ACCT 301 Saudi Electronic University Cost Accounting Paper

Cost Accounting 301 | Exercises For The Final Part_____________________________________________________________________
Q1. Referring to the concept of job costing in the manufacturing sector, identify
how you will record the following journal entries:
(Chapter 5)
a) When raw materials are received.
b) When raw materials are sent to the factory floor.
c) When labor costs are incurred.
d) When a job is completed.
e) When a job is shipped to a customer.
S/N
Accounts title and explanation
Debit
a
Raw material
10,000
Account payable
b
Work in progress
10,000
9,000
Raw material inventory
c
Work in progress
9,000
15,000
Wages payable
d
Finished goods inventory
15,000
32,000
Work in process inventory
e.
Accounts receivable
32,000
5,000
Sales revenue
Cost of goods sold
Finished goods inventory
Credit
5,000
26,000
26,000
____________________________________________________________________
Q2. Ahmad Company uses a job costing system with machine hours as the
allocation base for overhead. The company uses normal costing to develop the
overhead allocation rate. The following data are available for the latest accounting
period:
(Chapter 5)
Estimated fixed factory overhead cost $200,000
Estimated machine-hours 140,000
Actual fixed factory overhead cost incurred $220,000
Actual machine-hours used 160,000
Jobs worked on:
Job No.
1060
Machine Hours Used
12,000
a. Compute the overhead allocation rate.
b. find the overhead allocated for the job #1060
c. Determine total over or under applied overhead at the end of the year.
Answer:
A) Estimated overhead allocation rate =
Estimated fixed factory overhead cost
𝐸𝑠𝑡𝑖𝑚𝑎𝑡𝑒𝑑 𝑚𝑎𝑐ℎ𝑖𝑛𝑒−ℎ𝑜𝑢𝑟𝑠
200,000
= 140,000 = $1.43/hr
B) overhead allocated for the job #1060 = Estimated overhead allocation rate ×
𝑎𝑐𝑡𝑢𝑎𝑙 𝑢𝑠𝑎𝑑𝑒 𝑜𝑓𝑐𝑜𝑠𝑡 𝑎𝑙𝑙𝑜𝑐𝑎𝑡𝑖𝑜𝑛 𝑏𝑎𝑠𝑒
=12000×1.43
=$17160
C) Applied overhead = 160,000×$1.43 = $228,800
Actual overhead = $220,000
Overapplied Overhead = $228,800 – $220,000 = $8,800
______________________________________________________________
Q3. Given that Ahmed Manufacturing Company had the following information
for the year, find the estimated overhead allocation rate based on machine hours.
Estimated overhead
SAR 300,000
Actual overhead
SAR 320,000
Estimated direct labor hours
20,000
Actual direct labor hours
19,400
Estimated machine hours
10,000
Actual machine hours
11,000
(Chapter 5)
Answer:
Estimated overhead cost
Estimated overhead allocation rate =𝐸𝑠𝑡𝑖𝑚𝑎𝑡𝑒𝑑 𝑚𝑎𝑐ℎ𝑖𝑛𝑒 ℎ𝑜𝑢𝑟𝑠
300,000
= 10,000 = $30 /hr
__________________________________________________________________
Q4. Q: ANC Co. had July costs for Department 1 as follows:
(Chapter 6)
DM $170,000
CC $110,000
Total $280,000
There were no units in beginning or ending WIP inventory in July. During July
Department 1 started 70,000 units, and all 70,000 were completed in July.
Required:
a) What is the manufacturing cost/unit?
b) Suppose that 40,000 units were completed in July, and the units in ending WIP
were 1/3 complete. What is the manufacturing cost/unit?
Answer:
A) Manufacturing cost/Unit =$280,000/70,000=$4 per unit
B) Ending WIP units = 70,000 – 40,000=30,000 units
Total Equivalent units of Production = Total units transferred and completed +
Completed units of Ending Inventory
= 40,000 + 30,000 x 1/3 = 50,000.
Manufacturing cost per unit = $280,000/50,000=$5.6 per unit
Q5. August KD Corporation had 65,000 units in beginning WIP that were 75%
complete and 45,000 units in ending WP that were There were 205,000 units
completed and transferred to FG inventory
(Chapter 6)
Compute
a. No. of units started
b. Started and completed unit
Answer:
A) No. of units started = (Completed unit – BI) + EI
= (205,000 – 65,000) + 45,000 = 185,000 units
WIP Inventory -Unit
Beginning Inventory
(BI)
completed unit
Started
Ending Inventory
(EI)
WIP Inventory -Unit
65,000
205,000
185,000
45,000
B) Started and completed unit = Completed – Beginning Inventory
= 205,000 – 65,000 = 140,000
______________________________________________________________
Q6. Alpa Ltd. uses a process costing system for its sole processing department.
There were 24,000 units in beginning WIP inventory for March and 216,000 units
were started in March. The beginning WIP units were 60% complete and the
19,500 units in ending WIP were 40% complete. All materials are added at the
start of processing.
Required:
a) Compute the no. of units started & completed.
b) Compute the EUP for DM and CC using FIFO and WA methods.
Answer:
(Chapter 6)
A) No. of units started & completed = Units started in March – Units of closing WIP
Inventory = 216,000 – 19,500 = 196,500 Units
ORTHER WAY:
No. of units completed units = (started unit + BI) – EI = (216,000 + 24,000) – 19,500 =
220,500 units
WIP Inventory -Unit
Beginning Inventory
(BI)
completed unit
Started
Ending Inventory
(EI)
WIP Inventory -Unit
24,000
220,500
216,000
19,500
SO, Started and completed unit = Completed – Beginning Inventory
= 220,500 – 24,000 = 196,500 Units
B)
Units Summary
Beginning WIP
This Period’s Work
Complete Beg WIP
Start & Complete
Ending WIP
FIFO Equivalent Units
Physical
Units
24,000
24,000
196,500
19,500
240,000
Equivalent
Equivalent
Units (DM)
Units (CC)
24,000 100%
14,400 60%
0%
196,500 100%
19,500 100%
216,000
9,600 40%
196,500 100%
7,800 60%
213,900
WA Equivalent Units (with Beg WIP)
240,000
228,300
____________________________________________________________________
Q7. Axel Ltd. uses a process costing system for its sole processing department.
There were 24,000 units in beginning WIP inventory for March and 216,000 units
were started in March. The beginning WIP units were 75% complete and the
19,500 units in ending WIP were 60% complete. All materials are added at the
start of processing.
Required:
a) Compute the no. of units started & completed.
(Chapter 6)
b) Compute the EUP for DM and CC using FIFO and WA methods.
c) Calculate total manufacturing cost/EUP under both methods, if the following details
are available:
FIFO
WA
Direct Material Cost
SAR 700,000
SAR 910,000
Conversion Cost
SAR 920,000
SAR 1,210,000
Answer:
a) Computation of the # of units started & completed:
WIP Inventory – Units
24,000
216,000
19,500
BI Units
S&C Units
Completed
Units
220,500
b) Computation of the EUP for DM & CC:
Physical
Units Summary
Units
Beginning WIP
24,000
This Period’s Work
Complete Beg WIP
Start & Complete
Ending WIP
FIFO Equivalent Units
24,000
196,500
19,500
240,000
WA Equivalent Units (with Beg WIP)
220,500
Equivalent
Equivalent
Units (DM)
Units (CC)
24,000 100%
18,000 75%
0%
196,500 100%
19,500 100%
216,000
6,000 25%
196,500 100%
11,700 60%
214,200
240,000
232,200
c) Total manufacturing cost/EUP
Under FIFO
DM cost/EUP = SAR 700,000/216,000 EUP =
SAR 3.24/EUP
CC/EUP = SAR 920,000/214,200 EUP =
SAR 4.29/EUP
Total manufacturing cost/EUP =
SAR 7.53/EUP
Under WA
DM cost/EUP = SAR 910,000/240,000 EUP =
24,000
196,500
SAR 3.79/EUP
CC/EUP = SAR 1,210,000/232,200 EUP =
SAR 5.21/EUP
Total manufacturing cost/EUP =
SAR 9/EUP
_____________________________________________________________________
Q8. Toyland company Producers a small plastic toy. All direct materials are
added at the beginning of the production process. Data for the direct materials
used in the manufacture of plastic toys for the month of July is listed below.
Production data:
Beginning work in process
25,000 units
Units started during the period
50,000 units
Completed and transferred out
67,500 units
Manufacturing costs:
Beginning work in process (direct materials) $35,000
Direct material used $75,000
a. Under the FIFO method, how many units were started and completed with
respect to direct materials during the month?
b. Under the FIFO method, what is the cost of the direct materials in ending
work in process at the end of the month?
c. Under the FIFO method, what is the amount of direct materials cost
transferred out this period?
d. Calculate the direct materials cost per equivalent unit under the weighted
average method.
( Chapter 6)
Answer:
A) units started and completed = units completed – units in beginning inventory
= 67,500 – 25,000 = 42,500 units
B) Cost of the direct materials in ending inventory = number of units in ending
inventory × cost per EUP
75,000
= (50,000 – 42,500) × 50,000 = $11,250
C) Cost of direct material transferred out = beginning inventory + units started
and completed × cost per EUP
75,000
= 35,000+42,500 × 50,000 = $98,750
D) Direct material cost per equivalent unit under the weighted =
Total Cost of Materials/weighted average no of units =
($35,000+$75,000) / (25,000+50,000) = $110,000 / 75,000units
= $1.467/unit
_____________________________________________________________________
Q9. DD Company has two departments, Dept. A and Dept. You are provided the
following costs for five activities that occur at the manufacturing plant every
month:
Activity
Material handling
Supervision of direct labor
Janitorial and cleaning
Machining
Total costs
( Chapter 7)
Total Costs (SAR)
315,000
180,000
250,000
350,000
1,095,000
Total number of units of Cost Driver
450,000 parts
110 employees
5,500 hours
8,500 machine hours
The above activities are used by the two departments as follows:
Material handling
Supervision of direct labor
Time spent cleaning
Number of machine hours
Department A
220,000 parts
65 employees
2,500 hours
6,000 machine hours
Department B
230,000 parts
45 employees
3,000 hours
2,500 machine hours
a. How much of the material handling cost will be allocated to Department A?
b. What is the ABC allocation rate for supervision of direct labor?
Answer:
a. Rate for material handling = 315,000 /450,000 = 0.7
Cot allocated to Dept. A = 0.7 ×220,000 = SAR154, 000.
b. Rate of allocation for supervision of direct labor = 180,000 /110 = SAR 1,636 per
employee (round off value)
_____________________________________________________________________
Q10. T&T produces product ‘X’ as a part of its main product. Each year, the
company produces 75,000 units of product ‘X’. The costs of production are
mentioned below. An outside supplier has offered to deliver 75,000 units of
product ‘X’ annually at a cost of $7.35 per unit. A fixed production cost of $
120,000 is unavoidable for product ‘X’. Should T&T Co. make or buy product
‘X’?
( Chapter 4)
The production costs per unit for manufacturing a unit of product B are:
Production Cost
Amount ($)
Direct Materials
2.55
Direct Labor
1.95
Variable Manufacturing Overhead
1.20
Answer:
Direct Materials
2.55
Relevant
Direct Labor
1.95
Relevant
Variable Manufacturing
1.20
Relevant
Overhead
Fixed Manufacturing
120,000
75,000
=1.60 Irrelevant
Overhead
Total Relevant Cost = 2.55 + 1.95 + 1.20 = $ 5.70
Fixed Manufacturing Overhead Per Unit = 120,000/75,000
Cost of Buying
$7.35
Cost of Making
$5.70
=
$ 1.60
Advantage of Making over Buying = (7.35 – 5.70) = $1.65
Total Advantage for Making 75,000 units = $ 1.65 X
=
75,000
$ 123,750
T&T should make the product.
