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acc410 chpt 8, 10, 11.docx

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Department
Accounting
Course
ACC 410
Professor
Santoso Sugianto
Semester
Summer

Description
Chapter 8 – Measuring & Assigning Support Department Costs Common cost: the cost for a resource that is shared among two or more departments, activities, products, or other cost objects - We allocate the common costs of support departments to operating departments Operating departments: are the departments or divisions within an organization that manufacture goods or product services for external customers or clients - In mnfg. businesses, operating departments product goods for sale - In service organizations, operating departments product services for clients or customers - In retail or distribution business, operating departments sell merchandise to customers - Govern’t agencies provide services such as police, fire and emergency medical response; maintenance and repair of city streets; parks and recreational facilities; and special interest classes - Not-for-profit organizations (food banks, arts and cultural groups, and child care centres) also provide services Support departments: provide services internal to the organization that support the operating departments - Ex. A large auto manufacturer may operate a café for its employees and have a HR department that hires employees and keeps track of all employee benefits for all departments. These services are provided as support for departments that produce parts, subassemblies, and autos for sale to external customers, which generates revenues for the auto manufacturer - Typical support departments: accounting, info systems, HR, marketing, R&D, and general admin Objectives for Support Department Cost Allocation - Support department costs are generally treated as period expenses when preparing financial statements under GAAP, so they’re allocated for objectives other than financial statements reporting o External reporting – cost reports for govern’t contracts, income tax returns, reports prepared for reimbursement purposes o Motivation – provide incentives for efficient production and for appropriate use of support services, monitor use and production of support services o Strategic & operating decisions – new product/market intros, insource/outsource, pricing - Some organizations must allocate support service costs when reporting to outsiders o Ex. Unis allocate a portion of their OH costs to federally funded programs, hospitals prepare annual health care cost reports in accordance with the Canada Health Act - Some organizations allocate support department costs in order to motivate managers to improve cost control and efficiency - Managers of departments that provide support services are held responsible for their department costs, whereas managers of other departments are held responsible for their departments’ use of support services - An effective allocation system motivates both sets of managers to be efficient - Sometimes allocated support department costs are used in making strategic or operating decisions, such when to enter a new market, where to outsource an activity and how much to charge for services provided - Support costs are relevant to such decisions only if they would be affected by the decision o They often include FC that are less likely to be relevant for decision making The Process for Allocating Support Department Costs Process of allocated support department costs to operating departments: 1. Clarify the purpose of the allocation. o You need to know the purpose of the allocation – refer to objectives ^^ o The choices made in the following steps must be consistent with the purpose 2. Identify support and operating department cost pools. o You consider the purpose for allocating support department costs as you decide the type and number of support and operating department cost pools that will be used o Departments are often used as cost pools o The choice of cost pools is also influenced by the design of the accounting system  Some organizations have detailed accounting systems that make different types of costs more accessible o Sometimes fixed and variable costs are allocated separately – if they haven’t been assigned to separate cost pools in the accounting system, it might be time consuming and costly to separately allocate them o The ability to identify an appropriate allocation base influences the number and type of support department cost pools o More accurate cost allocations can be achieved by separating support costs into a larger number of cost pools. As the number of support cost pools increases, the cost of collecting info may also increase 3. Assign costs to cost pools. o Many costs can be directly traced to the cost pool (Ex. Employee salaries and supplies can be directly traced to individual departments) o Some costs can be indirect to the cost pool (ex. Rent costs for an entire facility would be indirect to the info tech costs cost pool) 4. For each support department cost pool, choose an allocation base. o A cause-and-effect relationship is desirable between the support costs and the allocation base that is used to allocate them o Best allocation base is a cost driver o If the department cost pool includes many different activities, an allocation base is chosen to reflect some of the activities provided o The cost of obtaining accurate allocation base info is an important consideration 5. Choose and apply a method for allocating support department costs to operating departments. o There are 3 allocation methods:  Direct method  Allocates the costs of all support departments to the operating departments only  Ignores the fact that support departments use each others’ services o To get the % take the operating department and divide by the total, then multiply that % by the support department  Step-down method  Allocates support department costs one department at a time to remaining support and operating departments in a cascading manner until all support department costs have been allocated  Goes beyond the direct method in recognizing that support departments provide support not only for the operating departments but also for the support departments  Ranks each support department according to the amount of service provided to other support departments  Support department costs are allocated sequentially, begins with the support department that provided the least service to other departments o The first support department’s costs are allocated to all operating and support departments that use its services o Each subsequent support department’s costs are allocated to all operating and support departments that use its services, except any support department whose costs were already allocated  To find which one to allocate first: take the support department and divide by all the operating departments  When allocating: take the % for the operating department and multiply by support department  Reciprocal method  Allocates costs among support departments and then from support departments to operating departments  Widely used b/c it allows for interactions among departments o This method reflects support department interactions more accurately than either the direct, which doesn’t address the interactions at all, or the step-down, which addresses only part of the interactions  This methst is performed in two phases: o 1 : support department costs are allocated among each other. A set of equations is creased and solved simultaneously.  