Cost & Budgeting in the implementation perspective .pptx

how to manage costs in budget

1. Cost Management (15%) Study Unit 7. Cost Allocation Techniques Study Unit 6. Cost Accumulation Systems Study Unit 5. Cost Management Terminology and Concepts. Part 1: Financial Planning, Performance and Control Study Unit 8. Operational Efficiency and Business Process Performance

2. Study Unit (7): Cost Allocation Techniques 7.1 Overhead Costs and Normal Costing 7.2 Allocating Service Department Costs to Production Departments 7.3 Absorption Versus Variable Costing Allocation and other Cost Concerns 7.4 Allocation of Common Costs Among Joint Products

3. Costing Systems

4. Product costing involves accumulating, classifying and assigning direct materials, direct labor, and factory overhead costs to products, jobs, or services. In developing a costing system, management accountants need to make choices in three categories of costing methods: 1) The cost measurement method to use in allocating costs to units manufactured (standard, normal, extended normal, or actual costing). 2) The cost accumulation method to use (job costing or process costing). 3) The method to be used to allocate overhead (volume-based or activity-based).

5. Work in Process Input Direct Materials Direct Labor Factory Overhead Cost of Goods Manufactured Output E.B W.I.P Cost of Goods Sold E.B F.G Cost Measurement Systems There are three main ways (plus one variation) in which costs are allocated to units manufactured. The four systems are: 1) Standard 2) Normal 3) Extended normal 4) Actual costing systems These costing systems are used for allocating both direct manufacturing costs (direct labor and direct materials) and indirect manufacturing (overhead) costs in order to value the products manufactured.

6. Input measure basis Extended normal Normal Standard Actual costing Work in Process Input Direct Materials Direct Labor Factory Overhead AQ × AP AH S × AR Work in Process Input Direct Materials Direct Labor Factory Overhead SQ × SP SH S × SR F.O.H applied Work in Process Input Direct Materials Direct Labor Factory Overhead AQ × AP AH S × AR Actual F.O.H Work in Process Input Direct Materials Direct Labor Factory Overhead AQ × S P (AH S × S R) F.O.H applied F.O.H applied

7. Example: Assume budgeted and actual quantity of output is 1,200 units and 1000 units. Assume also total factory O.H are budgeted to be $7,200 based on standard D.L.H, but actual factory O.H amounted to $7,500 Predetermined factory O.H rate = Budgeted, factory O.H ---> $7,200 Estimated Activity level of cost Driver-- -> 3D.L.H x 1,200 unit(3600DLH) Predetermined factory O.H rate = $2 of factory O.H per D.L.H Description Total Cost per unit SO 1200   AO 1000   SQ of input 2,400 Kilo 2 Kilo per unit AQ of input 3, 00 Kilo 3 Kilo per unit SP per Kilo of input   $20 AP per Kilo of input   $30 SHs per one unit of output   3 D.L.H per unit AHS worked 4,000 D.L.H 4 D.L.H per unit SR per D.L.H   $10 per D.L.H AR per D.L.H   $12 per D.L.H

8. 1-Actual costing system An actual costing system records the actual costs incurred for all costs-including direct labor, direct material, and overhead. The actual costs are determined by waiting until the end of the accounting period and then calculating the actual costs based on the recorded amounts. Benefits The primary benefit of actual costs is that they are more accurate (the costs used are actual costs, not estimated costs) than other costing systems. Limitations Delay in information because actual costs must be computed and applied, information is not available as quickly after the end of a period as it is with standard costing. Actual costing leads to fluctuations in job costs because the amount of actual overhead incurred fluctuates throughout the year. DR WIP-actual costing system CR BWIP CGM D.M used (AQ x AP) =3 Kilo x $30 per Kilo x 1000 unit=90,000 $   D.L (AH S worked x AR)=4 D.L.H x $12 per D.L.H x1000 unit=$48000   Actual Factory O.H applied actual = $7,500. EWIP

9. 2-standard costing system DR WIP-standard costing system CR BWIP CGM D.M used (SQ x SP) =2 Kilo x $ 20 per Kilo x 1000 unit = $40000   D.L (SH S worked x SR) = 3 D.L.H x $10 per D.L.H x 1000unit =$30000   Factory O.H. applied ( predetermind O.H. rate $2 x standard activity of cost driver for actual output 3 D.LH) x 1000 unit = $6000 EWIP

10. Benefits • Standard costing prescribes expected performance and provides control. The standards establish what the costs should be, who should be responsible for them, and what actual costs are under control. • If costs remain within the standards, managers can focus on other issues (management by exception). When costs vary significantly from the standards, managers are alerted that there may be problems requiring attention. • Standard costing can be used in either a job costing or a process costing environment. • It makes recordkeeping easier in either a job order or a process costing system, because subsidiary ledgers need to be maintained for quantities on hand, and their associated cost is the standard cost for the period. Limitations • If the variances from the standards are used in a negative manner , for instance to assign blame, employee morale suffers and employees are tempted to cover up unfavorable variances and to do things they should not do in order to make sure the variances will be favorable. • Output in many companies is not determined by how fast the employees work but rather by how fast the machines work. Therefore, direct labor quantity standards may not be meaningful.