_____________________________________________________________________
Q11. Rafique Inc. makes product A and sells at selling price of SAR 45 per unit.
Badr Inc. wants to buy 5,000 units at SAR 27 per unit. Rafique Inc. has a normal
capacity of 101,000 units and projected sales to regular customers this year is
92,000 units. Per unit costs traceable to the product (based on normal capacity of
92,000 units) are listed below?
Direct Materials
8.1
Direct Labor
6.0
Variable Mfg. Overhead
6.2
Fixed mfg. overhead
4.8
Fixed Selling Costs
0.4
Fixed administrative costs
0.8
Does the quantitative analysis suggest that the company should accept the special
order? (Chapter 4)
Answer:
Direct Materials
Direct Labor
Variable Mfg. Overhead
8.1
6.0
6.2
Relevant
Relevant
Irrelevant
Total Relevant Cost = 8.1 + 6.0 + 6.2 = 20.3 SAR
determining if there is sufficient idle capacity to accept this order without disrupting
normal operations:
Projected sales to regular customers
92,000 units
Special order
5,000 units
97,000 units
Rafique Inc has 4,000 units of idle capacity if the order is accepted.
Incremental profit if accept special order = (27 – 20.3) × 5,000 = 33,500 SAR
Yes, company should accept the special order.
_____________________________________________________________________
Q12. Abdullah Motors manufactures cars and currently uses only 50% of its
manufacturing facility (20,000 cars). The company could utilize more of its facility
by producing its own tires and using the total capacity. It currently purchases tires
at $30 per unit. Abdullah would incur $12 per unit for direct materials, $10 for
direct labor, and $24 for overhead (which is 30% variable) if it produces the tires.
a. Should Abdullah Motors make or buy the tires? Provide calculations that support
your answer.
b. Suppose Abdullah Motors could rent the unused portion of its plant and receive
$1,500 a month. Should the company make or buy the tires?
Provide calculations that support your answer.
Answer:
A)
Direct Materials
12
Relevant
Direct Labor
10
Relevant
Variable Manufacturing
30% × 24=
Relevant
Overhead
7.2
Total Relevant Cost = 12+ 10 + 7.2 = $ 29.2
Cost of Buying
$30
Cost of Making
$29.2
Advantage of Making over Buying = (30 – 29.2) = $0.8
Should make the tires because their manufacturing cost is less than the purchase price.
B) the revenue earned from buying = $1,500 ×12 = $18,000
Cost savings from making = 20,000 × ($30.00 – $29.20) = $16,000
Thus, Abdullah Motors should buy the tires.
_____________________________________________________________________
Q12. Z&C has two support departments, A1 and A2, and two operating
departments, B1 and B2. Z&C has decided to use the direct method and allocate
variable A1 dept. costs based on the number of transactions and fixed A1 dept.
costs based on the number of employees. A2 dept. variable costs will be allocated
based on the number of service requests and fixed costs will be allocated based on
the number of computers.
(Chapter 8)
The following information is provided:
Support Departments
Operating Departments
A1
A2
B1
B2
Total Department variable costs
5,000
6,000
38,000
21,000
Total department fixed costs
5,800
11,000
42,000
18,000
Number of transactions
15
18
80
45
Number of employees
5
7
15
12
Number of service requests
12
7
15
10
Number of computers
6
8
10
12
Allocate variable and fixed costs.
Answer:
Allocate Variable costs:
A1
80
(5,000)
A2
Total Variable costs
5,000× (80+45) = 3,200
15
45
5,000× (80+45) = 1,800
10
(6,000)
6,000× (10+15) = 3,600
6,000× (10+15) =2,400
0
38,000 + 3,200+ 3,600 =
44,800
21,000 + 1,800+2,400 =
25,200
0
Allocate fixed costs:
A1
A2
Total Fixed costs
15
(5,800)
5,800× (12+15) = 3,222
12
(11,000)
11,000× (12+10) =5,000
11,000× (12+10) = 6,000
0
42,000+3,222+ 5,000 =
50,222
18,000 + 2,578+6,000 =
26,578
0
Total Fixed and Variable costs
10
12
5,800× (12+15) =2,578
0
0
44,800+50,222=
25,200 +26,578 =
95,022
51,778
Q13. Fadel, Inc. allocates engineering costs on the basis of the supervisor’s time
and administration costs on the basis of the number of employees.
The following data have been collected:
Support Departments
Operating Departments
Engineering
Administration
Operating 1
Operating 2
$25,000
15,000
$200,000
$350,000
Number of employees
15
10
300
450
Engineering supervisor’s time
30
15
35
20
Department costs
Use the direct method to allocate support department costs to the different
departments.
(Chapter 8)
Answer:
Allocate costs:
Engineering
(25,000)
Administration
Totals
0
15,909
9,091
0
(15,000)
6,000
9,000
0
0
221,909
368,091
590,000
_____________________________________________________________________
Q14. ABC incorporation has two support departments, Administration
department and Information Technology department and two operating
departments, Assembly department and Finishing department. Company
allocates administration costs on the basis of the number of employees and
information technology cost on the basis of number of computers in each
department. Given the information below, use the direct method to allocate
support department costs.
(Chapter 8)
Details
Support Department
Information
Administration Technology
Operating
Departments
Assembly
Finishing
Total
Total
department
costs
Number of
employees
Number of
computers
$72,000
$108,000
$579,000
$273,000
$1,032,000
5
6
33
24
68
6
9
5
5
25
Answer:
Fill in the
below
Allocation of Costs
Administration
41,684
……..
Information
Technology
Totals
54,000
…….
674,684
$0
$0
30,316
………….. $0
54,000
……….. $0
357,316
$1,032,000
_____________________________________________________________________
Q15. Breakfast Bars has two support departments, Information Systems and
Personnel. The Information Systems Department costs of $120,000 are allocated
on the basis of hours used. The Personnel Department costs of $30,000 are
allocated based on the number of employees. Costs of the two operating
departments are $60,000 for Fruit Bars and $90,000 for Nut Bars. Data on
information systems hours used and number of employees are as follows:
(Chapter 8)
Support Departments
Operating Departments
Information
system
$120,000
Personnel
Fruit Bars
Nut Bars
$30,000
$60,000
$90,000
Information system hours
600
600
720
480
Engineering supervisor’s time
10
20
40
120
Department costs
Answer:
Allocate costs:
IS
(120,000)
Personnel
(30,000)
72,000
48,000
0
7,500
22,500
0
Totals
0
0
139,500
160,500
300,000
_______________________________________________________________________
Q16. the following value are related to a support department (IT) and two
operating departments 1 & 2: support department, operating department
Total department costs
Number of computers
IT
$32,000
10
Dept. 1
$40,000
20
Dept. 2
$50,000
30
Total
$122,000
60
Allocate support department costs (IT) to the operating department dept.1 and
dept.2 based on no. of computers.
(Chapter 8)
Answer:
Allocate costs:
IT
(32,000) 32,000× 20 = 12,800
(20+30)
32,000× (20+30) = 19,200
30
0
Totals
0
12,800 + 40,000 = 52,800
19,200 + 50,000 = 69,200
122,000
_____________________________________________________________________
Q17. SFC Company is in the manufacturing process of wooden products and
makes several wooden items. The following is the information related to three
products manufactured by SFC company: Product X, Y, and Z. The joint costs of
the three products in 2015 were SAR 110,000. The total number of units for each
product and the selling price per unit is given below:
(Chapter 9)
Products
Units
Selling Price per unit
X
5,000
SAR 150
Y
3,500
SAR 125
Z
2,200
SAR 100
Using the physical volume method and sales value at the split-off method,
allocate the joint costs to each product.
Answer:
1) By using the physical volume method
Products
Units
X
5,000
Y
3,500
Z
Totals
Relative weightage
5,000
Joint cost allocated
× 100 = 46.73%
46.73%× 110,000 = 51,403
× 100 = 32.71%
32.71%× 110,000 = 35,981
2,200
2,200
× 100 = 20.56%
10,700
20.56%110,000 = 22,616
10,700
100%
110,000
10,700
3,500
10,700
2) Sales value at spilt off method.
Products
Units
Selling
Total sales value at
Price per
split-off point
Relative weightage
Joint cost allocated
unit (SAR)
750,000
X
5,000
150
5,000×150= 750,000
1,407,500
× 100 =
53.29%
437,500
Y
3,500
125
3,500×125= 437,500
1,407,500
× 100 =
31.08%
Z
2,200
100
2,200×100= 220,000
220,000
× 100
1,407,500
= 15.63%
Totals
10,700
1,407,500
100%
53.29%× 110,000 =
58,619
31.08%× 110,000 =
34,188
15.63% × 110,000 =
17,193
110,000
Q18: Abdelaziz Co. produces 3 types of products.
During the year the joint costs of processing the 3 products were $350,000.
Production and sales value information were as follows:
Product
Units
produced
400,000
300,000
500,000
A
B
C
Spilt-Off
$10/units
$9/unit
$6/units
Separable
Cost
$6.00 /unit
$4.00/unit
$3.00/unit
(Chapter 9)
Selling Price
$40/unit
$28/unit
$18/unit
a. Allocate the joint costs using the physical output method.
b. Allocate the joint costs using the net realizable value method.
c. Allocate the joint costs using sales value at split-off point method.
Answer:
A)
Products
Units
Relative weightage
Joint cost allocated
X
400,000
33.33%
116,655
Y
300,000
25%
87,500
Z
500,000
41.67
145,845
Totals
1,200,000
100%
350,000
B)
Final Sales Separable
Products Units
(FS)
Cost
Total
Separable
NRV
Relatively
Joint cost
FS-TSC
NRV
allocated
Cost
(TSC)
X
400,000
16,000,000
Y
300,000
8,400,000
$6.00 /unit
2,400,000
13,600,000 48.06%
168,210
$4.00/unit
1,200,000
7,200,000
89,040
25.44%
Z
500,000
9,000,000
Totals
1,200,000 33,400,000
$3.00/unit
1,500,000
7,500,000
26.50%
5,100,000
28,300,000 100
92,750
350,000
C)
Spilt-Off
Products
Units
X
400,000
Y
300,000
Z
500,000
Totals
1,200,000
Total sales value
at split-off point
Relative weightage
Joint cost allocated
4,000,000
41.237%
144,329.5
27.835%
97,422.5
3,000,000
30.928%
108,248
9,700,000
100%
350,000
$10/units
$9/unit
2,700,000
$6/units
_____________________________________________________________________
Q19. JTC Corporation is a metal product manufacturer that produces three
products: A, B, and C. The joint costs of the three products in 2018 were SAR
50,000. The total number of units for each product and the selling price per unit
are given below:
(Chapter 9)
Product
Units
Selling Price per unit
A
20,000
SAR 6
B
12,500
SAR 5
C
7,500
SAR 4
Using the physical volume method and sales value at the split-off method, allocate
the joint costs to each product.
Answer:
Physical volume method
Product
Units
Relative
Allocated
Weight
Joint costs
A
20,000
50%
25,000
B
12,500
31.25%
15,625
C
7,500
18.75%
9,375
Sales Value at Split-Off Method
Product
Units
Selling price per
Total sales value
Relative
Allocated
unit
at Split-Off
Sales Value
Joint costs
A
20,000
6
120,000
56.47%
28,235
B
12,500
5
62,500
29.41%
14,705
C
7,500
4
30,000
14.12%
7,060
________________________________________________________________________
Q20. A company is planning to prepare a budget for the year 2017 and provides
you with the following information regarding the preparation of the budget:
Particulars
Amount
Budgeted selling price per unit
$650 per unit
Total fixed costs
$155,000
Variable costs
$175 per unit
You are required to prepare a flexible budget for 500, 600, 700, and 800 units.
