ACCT 102 Management Accounting Lecture 8

1
ACCT 102Management AccountingLecture 8
Cost Allocation Allocation of Joint Costs
2
Cost allocation
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
Cost allocation
Purpose of 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
Cost allocation
Criteria to guide cost-allocation decisions

• 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 objects ability to
  absorb the costs

5
Cost allocation
Cost allocation and costing systems

• 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

6
(No Transcript)
7
(No Transcript)
8
Cost allocation
Cost allocation joint products byproducts

• 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

9
(No Transcript)
10
Cost allocation
Cost allocation joint products byproducts

• 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
Cost allocation
Why allocate joint costs?

• 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
Cost allocation
Approaches to allocate joint costs

• 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

13
(No Transcript)
14
(No Transcript)
15
(No Transcript)
16
(No Transcript)
17
(No Transcript)
18
Cost allocation
Choosing a method

• 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
Cost allocation
Choosing a method

• 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
Cost allocation
Choosing a method

• 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