To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter Measuring and Assigning Support Department Costs LEARNING OBJECTIVES Chapter addresses the following questions: Q1 Q2 Q3 Q4 Q5 Q6 Q7 What are support departments, and why are their costs allocated to other departments? What process is used to allocate support department costs? How is the direct method used to allocate support costs to operating departments? How is the step-down method used to allocate support costs to operating departments? How is the reciprocal method used to allocate support costs to operating departments? What is the difference between single- and dual-rate allocations? What are the limitations of support cost allocations, and how can the quality of information be improved? These learning questions (Q1 through Q7) are cross-referenced in the textbook to individual exercises and problems COMPLEXITY SYMBOLS The textbook uses a coding system to identify the complexity of individual requirements in the exercises and problems Questions Having a Single Correct Answer: No Symbol This question requires students to recall or apply knowledge as shown in the textbook This question requires students to extend knowledge beyond the applications e shown in the textbook Open-ended questions are coded according to the skills described in Steps for Better Thinking (Exhibit 1.10):  Step skills (Identifying)  Step skills (Exploring)  Step skills (Prioritizing)  Step skills (Envisioning) To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 8-2 Cost Management QUESTIONS 8.1 Similarities: All of the methods allocate support department costs to operating departments All of the methods rely on allocation bases to assign costs of support departments to operating departments All of the methods result in a total allocated cost per unit All of the methods use cost pools, and those are usually departments Differences: Direct method ignores all interactions among support departments The step-down method takes into account some of the interactions among support departments The reciprocal method takes into account all of the interactions among support departments 8.2 Support department costs are direct costs of the department, but indirect costs when allocated to other departments Manufacturing overhead is a direct cost of the production process but it becomes an indirect cost when it is allocated to units 8.3 Management's objectives should be the determining factor, tempered by the availability of the data and the cost of performing the allocation For example, if the primary purpose is cost control, a method that recognizes interdepartmental relationships is appropriate If the firm has a computer and appropriate software, the reciprocal allocation method is preferred If the primary purpose is product costing and the firm has a manual system, the direct method may be preferred Following are other factors to consider in choosing an appropriate allocation method: As the number of cost pools increase, calculations become more complex under the reciprocal method, When there are four or more support cost pools, software is needed to perform the reciprocal method calculations The degree of interaction among support departments; fewer interactions result in fewer differences in allocation amounts 8.4 Costs that include support department allocations using a single cost pool and single allocation base for both fixed and variable costs would overstate the incremental costs used in short-term decisions This limits the use of these costs for decision-making However, when a dual rate system is developed, the variable costs are more likely to be relevant information for short-term decision-making 8.5 Following are factors to consider in choosing an allocation base Costs and benefits of the information gathered Does one of the bases better reflect the use of the support department resources? Will the allocation base be easy to measure and apply? Are data available for the allocation base? How accurate are the data? To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 8: Measuring and Assigning Support Department Costs 8-3 8.6 Department is an operating department because it works directly on the firm's final product 8.7 Operating departments manufacture goods or produce services that are sold to clients Support departments interact primarily with operating departments and other support departments, and not with outside customers Support departments provide operating departments with internal services such as accounting, research and development, maintenance, and so on 8.8 The dual rate separates fixed and variable support costs When this is done, the variable rate can be used as information for making decisions that require incremental costs, such as transfer prices and insource and outsource decisions A single rate includes both fixed and variable costs and cannot be used for any type of decision making Another advantage of the dual rate method is that the allocations more accurately represent the flow of resources because fixed and variable costs are separated and usually allocated using different allocation bases or actual usage of some sort 8.9 Because they include fixed costs and costs allocated from other departments, support department allocations result in very high charges for services Because they are so high, sub-optimal behavior occurs, such as managers duplicating services either by purchasing them from outside the organization or providing them in their own departments Often support departments are then underused, but the organization still incurs their costs In addition, extra costs are incurred because internal services are duplicated 8.10 Better short-term decisions would be made using the dual rate method because the variable costs of the support departments would be easy to use in decision-making It would depend on the type of long term decision being made whether either method would provide useful information 8.11 Estimated (budgeted) cost rates provide information for managers to use in budgeting and some of their decision-making Managers can predict charges as they use the service In addition, each department’s charges are not affected by other departments’ use of service A disadvantage of budgeted rates is that user departments have little incentive to use resources efficiently because their charge is already known, and will not change with usage, if it is based on a fixed rate 8.12 Accounting department costs could be allocated using number of employees, departmental direct costs, or time spent on activities for individual departments An advantage of number of employees is that it would be simple to use in calculations A disadvantage is that it probably does not reflect the use of the department by other departments An advantage of departmental direct costs is that accounting activities probably increase as direct costs increase, and direct costs are fairly easy to measure A disadvantage is that there are some accounting activities that not vary with direct costs And advantage of time spent