Understand Cost Accounting Methods

Cost Accounting
DMPalatino
FOH
Departmental Overhead Rates

Finishing Department
Painting Department
Shipping Department
A two-stage process is
necessary because different
departments may have
different cost drivers.

Stage One:
Costs assigned
to pools
Cost pools
Indirect
Labor
Indirect
Materials
Other
Overhead
Department
1
Department
2
Department
3

Stage One:
Costs assigned
to pools
Cost pools
Indirect
Labor
Indirect
Materials
Other
Overhead
Department
1
Department
2
Department
3

Stage One:
Costs assigned
to pools
Cost pools
Indirect
Labor
Indirect
Materials
Other
Overhead
Department
1
Department
2
Department
3

Stage One:
Costs assigned
to pools
Cost pools
Stage Two:
Costs applied
to products
Indirect
Labor
Indirect
Materials
Other
Overhead
Department
1
Department
2
Department
3
Direct
Labor
Hours
Machine
Hours
Raw
Materials
Cost
Products
Departmental Allocation Bases
Activity-Based Costing
In
In the
the ABC
ABC method,
method,
we
we recognize
recognize that
that many
many
activities
activities within
within aa
department
department drive
drive
overhead
overhead costs.
costs.
Assigning Costs to Activity

Centers
Assign costs to the
activity centers
where they are
accumulated while
waiting to be applied
to products.
Selecting Cost Drivers

Assign costs from
the activity center
to the product using
appropriate cost
drivers.
When selecting a cost

driver consider:
The ease of obtaining
data.
The degree to which
the cost driver
measures actual
consumption by
products.
Service Department Cost

Allocation
Production
Departments
Service
Departments
Carry out the

central purposes
of an organization.
Provide support
that facilitates the
activities of production
departments.

Allocation
How are service
department costs
charged to production
departments?
First, we identify the factor

that drives costs in the
service department.
This cost driver is called
the allocation base.

Allocation
How are service
department costs
departments?
Second, we measure the

consumption of the
allocation base in the
production departments.

Allocation
How are service
department costs
departments?
Third, we allocate the service

department cost based on
the relative amount of the
allocation base consumed in
each production department.

Allocation
What happens to
service department
costs after they are
allocated to
production
departments?
Allocated service department

costs become a part of the
manufacturing overhead in

Allocation
I get it. They become
a part of the overhead
that is applied to
products with a
predetermined
overhead rate.
Allocated service department

costs become a part of the
manufacturing overhead in

Allocation
I get it. They become
a part of the overhead
that is applied to
products with a
predetermined
overhead rate.
Thats right. Take a look at

this flow chart.
I think it will summarize
our discussion of the
allocation process.

Allocation
First Stage Allocations
Service
Department
(Cafeteria)
Service
Department
(Accounting)
Service
Department
(Personnel)
Service department costs are allocated to

production departments.
Production
Department
(Machining)
Production
Department
(Assembly)
The
Product

Allocation
Service
Department
(Cafeteria)
Service
Department
(Accounting)
Production
Department
(Machining)
Production
Department
(Assembly)
The
Product
Service
Second
Stage Allocations
Department
Production
department overhead costs, plus allocated service
(Personnel)
department
costs, are applied to products using
departmental predetermined overhead rates.
Selecting Allocation Bases

Personnel:
Number of
employees
Typical
Allocation
Bases
Receiving:
Units
handled
Security:
Square
footage
Custodial:
Square
footage
Cafeteria:
Number of
employees
Accounting:
Staff
hours
Power:
Kilowatt
hours

Personnel:
Number of
employees
Receiving:
Units
handled
Security:
Square
footage
Criteria for
selection
Simplicity
Accounting:
Staff
hours
Custodial:
Square
footage
Cafeteria:
Number of
employees
Power:
Kilowatt
hours

Personnel:
Number of
employees
Receiving:
Units
handled
Security:
Square
footage
Criteria for
selection
Custodial:
Square
footage
Availability
of space or
equipment
Cafeteria:
Number of
employees
Accounting:
Staff
hours
Power:
Kilowatt
hours

