Managerial accounting 5th jiambalvo ch06

Prepared by Debby Bloom-Hill CMA, CFM CHAPTER CHAPTER 66 Cost Allocation & Activity-Based Costing Slide 6-2 Purposes Purposes of of Cost Cost Allocation Allocation     Slide 6-3 To provide information for decision making To reduce frivolous use of common resources To encourage evaluation of services To provide “full cost” information Learning objective 1: Explain why indirect costs are allocated Purposes Purposes of of Cost Cost Allocation Allocation Slide 6-4 Learning objective 1: Explain why indirect costs are allocated Purposes Purposes of of Cost Cost Allocation Allocation  Provide information for decision making  When managers use a company resource they are receiving a charge for use  Allocated cost should measure the opportunity cost of using a company resource  Provides a useful benchmark  The closer to the opportunity cost of use, the better the allocation Slide 6-5 Learning objective 1: Explain why indirect costs are allocated Purposes Purposes of of Cost Cost Allocation Allocation  To reduce frivolous use of common resources  When managers are not charged for a service, they may tend to use it for frivolous or nonessential purposes  Frivolous use may have hidden cost such as slower service  Allocation provides incentive for departments to reduce frivolous use Slide 6-6 Learning objective 1: Explain why indirect costs are allocated Purposes Purposes of of Cost Cost Allocation Allocation  To encourage evaluation of services  If costs are not allocated, there is no incentive to evaluate the services and look for lower cost alternatives  With cost allocation, there is a strong incentive to critically evaluate the efficiency and necessity of services  Users will certainly bring lower cost alternatives to the company’s attention Slide 6-7 Learning objective 1: Explain why indirect costs are allocated Purposes Purposes of of Cost Cost Allocation Allocation  To provide “full cost” information  GAAP requires full costing for external reporting purposes  Full cost information is needed when the company has an agreement whereby revenue received depends upon cost incurred  Also called “cost-plus” contracts Slide 6-8 Learning objective 1: Explain why indirect costs are allocated Test Your Knowledge All of the following are reasons indirect costs are allocated to products, services and departments, except: a b c d To improve decision making To reduce frivolous use of resources To provide information on variable and fixed costs To encourage evaluation of services Answer: c Indirect costs are allocated to provide full cost information Slide 6-9 Learning objective 1: Explain why indirect costs are allocated Cost-Plus Cost-Plus Contracts Contracts Slide 6-10 Learning objective 1: Explain why indirect costs are allocated Common Common Activities Activities and and Associated Associated Cost Cost Drivers Drivers Slide 6-46 Learning objective 5: Discuss activity-based costing (ABC) and cost drivers Activity Activity Based Based CostingCostingMcMaster McMaster Screen Screen Technologies Technologies  McMaster Screen Technologies has two products and allocates overhead costs using a rate of $4 per dollar of labor  One product has a very low gross profit and the other has a very high gross profit   The CFO suspects that this may be due to problems with the costing system The CFO authorizes a study of how product costs will change if an ABC approach is taken Slide 6-47 Learning objective 5: Discuss activity-based costing (ABC) and cost drivers Activity Activity Based Based CostingCostingMcMaster McMaster Screen Screen Technologies Technologies  The study finds that overhead cost is related to drivers shown on the next slide   The ABC approach reveals that the high-volume product is very profitable However, the selling price does not come close to covering the full cost of the low volume product  The CFO’s intuition that the traditional product costing might be providing misleading information is correct Slide 6-48 Learning objective 5: Discuss activity-based costing (ABC) and cost drivers Activity Activity Based Based CostingCostingMcMaster McMaster Screen Screen Technologies Technologies Slide 6-49 Learning objective 5: Discuss activity-based costing (ABC) and cost drivers Test Your Knowledge Power Electronics uses two cost pools  Equipment setups    Total estimated cost $1,500,000 Estimated setups 10,000 Inspections   Total estimated cost $3,000,000 Estimated inspections 15,000 Calculate the cost per driver unit for each pool Equipment setups $1,500,000 / 10,000 = $150 per setup Inspections $3,000,000 / 15,000 = $200 per inspection Slide 6-50 Learning objective 5: Discuss activity-based costing (ABC) and cost drivers Test Your Knowledge 10 Power Electronics has two products:  EP150    10 setups inspections EP175   40 setups inspections Calculate the overhead applied to EP150 Equipment setups 10 * $150 per setup = $1,500 Inspections * $200 per inspection = $600 Total overhead $1,500 + $600 = $2,100 Slide 6-51 Learning objective 5: Discuss activity-based costing (ABC) and cost drivers Test Your Knowledge 11 Power Electronics has two products:  EP150    10 setups inspections EP175   40 setups inspections Calculate the overhead applied to EP175 Equipment setups 40 * $150 per setup = $6,000 Inspections * $200 per inspection = $1,600 Total overhead $6,000 + $1,600 = $7,600 Slide 6-52 Learning objective 5: Discuss activity-based costing (ABC) and cost drivers Pros Pros and and Cons Cons of of ABC ABC  Benefits  Less likely to undercost complex low volume products and overcost simple high volume products  Drivers used in ABC are not always volume related  ABC may lead to improvements in cost control  Costs are not buried in one or two pools Slide 6-53 Learning objective 5: Discuss activity-based costing (ABC) and cost drivers Pros Pros and and Cons Cons of of ABC ABC   Limitations More costly to develop and maintain than a traditional costing system   Used to develop full cost of products   Slide 6-54 Allocations are made from each cost pool to each product Includes fixed costs Lacks incremental information necessary for decision making Learning objective 5: Discuss activity-based costing (ABC) and cost drivers Fixed Fixed and and Variable Variable Costs Costs Slide 6-55 Learning objective 5: Discuss activity-based costing (ABC) and cost drivers Activity-Based Activity-Based Management Management  A tool that involves analyzing and costing activities with the goal of improving efficiency and effectiveness   ABC focus is on measuring cost of products and services ABM focus is on goal of managing the activities themselves  For example, ABC would calculate the cost per equipment setup  ABM would focus on ways to improve the setup process and reduce setup cost Slide 6-56 Learning objective 6: Distinguish activity-based costing (ABC) from activity-based management (ABM) Activity-Based Activity-Based Management Management Slide 6-57 Learning objective 6: Distinguish activity-based costing (ABC) from activity-based management (ABM) Cost Cost Allocation Allocation and and Decision Decision Making Making Slide 6-58 Learning objective 6: Distinguish activity-based costing (ABC) from activity-based management (ABM) Appendix Appendix  The steps in activity-based management are: Determine major activities Identify resources used by each activity Evaluate the performance of the activities Identify ways to improve the efficiency and/or effectiveness of the activities Slide 6-59 Learning objective 6: Distinguish activity-based costing (ABC) from activity-based management (ABM) Copyright Copyright © 2010 John Wiley & Sons, Inc All rights reserved Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc The purchaser may make back-up copies for his/her own use only and not for distribution or resale The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein Slide 6-60