on accounting activities for every department is that it is probably most accurately reflects the use of accounting by other departments, but it would be hard to track, and there is likely measurement error when time is not recorded as used, but estimated or recorded after the fact To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 8-4 Cost Management 8.13 a GAAP requires manufacturing overhead to be allocated to units of product or service, generally using a traditional cost accounting method such as job costing or process costing b Under GAAP, costs for departments that directly support the manufacturing function, such as material handling are allocated However, costs of departments that provide non-manufacturing support, such as accounting and human resources are not allocated to units or services, they are expensed as period costs To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 8: Measuring and Assigning Support Department Costs 8-5 EXERCISES 8.14 Allocation Rates A Estimated costs = $40,000 + $12(5,000) = $100,000 Estimated allocation rate = $100,000/5,000 hours = $20/hour B Estimated cost at actual output = $40,000 + $12(4,900) = $98,800 Actual rate = $98,800/4,900 hours = $20.16/hour C An advantage of using an estimated allocation rate is that managers know in advance what their costs will be A disadvantage is that there is no incentive to use housekeeping hours wisely because the cost rate is known and will not change during the period An advantage for using an actual allocation rate is that managers have a better idea about the effects of their use of housekeeping services on costs A disadvantage is that they not know their costs ahead of time, and they may have little control over whether the rate is higher or lower than expected 8.15 Allocating Support Costs to Units Monthly occupancy = 120 beds*0.8*30 days = 2,880 patient days Monthly costs = $240,000 + $90*2,880 = $499,200 Average daily charge = $499,200/2,880 = $173.33 8.16 Devon A Direct method allocation using direct labor hours: Dept A Support Departments Dept B Dept C Allocation Base: Direct labor hours Costs: Direct costs Department A Department B Department C Total allocated cost $88,000 (88,000) $63,000 $ $ (40,000) Total 6,000 60% 4,000 40% 10,000 100% $ 52,800 37,800 24,000 $114,600 $35,200 25,200 16,000 $76,400 $191,000 0 $191,000 $40,000 (63,000) $ Operating Departments Casting Machining To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 8-6 Cost Management Direct method allocation using costs to purchase outside: Dept A Support Departments Dept B Dept C Operating Departments Casting Machining Allocation Bases: Department A outside costs Department B outside costs Department C outside costs Costs: Direct costs Department A Department B Department C Total allocated cost $88,000 (88,000) $63,000 $ $ $50,000 45.45% $40,000 57.14% $20,000 40.00% $60,000 54.55% $30,000 42.86% $30,000 60.00% $110,000 100% $70,000 100% $50,000 100% $40,000 36,000 16,000 $92,000 $48,000 27,000 24,000 $99,000 $191,000 0 $191,000 $40,000 (63,000) $ (40,000) Total B Devon could use the cost of purchasing outside as a benchmark for both departments, but there are some advantages and disadvantages Using the direct method, no interactions of support department services are reflected This might understate the cost of services However, fixed costs are included, and many of these may be sunk costs, for example depreciation expense These could overstate the support department costs If the costs for internal and external support services are similar, the cost to purchase outside might provide a good benchmark if it is equal to or less than the cost of internally providing the support However, if the outside cost is more, incentive exists for increasing both the cost and use of services, which may be inefficient for the company overall Alternatively, if the outside cost is much less, departments may begin to outsource the services and this duplicates services and may be inefficient for the overall company as well 8.17 Petro-X A Direct method allocation Support Departments Physical Equipment Plant Maintenance Fixed Cost Allocation: Allocation bases: Square feet Machine hours Fixed costs: Physical plant Equipment maintenance Allocated fixed cost $39,000 (39,000) Operating Departments Dept X Dept Y 5,000 8,000 13,000 38.462% 61.538% 100.00% 10,000 15,000 25,000 40.00% 60.00% 100.00% $75,000 (75,000) Total $15,000 30,000 45,000 $ 24,000 45,000 69,000 $114,000 0 114,000 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 8: Measuring and Assigning Support Department Costs Variable Cost Allocation: Allocation bases: # of employees Maintenance hours Variable costs: Physical plant Equipment maintenance Allocated variable cost Total allocated cost (fixed + variable) 18,000 (18,000) $ 40 50 90 44.446% 55.556% 100.00% 200 400 600 33.333% 66.667% 100.00% 60,000 (60,000) $ 8-7 8,000 20,000 28,000 10,000 40,000 50,000 78,000 0 78,000 $73,000 $119,000 $192,000 B Step-down method allocation, with physical plant costs allocated first Support Departments Physical Equipment Plant Maintenance Fixed Cost Allocation: Allocation bases: Square feet 5,000 8,000 16,900 47.337% 100.00% 10,000 15,000 25,000 40% 60% 100.00% $75,000 9,000 (84,000) 0 18,000 (18,000) $ $ 18,462 50,400 68,862 $114,000 0 114,000 12 40 50 102 39.22% 49.02% 100.00% 60,000 2,118 (62,118) 0 $11,538 33,600 45,138 11.76% Maintenance hours $ Total 29.586% Variable Cost Allocation: Allocation bases: # of employees Total allocated cost (fixed + variable) Dept Y 3,900 $39,000 (39,000) Variable costs: Step 1: Physical plant Step 2: Equip maint Allocated variable cost Dept X 23.077% Machine hours Fixed costs: Step 1: Physical plant Step 2: Equip maint Allocated fixed cost Operating Departments 200 400 620 33.333% 66.667% 100.00% 7,059 20,706 27,765 8,823 41,412 50,235 78,000 0 78,000 $72,903 $119,097 $192,000 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 8-8 Cost Management C Step-down method allocation, with equipment maintenance costs allocated first Support Departments Physical Equipment Plant Maintenance Fixed Cost Allocation: Allocation bases: Machine hours Dept X Dept Y 10,000 15,000 25,000 0.00% 40% 60% 100.00% Square feet Fixed costs: Step 1: Equip maint Step 2: Physical plant Allocated fixed cost $39,000 (39,000) Variable Cost Allocation: Allocation bases: Maintenance hours $75,000 (75,000) Total allocated cost (fixed + variable) 5,000 8,000 13,000 38.462% 61.538% 100.00% $30,000 15,000 45,000 $ 45,000 24,000 69,000 $114,000 0 114,000 10 200 400 610 32.787% 65.574% 100.00% 18,000 984 (18,984) $ Total 1.639% # of employees Variable costs: Step 1: Equip maint Step 2: Physical plant Allocated variable cost Operating Departments 60,000 (60,000) 0 $ 40 50 90 44.44% 55.56% 100.00% 19,672 8,437 28,109 39,344 10,547 49,891 78,000 0 78,000 $73,109 $118,891 $192,000 D Ideally, departments should be allocated in the order their services are used, with departments providing more services to other departments according to their rank of services