11. 3- Under a normal costing system DR WIP -normal costing system CR BWIP CGM D.M used (AQ x AP) =3 Kilo x $30 per Kilo x 1000unit =$90000   D.L (AH S worked x AR) =4 D.L.H x $12per D.L.H X1000 unit =$48000   Factory O.H applied (predetermined O.H rate $2 per D.L.H x actual activity of cost driver 4 D.L.H) x 1000 unit = $8000 EWIP Benefits The use of normal costing avoids the fluctuations in cost per unit that occur under actual costing because of changes in the month-to-month volume of units produced and in month-to-month fluctuations in overhead costs. Manufacturing costs of a job are available earlier under a normal costing system than under an actual costing system. Limitations Using a predetermined factory overhead rate to apply overhead cost to products can cause total overhead applied to the units produced to be greater or lower than the actual overhead incurred. Normal costing is not appropriate for process costing because the actual costs would be too difficult to trace to individual units produced, so it is used primarily for job costing.

12. 4-Extended Normal Costing System DR WIP - Extended costing system CR BWIP CGM D.M used (AQ x SP ) =3 kilo x$20 x10 00 unit = $60000   D.L (AH S worked x SR ) =4 D.L.H x $10 x 1000 unit =$40000   Factory O.H applied (predetermined O.H rate $2 per D.L.H x actual activity of cost driver 4 D.L.H) x 1000unit =$8000 EWIP Extended normal costing would be most likely to be used in a job order environment and/or a service business. Extended costing system is used to: Avoid actual price or actual rate fluctuations during the year When the price of D.M or rate of D.L is subject to underlying that is not known until the end of the period. Benefits In addition to the benefits of normal costing, extended normal costing utilizes estimated labor rates, which may not be known until after the end of a reporting period. This makes it most appropriate for a professional service business. Limitations The limitations of extended normal costing are the same as the limitations of normal costing.

13. SHs per one unit of output   3 D.L.H per unit AHS worked 4,000 D.L.H 4 D.L.H per unit Assume also total factory O.H are budgeted to be $7,200 based on standard D.L.H, but actual factory O.H amounted to $7,500 Predetermined factory O.H rate = Budgeted, factory O.H ---> $7,200 Estimated Activity level of cost Driver-- -> 3D.L.H x 1,200 unit Predetermined factory O.H rate = $2 of factory O.H per D.L.H Actual quantity of output is 1,000 units Normal Standard Factory Overhead applied Cost Driver/Input 4 D.L.H Actual Activity driver AI × Actual Output 1,000 units AO P. F. O.H Rate $2 per D.L.H Factory Overhead applied 8000 $ = 4000 D.L.H PFOHR Factory Overhead applied Cost Driver/Input 3 D.L.H Standard Activity driver SI × Actual Output 1,000 units AO P. F. O.H Rate $2 per D.L.H Factory Overhead applied 6000 $ = 3000 D.L.H PFOHR

14. Normal Standard Factory Overhead applied Cost Driver/Input 4 D.L.H Actual Activity driver AI × Actual Output 1,000 units AO P. F. O.H Rate $2 per D.L.H Factory Overhead applied 8000 $ = 4000 D.L.H PFOHR Factory Overhead applied Cost Driver/Input 3 D.L.H Standard Activity driver SI × Actual Output 1,000 units AO P. F. O.H Rate $2 per D.L.H Factory Overhead applied 6000 $ = 3000 D.L.H PFOHR Actual Activity driver for Actual production (output)  predetermined O.H. application rate (AI  AO  R) Normal Costing System Planned activity driver for Actual production (output)  Predetermined O.H application rate (SI  AO  R) Standard Costing System

15. Question 1: XYZ Company manufactures a line of products distributed nationally through wholesalers. Presented below are planned manufacturing data for the year and the month of November also actual data for November of the current year. The company Applies overhead based on planned machine hours using a predetermined annual rate

