Slides calculate cost of a service and job with multiple cost

Calculate Cost Of A Service/Job With Multiple Cost Pools/Drivers Principles of Cost Analysis and Management © Dale R Geiger 2011 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 © Dale R Geiger 2011 Ted Terminal Learning Objective • • Task: Calculate Cost Of A Service/Job With Multiple Cost Pools/Drivers • Standard: with at least 80% accuracy: Condition: You are a cost advisor technician with access to all regulations/course handouts, and awareness of Operational Environment (OE)/Contemporary Operational Environment (COE) variables and actors • • • • Distinguish drivers as transactional, duration, or intensity Describe need for homogeneity in pools/drivers Describe need for correlation between pool and driver Select suitable driver for cost pool  © Dale R Geiger 2011 Assumptions • • • • Making assumptions is inescapable in managerial costing There is simply too much to measure and too many ways to measure it Reasonable assumptions simplify and facilitate the measurement process Bad assumptions result in poor management decision making © Dale R Geiger 2011 Homogeneity and Averaging • • Allocation methods implicitly assume sameness or homogeneity Allocating the dinner check based on number of eaters assumes that all eaters consume resources equally • Allocating facilities costs based on number of buildings assumes that all buildings consume facilities resources equally © Dale R Geiger 2011 Homogeneity and Averaging • The homogeneity assumption allows the use of average cost • • • To simplify the allocation process To minimize the cost of measurement To avoid detailed record keeping for every cost object © Dale R Geiger 2011 Types of Cost Drivers • Cost Drivers may be: • Unit-based: • • • Assumes a correlation between consumption of a unit of driver and consumption of cost pool Assumes all units of the driver are homogeneous Examples: purchase orders, headcount, etc © Dale R Geiger 2011 Types of Cost Drivers • Cost Drivers may be: • Duration-based: • • • Assumes a correlation between time spent on an activity and consumption of cost pool Will be stated in units of time (hours, minutes, etc.) Example: Machine hours or labor hours © Dale R Geiger 2011 Types of Cost Drivers • Cost Drivers may be: • Intensity-based: • • • Assumes a correlation between the level of effort expended and consumption of cost pool Usually stated as a percentage or proportion Example: Support services assign cost to projects based on effort expended on each project © Dale R Geiger 2011 Cause and Effect Relationships • A cause and effect relationship means: • • • Increasing driver usage will cause more consumption of resources Decreasing driver usage will cause less resource consumption Allocating cost based on this driver will reflect the underlying economics of cost consumption and approximate true cost © Dale R Geiger 2011 10 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 © Dale R Geiger 2011 39 Example: Returns Driver in IRS Audit Office # of returns 40 30 20 10 corporate complex individual other simple individual © Dale R Geiger 2011 40 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 © Dale R Geiger 2011 41 Precisely Wrong vs Roughly Right # of returns 40 level of effort 30 20 10 corporate complex other individual © Dale R Geiger 2011 simple other individual districts 42 Check on Learning • Why is level of effort sometimes a better driver than unit-based or durationbased drivers? • What is the primary criticism of the level of effort driver? © Dale R Geiger 2011 43 Cost of a Job • • • Let’s re-visit our job cost problem Mechanical service department incurs the following costs for the month of September: • • • • Mechanic labor $20K Parts 16K Clerical labor 8K Shop supplies 4K Is the overhead cost pool homogeneous? Total Overhead = $12K © Dale R Geiger 2011 44 Cost of a Job • • During the month four jobs are started and completed What is the total cost of each job if all overhead is allocated using parts dollars? Job: A B C D Total Parts $K 10 16 Labor $K 10 20 Overhead 3/16*12 2/16*12 1/16*12 10/16*12= 7.5 (Parts $K) = 2.25 = 1.5 = 75 7.25 6.5 6.75 Total $K © Dale R Geiger 2011 12 27.5 48 45 Cost Driver Analysis • • • • Which drivers are unit-based? Which are duration based? Are units of cost driver homogeneous? Is there a cause and effect relationship between the cost pool and the drivers? Job: A B C D Total Parts $K 10 16 Labor $K 10 20 Labor Hr 150 80 50 520 800 © Dale R Geiger 2011 46 Cost Driver Analysis • • Shop supplies are closely correlated to parts dollars -butDiscussion indicates that clerical efforts were expended in the following manner Job: Clerical Efforts A B 12% C 8% © Dale R Geiger 2011 D 30% Total 50% 100% 47 Cost of a Job • • • • • Use the allocation spreadsheet to allocate the overhead to each job What is the cost pool? What are the cost objects? What are the activities? What are the drivers for each activity? © Dale R Geiger 2011 48 Allocation Spreadsheet Enter activities and cost driver data as shown 49 © Dale R Geiger 2011 Allocation Spreadsheet Select cost drivers and view the new allocation 50 © Dale R Geiger 2011 Cost of a Job • How costs shift? Job: A B C D Total Parts $K 10 16 Labor $K 10 20 1.71 1.14 2.65 6.50 12.00 Overhead (two pool) Old Total 7.25 6.5 6.75 27.5 48 New Total Change © Dale R Geiger 2011 51 Check on Learning • How might this shift affect management decisions? Job: A B C D Total Parts $K 10 16 Labor $K 10 20 1.71 1.14 2.65 6.50 12.00 Overhead (two pool) Old Total 7.25 6.5 6.75 27.5 48 New Total 6.71 6.14 8.65 26.5 48 Change -.54 -.36 +1.9 -1 © Dale R Geiger 2011 52 Practical Exercise © Dale R Geiger 2011 53 ... Of A Service/ Job With Multiple Cost Pools/Drivers • Standard: with at least 80% accuracy: Condition: You are a cost advisor technician with access to all regulations/course handouts, and awareness... Cause and Effect Relationships • Give the cost manager another target for managing cost • • Managing the driver usage will result in managing cost Allow managers to make rational decisions based... and Averaging • • Allocation methods implicitly assume sameness or homogeneity Allocating the dinner check based on number of eaters assumes that all eaters consume resources equally • Allocating