provided Because services can be difficult to measure, direct costs are often used as a measure of services provided To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 8: Measuring and Assigning Support Department Costs 8-9 8.18 The Brown and Brinkley Brokerage A sample spreadsheet using Excel Solver for this problem is available on the Instructor’s web site for the textbook (available at www.wiley.com/college/eldenburg) Below are manual calculations Manual Calculations using Simultaneous Equations: Support Departments Research Administration Allocation Bases: Research hours Number of employees Department costs: Payroll costs Other costs Total department costs 200 20% 500 50% 32% 300 30% 10 40% $300,000 150,000 $450,000 $400,000 120,000 $520,000 $550,000 240,000 $790,000 28% $350,000 230,000 $580,000 Operating Departments Institutional Retail Total 1,000 100% 25 100.00% Given the above calculations, create simultaneous equations for the support costs: Research = $580,000 + 28% x Administration Administration = $450,000 + 20% x Research Set the two equations equal to each other and solve for the fully allocated cost of one support department: Research = $580,000 + 28% x ($450,000 + 20% x Research) Research = $580,000 + $126,000 + 5.6% x Research 94.4% x Research = $706,000 Research = $706,000/94.4% = $747,881 Then solve for the fully allocated cost of the other support department: Administration = $450,000 + 20% x Research = $450,000 + 20% x $747,881 = $450,000 + $149,576 = $599,576 $1,600,000 740,000 $2,340,000 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 8-10 Cost Management Finally, allocate the full cost of each support department to all departments: Support Departments Research Administration Allocation Bases: Research hours 200 20% Number of employees Total department costs Cost allocations: Research Administration Total allocated costs Operating Departments Institutional Retail 28% $ $580,000 $450,000 (747,881) 167,881 149,576 (599,576) $ 500 50% 32% $ 520,000 373,941 191,864 $1,085,805 300 30% 10 40% Total 1,000 100% 25 100.00% $ 790,000 224,364 239,831 $1,254,195 8.19 Paul’s Valley Protection Service A sample spreadsheet using Solver for this problem is available on the Instructor’s web site for the textbook (available at www.wiley.com/college/eldenburg) Below are manual calculations Manual Calculations using Simultaneous Equations: Let S1, S2 and S3 represent the full cost of providing each department's service The simultaneous equations for support department costs are: S1 = $30,000 + 0.1xS2 + 0.2xS3 S2 = $20,000 + 0.4xS1 + 0.2xS3 S3 = $40,000 + 0.1xS1 + 0.2xS2 Substitute S1 into the equation for S2 and solve for S2: S2 = $20,000 + 0.4($30,000 + 0.1xS2 + 0.2xS3) + 0.2xS3 S2 = $20,000 + $12,000 + 0.04xS2 + 0.08xS3 + 0.2xS3 0.96xS2 = $32,000 + 0.28xS3 S2 = $33,333.33 + 0.291667xS3 Substitute S1 into the equation for S3: S3 = $40,000 + 0.1($30,000 + 0.1xS2 + 0.2xS3) + 0.2xS2 S3 = $40,000 + $3,000 + 0.01xS2 + 0.02xS3 + 0.2xS2 0.98xS3 = $43,000 + 21xS2 Substitute S2 into the equation for S3 and solve for S3: 0.98xS3 = $43,000 + 0.21($33,333.33 + 0.291667xS3) 0.91875xS3 = $43,000 + $7,000 S3 = $54,422 $2,340,000 0 $2,340,000 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 8-32 Cost Management situation, incremental costs consist only of the direct costs As long as the fee at least covers the direct cost per scan of $50, the hospital is not expected to lose money and more patients will be served D The minimum acceptable fixed fee is the fee that would cover the hospital’s incremental costs, as discussed in Part C The calculation in Part C assumed that no fixed costs would change based on the state contract However, the hospital managers cannot be certain that fixed costs would be unaffected by the contract For example, demand for the machine is uncertain More paying patients might need the machine, leading to a capacity constraint In that case, the contract would cause the hospital to forego providing services to other patients (an opportunity cost) Even if no capacity constraint occurs, the hospital managers might want the state contract to cover some of its fixed costs In that case, the managers would need to decide which fixed costs to include in the bid calculations They cannot be certain which fixed costs to include because the inclusion of more costs would increase the bid price and reduce the likelihood of obtaining the contract E Possible arguments to discuss in favor of using total allocated costs: * * * * * The organization calculates them for other reports, so the information is readily available Because the information is available, the cost of providing reports for the state will be low if the hospital wins the contract By incorporating overhead costs into the bid, the hospital can recover some of those costs This cost measure approximates the complete cost of providing scan services, at the predicted volume levels It is not fair to require other hospital services to pay for support that is necessary for the scan services Possible arguments against using total allocated costs: * * * * It is not necessary to cover all costs; support costs such as administration are covered by the hospital’s primary activities Part of the hospital’s mission is to serve indigent individuals; it is unfair to use a cost measure that might reduce the availability of services to those in need The hospital might lose the contract if it uses total allocated costs; another hospital could submit a lower cost bid The total allocated cost changes as volumes change If the number of indigent patients varies widely from period to period, this cost can underestimate or overestimate the hospital’s actual costs by large amounts Factors such as economic changes and occasional flu epidemics that are worse than usual will affect volumes of indigent patients using services F This is an open-ended problem, so there is no single solution It is possible to reasonably argue for several different types of cost to be included or excluded The best solutions to this question provide: (1) a clear recommendation for the cost report, (2) reasonable arguments for the recommendation, (3) evidence of having considered multiple cost To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 8: Measuring and Assigning Support Department Costs 8-33 measures, (4) evidence of having considered major issues, and (5) support for the hospital’s interests while also considering interests of other stakeholders, such as the state, taxpayers, and service recipients In addition, the memo should follow proper formatting and conventions It should be concise, but at the same time provide sufficient information for the reader to evaluate the quality of the recommendation and to draw his or her own conclusions In this scenario, the memo can use technical accounting jargon because the hypothetical reader is the head of the accounting department However, if the memo were written to a non-accountant, technical jargon should be avoided 8.30 The Gleason Company A Building and grounds costs are