16. Description Financial and quantitative data (planned ) Annual November Fixed manufacturing overhead $ 1,200,000 $ 100,000 Variable manufacturing overhead 2,400,0000 20,0000 Direct labor hours(D.L.H) 48,000 4,000 Machine; Hours (M.H) 240,000 20,000   Actual Data for November Actual Direct labor hours (D.L.H ) 4200 Direct labor hours (plan based on output ) 4000 Actual Machine hours (M.H ) 21600 Machine hours (plan based on output ) 21000 Actual Fixed manufacturing overhead $ 101,200 Actual Variable manufacturing overhead $ 214,000 Pre-determined O.H. application rate based on M.H (single rate)=15$/ MH Total Budgeted Annual Factory O.H $1,200,000 + $2,400,000 Annual estimated activity of cost driver —» 240,000.M.H

17. Fixed manufacturing overhead $ 1,200,000 $ 100,000 Variable manufacturing overhead 2,400,0000 20,0000 Machine; Hours (M.H) 240,000 20,000   Actual Data for November Actual Machine hours (M.H ) 21600 Machine hours (plan based on output ) 21000 Actual Fixed manufacturing overhead $ 101,200 Actual Variable manufacturing overhead $ 214,000 Pre-determined O.H. application rate based on M.H (single rate)=15$/ MH Normal Standard Factory Overhead applied Cost Driver/Input ? MH Actual Activity driver AI × Actual Output ? AO P. F. O.H Rate $15 per M.H Factory Overhead applied 324,000 $ A I×AO =? PFOHR Factory Overhead applied Cost Driver/Input ? M.H Standard Activity driver SI × Actual Output ? AO P. F. O.H Rate $15 per M.H Factory Overhead applied 315,000 $ S I×AO =? PFOHR Actual F.O.H 315,200 $ Overapplied F. O.H 8,800 Underapplied F. O.H 200 21,600 M.H 21,000 M.H

18. Normal Standard Factory Overhead applied Cost Driver/Input ? MH Actual Activity driver AI × Actual Output ? AO P. F. O.H Rate $15 per M.H Factory Overhead applied 324,000 $ A I×AO = 21,600 M.H PFOHR Factory Overhead applied Cost Driver/Input ? M.H Standard Activity driver SI × Actual Output ? AO P. F. O.H Rate $2 per D.L.H Factory Overhead applied 315,000 $ S I×AO = 21,000 M.H PFOHR Actual F.O.H 315,200 $ Overapplied F. O.H 8,800 Underapplied F. O.H 200 Conclusion The amount and direction of over/under applied factory O.H depends on the costing application approach that is used and cost driver chosen.

19. Question 2 : Selected actual data of North coast's operations for the year just ended is presented below. Total factory overhead is applied based on direct labor cost using a predetermined plant-wide rate The budgeted activity for the year included 20 employees each working 2,250 productive hours per year to produce 540,000 units of product. The machines are highly automated, and each employee can operate two to four machines simultaneously. Normal activity is for each employee to operate three machines. Machine operators will paid $15 per hour" *Budgeted factory overhead costs for the last year for various levels of activity are shown in the table below. Description- actual data Amount Quantity of Products manufactured 648,000 units Machine utilization 130,000 hours Direct labor usage 53,000 hours Labor rate , $ 14.5 per hour Total factory overhead $ 1,389,442 Cost of good sold $ 1,720,960 Finished goods inventory(at year-end) ; $ 430,240 Work-in-process inventory (at year-end) $

20. North coast's Manufacturing Company Budgeted Annual Costs For Total Factory Overhead Units of product 360,000 540,000 720,000 Labor hours (12 units per D.L.H) 30,000 45,000 60,000 Machine hours 72,000 108,000 144,000 Total factory overhead costs       Plant supervision $70,000 $70,000 $70,000 Plant rent $40,000 $40,000 $40,000 Equipment depreciation ($4 per M.H) 288,000 432,000 576,000 Maintenance 42,000 56,000 60,000 Utilities 144,600 356,200 388,600 Indirect material 90,000 156,000 180,000 Other manufacturing costs 11,200 91,300 162,000 Total estimated factory overhead costs $685,800 1,201,500 $1,476,600 Predetermined factory O.H rate = Budgeted, factory O.H ---> $1,201,500 Estimated Activity level of cost Driver-- -> D.L. cost 45,000 DLH × 15$ =675,000$ PFOHR = 1.78 per D.L. cost

