Chapter Twelve Cost Accumulation, Tracing, and Allocation © 2015 McGraw-Hill Education.

Chapter Opening Managers must have reliable cost estimates to: Price products. Evaluate performance. Control operations. Prepare financial statements. Managers must have reliable cost estimates to: Price products. Evaluate performance. Control operations. Prepare financial statements. What does it cost? 12-2

Determine the Cost of Cost Objects Cost accumulation begins with identifying: 1.Cost objects 2.Cost drivers A cost object is any activity, product, or service to which accountants wish to trace costs. 12-3

Use of Cost Drivers to Accumulate Costs Machine hours Miles driven Labor hours Units produced A cost driver is any factor that causes or “drives” an activity’s costs 12-4

Estimated Versus Actual Cost Potential Inaccuracies TimelyRelevant Estimated Costs Managers use estimated costs to make decisions about the future. 12-5

The first step in the development of the new bonus strategy is to determine the costs of each department. Costs that can be traced to departments in a cost-effective manner are called direct costs. Costs that cannot be traced to departments in a cost-effective manner are called indirect costs. The first step in the development of the new bonus strategy is to determine the costs of each department. Costs that can be traced to departments in a cost-effective manner are called direct costs. Costs that cannot be traced to departments in a cost-effective manner are called indirect costs. Identifying Direct and Indirect Costs 12-6

Identifying Direct and Indirect Costs 12-7

Aggregating and Disaggregating Individual Costs into Cost Pools Utilities Cost Pool Electricity WaterGas Frequently, companies accumulate many individual costs into a single cost pool. Pooling should be limited to costs with common cost drivers. 12-8

Selecting the Best Cost Driver So which volume measure should I use? 12-9

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. The cost drivers of In Style, Inc. are: 12-10

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

 $9,360 ÷ 3 departments = $3,120 per department  $3,120 × 1 department = $3,120 Allocating Indirect Costs to Departments 12-12

 $18,400 ÷ 23,000 square feet = $0.80 per square foot  $0.80 × 12,000 Women’s square feet = $9,600 $0.80 × 7,000 Men’s square feet = $5,600 $0.80 × 4,000 Children’s square feet = $3,200 Allocating Indirect Costs to Departments 12-13

 $2,300 ÷ 23,000 square feet = $0.10 per square foot  $0.10 × 12,000 Women’s square feet = $1,200 $0.10 × 7,000 Men’s square feet = $700 $0.10 × 4,000 Children’s square feet = $400 Allocating Indirect Costs to Departments 12-14

 $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 Allocating Indirect Costs to Departments 12-15

 $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 Allocating Indirect Costs to Departments 12-16

Allocating Indirect Costs to Departments 12-17

Using Volume Measures to Allocate Variable Overhead Costs 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 Labor Hours Materials Used 12-18

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

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 priced higher than those produced in February. Will customers think this is reasonable? Allocating Costs to Solve Timing Problems 12-20

Allocating Fixed Costs When the Volume of Production Varies We solve this problem by using estimated costs and estimated production for the year to obtain a predetermined overhead rate (POHR). Estimated overhead for 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

Cost Allocations Have Behavioral Implications Using inappropriate cost drivers can distort allocations and lead managers to make choices that are detrimental to the company’s profitability. Cost allocations significantly affect individuals. They may influence managers’ performance evaluations and compensation. They may dictate the amount of resources various departments, divisions, and other organizational subunits receive

End of Chapter Twelve 12-23