Slides 3 4 calculate cost of service with multiple cost poo

Calculate Cost of Service with Multiple Cost Pools and Drivers Intermediate Cost Analysis and Management Why did this cost measurement method fail? Chez Paris Fillet and Lobster Chicken Kiev 15.00 Top Sirloin 20.00 Caesar Salad Carol 35.00 9.00 Coffee @1.00 2.00 House Wine @5.00 Champagne 20.00 24.00 Ice Cream 4.00 Chocolate Cheesecake 6.00 Sampler 10.00 Soup/Salad 8.00 Aperitif 00 Total Alice $160.00 Thank You Bob Ted Terminal Learning Objective • • • Task: Calculate Cost of Service with Multiple Cost Pools/Drivers Condition: You are training to become an ACE with access to ICAM course handouts, readings, and spreadsheet tools and awareness of Operational Environment (OE)/Contemporary Operational Environment (COE) variables and actors Standard: with at least 80% accuracy: • • • • • Identify methods of distribution Discuss relative merits of each Describe need for homogeneity in pools/drivers Describe need for correlation between pool and driver Select suitable driver for cost pool  Review: Managerial Costing cost pool raw accounting data managerial costing translation managerially useful information method = of distribution cost cost object object Review: Terminology • Method of distribution: • The mechanics of deriving management information from the cost pool • Example: • Determine unit cost by costs and method adding all input dividing by number of units of distribution Alternative Methods of Distribution • Managers can obtain the needed view of cost in several ways • • Guessing: gut feel of cost distribution Direct costing: detailed record keeping of all incurred cost transactions by every cost object • Allocation: distribution of cost pool in the same proportion as a cost driver Applications for Guessing • Simple situations where: • • • Cost of measurement error is small Need for credibility is low Ability to hold someone accountable is missing • Cost of cost measurement guessing and is high gut feel Detailed Record Keeping Applications • • • Labor cost can be accounted for by product through time and attendance reporting Project costs can include supplies and services charged by job order Product material costs can be through bill of materials determined detailed record keeping Examples of Detailed Record Keeping • • • Job order charges Bill of materials system Time and attendance reporting Why Not Use Detailed Record Keeping for All Cost? • May not be practical • • • • Will be more expensive May not be necessary Probably less flexible method of May not be possible • Joint costs and overhead consumed by more costs often distribution than one cost object 10 Learning Check • • What does “balloon squeezing” mean? What should be considered when choosing a cost driver? 58 Why Level of Effort Analysis? • Many costs are not easily correlated with cost objects • • • Less true in manufacturing Very true in service Level of effort analysis • technique easily: Produces a customized driver of reasonable accuracy allocation based on cost driver 59 Overhead: Likely Candidate for Level of Effort (LOE) • Overhead Areas Often Use LOE Since: • • • Work Usually Specialized and Not Consumed Uniformly by Line Organizations Like the Contracts Office Lack of Consumption Homogeneity May Mean that Common Drivers are Poor • i.e Square Feet, Direct Labor Hours, Mileage, etc., Do not Adequately Correlate to Cost Object Consumption of Overhead Resources 60 Developing LOE as a Driver • • • Interview Activity Manager Concentrate on People’s “Efforts” Supporting Cost Objects Find out What Proportion of Each Person’s Time would be “Invoiced” to Each Cost Object if Activity was a Business and Cost Object was a Customer 61 Precision and LOE • • • • • Activity Manager Will Only be Able to Make Rough Estimates Estimates Get Better Over Time Random Estimate Errors Tend to Offset Systematic Error Can Induce Bias Saliency Can Induce Bias 62 Beneficial By-Products • Staff/overhead organizations often misunderstand their role • • It’s easy for staff to think they are line Often helpful to organization when staff functions are forced to think of their line customers as paying the bills • Publicizing LOE creates a forum for cost and support issues 63 Level of Effort Example Effort Makers • • { A Ted 10% Bob 30% Sue 50% Linda 25% Average 29% B 50% 40% 50% 25% 41% C 40% 30% 0% 50% 30% Total 100% 100% 100% 100% 100% Staff manager has good idea of where people work and who they support The bottom line represents a “proportional” method allocation basis for the staff function 64 Don’t Forget Homogeneity Assumption • Implicit assumptions: • • • Effort costs the same for each person Other costs proportional to people If Ted is a lawyer and others are paralegals, the level of effort is biased • • Use weighting factor, or Make two separate activities if bias is significant 65 Random Error Ted Bob Sue Linda Average Old Average Error A 10% 25% 40% 30% 26% 29% -3% B 40% 50% 60% 30% 45% 41% 4% C 50% 25% 0% 40% 29% 30% -1% Total 100% 100% 100% 100% 100% 100% 0% up down • • • Random error tends to offset This error is probably not significant Both LOE estimates capture the major effects 66 Criticism of Level of Effort • Bias is possible due to “saliency” • • Recent problems are fresh in mind Suppose C had a big problem last month A Ted 10% Bob 20% Sue 50% Linda 20% Average 25% Old Average 29% Error -4% • B 40% 30% 40% 20% 33% 41% -9% C 50% 50% 10% 60% 43% 30% 13% Total 100% 100% 100% 100% 100% 100% 0% up down Produces significantly more error 67 Example: Returns Driver in IRS Audit Office # of returns 40 30 20 10 corporate complex individual other simple individual 68 IRS Quality Control Level of Effort Analysis people complex corporate individual other simple other individual districts QRS-1 11 5.0 5.0 0.0 1.0 QRS-2 12 2.0 5.5 4.0 0.5 0.8 0.8 0.4 0.0 0.0 0.0 0.0 2.0 27 7.8 11.3 4.4 3.5 100 28.8 41.8 16.3 12.9 TRAINING DISCLOSURE TOTAL PERCENT FOR BASIS 69 Precisely Wrong vs Roughly Right # of returns 40 level of effort 30 20 10 corporate complex individual other simple other individual districts 70 Learning Check • • Why is level of effort sometimes a better driver than a unit-based driver? What is the primary criticism of the level of effort driver? 71 Practical Exercise 72 ... Total Total Cost Cost Pool Pool $100K $100K Air Air Conditioning Conditioning General General Cost Cost Pool Pool Cost Cost Pool Pool $40K $40K $60K $60K A/C sq ft sq ft Company Facility Cost 28... Task: Calculate Cost of Service with Multiple Cost Pools/Drivers Condition: You are training to become an ACE with access to ICAM course handouts, readings, and spreadsheet tools and awareness of. .. suitable driver for cost pool  Review: Managerial Costing cost pool raw accounting data managerial costing translation managerially useful information method = of distribution cost cost object object