Management_Accounting_Information_for_Creating_and..._----_(Pg_296--321).pdf

Copyright © 2021. McGraw-Hill Education (Australia) Pty Limited. All rights reserved. Langfield-Smith, Kim, et al. Management Accounting : Information for Creating and Managing Value, McGraw-Hill Education (Australia) Pty Limited, 20...

Copyright © 2021. McGraw-Hill Education (Australia) Pty Limited. All rights reserved. Langfield-Smith, Kim, et al. Management Accounting : Information for Creating and Managing Value, McGraw-Hill Education (Australia) Pty Limited, 2021. ProQuest Ebook Central, http://ebookcentral.proquest.com/lib/curtin/detail.action?docID=6736469. Created from curtin on 2024-08-30 05:06:16. Copyright © 2021. McGraw-Hill Education (Australia) Pty Limited. All rights reserved. Langfield-Smith, Kim, et al. Management Accounting : Information for Creating and Managing Value, McGraw-Hill Education (Australia) Pty Limited, 2021. ProQuest Ebook Central, http://ebookcentral.proquest.com/lib/curtin/detail.action?docID=6736469. Created from curtin on 2024-08-30 05:06:16. Copyright © 2021. McGraw-Hill Education (Australia) Pty Limited. All rights reserved. Langfield-Smith, Kim, et al. Management Accounting : Information for Creating and Managing Value, McGraw-Hill Education (Australia) Pty Limited, 2021. ProQuest Ebook Central, http://ebookcentral.proquest.com/lib/curtin/detail.action?docID=6736469. Created from curtin on 2024-08-30 05:06:16. Copyright © 2021. McGraw-Hill Education (Australia) Pty Limited. All rights reserved. Langfield-Smith, Kim, et al. Management Accounting : Information for Creating and Managing Value, McGraw-Hill Education (Australia) Pty Limited, 2021. ProQuest Ebook Central, http://ebookcentral.proquest.com/lib/curtin/detail.action?docID=6736469. Created from curtin on 2024-08-30 05:06:16. Copyright © 2021. McGraw-Hill Education (Australia) Pty Limited. All rights reserved. Langfield-Smith, Kim, et al. Management Accounting : Information for Creating and Managing Value, McGraw-Hill Education (Australia) Pty Limited, 2021. ProQuest Ebook Central, http://ebookcentral.proquest.com/lib/curtin/detail.action?docID=6736469. Created from curtin on 2024-08-30 05:06:16. Copyright © 2021. McGraw-Hill Education (Australia) Pty Limited. All rights reserved. Langfield-Smith, Kim, et al. Management Accounting : Information for Creating and Managing Value, McGraw-Hill Education (Australia) Pty Limited, 2021. ProQuest Ebook Central, http://ebookcentral.proquest.com/lib/curtin/detail.action?docID=6736469. Created from curtin on 2024-08-30 05:06:16. Copyright © 2021. McGraw-Hill Education (Australia) Pty Limited. All rights reserved. Langfield-Smith, Kim, et al. Management Accounting : Information for Creating and Managing Value, McGraw-Hill Education (Australia) Pty Limited, 2021. ProQuest Ebook Central, http://ebookcentral.proquest.com/lib/curtin/detail.action?docID=6736469. Created from curtin on 2024-08-30 05:06:16. Copyright © 2021. McGraw-Hill Education (Australia) Pty Limited. All rights reserved. Langfield-Smith, Kim, et al. Management Accounting : Information for Creating and Managing Value, McGraw-Hill Education (Australia) Pty Limited, 2021. ProQuest Ebook Central, http://ebookcentral.proquest.com/lib/curtin/detail.action?docID=6736469. Created from curtin on 2024-08-30 05:06:16. Copyright © 2021. McGraw-Hill Education (Australia) Pty Limited. All rights reserved. Langfield-Smith, Kim, et al. Management Accounting : Information for Creating and Managing Value, McGraw-Hill Education (Australia) Pty Limited, 2021. ProQuest Ebook Central, http://ebookcentral.proquest.com/lib/curtin/detail.action?docID=6736469. Created from curtin on 2024-08-30 05:06:16. Copyright © 2021. McGraw-Hill Education (Australia) Pty Limited. All rights reserved. Langfield-Smith, Kim, et al. Management Accounting : Information for Creating and Managing Value, McGraw-Hill Education (Australia) Pty Limited, 2021. ProQuest Ebook Central, http://ebookcentral.proquest.com/lib/curtin/detail.action?docID=6736469. Created from curtin on 2024-08-30 05:06:16. Copyright © 2021. McGraw-Hill Education (Australia) Pty Limited. All rights reserved. Langfield-Smith, Kim, et al. Management Accounting : Information for Creating and Managing Value, McGraw-Hill Education (Australia) Pty Limited, 2021. ProQuest Ebook Central, http://ebookcentral.proquest.com/lib/curtin/detail.action?docID=6736469. Created from curtin on 2024-08-30 05:06:16. Copyright © 2021. McGraw-Hill Education (Australia) Pty Limited. All rights reserved. Langfield-Smith, Kim, et al. Management Accounting : Information for Creating and Managing Value, McGraw-Hill Education (Australia) Pty Limited, 2021. ProQuest Ebook Central, http://ebookcentral.proquest.com/lib/curtin/detail.action?docID=6736469. Created from curtin on 2024-08-30 05:06:16. Copyright © 2021. McGraw-Hill Education (Australia) Pty Limited. All rights reserved. Langfield-Smith, Kim, et al. Management Accounting : Information for Creating and Managing Value, McGraw-Hill Education (Australia) Pty Limited, 2021. ProQuest Ebook Central, http://ebookcentral.proquest.com/lib/curtin/detail.action?docID=6736469. Created from curtin on 2024-08-30 05:06:16. Copyright © 2021. McGraw-Hill Education (Australia) Pty Limited. All rights reserved. Langfield-Smith, Kim, et al. Management Accounting : Information for Creating and Managing Value, McGraw-Hill Education (Australia) Pty Limited, 2021. ProQuest Ebook Central, http://ebookcentral.proquest.com/lib/curtin/detail.action?docID=6736469. Created from curtin on 2024-08-30 05:06:16. Copyright © 2021. McGraw-Hill Education (Australia) Pty Limited. All rights reserved. Langfield-Smith, Kim, et al. Management Accounting : Information for Creating and Managing Value, McGraw-Hill Education (Australia) Pty Limited, 2021. ProQuest Ebook Central, http://ebookcentral.proquest.com/lib/curtin/detail.action?docID=6736469. Created from curtin on 2024-08-30 05:06:16. Copyright © 2021. McGraw-Hill Education (Australia) Pty Limited. All rights reserved. Langfield-Smith, Kim, et al. Management Accounting : Information for Creating and Managing Value, McGraw-Hill Education (Australia) Pty Limited, 2021. ProQuest Ebook Central, http://ebookcentral.proquest.com/lib/curtin/detail.action?docID=6736469. Created from curtin on 2024-08-30 05:06:16.  CHAPTER 7 A closer look at overhead costs 293 Allocating indirect costs to responsibility centres Let’s now consider the allocation of indirect costs to responsibility centres. In large businesses there may be several levels of cost allocation: At the corporate level. Some head office costs are allocated to business units (operating subsidiaries or LO 7.9 divisions). Within business units. Administrative costs of business units may be allocated to operating units. In the manufacturing plant. Indirect manufacturing costs may be allocated to the production departments. Reasons for allocating indirect costs to responsibility centres There are three main reasons for allocating indirect costs to responsibility centres: 1. To help managers understand the economic effects of their decisions. Allocating costs to responsibility centres helps the managers of the responsibility centres to be more aware of the effect of their actions on the organisation’s costs. For example, allocating some of a hotel’s electricity costs to its recreational department will assist the manager of that department to be more conscious of the economic effects of his or her actions. The amount of electricity charged to the recreational department will increase if the manager raises the temperature in the heated swimming pools or makes greater use of the floodlights on the tennis courts. 2. To encourage a particular pattern of resource usage. Organisations may allocate costs to encourage desired behaviour. For example, some head offices allocate part of their interest costs to individual responsibility centres, based on the centres’ usage of scarce funds. This encourages managers to manage their spending more effectively. On the other hand, some costs may not be allocated in order to encourage a greater use of a service. For example, if corporate management want to encourage their divisions to seek advice from the new cost management team, they may not charge divisions for using the service during the first year. 3. To support the product costing system. Some product costing systems assign overhead costs using overhead rates for each production department. Before these rates can be calculated, it is necessary to allocate any indirect factory costs to these production departments. This process involves support department cost allocation, which is described later in this chapter. Copyright © 2021. McGraw-Hill Education (Australia) Pty Limited. All rights reserved. Principles for allocating indirect costs to responsibility centres The general principles for allocating indirect costs to cost objects, described earlier, apply here. Direct costs can be traced to responsibility centres, but indirect costs must be allocated using cost pools and appropriate allocation bases. Ideally, the allocation bases will be cost drivers, where there is a clear and direct relationship between the amount of cost driver and the level of cost. Where cost drivers cannot be determined, some organisations use other criteria. Costs may be allocated to departments according to the benefits received. It may be felt, for example, that a company-wide advertising campaign provides more benefit to the retail departments of a company than to the administrative departments, and so the retail departments are allocated a greater share of the cost of the campaign. Cost allocation may also be guided by the centre’s ability to bear the additional costs. For example, corporate managers’ salaries may be allocated to operating divisions based on the relative sizes of the divisions’ sales or profits. The division with the largest profits would receive the largest share of the senior managers’ salaries as it is more able to absorb those costs than is a division with low profits. Using allocation bases that are not cost drivers is something that needs to be handled with extreme caution. If the purpose of the cost allocation is to obtain a reliable estimate of product costs or to help managers understand the economic effects of decisions, then cost drivers should be used as allocation bases. If the purpose is to encourage a particular pattern of resource usage, then other allocation bases may be appropriate. Langfield-Smith, Kim, et al. Management Accounting : Information for Creating and Managing Value, McGraw-Hill Education (Australia) Pty Limited, 2021. ProQuest Ebook Central, http://ebookcentral.proquest.com/lib/curtin/detail.action?docID=6736469. Created from curtin on 2024-08-30 05:06:16.  