most often allocated based on square feet None of the other potential allocation bases relate to the services provided by building and grounds The proportion of square feet used by each department is as follows: Administration Square feet Percent 500 5% Direct Costs Allocation: Building and grounds Total Assigned Costs $78,270 2,051 $80,321 Cafeteria 1,000 10% Machining Assembly Total 3,500 35% 5,000 50% 10,000 100% $4,920 $104,100 $146,700 $333,990 4,101 $9,021 14,353 $118,453 20,505 $167,205 41,010 $375,000 B Administration provides services to other departments, making it a support department Cafeteria provides meals for the employees, so it is a support department Products are machined and assembled in Machining and Assembly Because these products are then sold, these departments are considered operating departments C The support departments consist of Factory Administration and the Cafeteria, so this question requires selection and justification of an allocation base for the costs of each of these departments This is an open-ended question; there is no single answer The best solutions would evaluate the likelihood that a given allocation base would adequately differentiate between the service resources used by the other departments This means that reasonable judgment needs to be applied in evaluating how well the various allocation base options would correlate with the use of service resources Following are examples of reasonable arguments for each of the support departments: Allocation Base for Factory Administration: The services of Factory Administration relate to running the factory operations Square feet might be a reasonable choice if administrative services are driven by the physical space a department occupies However, this is unlikely The number of purchase orders might be a reasonable choice if administrative services are driven by responsibility for departmental costs, which may be related to the effort involved in purchasing and paying for supplies Using this same line of reasoning, the dollar amount of direct or assigned costs in each department might be appropriate as an allocation base Direct labor hours, total labor hours, or number of To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 8-34 Cost Management employees are reasonable choices if administrative services tend to be driven by the management of employees For Gleason, insufficient information is available about the types of activities that are most closely related to administration services However, the management of employees is often the primary administrative service in a factory, and number of employees is likely to be representative of this effort Therefore, the solution in Part D uses number of employees as the allocation base Allocation Base for Cafeteria: The services of the Cafeteria relate to providing meals for employees Because of this, a measure of employees (number or hours) would be the best choice Because each employee would probably eat one or two meals a day, regardless of hours worked, hours may not reflect the use of meals as well as number of employees In the following computations, the number of employees is used as the allocation base D In this part, students are NOT asked to calculate total allocated costs Instead, they are asked to calculate the amount of overhead costs allocated to each operating department using the step-down method and then to compute an overhead rate per direct labor hour For this reason, the calculations shown below not include the operating department direct costs Although the number of employees is used to allocate the costs for both support departments, the percentages are different because (1) the total volume of the allocation base does not include the volume of the support department being allocated, and (2) under the step-down method the total volume of the allocation base used in the second step excludes the volume of the support department that was allocated in the first step Support Departments Administration Cafeteria Number of employees: For administration allocation 18.1818% For cafeteria allocation 10% Support Costs (Part A) Allocations: Step 1: Administration Step 2: Cafeteria Allocated Overhead Costs Divide by direct labor hours Overhead rate per hour $ 80,321 36.3636% 44.4444% 45.4546% 55.5556% $ 9,021 (80,321) $ Operating Departments Machining Assembly $ 14,604 (23,625) Total 11 100% 100% $89,342 $29,208 10,500 $39,708 $36,509 13,125 $49,634 3,000 6,000 $13.236 $8.272 0 $89,342 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 8: Measuring and Assigning Support Department Costs 8-35 E Calculate the plant-wide overhead rate by dividing total overhead costs by total direct labor hours as follows: Total overhead costs (Part B) / Total operating department direct labor hours = $89,342 / (3,000+6,000) = $9.927 F When the step-down method is used, half of the support department interactions are reflected Because assembly uses more direct labor hours than machining, it receives more overhead cost when direct labor hours are used in a plant-wide, single cost pool Therefore, it receives more cost than if the services of departments are allocated based on use of the services The opposite is true for the machining department; it receives less cost under a plant-wide allocation rate than when support costs are allocated based on services used The step-down method more accurately reflects the use of resources G An advantage of this method is that it is easy to calculate and understand A disadvantage is that the cost per labor hour is likely to be high because it includes fixed costs that not change with the number of employees or hours worked High charges could lead other departments to consider reducing the number of employees in the department by outsourcing some service or product when it may not be cost effective to outsource Another disadvantage is that the allocation does not attempt to match the flow of resources to products, so some products will appear to be subsidizing other products because overhead resources used by all products is aggregated into only one pool H The machining department manager would consider the cost of outsourcing versus the cost of using direct labor Quality could also be a factor In addition, the manager would want to know how department performance would appear to change as a result of outsourcing If the manager receives a bonus based on the department’s performance (including allocated costs) and is able to offload part of the overhead allocation by reducing use of labor hours, then he/she would have a greater incentive to outsource I The Director of Finance would be unhappy with the decision to outsource The overhead that is not allocated to machining is spread among other departments, so the overhead allocations to other departments increase Because the machining manager’s decision increases incremental costs and does not reduce any of the overhead costs, it increases total cost and is suboptimal for the company as a whole 8.31 Steve Kurl A There are many uncertainties in