The allocated cost for each support department includes costs allocated from the other support departments nd o 2 : this new total cost per support department is allocated to all the other departments (support and operating) 6. If relevant, allocate support costs from the operating departments to units of goods or services o For some decisions, this may not be relevant o For long-term pricing decisions, this is likely to be relevant o For some types of business decisions, it is relevant – decisions to outsource support services & operating decisions  Variable support cost allocations under a dual-rate probably reflect the incremental costs of support services. However, relevant FC must be identified by analyzing costs and determining which would be avoidable if the dept. services were outsourced - Support cost allocations tend to be inaccurate when measuring relevant costs for operating dept. decisions – when evaluating costs for a keep-or-drop decision, support costs that are allocated to an operating dept. might not be eliminated if the operating dept. is dropped. Similarly, allocated support costs might be irrelevant when evaluating incremental costs for a special order, product emphasis or other decision Single vs. Dual Rate Allocations Single-rate allocation: the practice of using only one base to allocate both fixed and variable costs - Likely mis-measures resources used - Managers may believe that all support costs are variable, even when they include a large proportion of FC o Find the TC and divide it by what you’re looking for, then take that rate and multiply it by what you’re allocating Dual-rate allocation: support costs are separated into fixed and variable cost pools and cost drivers are identified for the VC pools to more accurately reflect the flow of resources - Compared to single-rate, the VC allocations reflect a more accurate estimation of the incremental costs of providing support services - Some organizations use VC to measure use of a department’s services and assign the FC as part of a department’s formally adopted budget - It costs more to develop and maintain, and uncertainties about how to classify fixed and variable can introduce additional mismeasurments o Change the fixed part by dividing by your x and then multiply it by what you have to allocate it, the VC stays the same Support Cost Allocations, Info Quality & Decision Making - Allocated support cost info can be low quality b/c of the judgement involved in the allocation process - Ex. The admin dept. cost pool in small organizations often includes costs related to the acc and HR functions, in addition to general mgmt. No allocation base will accurately reflect other depts’ use of admin b/c such a wide variety of services are pooled together. Even in organizations that maintain separate fixed and variable cost pools for each type of support services, the allocation base for a particular cost pool may not be a cost driver – either b/c no cost driver exists or b/c the cost of gathering reliable data for a cost drive would exceed the benefit - Transfer prices?? :S uncertainties (common sense) Estimated vs. Actual Support Costs - If the goal is to measure the value of support resources actually used, then actual costs and actual allocation base volumes are appropriate - Sometimes it’s okay to use estimates rather than actual values. The use of estimated rates simplifies and expedites the calculation of allocated support costs, but the use of it depends on the purpose of the allocation - When the purpose of support cost allocation is motivation, the goal is to charge other depts. in a way that will encourage managers to use support services efficiently - The general formula for charges to other departments: o Allocation rate = total support costs / total volume of allocation base o Charge = allocation rate x volume of support services used  May be based on actual or estimated values - Advantage of using budgeted values for the entire calculation is that managers of other depts. know the support charge in advance, and this charge is not affected by the amount of support service actually used – but it provides little incentive to use support services efficiently - Advantage of using actual values is that dept. managers are held responsible for the actual cost of the support services they use - For strategic or operating decisions, managers are interesting in estimating future costs, so if they are relevant to the decision, support cost allocations should be based on future estimated costs and volumes of the allocation base Fairness and allocation methods - All operating depts. Should be allocated costs based on their use of the support services, and no one operating dept. is more responsible for support costs than any other operating depts. - Criteria such as perceived fairness, are used to allocate common costs such as support dept. costs - Perceived fairness of an allocation system depends on the circumstances and sometimes on the ability to bear costs - Can also address perceived fairness by basing common cost allocations on estimates of the costs that would be incurred costs: o Stand alone method: common costs are allocated using weights based on info about the individual users of a cost object o Incremental cost allocation method: the most responsible user is allocated the cost that would have been incurred had the services not been shared with other users. The next most responsible user is allocated the incremental cost to use the shared resource Chapter 10 – Budgeting - Plans must be developed to anticipate revenues, expenses, and cash flows o These plans help the organization coordinate the activities needed to carry out the plan o At the end of the period, actual results are compared to the plans to identify gaps, or variances, from the plan - A budget: a formalized financial plan for operations of an organization for a specified future period o A budget is an organization’s financial roadmap, it reflects management’s forecast of the financial effects of an organization’s plans for one or more future time periods Master Budgets - A master budget: is a comprehensive plan for an upcoming financial period, usually a year o Begins with organizational strategies and operating plans o Developed using a set of budget assumptions, which are plans and predictions about next period’s operating activities - Operating budget: management’s plan for revenues, production and operating costs o The operating budget is created by preparing the following individual budgets in order:  Sales forecast  Revenue budget  Production budget (uses B.I levels, sales forecasts and desired E.I)  Direct materials budget  Direct labour budget  Manufacturing overhead budget  Cost of goods sold budget  Support department budgets - Financial budget: management’s plan for capital expenditures, long-term financing, cash flows, and short-term financing o Includes preparing the following individual budgets:  Capital budget  Long-term financing budget  Cash Receipts and Disbursements budget  Short-Term financing budget  Budgeted financial statements  Income  Balance Sheet
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