212 PART ONE MANAGEMENT ACCOUNTING, INFORMATION AND DECISONS
212 PART ONE MANAGEMENT ACCOUNTING, INFORMATION AND DECISONS
Note th at th e total cost of th e reven u e-produ cin g departm en ts after allocation , $1,474,385 + $568,596 + $2,957,019 = $5,000,000, is equ al to th e total of th e direct departm en t costs in all six departm en ts before allocation .
2. Th e step-down m eth od is sh own in th e lower h alf of Exh ibit 5-11. Th e costs of Adm in istrative an d Fiscal Services are allocated to all five oth er departm en ts. Becau se a departm en t’s own costs are n ot allocated to itself, th e cost driver con sists of th e $4,000,000 direct departm en t costs in th e five departm en ts exclu din g Adm in istrative an d Fiscal Services.
Plan t Operation s an d Main ten an ce is allocated secon d on th e basis of squ are m etres occu pied. No cost will be allocated to itself or back to Adm in istrative an d Fiscal Services. Th erefore, th e squ are m etres u sed for allocation is th e 100,000 squ are m etres occu pied by th e oth er fou r departm en ts.
Lau n dry is allocated th ird. No cost wou ld be allocated back to th e first two departm en ts, even if th ey h ad u sed lau n dry services.
As in th e direct m eth od, n ote th at th e total costs of th e reven u e-produ cin g departm en ts after allocation , $1,430,000 + $545,000 + $3,025,000 = $5,000,000, equ al th e total of th e direct departm en t costs before allocation .
3. Th e solu tion s are labelled 3a an d 3b in Exh ibit 5-11. Com pare th e u n it costs derived from th e direct m eth od with th ose of th e step-down m eth od. In m an y in stan ces, th e fin al produ ct costs m ay n ot differ en ou gh to warran t in vestin g in a cost-allocation m eth od th at is an y fan cier th an th e direct m eth od. Bu t som etim es even sm all differen ces m ay be sign ifican t to a govern m en t agen cy or an ybody payin g for a large volu m e of services based on costs. For exam ple, in Exh ibit 5-11, th e “cost” of an “average” laboratory test is eith er $11.37 or $10.90. Th is m ay be sign ifican t for th e fiscal com m ittee of th e h ospital’s board of tru stees, wh o m u st decide on h ospital prices. Th u s cost allocation is often a tech n iqu e th at h elps an swer th e vital qu estion , “Wh o sh ou ld pay for wh at, an d h ow m u ch ?”
Problem Two
Last year, TCY Company’s demand for product H17 was 14,000 units. At a recent meeting, the sales manager asked the controller about the expected cost for the sales-order activity for the current year. A new ABC system had been installed, and the controller had provided the sketch of the order-processing activity to the sales manager (see Exhibit 5-12). The sales manager wanted to know how the order- processing activity affects costs. The average sales order is for 20 units. The order- processing activity shown in Exhibit 5-12 requires a computer, processing labour, and telecommunications. The computer is leased at a cost of $2,000 per period. Salaries are $7,000, and telecommunication charges are $1.60 per minute.
1. How m an y labou r h ou rs does it take to process each order? How m u ch telecom m u n ication tim e does each order take?
2. Wh at is th e total cost form u la for th e order processin g activity? Wh at is th e total an d u n it cost for dem an d of 14,000 u n its?
3. Th e sales m an ager calcu lated th e cost per order to be $32.06 based on th e expected dem an d of 14,000 u n its of H17. Becau se h e believed th at
Chapter 5 Cost Allocation and Activity-Based Costing Systems
Solution
1. It takes .1 h ou rs or 6 m in u tes of labou r tim e an d 12 m in u tes of telecom m u n ication s tim e to process an order.
2. Th e total cost form u la for order processin g activity is: Total Cost = Fixed Costs + Variable Costs
= Lease Cost + Labour Cost + Telecom. cost/min. × min./order × no. of orders = $2,000 + $7,000 + $1.60 × 12 × Nu m ber of Orders
= $9,000 + $19.20 × Nu m ber of Orders
For 14,000 u n its, th ere will be 700 orders processed. Th e total cost to process th ese orders is:
Total Cost = $9,000 + ($19.20 × 700) = $22,440 an d th e u n it cost is
3. Th e sales m an ager h as fallen in to th e trap of ign orin g cost beh aviou r. His calcu lation assu m es th at u n it fixed costs will n ot ch an ge with
ch an ges in dem an d or th e cost driver. Th e correct prediction of total cost for a dem an d of 12,000 u n its (or 600 orders) is:
Total Cost = $9,000 + $19.20 × 600 = $20,520 Th is problem illu strates wh y it is im portan t to take cost beh aviou r in to con -
sideration wh en u sin g an y costin g system for plan n in g pu rposes.
TCY’s Order-Processing
Activity Salaries = $7,000
Lease cost = $2,000
Cost per minute = $1.60
COST DRIVER =
COST DRIVER =
COST DRIVER =
NO. OF TRANSACTION
LABOUR HOURS
ORDER PROCESSING
Fixed-Cost Resource
COST DRIVER = NO. OF ORDERS
Variable-Cost Resource Cost Object
Product H17
Other Products
r 14,000 Units Consumption Rate