Personnel:
Number of
employees
Receiving:
Units
handled
Security:
Square
footage
Criteria for
selection
Benefits received
by the production
department
Accounting:
Staff
hours
Custodial:
Square
footage
Cafeteria:
Number of
employees
Power:
Kilowatt
hours
Interdepartmental Services
Problem
Allocating costs when service departments
provide services to each other
Solutions
Direct Method
Step Method
Direct Method
Cost of services
between service
departments are
ignored and all
costs are
allocated directly
to production
departments.
Service
Department
(Cafeteria)
Production
Department
(Machining)
Service
Department
(Custodial)
Production
Department
(Assembly)
Direct Method Example

Departmental costs
before allocation
Number of employees
Square feet occupied
Service Departments
Production Departments
Cafeteria
Custodial
Machining
Assembly
$ 360,000
15
5,000
$ 90,000
10
2,000
$ 400,000
20
25,000
$ 700,000
30
50,000
Service Department
Allocation Base
Cafeteria
Custodial
Number of employees

Departmental costs
before allocation
Cafeteria allocation
Service Departments
Cafeteria
Custodial
Machining
Assembly
$ 360,000
$ 90,000
$ 400,000
$ 700,000
(360,000)
Custodial allocation
Total after allocation
144,000
?
$360,000
20
20 + 30
= $144,000
Allocation base: Number of employees
?
?

Departmental costs
before allocation
Service Departments
Cafeteria
Custodial
Machining
Assembly
$ 360,000
$ 90,000
$ 400,000
$ 700,000
144,000
216,000
(360,000)
?
$
$360,000
30
20 + 30
= $216,000

Departmental costs
before allocation
Service Departments
Cafeteria
Custodial
Machining
Assembly
$ 360,000
$ 90,000
$ 400,000
$ 700,000
144,000
216,000
(360,000)
(90,000)
$
25,000
$90,000
25,000 + 50,000
30,000
$ 574,000
= $30,000
Allocation base: Square feet occupied

Departmental costs
before allocation
Service Departments
Cafeteria
Custodial
Machining
Assembly
$ 360,000
$ 90,000
$ 400,000
$ 700,000
144,000
216,000
30,000
60,000
$ 574,000
$ 976,000
(360,000)
(90,000)
$
50,000
$90,000
25,000 + 50,000
= $60,000
Step Method
Service department
costs are allocated
to other service
departments and
to production
departments, usually
starting with the
service department
that serves the
largest number of
other service
departments.
Service
Department
(Cafeteria)
Production
Department
(Machining)
Service
Department
(Custodial)
Production
Department
(Assembly)
Step Method
Once a service
departments costs
are allocated,
other service
departments costs
are not allocated
back to it.
Service
Department
(Cafeteria)
Production
Department
(Machining)
Service
Department
(Custodial)
Production
Department
(Assembly)
Step Method
Custodial will
have a new
total to allocate
to production
departments: its
own costs plus
those costs
allocated from
the cafeteria.
Service
Department
(Cafeteria)
Production
Department
(Machining)
Service
Department
(Custodial)
Production
Department
(Assembly)
Step Method Example

We will use the same data used in the direct method example.
Departmental costs
before allocation
Number of employees
Service Departments
Cafeteria
Custodial
Machining
Assembly
$ 360,000
15
5,000
$ 90,000
10
2,000
$ 400,000
20
25,000
$ 700,000
30
50,000
Service Department
Allocation Base
Cafeteria
Custodial
Number of employees
Step Method Example

Departmental costs
before allocation
Service Departments
Cafeteria
Custodial
Machining
Assembly
$ 360,000
$ 90,000
$ 400,000
$ 700,000
(360,000)
60,000
?
$360,000
10
10 + 20 + 30
= $60,000
Step Method Example

Departmental costs
before allocation
Service Departments
Cafeteria
Custodial
Machining
Assembly
$ 360,000
$ 90,000
$ 400,000
$ 700,000
60,000
120,000
(360,000)
?
$
$360,000
20
10 + 20 + 30
= $120,000
?
?
Step Method Example

Departmental costs
before allocation
Service Departments
Cafeteria
Custodial
Machining
Assembly
$ 360,000
$ 90,000
$ 400,000
$ 700,000
60,000
120,000
180,000
(360,000)
?
$
$360,000
30
10 + 20 + 30
= $180,000
Step Method Example