21. Units of product 360,000 540,000 720,000 Labor hours (12 units per D.L.H) 30,000 45,000 60,000 Total estimated factory overhead costs $685,800 1,201,500 $1,476,600 Description- actual data Amount Quantity of Products manufactured 648,000 units Direct labor usage 53,000 hours Labor rate $ 14.5 per hour Total factory overhead $ 1,389,442 PFOHR = 1.78 per D.L. cost Normal Standard Factory Overhead applied Cost Driver/Input Factory Overhead applied 1,367,930 $ Factory Overhead applied Cost Driver/Input Factory Overhead applied 1,441,800 $ A I × AO D.L. Cost 53,000 hours × 14.5 =768,500 $ S I × AO D.L. Cost 648,000 units ÷ 12 units per D.L.H = 54,000 hours 54,000 hours × 15 =810,000 $ × × PFOHR = 1.78 per D.L. cost

22. Study Unit (7): Cost Allocation Techniques 7.1 Overhead Costs and Normal Costing 7.2 Allocating Service Department Costs to Production Departments 7.3 Absorption Versus Variable Costing Allocation and other Cost Concerns 7.4 Allocation of Common Costs Among Joint Products

23. 6.2 Allocating service department costs To production departments

24. 17- 24 Production Departments Service Departments Carry out the central purposes of an organization. Provide support that facilitates the activities of production departments. Service Department Cost Allocation support

25. 17- 25 Service Department (Cafeteria) Service Department (Accounting) Service Department (Personnel) Production Department (Machining) Production Department (Assembly) The Product Second Stage Allocations Production department overhead costs, plus allocated service department costs, are applied to products using departmental predetermined overhead rates. Service Department Cost Allocation First Stage Allocations Service department costs are allocated to production departments. 17-10

26. Production service departments Production departments Power Maintenance Assembly Machining Final products Administration Functions Human Resources Accounting Services Information Technology legal Period costs Administrative service Shared services are administrative services that are provided by a central department to the company’s operating units. Shared services are usually services such as human resources, information technology, maintenance, legal, and many accounting services such as payroll processing, invoicing and accounts payable. Although a service department may not directly add value to a product , a service department provides a service to other departments within a company that may directly add value to the products and services that the company offers. Factory Overhead The service department's factory O.H . is necessary costs for production activity and accordingly these costs are not period costs but rather it considered an indirect product costs (inventoriable) that must be allocated to production departments as an intermediate cost objective. Product costs

27. Production service departments Production departments Power Maintenance Assembly Machining Final products Administration Functions Human Resources Accounting Services Information Technology legal Period costs Administrative service Factory Overhead Product costs Managers may determine that service department costs should be allocated back to the operating departments because an operating department may not be able to provide its products without the support of the service department. For internal decision-making , the costs of shared service departments need to be allocated to the operating, or production, departments that use their services in order to calculate the full cost of production. Allocation of shared service costs does not make them product costs. The allocation of service costs to the production departments is strictly an internal function that is used for decision-making, and it is not reflected in the company’s external financial statements.

28. Reasons for allocating shared services costs include: It provides accurate departmental and product costs for use in making decisions, valuing inventory, and evaluating the efficiency of departments and the profitability of individual products; It provides an incentive for managers to make decisions that are consistent with the goals of top management; It provides a fair evaluation of the performance of segments and segment managers; It justifies costs, such as transfer prices; and It can also be used to compute reimbursement when a contract provides for cost reimbursement.

29. Production service departments Production departments Power Maintenance Assembly Machining Final products Administration Functions Human Resources Accounting Services Information Technology legal Period costs Administrative service Factory Overhead Product costs Allocation of service department costs has three phases: Phase 1: Identify overhead costs to the departments responsible for controlling the cost, whether production or service departments. (A responsibility reporting system would do this.) Phase 2: Allocate service department costs to production departments or other service departments, using one of the three methods discussed later in this topic. Then determine overhead rates, using the appropriate allocation base. Phase 3: Allocate overhead costs to products, using the overhead rates and the actual amounts of the allocation base.

30. Allocating Costs of Multiple Service or Support Departments

31. Service Departments Operating Departments Machining 25000$ Assembly 15000$ 50000KW Power 250000K.W Maintenance 2500 MH 62500$ 40000$ 15000$ +Allocation from service 25000$ +Allocation from service 150000KW 50000KW 250MH 1125MH 1125MH Predetermined departmental total factory O.H. application rate = Pooled annual budgeted departmental factory O.H. cost Annual budgeted activity of appropriate Cost driver for each production Department

32. Service Departments Operating Departments Machining 25000$ Assembly 15000$ 50000KW Power 250000K.W Maintenance 2500 MH 62500$ 40000$ 15000$ +Allocation from service 25000$ +Allocation from service 150000KW 50000KW 250MH 1125MH 1125MH A) Total factory O.H. costs expected to be incurred in upcoming year. Budgeted costs B) Using an appropriate cost driver for each production department the total budgeted manufacturing O.H. accumulated in each production department and the appropriate cost driver are combined to determine predetermined departmental total factory O.H. application rate.