allocating overhead costs to each game, and these uncertainties affect the allocation of costs and, in turn, the measurement of profits For example, until the season is over, no one knows how many games will be played Therefore, it is difficult to use number of games as the allocation base If more games are played than planned, there will also be extra overhead cost incurred, so uncertainties exist about the dollar amount that needs to be allocated If the number of total hours played is used, these would change with number of games played The number of players per game could be used, especially if a lot of overhead expense is tied to providing support To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 8-36 Cost Management for the players (physicians, coaches, etc.) The problem with this measure is that it will change if someone is injured or expelled for a number of games In addition, the amount of overhead costs that should be allocated against the profits of each game is uncertain At one extreme, it is possible to argue that administrative costs are not expenses at all for individual games because those costs are fixed and must be incurred to run the organization When Steve signed his contract, he might not have considered the possibility that any administrative expenses would be allocated to each game The owners, not surprisingly, would argue the opposite extreme—that all administrative costs occur because of the games and should be total allocated B This is an ethical issue for the owners, managers, and accountants of the team From Steve’s perspective, the team is unfairly allocating overhead expense Even if the parties agree that overhead should be allocated to each game, the method being used is likely to allocate more costs than the team incurs when there are post-season games If the allocated overhead is larger than actual overhead and no adjustments are made when profits are measured for player bonuses, Steve’s bonus is smaller than it should be The owners, managers, and accountants of the team might not view this as unfair to Steve because they might believe that team players are highly compensated through their regular contracts However, they have an ethical responsibility for fairness in the way they report profits for each game C If the budget is based on the number of regular season games, then the allocation might be unbiased if the team fails to play post-season games However, when the team plays championship games the total amount of allocated overhead is likely to exceed total actual overhead This bias occurs because many of the overhead costs are likely to be fixed and not increase proportionately with post-season play On the other hand, player strikes can cause fewer games to be played This could cause total allocated overhead to be less than actual costs D Some amount of administration work and public relations work needs to be performed for each game Presumably, these services contribute to both the team’s win-loss record and to ticket sales revenue and, thus, affect the profits of each game In addition, some portion of these costs is likely to be variable Additional costs are probably incurred during post-season play E Many of the administration and public relations costs are likely to be fixed costs and should not change with number of games Therefore, any allocation based on number of games is arbitrary and inaccurate Also, there are questions about what it means to measure the profit of each game Perhaps overhead costs not belong in a measure of game profitability F This is an open-ended problem, so there is no single solution If students decide that it is fair to allocate both fixed and variable administration and public relations costs against individual game profits, then one possibility would be to adjust the allocations at the end of the season based on the actual number of games Another possibility is to separately allocate fixed and variable overhead costs Fixed costs could be allocated only against regular season games, and the incremental costs would be individually subtracted from To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 8: Measuring and Assigning Support Department Costs 8-37 the profit of each game (regular and post-season) Still another possibility is to avoid allocations to individual games and to base bonuses on the overall profitability for the season Any logical and unbiased allocation method would be appropriate If students decide that it is not fair to allocate fixed costs, then they might recommend a system that measures profits for each game based on revenues minus variable costs 8.32 University Overhead Costs A Although cost-based contracts usually provide guidance about which costs to include and which allocation methods are acceptable, there is room for judgment about many different types of costs and about the method that would most fairly allocate costs The guidance usually provides large categories of costs that are acceptable or not acceptable, but does not address each individual cost Therefore, a number of costs are likely to require judgment as they are categorized for cost reports B Maximizing reimbursements under cost-based contracts is an ethical issue for accountants because of conflicting interests Managers, shareholders, and regular customers most likely prefer more costs to be assigned to cost-based contracts This preference conflicts with the interests of cost-based contract customers and, for governmental contracts, with the interests of governmental agencies, competitors, taxpayers, and other potential recipients of governmental funds The accountants who perform the accounting for cost-based contracts must consider these conflicting interests when using judgment to assign costs C Most people would agree that a large overstatement of costs under a cost-based contract is unethical, unless the overstatement is clearly accidental However, there is likely to be no consensus about smaller overstatements One perspective is that materiality is irrelevant An ethical issue concerns the welfare of various stakeholders Even if the amount seems immaterial, to be fair to everyone, the allocation process should consider the viewpoints of all parties affected by the allocations, no matter how large or small the amounts are In addition, it can be argued that there is no such thing as a ―small‖ ethical violation From this perspective, it is not the size of the overstatement that matters, but rather the intent behind the overstatement Any intentional misstatement would be considered unethical Another perspective is that misallocations of costs will always occur when judgment is involved As long as the misallocations are small, then it can be argued that no ethical issue was involved—i.e., that the organization did not attempt to maximize reimbursements under its cost-based contracts D The major stakeholder groups were identified in Part B above Below are brief comments about the preferences of each group Managers and shareholders: It is simple to say that managers and shareholders