Chapter 14 Cost

what are the types of departments

operating units/production departments

support/service departments

what are production departments

produce products or provide services for sale to external customers

generate revenues and incurs expenses

directly adds value to product or service

what are the subdivisions of operating units

division or segment (ex. pet food; hot chocolate, candy)

location or outlet

examples of operating units/production departments

departments- assembly, finishing, packaging

what are support/service departments

intermediate cost centers

support operating units - serve other departments including other service departments

have costs which should be allocated to products and services

link to product is indirect and weak

aid multiple departments at the same time

generally cost centers, not earning revenue on their own

costs are allocated to other departments

• included in overhead (MOH)

• eventually allocate to the cost object (product/service)

what are the reasons for allocation support department costs

financial reporting

decision making

motivate managers

cost reimbursement - ex. government contracts or grants

what is user department for support departments

consumes some services of another department

may be an operating unit or services department

examples of support departments

IT, HR, maintenance, shipping, security, administration, legal, accounting

can have one or multiple support departments

what does averaging support department costs and allocating the averaged cost assume

assumes that operating units all use support departments equally which is unlikley

why should we allocate SD costs rather than use averages

decision makers need to see the full cost of running operating units

decision makers can determine the individual profitabilitity of operating units

what are the cost allocation bases for support departments

cost allocation base must reflect how user department/units use the support department costs

determined for each SD

what are the considerations for selecting the cost allocation base for SD

types of services provided, benefits received, fairness of the allocation base

a predetermined rate is normally used

you want to use homogeneous cost pools: where the costs in the pool are driven by the same driver. may need many

what are the methods of allocating SD costs

most firms have multiple service departments

support departments utlize services of other support departments

direct, step, reciprocal methods

direct method

allocated SD costs to operating departmnets only based on proportional usage of the support departments

ignore usage of SD by other SD

what are the steps for the direct method

1. list costs of each department

2. calculate the budgeted rate for each support department (total cost/total driver)

3. allocate the support department costs to the operating departments by multiplying the budgeted rate by the base for that department

4. calculate total costs for the operating department

step down method

allocates SD costs to other service departments and operating departments in a sequential manner

recognizes that support departments provide services to each other

more precise than the direct method

what are the steps to the step down method

1. determine which support department mutual services must be recognized

2. rank support departments using company’s chosen metric/highest costs to run the department

• SD that renders the highest percentage of its total servics to other SD

• SD that provides highest dollar amount to other SD

3. allocate costs from highest ranked SD to operating units and other SD

• calc the budgeted rate for the SD and allocate costs to the other SD and operating departments

4. step down to the next line support department which has new higher costs now. allocate to remaining SD and operating units but not to the higher ranked departments

5. continue stepping down until all SD have had their costs allocated

6. calc total costs for the operating departments

reciprocal method

most realistic

all SD serve each other

captures exchange of services between SD and from SD to operating departments

most detailed adn truest indicator of how support department costs are used and allocated

fully allocates SD costs to other SD

uses repeated iterations of allocations; uses linear equations expresses relationships among epartments

steps for the reciprocal method

1. specify total cost equations for each SD

2. solve those equations

3. allocate each support departments total cost to all other SD and operating units

   1. calc total cost for operating department

which method convesys the most accurate costs

reciprocal method

what should be the same among all methods

the same total amount of SD costs is allocated regardless of the method

what is the differences between methods

the difference among the methods may be minor, compared to the care needed for the reciprocal method

what are common costs

cost shared by two or more users (product lines)

costs of operating a facilitiy, an activity, or other cost objects

shared by: operating units, products, organizations, people

what are the methods for common costs

stand alone

incremental

stand alone cost allocation method

consider each user as a seperate entity

prorate costs in proportion to stand alone costs

each bears a proportionate hare of total costs in relation to individual stand alone costs

costs are shared proportionally not equally

what are the steps for stand alone cost allocation method

1. identify the cost each entity would hae to pay if it bore the cost alone

2. allocated common costs based on the percentage each party would have paid, has the common costs not been shared

incremental method

identifies and ranks users of a cost to determine who is more responsibile for it

assigns the stand alone cost to the user who is more responsible for the cost, and any additional (incremenatl) amount is assigned to the next user

how to allocate revenue from sales of bundled products/services

Grouping several products and/or services together for one transaction price.

Individual components may be sold as separate items at their stand-alone prices

what are the methods of allocated sales price

stand alone

incremental

Allocate the sales price of bundle products to the component parts so a firm can accurately measure profitability.

FASB outlines a variety of ways to allocate transaction price of a bundled product which includes stand-alone and incremental.

• Internal decision-makers use the FASB revenue recognition guidelines unless:

  • Only for internal decision-making purposes, and no one is available to interpret and implement the FASB standard