294 PART 2 Costs and costing systems Using budgeted, not actual, allocation data In allocating indirect costs to responsibility centres, it is better to use budgeted amounts of the relevant allocation bases and budgeted costs for two main reasons: 1. to minimise the possibility that the activities of one department will affect the costs allocated to other departments 2. to provide better information for managers to plan and control their use of indirect resources. Minimising the effects of one department on the performance of another Using actual amounts of an allocation base or actual costs can cause the activities of one department to impact on the results of other departments. This may cause problems because the costs may be used to evaluate the performance of the department or its manager, and managers should not be held accountable for costs over which they have no control. If actual amounts of an allocation base are used to allocate costs, the use of the allocation base by one department will affect the costs allocated to other departments. Consider the example of allocating the costs of a computer department in a bank to the departments that use its services, using the actual amount of computer processing time as the allocation base. Assume that during the year, the tellers’ department reduced its use of processing time, while there were no changes in the other departments. The costs allocated to the tellers’ department would decrease but the fixed costs of the computer department would not change. Each of the other departments would be allocated a larger share of fixed costs even though their usage of computer processing had not changed and even though their managers had no control over these costs. This problem is best addressed by allocating fixed costs separately from variable costs, using longer-term estimates of allocation bases. If actual amounts of cost are allocated from a department, the efficiencies or inefficiencies of that department will affect the results of other departments. For example, if allocations were based on actual costs and the actual cost of the computer department rose above the budgeted amount, then the amount allocated to each user department would increase. These increased costs are not controllable by the managers of the user departments. Also, if budgeted rates are used there is an incentive for the computer department to manage its costs carefully, because if its costs exceed budget it does not have the flexibility to charge those cost increases to user departments. Providing better information for planning Copyright © 2021. McGraw-Hill Education (Australia) Pty Limited. All rights reserved. Knowing budgeted rates in advance allows the user departments to plan their activities with greater certainty. For example, if the managers of the user departments in the bank know that the computer department costs are to be allocated at a budgeted rate per minute of processing time, then they can manage allocated computer costs by carefully controlling their use of computer time. Allocating support department costs A common situation where the management accountant allocates indirect costs to responsibility centres is the allocation of support department costs to user departments. This process informs user department managers of the costs of the services provided by the support departments, which helps them to plan LO 7.10 and control their use of services. The same process can be used to allocate support department costs to production departments, to calculate departmental overhead rates for product costing. Support department costs and services at Hot Exhausts Ltd We will continue with the example of Hot Exhausts Ltd (HEL) to illustrate support department cost allocation. At this stage you may find it useful to return to ­Exhibit 7.5, which illustrates the two-stage process used to allocate overhead costs to products via departmental rates. Stage one involves two steps: first, overhead costs are distributed to all departments, and then the support department costs are allocated to production departments. At the end of Stage one, we obtain estimates of the overhead cost for each Langfield-Smith, Kim, et al. Management Accounting : Information for Creating and Managing Value, McGraw-Hill Education (Australia) Pty Limited, 2021. ProQuest Ebook Central, http://ebookcentral.proquest.com/lib/curtin/detail.action?docID=6736469. Created from curtin on 2024-08-30 05:06:16. Copyright © 2021. McGraw-Hill Education (Australia) Pty Limited. All rights reserved. Langfield-Smith, Kim, et al. Management Accounting : Information for Creating and Managing Value, McGraw-Hill Education (Australia) Pty Limited, 2021. ProQuest Ebook Central, http://ebookcentral.proquest.com/lib/curtin/detail.action?docID=6736469. Created from curtin on 2024-08-30 05:06:16. Copyright © 2021. McGraw-Hill Education (Australia) Pty Limited. All rights