prefer receiving greater payments under cost-based contracts and, thus, have incentives to overstate contract costs However, overstatement of contract costs can also have adverse reputation effects and reduce an organization’s ability to obtain future contracts Contract customers are also likely to increase their monitoring of contract costs, increasing the organization’s compliance costs To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 8-38 Cost Management Cost-based contract customers: Clearly, these customers prefer for contract costs to be accounted for properly However, they must be aware that it is impossible to unambiguously define all allowable and unallowable costs Therefore, they expect the use of judgment, which can lead to disagreements about allowable costs In addition, these contracts typically include provisions allowing the customer or an independent party (such as a CPA) to periodically audit compliance with contract provisions Regular customers: Regular customers are not directly affected by these issues However, companies that obtain greater reimbursement of overhead costs under costbased contracts may be able to charge lower prices to regular customers For cost-based governmental contracts: Governmental agencies: Governmental agencies are responsible for monitoring compliance with cost-based governmental contracts Their preferences are similar to those of the cost-based contract customers discussed above In addition, governmental agencies are charged with a fiduciary responsibility for spending public funds appropriately This additional responsibility increases their incentives to monitor contract compliance Competitors: If a cost-based customer pays more than its fair share of a company’s overhead, the company could be more competitive in pricing other business Competitors would prefer to have a level playing field Taxpayers: Taxpayers want to ensure that their funds are being used appropriately Thus, their preferences are similar to those of cost-based contract customers However, most taxpayers are not knowledgeable about accounting and might fail to recognize legitimate accounting uncertainties Other potential recipients of governmental funds: Other potential recipients want a level playing field, in which their opportunity to obtain funds is not diminished because of excessive spending on other organizations’ contracts Overcharging by other organizations reduces the quantity of available funds It also has indirect effects, such as a reduced willingness of taxpayers and governmental agencies to fund cost-based projects and an increase in compliance and monitoring costs E The trade-offs made by accountants in deciding whether to help their organizations maximize reimbursements under cost-based contracts include all of the issues discussed in the preceding questions—they must evaluate the implications to their own organization as well as to other stakeholders In addition, they must consider their own ethical values as they establish criteria for recording costs To clarify their values, they might consider asking questions such as the following Is it acceptable to recognize all costs under a cost-based contract except those that are explicitly disallowed? Should an attempt be made to classify costs from the perspective of the customer or other stakeholders? Does materiality matter? What are the short-term and long-term implications of assigning a particular cost to the contract? To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 8: Measuring and Assigning Support Department Costs 8-39 F There is no one answer to this part Sample solutions and a discussion of typical student responses will be included in assessment guidance on the Instructor’s web site for the textbook (available at www.wiley.com/college/eldenburg) 8.33 Vines Company A sample spreadsheet showing the calculations for this problem under the direct, step-down, and reciprocal methods is available on the Instructor’s web site for the textbook (available at www.wiley.com/college/eldenburg) A Below are excerpts from the sample spreadsheet for this problem, which show the direct, step-down, and reciprocal method allocations of fixed support costs The reciprocal method allocations were performed using Excel Solver Direct method DIRECT METHOD ALLOCATION FIXED SUPPORT COSTS Support Departments Human Resources Accounting Janitorial Allocation bases for direct method fixed support cost allocation: Direct costs % for allocation Employees % for allocation Square feet % for allocation Fixed support costs Allocations: Accounting Human resources Janitorial Total allocations $55,260 $100,696 (100,696) $0 Women's $800,000 62% 10 62.50% 5,000 50.0000% Men's (60,360) $0 Total $500,000 $1,300,000 38% 100% 16 37.50% 100% 5,000 10,000 50.0000% 100% $60,360 (55,260) $0 Operating Departments $216,316 34,006 62,935 30,180 $127,121 21,254 37,761 30,180 $89,195 0 $216,316 Step down method STEP-DOWN METHOD ALLOCATION FIXED SUPPORT COSTS Support Departments Human Resources Accounting Janitorial Allocation bases for step-down method fixed support cost allocation: Step 1: Employees % for allocation 9.0909% 18.1818% Step 2: Square feet 800 % for allocation 7.4074% Step 3: Direct costs % for allocation Fixed support costs Allocations: Step 1: Human resources Step 2: Janitorial Step 3: Accounting Total allocations $55,260 $100,696 $60,360 9,154 5,827 (70,241) $0 (100,696) 0 $0 18,308 (78,668) $0 Operating Departments Women's 10 45.4545% 5,000 46.2963% $800,000 61.5385% Men's Total 22 27.2727% 100% 5,000 10,800 46.2963% 100% $500,000 $1,300,000 38.4615% 100% $216,316 45,771 36,421 43,226 $125,417 27,463 36,421 27,016 $90,899 0 70,241 $216,316 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 8-40 Cost Management Reciprocal method RECIPROCAL METHOD ALLOCATION FIXED SUPPORT COSTS Support Departments Human Resources Accounting Janitorial Allocation bases for reciprocal method fixed support cost allocation: Direct costs $122,800 $120,720 % for allocation 7.9558% 7.8211% Employees % for allocation 9.0909% 18.1818% Square feet 800 1,000 % for allocation 6.7797% 8.4746% Operating Departments Women's $800,000 51.8296% 10 45.4545% 5,000 42.3729% Men's Total $500,000 $1,543,520 32.3935% 100% 22 27.2727% 100% 5,000 11,800 42.3729% 100% Solver for Variable Costs: Change cells for Solver Simultaneous equations AccountF $71,471 HRF $113,723 JanitorF $86,627 $71,471 $113,723 $86,627 Target function: $271,822 Fixed support costs Allocations: Accounting Human resources Janitorial Total allocations $55,260 $100,696 $60,360 (71,471) 10,338 5,873 ($0) 5,686 (113,723) 7,341 ($0) 5,590 20,677 (86,627) $0 $216,316 37,043 51,692 36,706 $125,442 23,152 31,015 36,706 $90,874 0 $216,316 B Below are excerpts from the sample spreadsheet for this problem, which show the direct, step-down, and reciprocal method allocations of variable support costs The reciprocal method allocations were performed using Excel Solver Direct method DIRECT METHOD ALLOCATION VARIABLE SUPPORT COSTS Support Departments Human Resources Accounting