PowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA Charles W. Caldwell, D.B.A., CMA Jon A. Booker, Ph.D., CPA, CIA Cynthia J. Rooney, Ph.D., CPA Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Chapter 21 C OST A LLOCATION AND P ERFORMANCE M EASUREMENT

Jobs Direct Labor Hours Machine Hours Raw Materials Cost Departmental Allocation Bases Stage Two: Costs applied to jobs Stage One: Costs assigned to departments T WO -S TAGE C OST A LLOCATION Service Dept. 2 Service Dept. 3 Service Dept. 1 Operating Dept.1 Operating Dept. 2 Operating Dept. 3 P 1

With the Activity-Based Costing (ABC) method, we recognize that many activities within a department drive overhead costs. A BC A C B A CTIVITY -B ASED C OST A LLOCATION Identify activities and assign indirect costs to those activities. Central idea... Products require activities. Activities consume resources. P 2

A CTIVITY -B ASED C OSTING S TEPS  Identify activities that consume resources.  Assign costs to a cost pool for each activity.  Identify cost drivers associated with each activity.  Compute overhead rate for each cost pool:  Assign costs to products: Overhead Actual Rate Activity × Rate = Estimated overhead costs in activity cost pool Estimated number of activity units P 2

D EPARTMENTAL E VALUATION The accounting system provides information about resources used and outputs achieved. Managers use this information to control operations, appraise performance, allocate resources, and plan strategy. The type of accounting information provided depends on whether the department is a... Evaluated on ability to control costs. Cost center Evaluated on ability to generate revenues in excess of expenses. Profit center Evaluated on ability to generate return on investment in assets. Investment center C 1

Direct expenses are incurred for the sole benefit of a specific department. Indirect expenses benefit more than one department and are allocated among departments benefited. D EPARTMENTAL E XPENSE A LLOCATION C 1

Service Dept. One Service Dept. Two Direct expenses are traced to each department without allocation. S TEP 1: D IRECT E XPENSE A CCUMULATION P 3 Operating Dept. One Operating Dept. Two

Indirect expenses are allocated to all departments using appropriate allocation bases. Allocation S TEP 2: I NDIRECT E XPENSE A LLOCATION P 3 Operating Dept. One Operating Dept. Two Service Dept. One Service Dept. Two

Operating Dept. One Operating Dept. Two Service department total expenses (original direct expenses + allocated indirect expenses) are allocated to operating departments. Allocation S TEP 3: S ERVICE D EPARTMENT E XPENSE A LLOCATION P 3 Service Dept. One Service Dept. Two

Departmental contribution...  Is used to evaluate departmental performance.  Is not a function of arbitrary allocations of indirect expenses. Departmental revenue – Direct expenses = Departmental contribution D EPARTMENTAL C ONTRIBUTION TO O VERHEAD A department may be a candidate for elimination when its departmental contribution is negative. P 3

I NVESTMENT C ENTER R ETURN ON T OTAL A SSETS (ROI) ROI = Investment Center Net Income Investment Center Average Invested Assets LCD Division earned more dollars of income, but it was less efficient in using its assets to generate income compared to S-Phone Division. A 1

Residual Income Investment Center Net Income Target Investment Center Net Income =– I NVESTMENT C ENTER R ESIDUAL I NCOME The target net income is 8% of divisional assets. A 1

Innovation and Learning How can we continually improve and create value? Internal Business Processes In which activities must we excel? B ALANCED S CORECARD Performance Measures Financial Perspective How do we look to the firm’s owners? Customer Perspective How do our customers see us? A 1

An accounting system that provides information... R ESPONSIBILITY A CCOUNTING S YSTEM Relating to the responsibilities of individual managers. To evaluate managers on controllable items. C 2

Amount of detail varies according to the level in the organization. A department manager receives detailed reports. A store manager receives summarized information from each department. R ESPONSIBILITY A CCOUNTING P ERFORMANCE R EPORTS C 2

INVESTMENT CENTER PROFIT MARGIN AND INVESTMENT TURNOVER A 2 Return on investment (ROI) = Profit Margin Investment turnover × Investment center sales Investment center average assets Investment center net income Investment center sales Domestic ROI = 16.64% International ROI = 2.56%

E ND OF C HAPTER 21