Departmental costs
before allocation
Service Departments
Cafeteria
Custodial
Machining
Assembly
$ 360,000
$ 90,000
$ 400,000
$ 700,000
60,000
120,000
180,000
(360,000)
(150,000)
$
New total = $90,000 original custodial cost

plus $60,000 allocated from the cafeteria.
Step Method Example

Departmental costs
before allocation
Service Departments
Cafeteria
Custodial
Machining
Assembly
$ 360,000
$ 90,000
$ 400,000
$ 700,000
60,000
120,000
180,000
(150,000)
50,000
(360,000)
25,000
$150,000
25,000 + 50,000
$ 570,000
= $50,000
Step Method Example

Departmental costs
before allocation
Service Departments
Cafeteria
Custodial
Machining
Assembly
$ 360,000
$ 90,000
$ 400,000
$ 700,000
60,000
120,000
180,000
(150,000)
50,000
100,000
$ 570,000
$ 980,000
(360,000)
50,000
$150,000
25,000 + 50,000
= $100,000
Comparison of Methods
Totals after allocation
Method
Direct
Step
Machining
Department
Assembly
Department
574,000
570,000
976,000
980,000
Algebraic Method
A service
departments costs
are interallocated to
other service
departments costs.
Service
Department
(Cafeteria)
Production
Department
(Machining)
Service
Department
(Custodial)
Production
Department
(Assembly)
Algebraic Method
Custodial & cafeteria
will have a new
total to allocate
to production
departments: its
own costs plus
those costs
allocated from other
service departments
Service
Department
(Cafeteria)
Production
Department
(Machining)
Service
Department
(Custodial)
Production
Department
(Assembly)
Algebraic Method Example

We will use the same data used in the direct method example.
Departmental costs
before allocation
Number of employees
Service Departments
Cafeteria
Custodial
Machining
Assembly
$ 360,000
15
5,000
$ 90,000
10
2,000
$ 400,000
20
25,000
$ 700,000
30
50,000
Service Department
Allocation Base
Cafeteria
Custodial
Number of employees

Departmental costs
before allocation
Service Departments
Cafeteria
Custodial
Machining
Assembly
$ 360,000
$ 90,000
$ 400,000
$ 700,000
(360,000)
60,000
?
10
$360,000 +
10 + 20 + 30
10
10 + 20 + 30
= $60,000

Departmental costs
before allocation
Service Departments
Cafeteria
Custodial
Machining
Assembly
$ 360,000
$ 90,000
$ 400,000
$ 700,000
(360,000)
60,000
?
$360,000
10
10 + 20 + 30
= $60,000

Departmental costs
before allocation
Service Departments
Cafeteria
Custodial
Machining
Assembly
$ 360,000
$ 90,000
$ 400,000
$ 700,000
60,000
120,000
(360,000)
?
$
$360,000
20
10 + 20 + 30
= $120,000
?
?

Departmental costs
before allocation
Service Departments
Cafeteria
Custodial
Machining
Assembly
$ 360,000
$ 90,000
$ 400,000
$ 700,000
60,000
120,000
180,000
(360,000)
?
$
$360,000
30
10 + 20 + 30
= $180,000

Departmental costs
before allocation
Service Departments
Cafeteria
Custodial
Machining
Assembly
$ 360,000
$ 90,000
$ 400,000
$ 700,000
60,000
120,000
180,000
(360,000)
(150,000)
$
New total = $90,000 original custodial cost

plus $60,000 allocated from the cafeteria.

Departmental costs
before allocation
Service Departments
Cafeteria
Custodial
Machining
Assembly
$ 360,000
$ 90,000
$ 400,000
$ 700,000
60,000
120,000
180,000
(150,000)
50,000
(360,000)
25,000
$150,000
25,000 + 50,000
$ 570,000
= $50,000

Departmental costs
before allocation
Service Departments
Cafeteria
Custodial
Machining
Assembly
$ 360,000
$ 90,000
$ 400,000
$ 700,000
60,000
120,000
180,000
(150,000)
50,000
100,000
$ 570,000
$ 980,000
(360,000)
50,000
$150,000
25,000 + 50,000
= $100,000
Fixed Versus Variable Costs

Are fixed
and variable
costs allocated
differently?

Problem
Allocating common
fixed costs using a
variable activity
allocation base
Result
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.