Janitorial Allocation bases for direct method variable support cost allocation: Time spent accounting % for allocation Employees % for allocation Time spent cleaning % for allocation Variable support costs Allocations: Accounting Human resources Janitorial Total allocations $18,420 $22,104 (22,104) $0 Women's 30% 55% 10 62.50% 30% 42.8571% Men's 25% 45% 37.50% 40% 57.1429% $60,360 (18,420) $0 Operating Departments (60,360) $0 Total 55% 100% 16 100% 70% 100% $100,884 10,047 13,815 25,869 $49,731 8,373 8,289 34,491 $51,153 0 $100,884 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 8: Measuring and Assigning Support Department Costs 8-41 Step-down method STEP-DOWN METHOD ALLOCATION VARIABLE SUPPORT COSTS Support Departments Human Resources Accounting Janitorial Allocation bases for step-down method variable support cost allocation: Step 1: Time spent cleaning 5% 10% % for allocation 5.8824% 11.7647% Step 2: Employees % for allocation 11.1111% Step 3: Time spent accounting % for allocation Variable support costs Allocations: Step 1: Janitorial Step 2: Human resources Step 3: Accounting Total allocations $18,420 $22,104 $60,360 3,551 3,245 (25,216) $0 7,101 (29,205) $0 (60,360) 0 $0 Operating Departments Women's 30% 35.2941% 10 55.5556% 30% 54.5455% Men's 40% 47.0588% 33.3333% 25% 45.4545% Total 85% 100% 18 100% 55% 100% $100,884 21,304 16,225 13,754 $51,283 28,405 9,735 11,462 $49,601 0 25,216 $100,884 Reciprocal method RECIPROCAL METHOD ALLOCATION VARIABLE SUPPORT COSTS Support Departments Human Resources Accounting Janitorial Allocation bases for reciprocal method variable support cost allocation: Time spent accounting 10% 20% % for allocation 11.7647% 23.5294% Employees % for allocation 9.0909% 18.1818% Time spent cleaning 5% 10% % for allocation 5.8824% 11.7647% Operating Departments Women's 30% 35.2941% 10 45.4545% 30% 35.2941% Men's 25% 29.4118% 27.2727% 40% 47.0588% Total 85% 100% 22 100% 85% 100% Solver for Variable Costs: Change cells for Solver Simultaneous equations AccountV $25,748 HRV $33,667 JanitorV $72,540 $25,748 $33,667 $72,540 $18,420 $22,104 $60,360 (25,748) 3,061 4,267 $0 3,029 (33,667) 8,534 $0 6,058 6,121 (72,540) $0 Target function: $131,954 Variable support costs Allocations: Accounting Human resources Janitorial Total allocations $100,884 9,087 15,303 25,602 $49,993 7,573 9,182 34,136 $50,891 0 $100,884 C For accounting I would use time spent because it probably reflects the use of accounting employees and their salaries would be a large part of the fixed costs Number of employees is already used for both fixed and variable costs, so I would continue to use it Time spent in janitorial services probably provides a more accurate reflection of the resources used by each department for janitorial staff, and it’s likely as they spend more time in an area they also use more supplies D Managers may want to use this information for benchmarks to compare current performance to past performance It’s possible that they use these calculations to develop a transfer price policy for the use of support services To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 8-42 Cost Management E If Vines is using this information for transfer prices, the variable portion is probably a better reflection of the marginal costs to the company of providing support services These categories also give more precise information for benchmarks It would be easier to investigate variances if cost pools are smaller and reflect only fixed or variable costs To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 8: Measuring and Assigning Support Department Costs 8-43 BUILD YOUR PROFESSIONAL COMPETENCIES 8.34 Focus on Professional Competency: Leverage Technology to Develop and Enhance Functional Competencies A sample spreadsheet for this problem is available on the Instructor’s web site for the textbook (available at www.wiley.com/college/eldenburg) A and Business decisions addressed in Chapter and relevant information that might be stored in an electronic database: Examples of Electronic Decisions in Chapter Database Information Data used to estimate future relevant Business Decisions: Insourcing or outsourcing costs: Historical costs Product pricing Data used to estimate future prices, costs and profits: Historical average product cost per unit, historical overhead costs Improve cost control and efficiency Data used to evaluate trends: Historical and budgeted costs, volumes, and profits Departments currently used for Accounting Method Decisions: Identifying appropriate cost pools for budgeting and accounting support and operating departments Whether to establish separate pools Evaluate the behavior of costs: for fixed and variable costs Historical costs and volumes of cost drivers How to assign costs to cost pools (this Electronically-stored policy manuals and includes classification of overhead contractual terms; Classifications used costs under governmental cost-based for similar items in the past based on contracts) historical accounting and cost report records Identifying the most appropriate Data currently available, such as allocation bases for each cost pool historical production volumes, employee time records, direct costs, etc Identifying the most appropriate Information for making this decision allocation method would not likely be stored electronically Whether the benefits exceed the costs Information for making this decision of establishing a more detailed support would not likely be stored electronically cost allocation system Under the step-down method, Historical data that could be used for identifying the best measure for ranking, such as direct costs ranking the amount of service provided by support departments Whether to allocate support costs Information for making this decision based on estimated versus actual costs would not likely be stored electronically and rates To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 8-44 Cost Management B A sample spreadsheet for this problem is available on the Instructor’s web site for the textbook (available at www.wiley.com/college/eldenburg) The documentation in the sample spreadsheet assumes that the data in the spreadsheet is not directly linked to the sources of the data Therefore, the spreadsheet includes comments describing the sources of information The sample spreadsheet does not include any other explanations for the reciprocal allocations because it is assumed that the spreadsheet will be used only by people who are familiar with the reciprocal method and how it is performed This answer will vary from student to student The purpose is to engage students in a discussion of what it means to document work performed and also to gain an appreciation of the need to design spreadsheets that can be easily understood by other people This answer will vary from student to student The purpose is to encourage students to implement recommendations C This answer will vary from student to student The purpose is to help students reflect on their approaches to technology adoption 8.35 Integrating