(Chapter 10)
Answer:
A flexible budget
Units
500units
600 units
700 units
800 units
Sales Revenue
500× 650 =
600× 650 =
700× 650 =
800× 650 =
$325,000
$390,000
$455,000
$520,000
(Less)Variable
500× 175 =
600× 175 =
700× 175 =
800× 175 =
Cost
87,500
105,000
122,500
140,000
Contribution
325,000 – 87,500 390,000 – 105,000
455,000 -122,500
520,000 – 140,000
margin
= $237,500
= $285,000
= $332,500
= $380,000
Less fixed
$155,000
$155,000
$155,000
$155,000
Operating
237,500-155,000
285,000 – 155,000 332,500 – 155,000
380,000 – 155,000
income
= $82,500
=$130,000
=$225,000
costs
= $177,500
_____________________________________________________________________
Q21. ABC Ltd. is preparing a budget for 2018. Following are the information
related to budget preparation:
(Chapter 10)
Budgeted selling price per unit
=
SAR 200 per unit
Total fixed costs
=
SAR 250,000
Variable costs
=
SAR 65 per unit
Required:
Prepare flexible budget for 2,000, 2,500, 3,000 and 3,500 units.
Answer:
Volume Levels
Sales in units
2,000
2,500
3,000
3,500
Revenues
400,000
500,000
600,000
700,000
Less: Variable costs
130,000
162,500
195,000
227,500
Contribution margin
270,000
337,500
405,000
472,500
Less: Fixed costs
250,000
250,000
250,000
250,000
Operating income
20,000
87,500
155,000
222,500
Q22. XYZ Co. is preparing a budget for 2018. The budgeted selling price per unit
is 60 SR, and total fixed costs for 2018 are estimated to be 1,500,000 SR. Variable
costs are budgeted at 20 SR/unit.
You are working in accounting department of XYZ, prepare a flexible budget for
the volume levels 120,000, 130,000, and 140,000 units.
One internship student having his training in XYZ Co requested you to explain
to him the difference between static and flexible budgets and arguments of using
each one of them?
(Chapter 10)
Answer:
Volume Levels
Sales in units
120,000
130,000
140,000
Revenues
7,200,000
7,800,000
8,400,000
Less: Variable costs
2,400,000
2,600,000
2,800,000
Contribution margin
4,800,000
5,200,000
5,600,000
Less: Fixed costs
1,500,000
1,500,000
1,500,000
Operating income
3,300,000
3,700,000
4,100,000
_____________________________________________________________________
Q23. ASC corporation makes a product ‘A’ for which the budgeted selling price per
unit is 130, budgeted variable cost per unit is 30 and total fixed costs are 125,000.
You are required to prepare a flexible budget for the 2,500 units.
The revenue of product ‘A’ = 2,500 × 130 = 325,000
The total variable cost = 2,500 × 30 = 75,000
Contribution margin = The revenue of product – The total variable cost
= 325,000 – 75,000 = 250,000
Operating income = Contribution margin – Fixed cost
= 250,000 – 125,000
= 125,000
(Chapter 10)
Q24. Here is information for Mohammed Manufacturing
Actual direct labor hours worked 20,000
Standard direct labor hours for units produced 22,000.
Actual variable overhead costs incurred $24,000.
Variable overhead efficiency variance $2,500 favorable
Standard variable overhead allocation rate per direct labor hour $1.25
find:
A. Variable overhead spending variance
B. Actual variable overhead per direct labor hour
(Chapter 11)
Answer:
A) VOSV = [AQ x SR] – actual VO
VOSV = (20,000 ×1.25) – 24,000 = 1,000 Favorable
B) Actual variable overhead per direct labor hour = 24000/20000hrs = $1.2
_____________________________________________________________________
Q25. Ahmad Division had the following information.
Operating income
$ 50,000
Adjusted after-tax operating income
35,000
Adjusted total assets
80,000
Average operating assets
90,000
Current liabilities
15,000
Revenue
120,000
Weighted average cost of capital
10%
from the list calculate:
a. return on investment
b. residual income
c. economic value added.
(Chapter15)
Answer:
A) ROI =
𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑖𝑛𝑐𝑜𝑚𝑒
Average operating assets
50,000
= 90,000 × 100 = 55.56%
B) RI = Operating Income – (WACC × average operating assets)
= $50,000 – (10% × $90,000)
= ($50,000 – $9,000)
= $41,000
C) EVA = Adjusted after-tax operating income – [Total assets – current liabilities)
× WACC]
= $35,000 – [($80,000 – $15,000) × 10%]
= $35,000 – $6,500
= $28,500
__________________________________________________________________
Q26. QCL industries has two divisions, X and Y. given the information below, compute
the return on investment (ROI) for each division.
Division X
Division Y
(Chapter15)
Operating income
$15,785
$7,695
Average operating assets
$225,500
$85,500
Answer:
ROI for Division X =
ROI for Division X =
𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑖𝑛𝑐𝑜𝑚𝑒
Average operating assets
𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑖𝑛𝑐𝑜𝑚𝑒
Average operating assets
15,785
= 225,500 × 100 = 7 %
7,695
= 85,500 × 100 = 9 %
__________________________________________________________________
Q27. The following information is related to MCD Ltd:
Operating income
(Chapter15)
Division X
Division X
$24,000
$6,000
Average operating assets $300,000
$50,000
Equity
$150,000
$20,000
Sales
$500,000
$100,000
Compute the return on investment (ROI) for each division:
Answer:
ROI for Division X =
ROI for Division X =
𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑖𝑛𝑐𝑜𝑚𝑒
Average operating assets
𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑖𝑛𝑐𝑜𝑚𝑒
Average operating assets
24,000
= 300,000 × 100 = 8 %
6,000
= 50,000 × 100 = 12 %
College of Administration and Finance Sciences
Assignment (2)
Deadline: Saturday 03/06/2023 @ 23:59
Course Name: Cost Accounting
Student’s Name:
Course Code: ACCT 301
Student’s ID Number:
Semester: 3rd
CRN:
Academic Year: 1444 H
For Instructor’s Use only
Instructor’s Name:
Students’ Grade:
/15
Level of Marks: High/Middle/Low
Instructions – PLEASE READ THEM CAREFULLY
• The Assignment must be submitted on Blackboard (WORD format only) via allocated
folder.
• Assignments submitted through email will not be accepted.
• Students are advised to make their work clear and well presented, marks may be
reduced for poor presentation. This includes filling your information on the cover
page.
• Students must mention question number clearly in their answer.
• Late submission will NOT be accepted.
• Avoid plagiarism, the work should be in your own words, copying from students or
other resources without proper referencing will result in ZERO marks. No exceptions.
• All answers must be typed using Times New Roman (size 12, double-spaced) font.
No pictures containing text will be accepted and will be considered plagiarism.
• Submissions without this cover page will NOT be accepted.
College of Administration and Finance Sciences
Assignment Question(s):
(Marks 15)
Q1. What are non-routine operating decisions? Explain with suitable numerical examples how
companies decide to take the following decisions:
i.
Keep or drop decisions
ii.
Constrained Resource Decisions (Two Products; One Scarce Resource)
(3 Marks)
Note: Your answer must include numerical examples for these two decisions. You are required to
assume values of your own and they should not be copied from any sources.
(Chapter 4)
Answer:
Q2. a) What are the differences between single and dual rate allocation? Explain with suitable
examples.
(2 Marks)
b) Provide a numerical example for single rate allocation and dual rate allocation and explain
the process of allocating support department costs to the operating department, assuming that:
•
The company has two support departments “S1 & S2” and two operating departments “O1 &
O2.”
•
The company use the direct method to allocate support department costs.
(2 Marks)
Note: You are required to provide numerical examples assuming the values of your own and they
should not be copied from any sources.
Answer:
(Chapter 8)
College of Administration and Finance Sciences
Q3. OFL Ltd. manufactures plastic products and makes three products, P1, P2 and P3. In 2016,
the joint costs of three products were SAR 135,000. Following are the details related to the
number of units and selling price per unit:
(4 Marks)
Product
Units
Selling Price per unit
P1
6,000
SAR 30
P2
3,000
SAR 20
P3
1,000
SAR 15
Allocate the joint costs to each product using:
i.
Physical volume method
ii.
Sales value at the split-off method
(Chapter 9)
Answer:
Q4. The following data are related to FDL Company for the year 2017:
Budgeted selling price per unit
=
SAR 425 per unit
Total fixed costs
=
SAR 84,000
Variable costs
=
SAR 110 per unit
You are required to prepare a flexible budget for 400, 500, 600 and 700 units.
Answer:
(4 Marks)
(Chapter 10)
Cost Management
Measuring, Monitoring, and Motivating Performance
Chapter 10
Static and Flexible Budgets
© John Wiley & Sons, 2011
Chapter 10: Static and Flexible Budgets
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 1
Chapter 10: Static and Flexible Budgets
Learning objectives
•
Q1: How do budgets contribute to the strategic management
process?
•
Q2: What is a master budget and how is it prepared?
•
Q3: What are flexible budgets and how can they be used for
sensitivity analysis?
•
Q4: How are budget variances calculated and used as
performance measures?
•
Q5: How do behavioral tensions influence the budgeting process?
•
Q6: What approaches exist for addressing the problems of
traditional budgeting?
© John Wiley & Sons, 2011
Chapter 10: Static and Flexible Budgets
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 2
Q1: Budgets & Strategic Management Process
• A budget is
• A formalized financial plan.
• A translation of an organization’s strategies.
• A method of communicating.
• A way to define areas of responsibility and
decision rights.
• The budget cycle is the series of
sequential steps followed to create and
use budgets.
© John Wiley & Sons, 2011
Chapter 10: Static and Flexible Budgets
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 3
Q1: Budgets & Strategic Management Process
• Budgeting process begins with the organizational
vision, core competencies, and risk appetite
• Organizational strategies designed to achieve the
vision will drive the capital expenditures and long
term financing plans
• Operating plans are then created in line with the
organizational strategies
• Actual results must be monitored, measured, and
analyzed compared to budgeted plans
© John Wiley & Sons, 2011
Chapter 10: Static and Flexible Budgets
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 4
Q1: Budgets & Levers of Control
Belief Systems
• Communicates
organizational
strategies and
goals
• Motivates
managers to
plan in
advance and
coordinate
activities
© John Wiley & Sons, 2011
Boundary
Systems
Interactive
Control Systems
Diagnostic
Control Systems
• Authorizes
employees to
engage in
planned
activities and
spend within
budget limits
• Ensures
sufficient cash
flow for
financial
viability
• Utilize
variances to
identify
opportunities
and threats to
the business
• Revaluate
strategies and
operating plans
as conditions
changes
• Assign
responsibility
and reward
employees for
achieving
budget targets
• Motivate
managers to
provide good
estimates and
use resources
appropriately
Chapter 10: Static and Flexible Budgets
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 5
Q2: Master Budgets
• A master budget is
• A comprehensive plan for the upcoming
accounting period.
• Usually prepared for a one-year period.
• Is based on a series of budget assumptions.
• The master budget consists of several
subsidiary budgets, in two categories:
• Operating budgets.
• Financial budgets.
© John Wiley & Sons, 2011
Chapter 10: Static and Flexible Budgets
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 6
Q2: Operating Budgets
© John Wiley & Sons, 2011
Chapter 10: Static and Flexible Budgets
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 7
Q2: Operating Budgets
The operating budget is created by preparing
the following individual budgets, in this order:
• Revenue budget
• Production budget
• Direct materials budget
• Direct labor budget
• Manufacturing overhead budget
• Inventory and cost of goods sold budget
• Support department budgets
• Budgeted income statement
© John Wiley & Sons, 2011
Chapter 10: Static and Flexible Budgets
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 8
Q2: Financial Budgets
The financial budget is created by preparing
the following individual budgets, in this order:
• Capital budget
• Long-term financing budget
• Cash budget
• Budgeted balance sheet
• Budgeted statement of cash flows
© John Wiley & Sons, 2011
Chapter 10: Static and Flexible Budgets
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 9
Q2: Operating Budget Example
Stanley J, Inc., makes a tool used by auto mechanics that sells for
$68/unit. It expects to sell 6,000 units in April and 7,000 units in May.
