,750 $ 3,000

End of Chapter 7