33. C) When allocating (distributing) service department costs to production departments the appropriate criteria are: 1- Cause and effect criterion , it is considered the most appropriate. 2-Benefit (Mass ache setts) formula is used when no appropriate causality is found. 3) Ability to bear (based on profits) is usually unacceptable because of its Dysfunctional effect on managerial motivation. Note: whatever the criterion chosen the allocation should be fair; Fairness is an objective not criterion.

34. Methods of Allocating Support Costs to Production Departments Direct Step-Down Reciprocal

35. Direct Method Allocates support costs only to Operating Departments No Interaction between Support Departments prior to allocation hence direct method is the least accurate method of indirect factory O.H. cost allocation methods.

36. Description Service Departments Production Department Total Power Maintenance Machining Assemb1y Budgeted Direct factory O.H costs $62,500 $40,000 $25,000 $15,000 $142,500 TOTAL Assembly 50000 25% Allocating of power costs Machining 150000 75% Assembly 1125 50% Allocating of maintenance Machining 1125 50% ($62,500) $46,875 $15,625 ($40,000) …… …… $20,000 $20,000 $0 $0 $0 $0 $91,875 $50,625 $142,500

37. Step-Down Method Allocates support costs to other support departments and to operating departments that partially recognizes the mutual services provided among all support departments One-Way Interaction between Support Departments prior to allocation

38. 50000KW Power 250000K.W Maintenance 2500 MH 250MH Power provides 20% of its services to maintenance. Maintenance provides 10% of its services to power. 62500$ 40000$ + 12,500$ 31% + 4,000$ 6% Which support department should be allocated first? Answer, start with service department that provides 1) Highest service (%) to other service departments 2) Highest service ($) to other service departments 3) Provides services to the Highest number of other service departments

39. Description Service Departments Production Department Total Power Maintenance Machining Assemb1y Budgeted Direct factory O.H costs $62,500 $40,000 $25,000 $15,000 $142,500 Subtotal Total Allocating of power costs Maintenance 50000 20% Machining 150000 60% Assembly 50000 20% ($ 62,500 ) $0 $0 $0 $0 $0 $12,500 $37,500 $12,500 $52,500 $62,500 $27,500 $142,500 ……. ($52,500) $26,250 $26,250 $88,750 $53,750 $142,500 Allocating of maintenance Machining 1125 50% Assembly 1125 50%

40. Reciprocal Method Allocates support department costs to operating departments by fully recognizing the mutual services provided among all support departments Full Two-Way Interaction between Support Departments prior to allocation Reciprocal method should be used when management is using the results of cost Allocations to make decisions on pricing products

41. Power Maintenance Machining Assemb1y Power - 20% 60% 20% Maintenance 10% – 45% 45% Power cost = $62500 + .10 M M aintenance cost= $40000+ .20P P =$62,500 + $4,000 + .02 P P =$62,500 + 10% ($40,000 + 20% P) M =$53,571 P = $67,857 by plugging the amount of P to equation (2) M = $40,000 + 20% × $67,857 Reciprocal Method P- .02 P =$66,500 .98 P =$66,500 P =$66,500 ÷ .98

42. Description Service Departments Production Department Total Power Maintenance Machining Assemb1y Budgeted Direct factory O.H costs $62,500 $40,000 $25,000 $15,000 $142,500 Total Allocating of power costs Maintenance 50000 20% Machining 150000 60% Assembly 50000 20% Allocating of maintenance Power 250 10% Machining 1125 45% Assembly 1125 45% ($67,857) $0 $0 $0 $0 $13,571 $40,715 $13,571 ($53,571) $5,357 $24,107 $24,107 $89,822 $52,678 $142,500 Power Maintenance Machining Assemb1y Power - 20% 60% 20% Maintenance 10% – 45% 45% M =$53,571 P = $67,857

43. Benefits of cost allocation 1- Product costing and product pricing when pricing is based on cost 2- Investment and disinvestment decisions 3- Make-or-buy decisions, 4- Measuring income and assets for external reporting purposes based on full absorption costing approach. 5- Determination of profitability of a product, product line or department. Cost allocation is an internal matter that does not affect demand except to the extent it results in a change in price.  Cost allocation is not necessary for cash budgeting  Cost allocation is not necessary for controlling expenditures.  Cost allocations are not needed for some versions of variable costing, which Concerns direct, not indirect, costs

44. Question 1: Allocation of service department costs to the production departments is necessary to A. Control costs. B. Coordinate production activity. C. Determine overhead rates. D. Maximize efficiency. Answer (C) is correct. Service department costs are indirect costs allocated to production departments to better determine overhead rates when the measurement of full (absorption) costs is desired. Overhead should be charged to production on some equitable basis to provide information useful for such purposes as better allocation of scarce resources, pricing, measurement of profits, and cost reimbursement.

