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Agenda for Session 14

Agenda for Session 14. Review motivation for cost allocation Review the criteria used to allocate cost in the US today Study 3 inter-activity allocation methods Illustrate the opportunity to influence costs using the step-down method. Discuss problem assignments.

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Agenda for Session 14

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  1. Agenda for Session 14 • Review motivation for cost allocation • Review the criteria used to allocate cost in the US today • Study 3 inter-activity allocation methods • Illustrate the opportunity to influence costs using the step-down method. • Discuss problem assignments A&MIS 525

  2. Motivation for Cost Allocation • Provide unbiased information for economic decisions • Management planning & control • Operating control Example: Prairie State Paper Case Example: Nebraska Social Services Example: Canadian Air Force A&MIS 525

  3. Motivation for Cost Allocation • Incent managers and employees • Financial plans & incentives • Feedback & scorekeeping • Make managers aware of the cost impact of their activities • A fundamental issue in this context is to attribute costs, revenues, cash flows, and investment to the responsible entities and individuals A&MIS 525

  4. Motivation for Cost Allocation • Implement agreements • Cost sharing (joint ventures) • Cost reimbursement (programs, activities) • Cost-plus pricing (various contracts) • Determine, justify and defend actions • Price discrimination lawsuits • Regulated industries • Antitrust proceedings A&MIS 525

  5. Other Objectives • To satisfy financial, tax, and regulatory reporting requirements: • Quarterly reports to shareholders • Quarterly reports to creditors (if not more frequent) • Tax shifting and sharing among countries in which company operates • Regulatory reports A&MIS 525

  6. Cost Allocation In many settings, the manner in which costs are allocated can have a significant impact on the apparent success of projects, departments, programs, products, services, and managers. It is both an intra-firm issue and an inter-firm one. A&MIS 525

  7. Criteria Used to Allocate Costs • Economic validity • Search for cause-effect relationships based on actual data • Find the more important cost drivers based on actual data • Has face validity A&MIS 525

  8. Another Criterion • Benefits received • Use of common facilities • Utilization of common facilities • Products or services received • Use of resources or creation of liabilities • Billings for services rendered per agreement or letter of engagement A&MIS 525

  9. More Criteria • Fairness or equity • Implementation of an agreement • Appropriate in uncertain environments • Can reduce the risk premium A&MIS 525

  10. More Criteria • Ability to pay • May or may not be “fair” • Joint product costing is a good example • Allocation of corporate expenses A&MIS 525

  11. Criteria to Evaluate Methods • Validity of the results in an economic, accounting sense • Understandability by users • Perceived fairness of the results • Usefulness to customers of the information • Impact on the system (firm, economy, other) A&MIS 525

  12. Types of Costs Involved • Variable costs (direct materials in joint processes) • Capacity costs • Common costs • Joint purchases • Shared costs (by agreement) A&MIS 525

  13. Allocation Methods • Activity rates to charge users • Proportional usage as in support activity cost allocation • Estimates of relative exit values as in joint-product costing • Opportunity cost as in linear programming • Game theoretic as in Shapely method A&MIS 525

  14. Changing Directions….. A&MIS 525

  15. Attributes of Support Activity Cost Allocation Models • Direct allocation to production activities • unique answer • biased if any service relationships are ignored in the process • answer always exists and can be computed using general purpose software A&MIS 525

  16. Step or sequential method • Answer is unique only when the activities are acyclic and the allocation incorporates all service relationships. • Answer always exists to realistic problems. • Specialized software is needed to determine if activities are acyclic and to put them in the proper sequence. A&MIS 525

  17. Reciprocal Method • Answer is unique. • Answer is unbiased. • Answer to the allocation equations always exists. • Allocations can be done with standard software packages. A&MIS 525

  18. Summary of Attributes A&MIS 525

  19. Consider Hoosier Industries Let’s work through a problem next Please get the Hoosier industries problem from your packet now. A&MIS 525

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