Stanley J prefers to end each period with a finished goods inventory
equal to 10% of the next period’s sales in units and a direct materials
inventory equal to 20% of the direct materials required for the next
period’s production. The company never has any beginning or ending
work-in-process inventories. There were 400 units in finished goods
inventory on April 1. Prepare the revenue and production budgets for
April.
Production budget
Revenue budget
Budgeted sales in units in April
6,000 Budgeted sales in units in April
Budgeted selling price per unit
$68.00 Desired ending FG inventory
Budgeted revenues
$408,000 Total units required
Less: beginning FG inventory
Required production in units
© John Wiley & Sons, 2011
Chapter 10: Static and Flexible Budgets
Eldenburg & Wolcott’s Cost Management, 2e
6,000
700
6,700
(400)
6,300
Slide # 10
Q2: Operating Budget Example
Stanley J’s product uses 0.3 pounds of direct material per unit, at a cost
of $4/lb. There were 220 lbs. of direct material on hand on April 1.
Assume that budgeted production for May is 6,500 units. Prepare the
direct materials purchases and usage budget for April.
Direct materials budget
Required production in units
DM required per unit, in pounds
Total DM required, in pounds
Less: Beginning DM inventory
Plus: Desired ending DM inventory
Required DM purchases in pounds
Budgeted DM cost per pound
Budgeted cost of DM
6,300
0.3
1,890
(220)
390
2,060
$4.00
$8,240
Usage Budget = 1,890 pounds * $4 per pound = $7,560
© John Wiley & Sons, 2011
Chapter 10: Static and Flexible Budgets
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 11
Q2: Operating Budget Example
Stanley J’s product uses 0.2 hours of direct labor at a cost of $12/hr.
Prepare the direct labor budget for April.
Direct labor budget
Required production in units
DL required per unit, in hours
Total DL hours required
Budgeted cost per DL hour
Budgeted cost of DL
© John Wiley & Sons, 2011
Chapter 10: Static and Flexible Budgets
Eldenburg & Wolcott’s Cost Management, 2e
6,300
0.2
1,260
$12.00
$15,120
Slide # 12
Q2: Operating Budget Example
Stanley J’s budgeted fixed manufacturing overhead for April is $167,000,
and variable manufacturing overhead is budgeted at $6 per direct labor
hour. Prepare the manufacturing overhead budget for April.
Manufacturing overhead budget
Total DL hours required
Budgeted variable overhead per DL hour
Total budgeted variable overhead
Budgeted fixed overhead
Total budgeted overhead
© John Wiley & Sons, 2011
Chapter 10: Static and Flexible Budgets
Eldenburg & Wolcott’s Cost Management, 2e
1,260
$6.00
$7,560
$167,000
$174,560
Slide # 13
Q2: Operating Budget Example
Assume that Stanley J’s April 1 direct materials inventory had a cost of
$1,560. Prepare the April ending inventories budget for direct materials.
Ending inventories budgets
Budgeted cost of DM purchases
$8,240
Beginning DM inventory
$854
DM available for use
$9,094
Budgeted cost of desired ending DM inventory:
[6,500 units x 0.3 lbs/unit] x 20% x $4/lb
$1,560
Budgeted cost of DM to be used
$7,534
© John Wiley & Sons, 2011
Chapter 10: Static and Flexible Budgets
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 14
Q2: Operating Budget Example
Prepare the April ending inventories budget for finished goods.
Budgeted cost of DM to be used
Budgeted cost of DL
Total budgeted overhead
Total budgeted manufacturing costs
Required production in units
Budgeted manufacturing cost per unit
Budgeted ending FG inventory in units
Budgeted cost of ending FG inventory
© John Wiley & Sons, 2011
Chapter 10: Static and Flexible Budgets
Eldenburg & Wolcott’s Cost Management, 2e
$7,534
$15,120
$174,560
$197,214
6,300
$31.3037
700
$21,913
Slide # 15
Q2: Operating Budget Example
Assume that Stanley J’s April 1 finished goods inventory had a cost of
$12,146. Prepare the cost of goods sold budget for April.
Cost of goods sold budget
Beginning FG inventory
Total budgeted manufacturing costs
Cost of goods available for sale
Less: budgeted ending FG inventory
Budgeted cost of goods sold
© John Wiley & Sons, 2011
Chapter 10: Static and Flexible Budgets
Eldenburg & Wolcott’s Cost Management, 2e
$12,146
$197,214
$209,359
$21,913
$187,447
Slide # 16
Q2: Operating Budget Example
Stanley J’s budget for April includes $22,000 for administrative costs,
$34,000 for fixed distribution costs, $18,000 for research and
development, and $13,000 for fixed marketing costs. Additionally, the
budgeted variable costs for distribution are $0.75/unit sold and the
budgeted variable costs for marketing are 4% of sales revenue. Prepare
the support department budget for April.
Support department budget
Administration
$22,000
Distribution: Fixed costs
$34,000
Variable costs
$4,500 $38,500
Research & development
$18,000
Marketing: Fixed costs
$13,000
Variable costs
$16,320 $29,320
Total budgeted support department costs
$107,820
© John Wiley & Sons, 2011
Chapter 10: Static and Flexible Budgets
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 17
Q2: Operating Budget Example
Suppose that Stanley J’s income tax rate is 28%. Prepare the budgeted
income statement for April.
Budgeted income statement
Sales revenue
Cost of goods sold
Gross margin
Operating costs:
Administration
Distribution
Research & development
Marketing
Net income before taxes
Income taxes
Net income
© John Wiley & Sons, 2011
$408,000
$187,447
$220,553
$22,000
$38,500
$18,000
$29,320 $107,820
$112,733
$31,565
$81,168
Chapter 10: Static and Flexible Budgets
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 18
Q4: Budget Variances
• Managers compare actual results to
budgeted results in order to
• Monitor operations, and
• Motivate appropriate performance.
• Differences between budgeted and
actual results are called budget
variances.
• Variances are stated in absolute value
terms, and labeled as Favorable or
Unfavorable.
© John Wiley & Sons, 2011
Chapter 10: Static and Flexible Budgets
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 19
Q4: Budget Variances
• Reasons for budget variances are
investigated.
• The investigation may find:
• Inefficiencies in actual operations that can
be corrected.
• Efficiencies in actual operations that can be
replicated in other areas of the
organization.
• Uncontrollable outside factors that require
changes to the budgeting process.
© John Wiley & Sons, 2011
Chapter 10: Static and Flexible Budgets
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 20
Q3: Static Budgets
• A budget prepared for a single level of
sales volume is called a static budget.
• Static budgets are prepared at the
beginning of the year.
• Differences between actual results and
the static budget are called static budget
variances.
© John Wiley & Sons, 2011
Chapter 10: Static and Flexible Budgets
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 21
Q3: Flexible Budgets
• A budget prepared for a multiple levels of sales
volume is called a flexible budget.
• Flexible budgets are prepared at the beginning
of the year for planning purposes and at the end
of the year for performance evaluation.
• Flexible budgets are also used for sensitivity
analysis and to manage risk due to uncertainty.
• Differences between actual results and the
flexible budget are called flexible budget
variances.
© John Wiley & Sons, 2011
Chapter 10: Static and Flexible Budgets
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 22
Q3, Q4: Flexible Budget Example
Tina’s Trinkets is preparing a budget for 2006. The budgeted selling price
per unit is $10, and total fixed costs for 2006 are estimated to be $5,000.
Variable costs are budgeted at $3/unit. Prepare a flexible budget for the
volume levels 1,000, 1,100, and 1,200 units.
Sales in units
Revenues
Variable costs
Contribution margin
Fixed costs
Operating income
© John Wiley & Sons, 2011
Volume Levels
1,000
1,100
1,200
$10,000 $11,000 $12,000
$3,000 $3,300 $3,600
$7,000 $7,700 $8,400
$5,000 $5,000 $5,000
$2,000 $2,700 $3,400
Chapter 10: Static and Flexible Budgets
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 23
Q3, Q4: Static Budget Variances Example
Suppose that Tina’s 2006 static budget was for 1,100 units of sales. The
actual results are given below. Compute the static budget variances for
each row and discuss.
Static
Budget
Sales in units
1,100
Revenues
$11,000
$3,300
Variable costs
Contribution margin $7,700
Fixed costs
$5,000
$2,700
Operating income
© John Wiley & Sons, 2011
Static
Actual Budget
Results Variance
980
$9,604 $1,396 Unfavorable
$311 Favorable
$2,989
$6,615 $1,085 Unfavorable
$4,520
$480 Favorable
$605 Unfavorable
$2,095
Chapter 10: Static and Flexible Budgets
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 24
Q3, Q4: Flexible Budget Variances Example
Compute the flexible budget variances for Tina and discuss the results.
Compare the flexible budget variances to the static budget variances on the
prior page.
Year-end
Flexible
Flexible Actual Budget
Budget Results Variance
Sales in units
980
980
Revenues
$9,800 $9,604
$196 Unfavorable
Variable costs
$2,940 $2,989
$49 Unfavorable
Contribution margin $6,860 $6,615
$245 Unfavorable
Fixed costs
$5,000 $4,520
$480 Favorable
Operating income
$1,860 $2,095
$235 Unfavorable
© John Wiley & Sons, 2011
Chapter 10: Static and Flexible Budgets
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 25
Q3, Q4: Performance Evaluation
• A static budget variance includes effects from
output volume.
• A flexible budget variance removes these
output volume effects.
• Other adjustments to the year-end flexible
budget may be made for a fair performance
evaluation, such as
• Input price changes outside the control of the
manager under evaluation
• Fixed cost increases outside the control of the
manager under evaluation
© John Wiley & Sons, 2011
Chapter 10: Static and Flexible Budgets
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 26
Q5: Behavior Tensions in Budgeting
• Budgets used to evaluate performance and
compensation can create behavioral tension
• Participative budgeting – when managers who are
responsible for the budgets prepare the budget
forecasts
– Can result in budgetary slack – when managers set
targets so low that goals can be met easily (and bonuses
achieved)
• Budget ratcheting – when top managers set targets
– If targets unachievable, this can result in employees
having little motivation to meet targets
• Organizations must watch for budget manipulation
© John Wiley & Sons, 2011
Chapter 10: Static and Flexible Budgets
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 27
Q6: Other Budgeting Approaches
• Zero based budgets are prepared without using
past information as justification.
• Rolling budgets are prepared frequently for
overlapping time periods and actual results may be
used to update the budget for the next period.
• Kaizen budgets plan cost reductions over time.
• Activity based budgets use more cost pools and
cost drivers.
• GPK and RCA budgets identify fixed and variable
cost functions at the resource center level.
• Beyond budgeting uses external benchmarks to
evaluate managers’ performance
© John Wiley & Sons, 2011
Chapter 10: Static and Flexible Budgets
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 28
Cost Management
Measuring, Monitoring, and Motivating Performance
Chapter 9
JOINT PRODUCT AND BY-PRODUCT COSTING
© John Wiley & Sons, 2011
Chapter 9: Joint Product and By-Product Costing
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 1
Chapter 9: Joint Product and By-Product Costing
Learning objectives
•
Q1: What is a joint process, and what is the difference between a
by-product and a main product?
•
Q2: How are joint costs allocated?
•
Q3: What factors are considered in choosing a joint cost
allocation method?
•
Q4: What information is relevant for deciding whether to process a
joint product beyond the split-off point?
•
Q5: What methods are used to account for the sale of byproducts?
•
Q6: How does a sales mix affect joint cost allocation?
•
Q7: How do joint cost allocations affect decisions and
managerial incentives?
© John Wiley & Sons, 2011
Chapter 9: Joint Product and By-Product Costing
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 2
Q1: Joint Processes and Costs
• A process that yields one or more products is
called a joint process.