45. Question 2: Cotton Company has two service departments and three operating departments. In allocating service department costs to the operating departments, which of the following three methods (direct, step-down, reciprocal) will result in the same amount of service department costs being allocated to each operating department, regardless of the order in which the service department costs are allocated? a. Direct and reciprocal methods only. b. Step-down and reciprocal methods only. c. Direct and step-down methods only. d. Direct method only. Answer (A) is correct. Depending on the step-down sequence used, different allocation of support departments to operating departments will result. Therefore, the correct response is direct and reciprocal methods only.

46. Question 3: Wilcox Industrial has two support departments, the Information Systems Department and the Personnel Department, and two manufacturing departments, the Machining Department and the Assembly Department. The support departments service each other as well as the two production departments. Company studies have shown that the Personnel Department provides support to a greater number of departments than the Information Systems Department. Which one of the following departmental allocations is present in the reciprocal method of departmental allocation? The costs of the a. Assembly Department are allocated to the Information Systems Department and the Personnel Department. b. Information Systems Department are allocated to the Machining Department and the costs of the Machining Department are allocated to the Assembly Department. c. Personnel Department are allocated solely to the Information Systems Department. d. Information Systems Department are allocated to the Personnel Department, Machining Department, and Assembly Department. Answer (D) is correct. The reciprocal method of departmental allocation explicitly includes the mutual services provided among all support departments. Therefore, the Information Systems Department would be allocated all users including the Personnel Department.

47. Question 4: Wilcox Industrial has two support departments, the Information Systems Department and the Personnel Department, and two manufacturing departments, the Machining Department and the Assembly Department. The support departments service each other as well as the two production departments. Company studies have shown that the Personnel Department provides support to a greater number of departments than the Information Systems Department. If Wilcox uses the step-down method of departmental allocation, which one of the following cost allocations would not occur ? Some of the costs of the a. Personnel Department would be allocated to the Information Systems Department. b. Information Systems Department would be allocated to the Personnel Department. c. Personnel Department would be allocated to the Assembly Department. d. Personnel Department would be allocated to the Assembly Department and the Machining Department. Answer (B) is correct. The general step-down sequence begins with the support department that renders the greatest amount of service. There, the Personnel Department would be first and the Information Systems Department would not be allocated to the Personnel Department.

48. Question 5: Wilcox Industrial has two support departments, the Information Systems Department and the Personnel Department, and two manufacturing departments, the Machining Department and the Assembly Department. The support departments service each other as well as the two production departments. Company studies have shown that the Personnel Department provides support to a greater number of departments than does the Information Systems Department. If Wilcox uses the direct method of departmental allocation, which one of the following cost allocations would occur? Some of the costs of the a. Personnel Department would be allocated to the Information Systems Department. b. Machining Department would be allocated to the Information Systems Department. c. Information Systems Department would be allocated to the Assembly Department. d. Assembly Department would be allocated to the Machining Department. Answer (C) is correct. Using the direct method of cost allocation, all support departments are allocated directly to production departments. Relationships between support departments are not included in the allocation.

49. Question 6: Render Inc. has four support departments (maintenance, power, human resources, and legal) and three operating departments. The support departments provide services to the operating departments as well as to the other support departments. The method of allocating the costs of the support departments that best recognizes the mutual services rendered by support departments to other support departments is the a. direct allocation method. b. dual-rate allocation method. c. step-down allocation method. d. reciprocal allocation method. Answer (D) is correct. The reciprocal allocation method allocates costs by explicitly including the mutual services provided among support departments and allows for the full incorporation of interdepartmental relationships.

50. Question 7: Logo Inc. has two data services departments (the Systems Department and the Facilities Department) that provide support to the company’s three production departments (Machining Department, Assembly Department, and Finishing Department). The overhead costs of the Systems Department are allocated to other departments on the basis of computer usage hours. The overhead costs of the Facilities Department are allocated based on square feet occupied (in thousands). Other information pertaining to Logo is as follows. Computer Square Feet Department Overhead Usage Hours Occupied Systems $200,000 300 1,000 Facilities 100,000 900 600 Machining 400,000 3,600 2,000 Assembly 550,000 1,800 3,000 Finishing 620,000 2,700 5,000 9,300 11,600 If Logo employs the direct method of allocating service department costs, the overhead of the Systems Department would be allocated by dividing the overhead amount by a. 1,200 hours. b. 8,100 hours. c. 9,000 hours. d. 9,300 hours. Answer (B) is correct. Using the direct method of allocation, only the hours of the production departments would be included in the allocation base (3600 + 1800 + 2700 = 8100).

