Responsibility Accounting and Controllable Costs
One of the primary uses of managerial
accounting is to evaluate the performance of
managers and the operations under their control
Evaluation is facilitated by a system which traces revenues and costs to units with related
responsibility for generating revenue and controlling costs
This system is referred to as a responsibility accounting system
Responsibility Accounting and Controllable Costs
Cost allocation is generally required in a responsibility accounting system
One unit is often responsible for the costs incurred by another unit
Some allocations are not consistent with a responsibility accounting system
Managers should be held responsible for controllable costs only
Controllable costs are affected by a manager’s decisions
Arbitrary Allocations
Cost allocations are inherently arbitrary
Typically there are numerous allocation bases that are equally justifiable
In almost all situations, determining the true allocation is impossible
Managers support the allocation which makes them look best
Managers reject allocations which cast an unfavorable light on their performance
Unitized Fixed Costs
The allocation process may make fixed costs appear to be variable costs
This happens when fixed costs are unitized
Unitized fixed costs are stated on a per unit basis
When managers increase sales they also increase their allocated general and
administrative costs
This could lead to decisions which could hurt the profitability of the company
Lump Sum Allocations
Allocations of fixed costs must be made in such a way that they appear fixed to
managers
This is achieved by lump-sum allocations of fixed costs
A lump-sum allocation is not affected by changes in the activity level of the
organizational unit
Lump-sum allocations generally should
When fixed costs are stated on a per unit basis:
a. Fixed costs are said to be controllable b. Fixed costs may appear to be variable to
managers receiving allocations
c. A lump-sum allocation has been made
d. Divisions with high sales receive a low amount of allocated costs
Answer: b
Fixed costs may appear to be variable to managers
Test Your Knowledge 7
Too Few Cost Pools
Some companies assign overhead to
products using only one or two overhead cost pools
Although simple, this may lead to distortion of cost allocation
Some products will be overcosted
Some products will be undercosted
This problem is solved by setting up separate cost pools for overhead
Product costs will be more accurate when more overhead cost pools are used
Decisions that rely on product cost information will be improved
However, more cost pools equals more expensive record keeping
Must analyze cost-benefit relationship of more cost pools
Too Few Cost Pools
Too Few Cost Pools
Using Only Volume-Related Allocation Bases
Some firms allocate manufacturing overhead based on volume, using allocation bases like
Direct labor hours, or
Machine hours
Not all overhead costs vary with volume
Referred to as the traditional approach
Using Only Volume-Related Allocation Bases
The problem with the traditional approach is that it assumes that all overhead costs are proportional to production volume
Many overhead costs are not proportional to volume
The cost of setting up equipment for a production run
The cost of inspecting raw materials
Among others
Which of the following is not a volume-related cost driver?
a. Direct labor hours b. Direct labor cost c. Machine time
d. Time to set up a production run
Answer: d
A production run will take the same amount of time to set up no matter how many units are in the production
Test Your Knowledge 8
Activity-Based Costing (ABC)
Using the ABC approach, companies identify major activities that cause overhead costs to be incurred
Some activities are related to production volume, some are not
The cost of resources consumed performing these activities are grouped into cost pools
Costs are assigned to products using a measure of activity referred to as a cost driver
The ABC Approach
Relating Cost Pools to Products Using Cost Drivers
The company will estimate the total cost assigned to each cost pool
The company will then decide on an appropriate driver, such as number of inspections for inspection costs
The company will then estimate the activity in the driver
The overhead allocation rate is:
Common Activities and Associated Cost Drivers
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
Activity Based Costing-
McMaster Screen Technologies
The study finds that overhead cost is related to 7 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
Activity Based Costing-
McMaster Screen Technologies
Activity Based Costing-
McMaster Screen Technologies
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
Test Your Knowledge 9
Power Electronics has two products:
EP150
10 setups
3 inspections
EP175
40 setups
8 inspections
Calculate the overhead applied to EP150