• The products are called joint products.
• The costs of the process are called joint costs.
• The split-off point is the stage in the joint process
where the separate products become
identifiable.
• Joints costs are incurred prior to the split-off point.
• Costs incurred past split-off are separable costs.
• Joint products that have minimal sales value
compared to the main product are called byproducts.
© John Wiley & Sons, 2011
Chapter 9: Joint Product and By-Product Costing
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 3
Q1: Joint Processes and Costs
Sawdust
Bark
Joint costs
include DM,
DL &
Overhead.
© John Wiley & Sons, 2011
Planks
If sawdust sells for a
relatively minimal amount,
it is a byproduct.
The costs of
processing
planks further
are separable
costs.
Wall
paneling
Joint products
Chapter 9: Joint Product and By-Product Costing
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 4
Q2: Methods of Allocating Joint Costs
• Physical output methods
• Can be used only when joint products are
measured the same way (e.g. pounds or feet).
• Market-based methods
• Sales value at split-off method
• Often used when all products sold at split-off.
• Net realizable value (NRV) method
• NRV = Final selling price – Separable costs.
• Constant gross margin (GM) NRV method
• The two NRV methods can be used when
some products are processed past split-off.
© John Wiley & Sons, 2011
Chapter 9: Joint Product and By-Product Costing
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 5
Q2: Physical Volume Method Example
Pleasing Peaches grows peaches and processes three different peach
products that are sold to a canning company. The pounds produced for
each product, and the selling price per pound, is given below. The joint
costs of processing the 280,000 pounds of products were $70,000.
Allocate the joint costs to each product using the physical volume method.
Pounds
Product
Produced
Peach halves 160,000
Peach slices
80,000
Peach purée
40,000
280,000
© John Wiley & Sons, 2011
Selling Total Sales
Price per
Value at
Pound
Split-Off
$0.50
$80,000
$0.40
$32,000
$0.30
$12,000
$124,000
Chapter 9: Joint Product and By-Product Costing
Eldenburg & Wolcott’s Cost Management, 2e
Relative
Allocated
Weight Joint Costs
57.1%
$40,000
28.6%
$20,000
14.3%
$10,000
100.0%
$70,000
Slide # 6
Q2: Sales Value at Split-Off Method Example
Allocate the joint costs of $70,000 to each of Pleasing Peaches products
using the sales value at split-off method.
Product
Peach halves
Peach slices
Peach purée
© John Wiley & Sons, 2011
Pounds
Produced
160,000
80,000
40,000
280,000
Selling Total Sales
Price per
Value at
Pound
Split-Off
$0.50
$0.40
$0.30
$80,000
$32,000
$12,000
$124,000
Chapter 9: Joint Product and By-Product Costing
Eldenburg & Wolcott’s Cost Management, 2e
Relative
Sales
Allocated
Value Joint Costs
64.5%
25.8%
9.7%
100.0%
$45,161
$18,065
$6,774
$70,000
Slide # 7
Q2, 6: Compare the Physical Volume and
Sales Value at Split-Off Methods
Compute the gross margin for each product for each of the two allocation
methods. Discuss the differences between the two methods.
Allocated Joint
Costs
Total
Sales
Sales
Physical Value at
Value at Volume Split-Off
Product
Split-Off Method
Method
Peach halves $80,000 $40,000 $45,161
Peach slices
$32,000 $20,000 $18,065
Peach purée
$12,000 $10,000 $6,774
$124,000 $70,000 $70,000
© John Wiley & Sons, 2011
Gross Margin
Sales
Physical Value at
Volume Split-Off
Method
Method
$40,000 $34,839
$12,000 $13,935
$2,000 $5,226
$54,000 $54,000
Chapter 9: Joint Product and By-Product Costing
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 8
Q2, 6: Compare the Physical Volume and
Sales Value at Split-Off Methods
Compute the gross margin ratio (GM/Sales) for each product under both of
the methods and discuss.
Product
Peach halves
Peach slices
Peach purée
© John Wiley & Sons, 2011
Total
Sales
Value at
Split-Off
$80,000
$32,000
$12,000
$124,000
Gross Margin
Sales
Physical Value at
Volume
Split-Off
Method
Method
$40,000 $34,839
$12,000 $13,935
$2,000 $5,226
$54,000 $54,000
Chapter 9: Joint Product and By-Product Costing
Eldenburg & Wolcott’s Cost Management, 2e
Gross Margin Ratio
Sales
Physical Value at
Volume Split-Off
Method
Method
50.0%
43.5%
37.5%
43.5%
16.7%
43.5%
43.5%
43.5%
Slide # 9
Q2: Net Realizable Value (NRV) Method Example
Pleasing Peaches could process each of its three products beyond split off.
It could can the peach halves itself, make the peach slices into frozen
peach pie, and make juice out of the peach purée. The retail value of the
new products and the separable costs for the additional processing are
given below. Compute the joint costs allocated to each of the products
using the NRV method.
Final
Allocated
Sales Separable
Relative
Joint
Product
Value
Costs
NRV NRV
Costs
Canned peaches $180,000 $60,000 $120,000
64.2% $44,920
Peach pie
$120,000 $70,000
$50,000
26.7% $18,717
Peach juice
$50,000 $33,000
$17,000
9.1% $6,364
$350,000 $163,000 $187,000 100.0% $70,000
© John Wiley & Sons, 2011
Chapter 9: Joint Product and By-Product Costing
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 10
Q2: Constant GM NRV Method
• Under the constant GM NRV method, all products
are allocated joint costs to achieve the same gross
margin ratio (GM%).
• First compute overall gross margin and GM%:
GM = Revenue – Joint costs – Separable costs
GM% = GM/Sales
• Then compute the GM for each product:
GM = Final sales value x GM%
• All products end up with the same gross margin ratio;
for each product solve for allocated joint costs:
Final sales value – joint costs – separable costs = GM
© John Wiley & Sons, 2011
Chapter 9: Joint Product and By-Product Costing
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 11
Q2: Constant GM NRV Method Example
Compute the joint costs that Pleasing Peaches would allocate to each of
the products using the constant GM NRV method.
First compute the overall GM and GM ratio:
GM = $350,000 – $163,000 – $70,000 = $117,000
GM% = $117,000/$350,000 = 33.43%
Allocated
Final
Sales Separable
Joint Gross
Product
Value
Costs
Costs Margin
Canned peaches $180,000 $60,000
$59,829 $60,171
Peach pie
$120,000 $70,000
$9,886 $40,114
Peach juice
$50,000 $33,000
$286 $16,714
$350,000 $163,000
$70,000 $117,000
Gross
Margin
Ratio
33.4%
33.4%
33.4%
Values are rounded as appropriate.
© John Wiley & Sons, 2011
Chapter 9: Joint Product and By-Product Costing
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 12
Q2, 6: Compare the NRV and
Constant GM NRV Methods
Compute the gross margin (GM) and the gross margin ratio (GM%) for each
product under NRV method. Compare this to the results of the constant
GM NRV method and discuss.
Product
Peach halves
Peach slices
Peach purée
Final
Sales
Value
$180,000
$120,000
$50,000
$350,000
Gross Margin
Gross Margin Ratio
Constant
Constant
NRV
GM NRV
NRV
GM NRV
Method
Method Method
Method
$75,080
$60,171
41.7%
33.4%
$31,283
$40,114
26.1%
33.4%
$10,636
$16,714
21.3%
33.4%
33.4%
$117,000 $117,000
33.4%
Values are rounded as appropriate.
© John Wiley & Sons, 2011
Chapter 9: Joint Product and By-Product Costing
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 13
Q3: Choosing a Joint Cost Allocation Method
• Allocated joint costs should not be used in
decision making.
• Still, avoid a method that shows one product
to be unprofitable.
• Under the physical volume method, the
product with the greatest relative physical
volume is allocated the most joint costs,
regardless of product’s sales value.
• Both of the NRV methods allocate joint
costs based on the products’ “ability to
bear the cost”.
© John Wiley & Sons, 2011
Chapter 9: Joint Product and By-Product Costing
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 14
Q4: Sell or Process Further Decisions
• Companies often can choose to sell a product
at the split-off point or to process it further.
• Compare the incremental revenue of
processing further to the product’s separable
costs.
• Incremental revenue of processing further
= Final sales value – Sales value at split-off
• Process further only when the incremental
revenue exceeds the separable costs.
© John Wiley & Sons, 2011
Chapter 9: Joint Product and By-Product Costing
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 15
Q4: Sell or Process Further Example
Peg’s Plastic Products makes the molded plastic parts for three model car
kits, A, B & C from a joint production process. The joint costs of this
process are $150,000. In each case, Peg could decide to make the entire
kit rather than just the plastic parts. Information about the sales values and
separable costs for each kit is given below. Determine which kits Peg
should sell at the split-off point and which she should process further.
Kit
A
B
C
Final
Sales
SepIncreSales
Value at arable
mental
Value
Split-Off Costs Revenue
$200,000 $180,000 $25,000 $20,000
$120,000 $60,000 $40,000 $60,000
$80,000 $40,000 $10,000 $40,000
© John Wiley & Sons, 2011
Chapter 9: Joint Product and By-Product Costing
Eldenburg & Wolcott’s Cost Management, 2e
IncreSell at
mental Split-Off
Profit if
or
Process Process
Further Further?
($5,000) Sell
$20,000 Process
$30,000 Process
Slide # 16
Q5: Accounting for By-Products
• When by-products have no sales value, there
is no reason to account for them.
• Otherwise, there are two accounting methods
available:
• Recognize by-product value at time of
production
• Recognize by-product value at time of
by-product sale
© John Wiley & Sons, 2011
Chapter 9: Joint Product and By-Product Costing
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 17
Q5: Recognize By-Product Value
at Time of Production
• This method is also known as the offset approach or
the NRV approach.
• Joint cost of the main products is reduced by the
NRV of the by-products, even if by-products are not
yet sold.
• NRV of the by-products is kept in ending
inventory until sold.
• At sale of by-product, ending inventory is
reduced; there is no gain/loss on sale.
• This method allows managers to control by-products.
© John Wiley & Sons, 2011
Chapter 9: Joint Product and By-Product Costing
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 18
Q5: By-Product Value Recognized
at Time of Production Example
SJ Enterprises produces a main product and one by-product in a joint
process. The joint costs totaled $480,000. The main product sells for
$10/unit and the by-product sells for $1/unit. Information about the
production and sales of the 2 products is given below. Use the NRV
method to compute the production cost per unit for the main product.
Information in Units of Each Product
Beginning ProdEnding
Inventory uction Sales Inventory
Main product
0 100,000 95,000
5,000
By-product
0 10,000 3,000
7,000
Production costs
$480,000
Less: NRV of by-product
10,000
Net joint product cost
$470,000
Net product cost per unit
© John Wiley & Sons, 2011
Chapter 9: Joint Product and By-Product Costing
Eldenburg & Wolcott’s Cost Management, 2e
$4.70
Slide # 19
Q5: By-Product Value Recognized
at Time of Production Example
Prepare an income statement for SJ Enterprises and compute the costs
attached to ending inventory using the NRV method, assuming that nonmanufacturing costs totaled $250,000.
Revenue: 95,000 units at $10/unit
$950,000
Cost of goods sold: 95,000 units at $4.70/unit 446,500
Gross margin
503,500
Less: nonmanufacturing expenses
250,000
Operating income
$253,500
Ending inventory:
Main product: 5,000 units at $4.70
By-product: 7,000 units at $1
Value of ending inventory for balance sheet
© John Wiley & Sons, 2011
Chapter 9: Joint Product and By-Product Costing
Eldenburg & Wolcott’s Cost Management, 2e
$23,500
7,000
$30,500
Slide # 20
Q5: Recognize By-Product Value
at Time of Sale
• This method is also known as the Realized Value
Approach or the RV Approach.