51. Question 8: Adam Corporation manufactures computer tables and has the following budgeted indirect manufacturing cost information for next year. Support Departments Operating Departments Total Maintenance Systems Machining Fabrication Budgeted overhead $360,000 $95,000 $200,000 $300,000 $955,000 Support work furnished From Maintenance 10% 50% 40% 100% From Systems 5% 45% 50% 100% If Adam uses the direct method to allocate support department costs to production departments, the total overhead (rounded to the nearest dollar) for the Machining Department to allocate to its products would be a. $418,000. b. $422,750. c. $442,053. d. $445,000. Answer (D) is correct. Maintenance Machining $200,000 50% ÷ (40% + 50%) = .555 .555 x $360,000 = $200,000 Systems 45% ÷ (45% + 50%) = .4736842 .4736842 x $95,000 = $45,000 Total allocation $200,000 + $45,000 + $200,000 = $445,000

52. Question 9 : Adam Corporation manufactures computer tables and has the following budgeted indirect manufacturing cost information for next year. Support Departments Operating Departments Total Maintenance Systems Machining Fabrication Budgeted overhead $360,000 $95,000 $200,000 $300,000 $955,000 Support work furnished From Maintenance 10% 50% 40% 100% From Systems 5% 45% 50% 100% If Adam uses the step-down method , beginning with the Maintenance Department, to allocate support department costs to production departments, the total overhead (rounded to the nearest dollar) for the Machining Department to allocate to its products would be a. $415,526. b. $422,750. c. $442,053. d. $445,000. Answer (C) is correct. Maintenance Machining $200,000 Systems ($360,000 x .5) 180,000 $95,000 ($360,000 x .10) 36,000 $131,000 45% ÷ (45% + 50%) = .4736842 .4736842 x $131,000 = $62,053 Total allocation $200,000 + $62,053 + $180,000 = $442,053

53. Allocating Costs of A Single (One) Service or Support Department to Multiple Users

54. Fact pattern: The following information is from the 2016 budget for Bozo Co. Bozo has one service department, its Maintenance Department, that serves its Manufacturing and Sales departments. The Maintenance Department has a practical capacity of 5,000 hours of maintenance service available each year. Description Budgeted Actual Manufacturing Department Sales Department Manufacturing Department Sales Department Fixed costs $247,500 $250,500 Variable cost $25 per hour $26 per Hour Usage 3,500 hours 1,000 hours 3,600 hours 1,100 hours Maintenance Department Practical capacity of 5,000 hours Budgeted Actual Fixed costs $247,500 $250,500 Budgeted Actual Variable costs $25 per hour $26 per hour Manufacturing Sales Budgeted usage Actual usage 3,600 hours 1,000 hours 1,100 hours 3,500 hours

55. Maintenance Department Practical capacity of 5,000 hours Budgeted Actual Fixed costs $247,500 $250,500 Budgeted Actual Variable costs $25 per hour $26 per hour Manufacturing Sales Budgeted usage Actual usage 3,600 hours 1,000 hours 1,100 hours 3,500 hours Using a single-rate method, the budgeted total cost pool will be $247,500 fixed cost + (4,500 hours × $25) variable cost = $360,000 The allocation rate for the total maintenance cost is $360,000 ÷ 4,500 hours, which is $80 per hour. The single-rate method is usually used with the second allocation base option: budgeted rate and actual hours used Therefore, the amounts of Maintenance department costs that will be allocated to the Manufacturing and Sales departments are: Manufacturing 3,600 × $80 = $288,000 Sales 1,100 × $80 = 88,000 Total cost allocated $376,000

56. Maintenance Department Practical capacity of 5,000 hours Budgeted Actual Fixed costs $247,500 $250,500 Budgeted Actual Variable costs $25 per hour $26 per hour Manufacturing Sales Budgeted usage Actual usage 3,600 hours 1,000 hours 1,100 hours 3,500 hours Budgeted rate and budgeted hours to be used by the operating divisions. Budgeted rate and actual hours used by operating divisions. The allocation rate for the fixed cost is $247,500 ÷ 4,500 hours, or $55 per hour. The allocation rate for the variable cost is $25 per hour. Sales: Fixed Costs $55 × 1,000 hours = $ 55,000 Variable Costs: $25 × 1,100 hours = 27,500 Total allocated to Sales $ 82,500 Total cost allocated $365,000 Manufacturing: Fixed Costs: $55 × 3,500 hours= $192,500 Variable Costs: $25 × 3,600 hours= 90,000 Total allocated to manufacturing $282,500

