ACCT 102 Management Accounting Lecture 8

1. ACCT 102Management AccountingLecture 8

2. 2 Cost allocation Cost allocation provides information needed for both strategic and operating decisions Indirect costs of a particular cost object are costs that are related to that cost object but cannot be traced to it in an economically feasible (cost-effective) way

3. 3 Cost allocation To provide information for economic decisions To motivate managers and other employees To justify costs or compute reimbursement amounts To measure income and assets

4. 4 Cost allocation Cause and effect Allocation based on the resources consumed by the cost object Benefits received Allocation based on the benefits received from the cost object Fairness or equity Allocation based on what is considered fair (subjective) Ability to bear Allocation based on the cost object�s ability to absorb the costs

5. 5 Cost allocation Use an illustration from Hongren, Datar, and Foster (12th edn, p. 496 � 501) Objective of cost allocation: To provide information for economic decisions such as pricing by measuring the full costs of delivering products based on an Activity-Based Costing (ABC) system Key steps Corporate costs allocated to divisions Division costs allocated to product

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8. 8 Cost allocation Joint costs are the costs of a production process that yields multiple products simultaneously The splitoff point is the juncture in a joint production process when two or more products becomes separately identifiable Separable costs are all costs incurred beyond the splitoff point that are assignable to each of the specific products identified at the splitoff point

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10. 10 Cost allocation Main product: Product with high total sales value compared with the total sales values of other products of the process Joint products: Products with high total sales values compared with the total sales values of other products (if any) Byproducts: Product(s) with low total sales value compared with the total sales value of the main product or of joint products

11. 11 Cost allocation Computation of inventoriable costs and cost of goods sold for financial accounting purposes and reporting to tax authorities. Computation of inventoriable costs and cost of goods sold for internal reporting purposes, e.g., in division profitability analysis Cost reimbursement for goods or services provided under cost-plus contracts

12. 12 Cost allocation Sales value at splitoff method Physical-measure at splitoff method Net realizable value (NRV) method Constant Gross-Margin Percentage NRV method Not allocating joint costs

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18. 18 Cost allocation Sales value at splitoff method is preferred because: Measurement of the value of the joint products at the splitoff point (Benefits received criterion) No anticipation of subsequent management decisions Availability of a common basis to allocate joint costs to products Simplicity

19. 19 Cost allocation When selling prices at the splitoff are not available, the NRV method is commonly used because it attempts to approximate sales value at splitoff Main advantage of the constant margin percentage NRV method is that it is relatively easy to implement because it treats joint products as a single product. Assumption that all products have constant cost to sales ratio is likely to be unreasonable

20. 20 Cost allocation The physical-measure method is generally not preferred because of a lack of matching of cost with benefits. May be used because of in circumstances when there is a circular reasoning i) in the use of prices to allocate costs and ii) the use of costs to set prices Methods for allocating joint costs arbitrary, so some companies do not allocate joint costs