• Joint cost of the main products is not reduced by
the NRV of the by-products, regardless if byproducts are sold.
• NRV of the by-products is not kept in ending
inventory.
• At sale of by-product, either Other Income is
recorded or Cost of Goods Sold is reduced.
© John Wiley & Sons, 2011
Chapter 9: Joint Product and By-Product Costing
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 21
Q5: By-Product Value Recognized
at Time of Sale Example
SJ Enterprises produces a main product and one by-product in a joint
process. The joint costs totaled $480,000. The main product sells for
$10/unit and the by-product sells for $1/unit. Information about the
production and sales of the 2 products is given below. Use the RV method
to compute the production cost per unit for the main product.
Information in Units of Each Product
Beginning ProdEnding
Inventory uction Sales Inventory
Main product
0 100,000 95,000
5,000
By-product
0 10,000 3,000
7,000
Production costs
Net product cost per unit
© John Wiley & Sons, 2011
Chapter 9: Joint Product and By-Product Costing
Eldenburg & Wolcott’s Cost Management, 2e
$480,000
$4.80
Slide # 22
Q5: By-Product Value Recognized
at Time of Sale Example
Prepare an income statement for SJ Enterprises and compute the costs
attached to ending inventory using the RV method, assuming that nonmanufacturing costs totaled $250,000. By-product sales is recorded as
other income.
Revenue: 95,000 units at $10/unit
$950,000
By-product sales: 3,000 units at $1/unit
3,000
Total revenue
953,000
Cost of goods sold: 95,000 units at $4.80/unit 456,000
Gross margin
497,000
Less: nonmanufacturing expenses
250,000
Operating income
$247,000
Ending inventory:
Main product: 5,000 units at $4.80
© John Wiley & Sons, 2011
Chapter 9: Joint Product and By-Product Costing
Eldenburg & Wolcott’s Cost Management, 2e
$24,000
Slide # 23
Q7: Decision Making & Joint Cost
• Joint cost information is required for
financial statement & tax return preparation
when production does not equal sales
(inventory and cost of goods sold).
• Allocated joint costs are irrelevant for most
decisions, especially regarding individual
products
• Joint cost information should not be
used to make product mix decisions.
© John Wiley & Sons, 2011
Chapter 9: Joint Product and By-Product Costing
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 24
Cost Management
Measuring, Monitoring, and Motivating Performance
Chapter 10
Static and Flexible Budgets
© John Wiley & Sons, 2011
Chapter 10: Static and Flexible Budgets
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 1
Chapter 10: Static and Flexible Budgets
Learning objectives
•
Q1: How do budgets contribute to the strategic management
process?
•
Q2: What is a master budget and how is it prepared?
•
Q3: What are flexible budgets and how can they be used for
sensitivity analysis?
•
Q4: How are budget variances calculated and used as
performance measures?
•
Q5: How do behavioral tensions influence the budgeting process?
•
Q6: What approaches exist for addressing the problems of
traditional budgeting?
© John Wiley & Sons, 2011
Chapter 10: Static and Flexible Budgets
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 2
Q1: Budgets & Strategic Management Process
• A budget is
• A formalized financial plan.
• A translation of an organization’s strategies.
• A method of communicating.
• A way to define areas of responsibility and
decision rights.
• The budget cycle is the series of
sequential steps followed to create and
use budgets.
© John Wiley & Sons, 2011
Chapter 10: Static and Flexible Budgets
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 3
Q1: Budgets & Strategic Management Process
• Budgeting process begins with the organizational
vision, core competencies, and risk appetite
• Organizational strategies designed to achieve the
vision will drive the capital expenditures and long
term financing plans
• Operating plans are then created in line with the
organizational strategies
• Actual results must be monitored, measured, and
analyzed compared to budgeted plans
© John Wiley & Sons, 2011
Chapter 10: Static and Flexible Budgets
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 4
Q1: Budgets & Levers of Control
Belief Systems
• Communicates
organizational
strategies and
goals
• Motivates
managers to
plan in
advance and
coordinate
activities
© John Wiley & Sons, 2011
Boundary
Systems
Interactive
Control Systems
Diagnostic
Control Systems
• Authorizes
employees to
engage in
planned
activities and
spend within
budget limits
• Ensures
sufficient cash
flow for
financial
viability
• Utilize
variances to
identify
opportunities
and threats to
the business
• Revaluate
strategies and
operating plans
as conditions
changes
• Assign
responsibility
and reward
employees for
achieving
budget targets
• Motivate
managers to
provide good
estimates and
use resources
appropriately
Chapter 10: Static and Flexible Budgets
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 5
Q2: Master Budgets
• A master budget is
• A comprehensive plan for the upcoming
accounting period.
• Usually prepared for a one-year period.
• Is based on a series of budget assumptions.
• The master budget consists of several
subsidiary budgets, in two categories:
• Operating budgets.
• Financial budgets.
© John Wiley & Sons, 2011
Chapter 10: Static and Flexible Budgets
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 6
Q2: Operating Budgets
© John Wiley & Sons, 2011
Chapter 10: Static and Flexible Budgets
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 7
Q2: Operating Budgets
The operating budget is created by preparing
the following individual budgets, in this order:
• Revenue budget
• Production budget
• Direct materials budget
• Direct labor budget
• Manufacturing overhead budget
• Inventory and cost of goods sold budget
• Support department budgets
• Budgeted income statement
© John Wiley & Sons, 2011
Chapter 10: Static and Flexible Budgets
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 8
Q2: Financial Budgets
The financial budget is created by preparing
the following individual budgets, in this order:
• Capital budget
• Long-term financing budget
• Cash budget
• Budgeted balance sheet
• Budgeted statement of cash flows
© John Wiley & Sons, 2011
Chapter 10: Static and Flexible Budgets
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 9
Q2: Operating Budget Example
Stanley J, Inc., makes a tool used by auto mechanics that sells for
$68/unit. It expects to sell 6,000 units in April and 7,000 units in May.
Stanley J prefers to end each period with a finished goods inventory
equal to 10% of the next period’s sales in units and a direct materials
inventory equal to 20% of the direct materials required for the next
period’s production. The company never has any beginning or ending
work-in-process inventories. There were 400 units in finished goods
inventory on April 1. Prepare the revenue and production budgets for
April.
Production budget
Revenue budget
Budgeted sales in units in April
6,000 Budgeted sales in units in April
Budgeted selling price per unit
$68.00 Desired ending FG inventory
Budgeted revenues
$408,000 Total units required
Less: beginning FG inventory
Required production in units
© John Wiley & Sons, 2011
Chapter 10: Static and Flexible Budgets
Eldenburg & Wolcott’s Cost Management, 2e
6,000
700
6,700
(400)
6,300
Slide # 10
Q2: Operating Budget Example
Stanley J’s product uses 0.3 pounds of direct material per unit, at a cost
of $4/lb. There were 220 lbs. of direct material on hand on April 1.
Assume that budgeted production for May is 6,500 units. Prepare the
direct materials purchases and usage budget for April.
Direct materials budget
Required production in units
DM required per unit, in pounds
Total DM required, in pounds
Less: Beginning DM inventory
Plus: Desired ending DM inventory
Required DM purchases in pounds
Budgeted DM cost per pound
Budgeted cost of DM
6,300
0.3
1,890
(220)
390
2,060
$4.00
$8,240
Usage Budget = 1,890 pounds * $4 per pound = $7,560
© John Wiley & Sons, 2011
Chapter 10: Static and Flexible Budgets
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 11
Q2: Operating Budget Example
Stanley J’s product uses 0.2 hours of direct labor at a cost of $12/hr.
Prepare the direct labor budget for April.
Direct labor budget
Required production in units
DL required per unit, in hours
Total DL hours required
Budgeted cost per DL hour
Budgeted cost of DL
© John Wiley & Sons, 2011
Chapter 10: Static and Flexible Budgets
Eldenburg & Wolcott’s Cost Management, 2e
6,300
0.2
1,260
$12.00
$15,120
Slide # 12
Q2: Operating Budget Example
Stanley J’s budgeted fixed manufacturing overhead for April is $167,000,
and variable manufacturing overhead is budgeted at $6 per direct labor
hour. Prepare the manufacturing overhead budget for April.
Manufacturing overhead budget
Total DL hours required
Budgeted variable overhead per DL hour
Total budgeted variable overhead
Budgeted fixed overhead
Total budgeted overhead
© John Wiley & Sons, 2011
Chapter 10: Static and Flexible Budgets
Eldenburg & Wolcott’s Cost Management, 2e
1,260
$6.00
$7,560
$167,000
$174,560
Slide # 13
Q2: Operating Budget Example
Assume that Stanley J’s April 1 direct materials inventory had a cost of
$1,560. Prepare the April ending inventories budget for direct materials.
Ending inventories budgets
Budgeted cost of DM purchases
$8,240
Beginning DM inventory
$854
DM available for use
$9,094
Budgeted cost of desired ending DM inventory:
[6,500 units x 0.3 lbs/unit] x 20% x $4/lb
$1,560
Budgeted cost of DM to be used
$7,534
© John Wiley & Sons, 2011
Chapter 10: Static and Flexible Budgets
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 14
Q2: Operating Budget Example
Prepare the April ending inventories budget for finished goods.
Budgeted cost of DM to be used
Budgeted cost of DL
Total budgeted overhead
Total budgeted manufacturing costs
Required production in units
Budgeted manufacturing cost per unit
Budgeted ending FG inventory in units
Budgeted cost of ending FG inventory
© John Wiley & Sons, 2011
Chapter 10: Static and Flexible Budgets
Eldenburg & Wolcott’s Cost Management, 2e
$7,534
$15,120
$174,560
$197,214
6,300
$31.3037
700
$21,913
Slide # 15
Q2: Operating Budget Example
Assume that Stanley J’s April 1 finished goods inventory had a cost of
$12,146. Prepare the cost of goods sold budget for April.
Cost of goods sold budget
Beginning FG inventory
Total budgeted manufacturing costs
Cost of goods available for sale
Less: budgeted ending FG inventory
Budgeted cost of goods sold
© John Wiley & Sons, 2011
Chapter 10: Static and Flexible Budgets
Eldenburg & Wolcott’s Cost Management, 2e
$12,146
$197,214
$209,359
$21,913
$187,447
Slide # 16
Q2: Operating Budget Example
Stanley J’s budget for April includes $22,000 for administrative costs,
$34,000 for fixed distribution costs, $18,000 for research and
development, and $13,000 for fixed marketing costs. Additionally, the
budgeted variable costs for distribution are $0.75/unit sold and the
budgeted variable costs for marketing are 4% of sales revenue. Prepare
the support department budget for April.
Support department budget
Administration
$22,000
Distribution: Fixed costs
$34,000
Variable costs
$4,500 $38,500
Research & development
$18,000
Marketing: Fixed costs
$13,000
Variable costs
$16,320 $29,320
Total budgeted support department costs
$107,820
© John Wiley & Sons, 2011
Chapter 10: Static and Flexible Budgets
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 17
Q2: Operating Budget Example
Suppose that Stanley J’s income tax rate is 28%. Prepare the budgeted
income statement for April.
Budgeted income statement
Sales revenue
Cost of goods sold
Gross margin
Operating costs:
Administration
Distribution
Research & development
Marketing
Net income before taxes
Income taxes
Net income
© John Wiley & Sons, 2011
$408,000
$187,447
$220,553
$22,000
$38,500
$18,000
$29,320 $107,820
$112,733
$31,565
$81,168
Chapter 10: Static and Flexible Budgets
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 18
Q4: Budget Variances
• Managers compare actual results to
budgeted results in order to
• Monitor operations, and
• Motivate appropriate performance.
• Differences between budgeted and
actual results are called budget
variances.
• Variances are stated in absolute value
terms, and labeled as Favorable or
Unfavorable.
