Cost Accumulation and Allocation in Management Accounting

Why do managers need reliable cost estimates?

Managers need reliable cost estimates to: - Price products - Evaluate performance - Control operations - Prepare financial statements.

What are cost objects?

Cost objects are the things for which costs are determined. Examples include: - Products - Processes - Departments - Services - Activities.

What is the difference between direct and indirect costs?

- *Direct costs: Easily traced to a specific cost object (e.g., materials, labor). - Indirect costs (overhead):* Cannot be directly traced to a specific cost object (e.g., utilities, rent).

What is cost accumulation?

Cost accumulation involves identifying: 1. Cost objects to trace costs. 2. Cost drivers with cause-and-effect relationships to cost objects.

What is a cost driver?

A cost driver has a cause-and-effect relationship with a cost object. For example, square footage can drive rental costs allocation.

How do cost drivers affect cost accumulation?

Cost drivers help identify what drives the costs of secondary cost objects, allowing for accurate cost accumulation.

Provide an example of cost accumulation.

Consider a promotion by the Atlanta Braves. The primary cost object is the promotion cost. Secondary cost objects include the cost of caps, advertising, and labor. These costs are accumulated to determine the total promotion cost.

What is the difference between estimated and actual costs?

- *Estimated costs: Used for planning and decision-making when actual costs are not available. - Actual costs:* More accurate but may not be available in time for planning.

Why are estimated costs used?

Estimated costs are used to set prices, make bids, evaluate proposals, distribute resources, plan production, and set goals.

Why did ISI change its bonus strategy?

ISI changed its bonus strategy from sales revenue to profitability to encourage cost control. Managers were previously incentivized to maximize sales without considering costs.

What are the direct and indirect costs for ISI?

- *Direct costs: Cost of goods sold, sales commissions, department managers' salaries, depreciation. - Indirect costs:* Store manager's salary, store rental, utilities, advertising, supplies.

What is cost allocation?

Cost allocation involves dividing a total cost into parts and assigning them to designated cost objects. Common costs support multiple objects but cannot be directly traced to any one object.

How are rental costs allocated in ISI?

Rental costs are allocated based on square footage. The allocation rate is calculated by dividing the total rental cost by the total square footage, then multiplying this rate by the square footage of each department.

How are utility costs allocated in ISI?

Utility costs are allocated based on square footage.

Allocation Rate

The allocation rate is calculated by dividing the total utility cost by the total square footage, then multiplying this rate by the square footage of each department.

Cost Pools

Cost pools are collections of individual costs accumulated together. Cost pooling should be limited to costs with common cost drivers.

Selecting a Cost Driver

Companies should select the driver with the strongest cause-and-effect relationship. For example, ISI's shopping bag cost can be linked to sales transactions or total sales amount.

Example of Selecting a Cost Driver

In ISI, the cost of shopping bags is best linked to the number of sales transactions because every transaction uses a bag, regardless of the sales amount.

Allocating Supplies Costs

Supplies costs are allocated based on total sales. The allocation rate is calculated by dividing the total supplies cost by total store sales, then multiplying this rate by each department's sales.

Allocating Advertising Costs

Advertising costs are allocated based on total sales. The allocation rate is calculated by dividing the total advertising cost by total store sales, then multiplying this rate by each department's sales.

Allocating Store Manager's Salary

The store manager's salary is allocated arbitrarily among departments since there is no strong cause-and-effect relationship.

Profit Analysis by Department

Profit analysis helps evaluate departmental performance and decision-making by considering both revenues and allocated costs.

Variable Overhead Costs

Variable overhead costs increase with production volume. Examples of volume-based drivers include units produced, labor hours, and direct materials used.

Fixed Overhead Costs

Fixed costs are allocated by spreading them equally over total production using rational allocation bases (e.g., units produced).

Human Factor in Cost Allocation

Cost allocations influence performance evaluations, compensation, and departmental resources, potentially leading to disagreements over allocation methods.

Interpersonal Skills in Cost Allocation

Technical expertise alone is insufficient; accountants must understand how their reports impact people within the organization.

Importance of Cost Estimation

Cost estimation is crucial for pricing, performance evaluation, operational control, and financial reporting.

Impact of Indirect Costs on Cost Objects

Indirect costs support multiple cost objects but cannot be directly traced to any specific object.

Role of Cost Drivers in Cost Allocation

Cost drivers help allocate indirect costs by identifying the cause-and-effect relationship between the cost and the cost object.

Allocating Rental Costs

Rental costs are allocated based on square footage occupied by each department.

Rental costs allocation

Rental costs are allocated based on square footage occupied by each department.

Utility costs allocation

Utility costs are allocated based on square footage occupied by each department.

Purpose of cost pools

Cost pools accumulate individual costs with common cost drivers for easier allocation.

Importance of selecting the right cost driver

The right cost driver ensures that costs are allocated accurately based on cause-and-effect relationships.

Supplies costs allocation

Supplies costs are allocated based on total sales in each department.

Advertising costs allocation

Advertising costs are allocated based on total sales in each department.

Store manager's salary allocation

The store manager's salary is allocated equally among departments.

Purpose of profit analysis by department

Profit analysis helps evaluate departmental performance and decision-making.

Variable overhead costs

Variable overhead costs increase with production volume.

Fixed overhead costs

Fixed overhead costs remain constant regardless of production volume.

Impact of fixed overhead costs on cost allocation

Fixed costs are allocated equally over total production.

Impact of cost allocation on employee motivation

Cost allocation affects performance evaluations and compensation.

Importance of interpersonal skill in cost allocation

Interpersonal skills help manage the impact of cost reports on employees.

Role of estimated costs in decision-making

Estimated costs are used when actual costs are not available for planning and decision-making.

Difference between estimated costs and actual costs

Estimated costs are less accurate but more timely than actual costs.

Example of using estimated costs

Estimated costs are used to set prices, make bids, and plan production.

Reason for ISI changing its bonus structure

ISI changed its bonus structure to focus on profitability rather than sales revenue to encourage cost control.

Implications of ignoring cost control in ISI

Ignoring cost control led to increased sales but uncontrolled costs.

Difference between cost tracing and cost allocation

Cost tracing involves assigning direct costs to cost objects, while cost allocation involves assigning indirect costs.

Controllable costs

Controllable costs are costs that can be influenced by a manager's decisions and actions.

How ISI allocates costs to departments

ISI allocates costs using cost drivers like square footage for rent and utilities, and sales for supplies and advertising.

Role of cost allocation in financial reporting

Cost allocation helps in preparing accurate financial statements by assigning all relevant costs to products or services.

Impact of cost allocation on decision-making

Cost allocation provides managers with a complete picture of costs, aiding in strategic decision-making.

Potential inaccuracies of estimated costs

Estimated costs may be based on assumptions that could lead to inaccuracies.