Across the Curriculum: Governmental Accounting A This answer will vary from student to student Additional guidance for locating information on the web about state or local government internal service funds is available on the textbook web site (www.wiley.com/college/eldenburg) The descriptions of funds for the state and local governments listed in the problem are as follows: City of Laguna Beach, California:1 An internal service fund is a revolving fund established to isolate the costs of a particular function and then to allocate those costs to the various operating divisions Costs for the functions of the internal service funds are allocated to individual operating divisions through the use of an annual rate which is adjusted each year to reflect anticipated costs For example, the rates for vehicle replacement are based on the specific vehicles assigned to each division, and the rates for employee medical insurance are based on the number of employees in each division Based on this rate, each division pays to the internal service fund an annual amount which is shown as an expenditure item in the division budget This Quoted from ―Internal Service Funds,‖ Adopted Budget—Fiscal Year 2003–04, City of Laguna Beach, California, available at 4.18.61.11/government/reference/budget/ To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 8: Measuring and Assigning Support Department Costs 8-45 payment becomes the revenue for the internal service fund which in turn directly pays for the goods and services provided, such as new vehicles or medical insurance State of Michigan, Department of Management and Budget:2 The State Sponsored Group Insurance Fund, which was administratively established to reflect financial transactions of the state -sponsored insurance plans The Information Technology and Energy Fund was established to account for various services provided to all state agencies These services include telecommunication and information technology and the purchase of bulk natural gas used by State agencies The Motor Transport Fund was created to provide vehicle and travel services to state agencies Services include lease, purchase, replacement, and maintenance of automotive equipment Vehicles are furnished to agencies on a permanently assigned basis or through the motor pool for short-term usage The Office Services Revolving Fund was created to provide printing, reproduction, microfilm, mailing, and material management services The cost of these services is charged to user departments and agencies The Risk Management Fund was established to account for centralized risk management functions performed by DMB [Department of Management and Budget] for other state agencies The Fund provides automotive and other insurance coverage to state departments and agencies City of Arlington, Texas: Internal Service Funds - includes General Services, Communication Services, Fleet Services, and Information Technology Services These funds provide services such as printing, computer support, communications and vehicle maintenance for all City departments, and are supported by scheduled transfers or direct charges from other funds Multnomah County, Oregon:4 These funds account for activities and services performed primarily for other organizational units within the County Charges to the County agencies are calculated to recover costs and maintain capital The County accounts for certain Adapted from Executive Digest #0713701, Selected Internal Service Funds, Michigan Office of the Auditor General, June 2002, available at www.audgen.michigan.gov/digests/01_02/0713701.htm Quoted from Executive Summary, FY 2004 Annual Operating Budget, City of Arlington, Texas, available at www.ci.arlington.tx.us/budgets/ Quoted from Internal Service Funds (under Supplementary Information), Comprehensive Annual Financial Report, fiscal year ended June 30, 2002, available at www.co.multnomah.or.us/dbcs/finance/cafr2002/ To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 8-46 Cost Management expenditures of the Internal Service Funds for budgetary purposes on the modified accrual basis of accounting For financial reporting purposes the accrual basis of accounting is used Such differences relate primarily to the methods of accounting for depreciation and capital outlay Funds included are: * * * * * * Risk Management Fund - accounts for the County's risk management activities including insurance coverage Fleet Management Fund - accounts for the County's motor vehicle fleet operations Telephone Fund - accounts for the County's telephone operations Data Processing Fund - accounts for the County's data processing operations Mail/Distribution Fund - accounts for the County's mail/distribution operations Facilities Management Fund - accounts for the management of all County owned and leased property B Internal service funds allow governments to measure the cost of support services and to assign their cost to other departments that use the support resources C Many internal services are accounted for in the general fund of a state or local government, which is similar to an overall administration cost pool in a business organization If internal services are used by non-administration government activities, then the pooling of internal services with general administration overstates the cost of general government management Essentially, 100% of the internal service costs are assigned to general management, which understates the cost of other activities which should have received a portion of the internal service costs The result is that general government costs appear to be higher than they actually are, making the general government appear to be less efficient At the same time, the costs of other services appear to be lower than they actually are, making those services appear to be more efficient D There is no single answer to this question The benefits must be weighed against the costs in reaching a conclusion to this question While internal service fund accounting might improve cost measurement, several costs and limitations must also be considered For example, if general government uses most of an internal service, then there may be no benefit from establishing a separate fund Legal and political issues should also be considered The creation of new funds often requires the passage of legislation It can be quite costly to legally establish a new fund and then to modify information systems to account for it ... ebook, solutions and test bank, visit http://downloadslide.blogspot.com 8-14 Cost Management Problem 8.21: Lake County Library Direct Costs Salaries Supplies Other Costs Building lease Total Costs... resources because fixed and variable costs are separated and usually allocated using different allocation bases or actual usage of some sort 8.9 Because they include fixed costs and costs allocated from... Bases: Department A outside costs Department B outside costs Department C outside costs Costs: Direct costs Department A Department B Department C Total allocated cost $88,000 (88,000) $63,000