© John Wiley & Sons, 2011
Chapter 10: Static and Flexible Budgets
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 19
Q4: Budget Variances
• Reasons for budget variances are
investigated.
• The investigation may find:
• Inefficiencies in actual operations that can
be corrected.
• Efficiencies in actual operations that can be
replicated in other areas of the
organization.
• Uncontrollable outside factors that require
changes to the budgeting process.
© John Wiley & Sons, 2011
Chapter 10: Static and Flexible Budgets
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 20
Q3: Static Budgets
• A budget prepared for a single level of
sales volume is called a static budget.
• Static budgets are prepared at the
beginning of the year.
• Differences between actual results and
the static budget are called static budget
variances.
© John Wiley & Sons, 2011
Chapter 10: Static and Flexible Budgets
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 21
Q3: Flexible Budgets
• A budget prepared for a multiple levels of sales
volume is called a flexible budget.
• Flexible budgets are prepared at the beginning
of the year for planning purposes and at the end
of the year for performance evaluation.
• Flexible budgets are also used for sensitivity
analysis and to manage risk due to uncertainty.
• Differences between actual results and the
flexible budget are called flexible budget
variances.
© John Wiley & Sons, 2011
Chapter 10: Static and Flexible Budgets
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 22
Q3, Q4: Flexible Budget Example
Tina’s Trinkets is preparing a budget for 2006. The budgeted selling price
per unit is $10, and total fixed costs for 2006 are estimated to be $5,000.
Variable costs are budgeted at $3/unit. Prepare a flexible budget for the
volume levels 1,000, 1,100, and 1,200 units.
Sales in units
Revenues
Variable costs
Contribution margin
Fixed costs
Operating income
© John Wiley & Sons, 2011
Volume Levels
1,000
1,100
1,200
$10,000 $11,000 $12,000
$3,000 $3,300 $3,600
$7,000 $7,700 $8,400
$5,000 $5,000 $5,000
$2,000 $2,700 $3,400
Chapter 10: Static and Flexible Budgets
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 23
Q3, Q4: Static Budget Variances Example
Suppose that Tina’s 2006 static budget was for 1,100 units of sales. The
actual results are given below. Compute the static budget variances for
each row and discuss.
Static
Budget
Sales in units
1,100
Revenues
$11,000
$3,300
Variable costs
Contribution margin $7,700
Fixed costs
$5,000
$2,700
Operating income
© John Wiley & Sons, 2011
Static
Actual Budget
Results Variance
980
$9,604 $1,396 Unfavorable
$311 Favorable
$2,989
$6,615 $1,085 Unfavorable
$4,520
$480 Favorable
$605 Unfavorable
$2,095
Chapter 10: Static and Flexible Budgets
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 24
Q3, Q4: Flexible Budget Variances Example
Compute the flexible budget variances for Tina and discuss the results.
Compare the flexible budget variances to the static budget variances on the
prior page.
Year-end
Flexible
Flexible Actual Budget
Budget Results Variance
Sales in units
980
980
Revenues
$9,800 $9,604
$196 Unfavorable
Variable costs
$2,940 $2,989
$49 Unfavorable
Contribution margin $6,860 $6,615
$245 Unfavorable
Fixed costs
$5,000 $4,520
$480 Favorable
Operating income
$1,860 $2,095
$235 Unfavorable
© John Wiley & Sons, 2011
Chapter 10: Static and Flexible Budgets
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 25
Q3, Q4: Performance Evaluation
• A static budget variance includes effects from
output volume.
• A flexible budget variance removes these
output volume effects.
• Other adjustments to the year-end flexible
budget may be made for a fair performance
evaluation, such as
• Input price changes outside the control of the
manager under evaluation
• Fixed cost increases outside the control of the
manager under evaluation
© John Wiley & Sons, 2011
Chapter 10: Static and Flexible Budgets
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 26
Q5: Behavior Tensions in Budgeting
• Budgets used to evaluate performance and
compensation can create behavioral tension
• Participative budgeting – when managers who are
responsible for the budgets prepare the budget
forecasts
– Can result in budgetary slack – when managers set
targets so low that goals can be met easily (and bonuses
achieved)
• Budget ratcheting – when top managers set targets
– If targets unachievable, this can result in employees
having little motivation to meet targets
• Organizations must watch for budget manipulation
© John Wiley & Sons, 2011
Chapter 10: Static and Flexible Budgets
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 27
Q6: Other Budgeting Approaches
• Zero based budgets are prepared without using
past information as justification.
• Rolling budgets are prepared frequently for
overlapping time periods and actual results may be
used to update the budget for the next period.
• Kaizen budgets plan cost reductions over time.
• Activity based budgets use more cost pools and
cost drivers.
• GPK and RCA budgets identify fixed and variable
cost functions at the resource center level.
• Beyond budgeting uses external benchmarks to
evaluate managers’ performance
© John Wiley & Sons, 2011
Chapter 10: Static and Flexible Budgets
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 28
Q5: Comparison of ABC, GPK, and RCA
ABC
GPK
RCA
Character of cost
accounting system
Full costing
Marginal costing
Full and marginal
costing
Location of data
Database separate
from general ledger
Comprehensive
accounting system
Comprehensive
accounting system
Primary decision
relevance
Mid- to long-term
Short-term
Short-, Mid-, and
Long term
Allocation of
overhead based on
Activities
Cost Centers
Resources and/or
activities
Cost Drivers
Activity –Based
Resource Output
related
Resource output or
activity related
Fixed cost
allocation rate
denominator
Actual, budgeted,
or practical
capacity
Budgeted or
practical capacity
Theoretical
capacity
© John Wiley & Sons, 2011
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 26
Q6: Decision Making with ABC, GPK, and RCA
• Benefits
• more accurate and relevant product cost information
• employees focus attention on activities
• measurement of the costs of activities and business
processes
• identify non-value-added activities and reduce costs
• Costs
• systems can be difficult to design and maintain
• more information must be captured
• decision makers may not use the information
appropriately
© John Wiley & Sons, 2011
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 27
Q6: Uncertainties in ABC and ABM
Implementation
• Judgment is required when determining
activities.
• Judgment is required when selecting cost
drivers.
• Denominator levels for cost drivers are
estimates.
• ABC information includes unitized fixed
costs, so decision makers must use ABC
information correctly.
© John Wiley & Sons, 2011
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 28
Cost Management
Measuring, Monitoring, and Motivating Performance
Chapter 8
Measuring and Assigning Support
Department Costs
© John Wiley & Sons, 2011
Chapter 8: Measuring and Assigning Support Department Costs
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 1
Chapter 8: Measuring and Assigning Support
Department Costs
Learning objectives
•
•
•
•
•
•
•
Q1: What are support departments, and why are their costs
allocated to other departments?
Q2: What process is used to allocate support department costs?
Q3: How is the direct method used to allocate support costs to
operating departments?
Q4: How is the step-down method used to allocate support costs
to operating departments?
Q5: How is the reciprocal method used to allocate support costs to
operating departments?
Q6: What is the difference between single- and dual-rate
allocations?
Q7: How do support cost allocations affect decisions and
managerial incentives?
© John Wiley & Sons, 2011
Chapter 8: Measuring and Assigning Support Department Costs
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 2
Q1: Support versus Operating Departments
• The operating departments of an organization
produce products or services that generate
revenue.
• The support departments of an organization
produce products or provide services to the
operating and other support departments.
• The support department costs are common
costs that are shared between two or more
other departments.
© John Wiley & Sons, 2011
Chapter 8: Measuring and Assigning Support Department Costs
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 3
Q1: Reasons for Allocating Support
Department Costs
• External reporting
• Motivation
• appropriate consumption of support
department resources
• efficiency of support department
• monitor consumption of support
department services
• Decision making
• product pricing
• make or buy decisions
© John Wiley & Sons, 2011
Chapter 8: Measuring and Assigning Support Department Costs
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 4
Q1: Support Department Allocation Process
© John Wiley & Sons, 2011
Chapter 8: Measuring and Assigning Support Department Costs
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 5
Q2: Process for Allocating Support
Department Costs
1. Clarify allocation purpose
2. Identify cost pools
3. Assign costs to cost pools
4. Choose allocation bases for each cost pool
5. Choose allocation method; allocate support
department costs
6. Allocate updated operating department costs to
units of goods or services, if relevant
© John Wiley & Sons, 2011
Chapter 8: Measuring and Assigning Support Department Costs
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 6
Q2: Process for Allocating Support
Department Costs
1. Clarify allocation purpose
•
if the purpose is to motivate the use of the services
of a newly formed department, perhaps no costs
should be allocated
•
if the purpose is to discourage operating department
managers from over-use of the services of support
departments, then a rate per unit of service might be
large and not based on actual costs
•
if the purpose is to determine the full cost of products
or services for long-term pricing decisions, then all
support costs should be allocated
© John Wiley & Sons, 2011
Chapter 8: Measuring and Assigning Support Department Costs
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 7
Q2: Process for Allocating Support
Department Costs
2. Identify cost pools
• the purpose will determine whether both fixed
and variable support department costs
should be allocated
• the purpose will determine which costs
should be allocated
© John Wiley & Sons, 2011
Chapter 8: Measuring and Assigning Support Department Costs
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 8
Q2: Process for Allocating Support
Department Costs
3. Assign costs to cost pools
• some costs will be direct to the cost pool
(e.g. toner cartridge costs would be direct to
the “variable copying costs” cost pool)
• some costs will be indirect to the cost pool
(e.g. rent costs for an entire facility would be
indirect to the “information technology costs”
cost pool)
© John Wiley & Sons, 2011
Chapter 8: Measuring and Assigning Support Department Costs
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 9
Q2: Process for Allocating Support
Department Costs
4. Choose allocation bases for each cost pool
• an allocation base with a good cause-andeffect relationship with the cost pool provides
a reasonable allocation rate
• users of support department services will
carefully monitor their consumption of the
allocation base
© John Wiley & Sons, 2011
Chapter 8: Measuring and Assigning Support Department Costs
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 10
Q2: Process for Allocating Support
Department Costs
5. Choose allocation method and allocate support
department costs
• in this chapter we cover three allocation
methods
• each of these three methods could be
implemented using
• a single- or dual-rate approach (covered later)
• actual or budgeted costs and allocation bases
(covered later)
© John Wiley & Sons, 2011
Chapter 8: Measuring and Assigning Support Department Costs
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 11
Q2: Process for Allocating Support
Department Costs
6. Allocate updated operating department costs to
units of goods or services, if relevant
• for some decisions, this may not be relevant
• for long-term pricing decisions, this is likely to
be relevant
© John Wiley & Sons, 2011
Chapter 8: Measuring and Assigning Support Department Costs
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 12
Q3: The Direct Method of Allocating
Support Department Costs
• The direct method ignores the fact that
support departments use each others’
services.
• Each support department’s costs are
allocated only to operating departments.
• This method is the easiest
computationally and the easiest to
explain.
© John Wiley & Sons, 2011
Chapter 8: Measuring and Assigning Support Department Costs
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 13
Q3: The Direct Method Example
Philco Toys makes metal and plastic toys in separate departments. It has
two support departments, Accounting and Information Systems. Philco has
decided to allocate Accounting department costs based on the number of
employees in each department and Information Systems costs based on
the number of computers in each department. Given the information below,
use the direct method to allocate support department costs.
Support Dep’ts
Total department costs
Number of employees
Number of computers
Operating Departments
AccInfo
Plastic
Metal
ounting Systems Products
Products
Total
$48,000 $72,000 $386,000 $182,000 $688,000
3
4
22
16
45
4
6
3
3
16
Allocate costs:
Accounting
(48,000)
Information Systems
Totals
© John Wiley & Sons, 2011
$0
27,789
20,211
$0
(72,000)
36,000
36,000
$0
$0
$449,789
$238,211
$688,000
Chapter 8: Measuring and Assigning Support Department Costs
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 14
Q3: The Direct Method Example
Plastic Products is allocated
Plastic and Metal Product share
22/(22+16) of Accounting
Info Systems costs equally
department costs, and Metal
because they have the same
Products is allocated
number of computers in each
16/(22+16). Notice that the
department. Notice that the
number of employees in the
number of computers in the
support departments is ignored
departments
is ignored
Support Dep’ts support
Operating
Departments
under the direct method.
under the direct method.