57. Allocating Costs of A Single (One) Service or Support Department to Multiple Users Single-Rate Method – The single-rate method does not separate fixed costs of service departments from their variable costs. It puts all of the service department costs into one cost pool and allocates the costs using one allocation base. Allocation bases for the single-rate: Budgeted rate and actual hours used by operating divisions Benefits • The cost to implement it is low because it avoids the analysis needed to classify all of the service department’s cost into fixed and variable costs. Limitations • The single-rate method makes fixed costs of the service department appear to be variable costs to the user departments, possibly leading to outsourcing that hurts the organization as a whole. Single-Rate Method Dual-Rate Method Manufacturing Sales $288,000 $88,000 $282,500 $82,500

58. Dual-Rate Method – The dual-rate method breaks the cost of each service department into two pools, a variable-cost pool and a fixed-cost pool, and allocates each cost pool using a different cost-allocation base. Allocation bases for the dual-rate method can be: (Fixed costs) Budgeted rate and budgeted hours to be used by the operating divisions. (Variable costs) Budgeted rate and actual hours used by operating divisions. Benefits • It helps user department managers see the difference in the ways that fixed costs and variable costs behave. And it guides user department managers to make decisions that are in the best interest of the organization as a whole, as well as each individual department. Limitations • The cost is higher than the cost of the single-rate method because of the need to classify all of the costs of the service department into fixed and variable costs.

59. Question10: The variable costs of service departments should be allocated to production departments by using: A. Actual short-run output based on predetermined rates. B. Actual short-run output based on actual rates. C. The service departments expected costs of long-run capacity. D. The service departments actual costs based on actual services. Answer (A) is correct. The most appropriate method of factory overhead allocation of variable service department costs to production departments is to multiply the actual usage” of the production department by the predetermined rate. This basis establishes the user department’s responsibility for the actual usage at the predetermined rate. Thus, normal costing approach is the best approach to allocate the variable costs of service departments to production departments.

60. Question11: The fixed costs of service departments should be allocated to production departments based on A. Actual short-run use based on predetermined rates. B. Actual short-run units based on actual rates. C. The service departments expected costs of long-run capacity. D. The service department’s actual costs based on actual use of services. Answer (C) is correct. The fixed costs of service departments should be allocated to production departments in lump-sum amounts on the basis of the service department's budgeted costs of long-term capacity to serve. This basis allows the production department to develop (budget), a certain capacity needed from the service departments and to agree on the assessment of costs. Analysis of actual results permits evaluation of the service department’s ability to provide the estimated volume of service and any savings or overspending would be accountable at the service department’s level.

61. Question12: When allocating costs from one department to another, a dual-rate cost-allocation method may be used. The dual-rate cost-allocation method is most useful when a. two or more cost pools are to be allocated. b. two or more departments’ costs are to be allocated. c. two or more products are produced. d. costs are separated into variable-cost and fixed-cost subpools . Answer (D) is correct. The dual-rate cost-allocation method classifies costs in each cost pool into two subcost pools, a variable-cost subpool and a fixed cost subpool , with each of these subpools having a different cost allocation base.

62. Question 13: The management of ROX Company wishes to encourage all other departments to use the legal department, as circumstances warrant. To accomplish this, legal department costs should be a. allocated to users on the basis of the actual cost of hours used. b. allocated to users on the basis of the budgeted cost of actual hours used. c. allocated to users on the basis of standard cost for the type of service provided. d. absorbed as a corporate expense. Answer (D) is correct. If the cost of legal services is allocated on the basis of usage, departments will be very careful about usage. To encourage usage , the cost should be absorbed as a corporate expense.

63. Question 14: Boston Furniture Company manufactures several steel products. It has three production departments, Fabricating, Assembly, and Finishing. The service departments include Maintenance, Material Handling, and Designing. Currently, the company does not allocate service department costs to the production departments. John Baker, who has recently joined the company as the new cost accountant, believes that service department rates should be developed and charged to the production departments for services requested. If the company adopts this new policy, the production department managers would be least likely to a. request an excessive amount of service. b. replace outdated and inefficient systems. c. refrain from using necessary services. d. be encouraged to control costs. Answer (A) is correct. Allocating service department costs to production departments is most likely to cause production managers to be more careful about the use of services and not request excessive service.