Problem
Allocating common
fixed costs using a
variable activity
allocation base
Solution
Use dual allocation
method, allocating
fixed and variable
costs separately.
Dual Cost Allocation

Variable
Costs
Fixed
Costs
Charge to
production
departments at a
budgeted rate times
actual short-run usage of
the allocation base.
Allocate
budgeted amounts
to operating departments
in proportion to the
long-run average
usage of the
allocation base.

Variable
Costs
Fixed
Costs
Allocate
Charge to
budgeted amounts
production
to operating departments
departments at a
in proportion to the
budgeted rate times
long-run average
actual short-run usage of
usage of the
the allocation
base. costs should be allocated
Budgeted
allocation base.
to avoid passing on inefficiencies

from the service departments.

Example
SimCo has a maintenance department and two production

departments: cutting and assembly. Variable maintenance
costs are budgeted at $0.60 per machine hour. Fixed
maintenance costs are budgeted at $200,000 per year.
Data relating to the current year are:
Production
Departments
Cutting
Assembly
Total
Long-run
Maintenance
Usage as a
% of Total
60%
40%
100%
Actual
Hours
Used
80,000
40,000
120,000
Allocate maintenance costs to the two operating departments.

Example
Cutting
Department
Variable cost allocation:
$0.60 80,000 hours used
$0.60 40,000 hours used
Fixed cost allocation
Assembly
Department
48,000
$
24,000
Total allocated cost
Variable costs are allocated based on hours used.

Example
Cutting
Department
Variable cost allocation:
$0.60 80,000 hours used
$0.60 40,000 hours used
Fixed cost allocation
60% of $200,000
40% of $200,000
Total allocated cost
Assembly
Department
48,000
$
24,000
80,000
104,000
120,000
$
168,000
Variable costs are allocated based on hours used.

Fixed costs are allocated based long-run average usage.
A Behavioral Problem
Problem
Solution
Department managers
may underestimate
long-run average usage
to reduce fixed cost
allocations.
Reward managers for

making accurate estimates
of long-run average
service department needs.
The New Manufacturing

Environment
More
More accurate
accurate cost
cost tracing
tracing systems
systems
reduce
reduce the
the need
need for
for allocation
allocation
of
of indirect
indirect costs.
costs.
The Rise of Activity-Based Costing

Service
Department
(Cafeteria)
Service
Department
(Accounting)
Service
Department
(Personnel)
First stage allocations are to

activities, not departments.
Activity
One
The
Product
Activity
Two
Departmentalized Factory Overhead
Departmentalized Factory Overhead (contd)
End of Chapter

Understand Cost Accounting Methods

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Understand Cost Accounting Methods

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Cost Accounting

Departmental Overhead Rates

Departmental Overhead Rates

Departmental Overhead Rates

Departmental Overhead Rates

Departmental Overhead Rates

Assigning Costs to Activity

Selecting Cost Drivers

When selecting a cost

Service Department Cost

Carry out the

Service Department Cost

First, we identify the factor

Service Department Cost

Second, we measure the

Service Department Cost

Third, we allocate the service

Service Department Cost

Allocated service department

Service Department Cost

Allocated service department

Service Department Cost

Thats right. Take a look at

Service Department Cost

Service department costs are allocated to

Service Department Cost

Selecting Allocation Bases

Selecting Allocation Bases

Selecting Allocation Bases

Selecting Allocation Bases

Direct Method Example

Direct Method Example

Allocation base: Number of employees

Direct Method Example

Allocation base: Number of employees

Direct Method Example

Allocation base: Square feet occupied

Direct Method Example

Allocation base: Square feet occupied

Step Method Example

Step Method Example

Allocation base: Number of employees

Step Method Example

Allocation base: Number of employees

Step Method Example

Allocation base: Number of employees

Step Method Example

New total = $90,000 original custodial cost

Step Method Example

Allocation base: Square feet occupied

Step Method Example

Allocation base: Square feet occupied

Algebraic Method Example

Algebraic Method Example

Allocation base: Number of employees

Algebraic Method Example

Allocation base: Number of employees

Algebraic Method Example

Allocation base: Number of employees

Algebraic Method Example

Allocation base: Number of employees

Algebraic Method Example