Total department costs
Number of employees
Number of computers
AccInfo
Plastic
Metal
ounting Systems Products
Products
Total
$48,000 $72,000 $386,000 $182,000 $688,000
3
4
22
16
45
4
6
3
3
16
Allocate costs:
Accounting
(48,000)
Information Systems
Totals
© John Wiley & Sons, 2011
$0
27,789
20,211
$0
(72,000)
36,000
36,000
$0
$0
$449,789
$238,211
$688,000
Chapter 8: Measuring and Assigning Support Department Costs
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 15
Q4: The Step-Down Method of Allocating
Support Department Costs
• The step-down method allocates some (but not all)
support department costs to other support
departments.
• The first support department’s costs are allocated
to all operating and support departments that use
its services.
• 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.
• Allocation order must be determined.
© John Wiley & Sons, 2011
Chapter 8: Measuring and Assigning Support Department Costs
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 16
Q4: The Step-Down Method Example
Given the information for Philco, use the step-down method to allocate
support department costs. Allocate the costs of the support department that
provides the largest percentage of its services to the other support
department first.
First determine
allocation order:
Accounting provided 4/(4+22+16) = 4/42
= 9.5% of its services to Info Systems.
Information Systems provided 4/(4+3+3) = 4/10 = 40% of its
services to Accounting, so Information Systems goes first.
Support Dep’ts
Total department costs
Number of employees
Number of computers
© John Wiley & Sons, 2011
Operating Departments
AccInfo
Plastic
Metal
ounting Systems Products
Products
Total
$48,000 $72,000 $386,000 $182,000 $688,000
3
4
22
16
45
4
6
3
3
16
Chapter 8: Measuring and Assigning Support Department Costs
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 17
Q4: The Step-Down Method Example
Given the information for Philco, use the step-down method to allocate
support department costs.
Now perform the allocation:
Support Dep’ts
Total department costs
Number of employees
Number of computers
Operating Departments
Metal
Plastic
Info
AccTotal
Products
ounting Systems Products
$48,000 $72,000 $386,000 $182,000 $688,000
45
16
22
4
3
16
3
3
6
4
Allocate costs:
Accounting
(76,800)
(48,000)
Information Systems
28,800
$0
Totals
© John Wiley & Sons, 2011
44,463
27,789
32,337
20,211
$0
$0
(72,000)
21,600
21,600
21,600
$0
$0
$0
$435,389
$452,063
$223,811
$235,937
$659,200
$688,000
Chapter 8: Measuring and Assigning Support Department Costs
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 18
Q4: The Step-Down Method Example
Info Systems costs are allocated
to Accounting, Plastic, & Metal
based on each department’s
number of computers compared
to total non-Info Systems
Support Dep’ts
computers: 4+3+3=10.
Total department costs
Number of employees
Number of computers
Accounting costs are allocated
only to Plastic & Metal based on
each department’s number of
employees compared to total
non-Accounting and non-Info
Operatingemployees:
Departments
Systems
22+16=38
AccInfo
Plastic
Metal
ounting Systems Products
Products
Total
$48,000 $72,000 $386,000 $182,000 $688,000
3
4
22
16
45
4
6
3
3
16
Allocate costs:
Accounting
(76,800)
Information Systems
28,800
$0
Totals
44,463
32,337
$0
(72,000)
21,600
21,600
$0
$0
$452,063
$235,937
$688,000
Total costs allocated out of Accounting are now higher because of
the Info Systems costs allocated to Accounting.
© John Wiley & Sons, 2011
Chapter 8: Measuring and Assigning Support Department Costs
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 19
Q4: The Step-Down Method Example
(22/38) x $76,800
(4/10) x $72,000
(16/38) x $76,800
(3/10) x $72,000
Support Dep’ts
Total department costs
Number of employees
Number of computers
(3/10) x $72,000
Operating Departments
AccInfo
Plastic
Metal
ounting Systems Products
Products
Total
$48,000 $72,000 $386,000 $182,000 $688,000
3
4
22
16
45
4
6
3
3
16
Allocate costs:
Accounting
(76,800)
Information Systems
28,800
$0
Totals
© John Wiley & Sons, 2011
44,463
32,337
$0
(72,000)
21,600
21,600
$0
$0
$452,063
$235,937
$688,000
Chapter 8: Measuring and Assigning Support Department Costs
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 20
Q5: The Reciprocal Method of Allocating
Support Department Costs
• The reciprocal method allocates all support
department costs to other support
departments.
• The first step is to compute the total costs of
each support department when its usage of
other support department services is taken
into consideration.
• Support department costs are then allocated
to all other operating and support
departments that consume its services.
© John Wiley & Sons, 2011
Chapter 8: Measuring and Assigning Support Department Costs
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 21
Q5: The Reciprocal Method Example
Given the information for Philco, use the reciprocal method to allocate
support department costs.
First determine total costs for each support department by writing an equation for its
costs (use A and IS as abbreviations).
A = $48,000 + [4/(4+3+3)] x IS; IS = $72,000 + [4/(4+22+16)] x A
Then solve: A = $48,000 + (4/10) x [$72,000 + (4/42) x A]
A = $48,000 + $28,800 + (16/420) x A]
(404/420) x A = $76,800
A = $76,800 x (420/404) = $79,842
IS = $72,000 + (4/42) x $79,842 = $79,604
Support Dep’ts
Total department costs
Number of employees
Number of computers
© John Wiley & Sons, 2011
Operating Departments
AccInfo
Plastic
Metal
ounting Systems Products
Products
Total
$48,000 $72,000 $386,000 $182,000 $688,000
3
4
22
16
45
4
6
3
3
16
Chapter 8: Measuring and Assigning Support Department Costs
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 22
Q5: The Reciprocal Method Example
Given the information for Philco, use the reciprocal method to allocate
support department costs.
Now perform the allocation:
Support Dep’ts
Total department costs
Number of employees
Number of computers
Operating Departments
AccInfo
Plastic
Metal
ounting Systems Products
Products
Total
$48,000 $72,000 $386,000 $182,000 $688,000
3
4
22
16
45
4
6
3
3
16
Allocate costs:
Accounting
Information Systems
Totals
© John Wiley & Sons, 2011
(79,842)
7,604
41,822
(79,842)
7,604
41,822
31,842 (79,604)
(79,604)
23,881
31,842
23,881
$0
$0 $451,703
$451,703
$0
$0
Chapter 8: Measuring and Assigning Support Department Costs
Eldenburg & Wolcott’s Cost Management, 2e
30,416
30,416
23,881
23,881
$0
$0
$236,297
$236,297
$688,000
Slide # 23
Q5: The Reciprocal Method Example
These numbers are the
solutions to the
simultaneous equations.
(4/42) x $79,842
(22/42) x $79,842
(16/42) x $79,842
Support Dep’ts
Total department costs
Number of employees
Number of computers
Operating Departments
AccInfo
Plastic
Metal
ounting Systems Products
Products
Total
$48,000 $72,000 $386,000 $182,000 $688,000
3
4
22
16
45
4
6
3
3
16
Allocate costs:
Accounting
Information Systems
Totals
© John Wiley & Sons, 2011
(79,842)
7,604
41,822
(79,842)
7,604
41,822
31,842 (79,604)
(79,604)
23,881
31,842
23,881
$0
$0 $451,703
$451,703
$0
$0
Chapter 8: Measuring and Assigning Support Department Costs
Eldenburg & Wolcott’s Cost Management, 2e
30,416
30,416
23,881
23,881
$0
$0
$236,297
$236,297
$688,000
Slide # 24
Q5: The Reciprocal Method Example
(4/10) x $79,604
(3/10) x $79,604
(3/10) x $79,604
Support Dep’ts
Total department costs
Number of employees
Number of computers
Operating Departments
AccInfo
Plastic
Metal
ounting Systems Products
Products
Total
$48,000 $72,000 $386,000 $182,000 $688,000
3
4
22
16
45
4
6
3
3
16
Allocate costs:
Accounting
Information Systems
Totals
© John Wiley & Sons, 2011
(79,842)
7,604
41,822
(79,842)
7,604
41,822
31,842 (79,604)
(79,604)
23,881
31,842
23,881
$0
$0 $451,703
$451,703
$0
$0
Chapter 8: Measuring and Assigning Support Department Costs
Eldenburg & Wolcott’s Cost Management, 2e
30,416
30,416
23,881
23,881
$0
$0
$236,297
$236,297
$688,000
Slide # 25
Q6: Single- versus Dual-Rate Allocation
• In single-rate allocation, each cost pool
includes fixed and variable costs.
• In dual-rate allocation, fixed and variable
costs are in separate cost pools.
• Both methods can be employed with the
direct, step-down, or reciprocal methods.
• The prior three examples used the singlerate allocation method.
© John Wiley & Sons, 2011
Chapter 8: Measuring and Assigning Support Department Costs
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 26
Q6: Single- versus Dual-Rate Example
Philco has decided to use the direct method and allocate variable
Accounting costs based on the number of transactions and fixed
Accounting costs based on the number of employees. The Info Systems
variable costs will be allocated based on the number of service requests
and fixed costs will be allocated based on the number of computers. The
required information is presented below.
Support Dep’ts
Total department variable costs
Total department fixed costs
Number of transactions
Number of employees
Number of service requests
Number of computers
Operating Departments
AccInfo
Plastic
Metal
ounting Systems Products
Products
$20,000 $22,000 $186,000 $100,000
$28,000 $50,000 $200,000
$82,000
20
32
140
86
3
4
22
16
18
5
12
8
4
6
3
3
Now perform the allocation…
© John Wiley & Sons, 2011
Chapter 8: Measuring and Assigning Support Department Costs
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 27
Q6: Single- versus Dual-Rate Example
Total department variable costs
Total department fixed costs
Number of transactions
Number of employees
Number of service requests
Number of computers
Support Dep’ts
Operating Departments
AccInfo
Plastic
Metal
ounting Systems Products
Products
$20,000 $22,000 $186,000 $100,000
$28,000 $50,000 $200,000
$82,000
20
32
140
86
3
4
22
16
18
5
12
8
4
6
3
3
Allocate variable costs:
Accounting
(20,000)
12,389
7,611
(22,000)
13,200
8,800
$0
$211,589
$116,411
$0
(50,000)
$0
16,211
25,000
$241,211
11,789
25,000
$118,789
$0
$0
$452,800
$235,200
Information Systems
Total variable costs
Allocate fixed costs:
Accounting
Information Systems
Total fixed costs
Total fixed and variable costs
© John Wiley & Sons, 2011
$0
(28,000)
Chapter 8: Measuring and Assigning Support Department Costs
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 28
Q7: Decision Making with Support Costs
• Support costs need to be considered when
evaluating decisions such as make/buy, keep/drop,
special order, and constrained resource
• Necessary to isolate relevant support costs
– This may not be the same as the allocated support costs
– For example, outsourcing an operating department may
not result in a reduction in support department costs
© John Wiley & Sons, 2011
Chapter 8: Measuring and Assigning Support Department Costs
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 29
Q7: Establishing Transfer Prices for
Support Departments
• Transfer prices should be set to motivate efficient
use of the support department resources
– If transfer price is set too high, user departments may
outsource the service
– If transfer price is set too low, user departments may
utilize the support department inefficiently
• The best transfer pricing approach is the
Opportunity Cost approach
– Each department is charged an amount that reflects the
value of any opportunities forgone by not using the
service for its next best alternative use.
– This is often difficult in practice so most companies us…

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