Management Acc Chapter 5 | Lecture notes Management Accounting

Management Accounting

Chapter 5:

Four purposes for allocating indirect costs to cost objects:

–to provide information for economics decisions

–to motivate managers and employees

–to justify costs or calculate reimbursement

–to measure income and assets for reporting to external parties

homogenous cost pool: one in which all the activities whose costs are included in the pool have the

same or a similar cause-and-effect relationship or benefits-received relationship between the cost

allocator and the costs of the activity → important, because using homogenous indirect-cost pools

enables more accurate product, service and customer costs to be obtained

→ The greater the degree of homogeneity, the fewer cost pools required to explain accurately the

differences in how products use resources of the organization

Factors for recognizing multiple cost pools where a single cost pool is currently being used:

–the views of line managers and personnel

–changes made in plant layout, general operations and so on, such that all products do not use

the facility in an equivalent way

–changes in the diversity of products (or services) produced or in the way those products use

the resources in the cost pool

Allocating costs from one department to another:

three key issues:

–single-rate or dual-rate method

–budgeted rates or actual

–budgeted quantities or actual

single-rate cost-allocation method: pools all costs in one cost pool and allocates them to cost

objects using the same rate per unit of the single allocation base → no distinction between the costs

in the cost pool in terms of costs variability

→ benefit: low cost of implementation

→ however, may lead divisions to take actions that appear to be in their own best interest but are

not in the best interest of the organization as a whole

dual-rate cost-allocation method: first classifies costs in one cost pool into two subpools

(typically into a variable-cost subpool and a fixed-cost subpool). Each subpool has a different

allocation rate or a different allocation base

→ benefit: it signals to division managers how variable costs and fixed costs behave differently

Budgeted versus actual rates:

Budgeted rates let the user department know the cost rates they will be charged in advance. Users

are then better equipped to determine the amount of the service to request and, if the option exists,

wether to use the internal department source or an external supplier. → also help motivate

managers to improve efficiency

When actual rates are used, the user department will not know the rates charged until the end of the

period.

Budgeted versus actual usage allocation bases:

When actual usage is the allocation base, user divisions will not know how much cost is allocated

to them until the end of the budget period.

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Management Accounting Chapter 5: Four purposes for allocating indirect costs to cost objects:

to provide information for economics decisions
to motivate managers and employees
to justify costs or calculate reimbursement
to measure income and assets for reporting to external parties homogenous cost pool: one in which all the activities whose costs are included in the pool have the same or a similar cause-and-effect relationship or benefits-received relationship between the cost allocator and the costs of the activity → important, because using homogenous indirect-cost pools enables more accurate product, service and customer costs to be obtained → The greater the degree of homogeneity, the fewer cost pools required to explain accurately the differences in how products use resources of the organization Factors for recognizing multiple cost pools where a single cost pool is currently being used:
the views of line managers and personnel
changes made in plant layout, general operations and so on, such that all products do not use the facility in an equivalent way
changes in the diversity of products (or services) produced or in the way those products use the resources in the cost pool Allocating costs from one department to another: three key issues:
single-rate or dual-rate method
budgeted rates or actual
budgeted quantities or actual single-rate cost-allocation method: pools all costs in one cost pool and allocates them to cost objects using the same rate per unit of the single allocation base → no distinction between the costs in the cost pool in terms of costs variability → benefit: low cost of implementation → however, may lead divisions to take actions that appear to be in their own best interest but are not in the best interest of the organization as a whole dual-rate cost-allocation method: first classifies costs in one cost pool into two subpools (typically into a variable-cost subpool and a fixed-cost subpool). Each subpool has a different allocation rate or a different allocation base → benefit: it signals to division managers how variable costs and fixed costs behave differently Budgeted versus actual rates: Budgeted rates let the user department know the cost rates they will be charged in advance. Users are then better equipped to determine the amount of the service to request and, if the option exists, wether to use the internal department source or an external supplier. → also help motivate managers to improve efficiency When actual rates are used, the user department will not know the rates charged until the end of the period. Budgeted versus actual usage allocation bases: When actual usage is the allocation base, user divisions will not know how much cost is allocated to them until the end of the budget period.

When budgeted usage is the allocation base, user divisions will know their allocated costs in advance. Stick and carrot approach operating department (production department in manufacturing companies ): adds value to a product or service that is observable by a customer support department (service department): provides the services that maintain other internal departments in the organization But:

organizations differ in the department located at the corporate and division levels
organizations differ in their definitions of operating and support departments
organizations differ in the percentage of total support costs allocated using these methods direct allocation method: most widely used, allocates each support department's costs directly to the operating departments → benefit: simplicity → less accurate step-down allocation method (sequential): allows for partial recognition of the services rendered by support departments to other support departments, requires the support departments to be ranked → Approach A: Rank support departments on the percentage of the support department's total support provided to other support departments → less accurate → Approach B: Rank support departments on the total euros of service to other support departments reciprocal allocation method: allocates costs by explicitly including the mutual services provided among all support departments, enables us to incorporate interdepartmental relationships fully into the support department cost allocations complete reciprocated cost: the actual costs incurred by a support department plus a part of the costs of the other support departments that provide service to it artificial costs: complete reciprocated costs figure, always larger than the actual costs common cost: a cost of operating a facility, operation, activity or other cost object that is shared by two or more users Two methods: stand-alone cost-allocation method: uses information pertaining to each cost object as a separate operating entity to determine the cost-allocation weights → equity or fairness rationale incremental cost-allocation method: ranks the individual cost objects and then uses this ranking to allocate costs among those cost objects (primary party=first ranked, incremental party=second ranked) As companies change from labor-paced to machine-paced operation, they increase their use of machine-hours-related allocation bases. labor-paced operations: worker dexterity and productivity determine the speed of production machine-paced operations: machines conduct most (or all) phases of production, such as movement of materials to the production line, assembly and other activities on the production line and shipment of finished goods to the delivery bay areas In machine-paced operations, machine-hours will probably better capture cause-and-effect relationships than the direct labor-hours allocation base. Consequences of an inappropriate allocation base:
Product managers may make excessive use of external suppliers for parts that have a high direct manufacturing labor content
Manufacturing managers may pay excessive attention to controlling direct manufacturing labor-hours relative to the attention paid to controlling the more costly categories of materials and machining

Management Acc Chapter 5, Lecture notes of Management Accounting

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