reserved. Langfield-Smith, Kim, et al. Management Accounting : Information for Creating and Managing Value, McGraw-Hill Education (Australia) Pty Limited, 2021. ProQuest Ebook Central, http://ebookcentral.proquest.com/lib/curtin/detail.action?docID=6736469. Created from curtin on 2024-08-30 05:06:16. Copyright © 2021. McGraw-Hill Education (Australia) Pty Limited. All rights reserved. Langfield-Smith, Kim, et al. Management Accounting : Information for Creating and Managing Value, McGraw-Hill Education (Australia) Pty Limited, 2021. ProQuest Ebook Central, http://ebookcentral.proquest.com/lib/curtin/detail.action?docID=6736469. Created from curtin on 2024-08-30 05:06:16. Copyright © 2021. McGraw-Hill Education (Australia) Pty Limited. All rights reserved. Langfield-Smith, Kim, et al. Management Accounting : Information for Creating and Managing Value, McGraw-Hill Education (Australia) Pty Limited, 2021. ProQuest Ebook Central, http://ebookcentral.proquest.com/lib/curtin/detail.action?docID=6736469. Created from curtin on 2024-08-30 05:06:16. Copyright © 2021. McGraw-Hill Education (Australia) Pty Limited. All rights reserved. Langfield-Smith, Kim, et al. Management Accounting : Information for Creating and Managing Value, McGraw-Hill Education (Australia) Pty Limited, 2021. ProQuest Ebook Central, http://ebookcentral.proquest.com/lib/curtin/detail.action?docID=6736469. Created from curtin on 2024-08-30 05:06:16. Copyright © 2021. McGraw-Hill Education (Australia) Pty Limited. All rights reserved. Langfield-Smith, Kim, et al. Management Accounting : Information for Creating and Managing Value, McGraw-Hill Education (Australia) Pty Limited, 2021. ProQuest Ebook Central, http://ebookcentral.proquest.com/lib/curtin/detail.action?docID=6736469. Created from curtin on 2024-08-30 05:06:16.  CHAPTER 7 A closer look at overhead costs 301 parentheses in the quality control column is that department’s total cost, as calculated using the simultaneous equations. This $70 202 total cost is allocated as follows: 20 per cent (or $14 040) to material handling, because that department uses 20 per cent of quality control’s services 5 per cent (or $3 510) to equipment maintenance, because that department uses 5 per cent of quality control’s services 25 per cent (or $17 551) to bending, because that department uses 25 per cent of quality control’s services 50 per cent (or $35 101) to welding, because that department uses 50 per cent of quality control’s services. A similar explanation underlies the material handling row and the equipment maintenance row in ­ xhibit 7.17. The total support department costs allocated to HEL’s two production departments are as E follows: $120 018 to bending and $229 982 to welding. Notice that these two amounts add up to $350 000, which is the total of the original traceable costs for the three support departments. Thus, all support department costs have been fully allocated. Overhead costs allocated to products under the reciprocal method Under the reciprocal method, the total budgeted overhead cost for the bending and welding departments is $630 018 and $314 982, respectively. This would result in overhead rates of $14.0004 per machine hour for the bending department ($630 018 ÷ 45 000 machine hours) and $5.9997 per direct labour hour for the welding department ($314 982 ÷ 52 500 direct labour hours). These rates are very similar to the rates obtained using the direct method and have virtually no impact on the estimated overhead cost of the two exhaust systems. The reciprocal services method is more accurate than the direct and step-down methods because it accounts fully for reciprocal services. However, if you compare the allocations under the reciprocal method to the direct and step-down allocations in the chapter, you will notice that the difference is not large. At HEL, the decision to use the direct method, which is simple and results in only minor inaccuracies, makes sense. Which support department cost allocation method is the best? You will note that, in the HEL case, the direct, step-down and reciprocal methods of support department cost allocation gave slightly different total overhead costs and overhead rates for each production Copyright © 2021. McGraw-Hill Education (Australia) Pty Limited. All rights reserved. department. This was due to the different recognition that each method gives to support relationships. The direct method does not recognise any relationships that exist between support departments, while the step- down method gives only partial recognition to these relationships. The reciprocal method recognises all support relationships. Does this imply that the reciprocal method is the best and the direct method is the worst? Not necessarily. The choice of method is simply one of costs versus benefits. At HEL the more complex methods made little difference to costs eventually allocated. In other situations, where there are stronger reciprocal relationships between support departments, the benefits of the reciprocal method are likely to be greater. The choice of allocation bases is also a cost versus benefits decision. In the HEL example, the cost allocations were made using various allocation bases, including departmental size, number of employees and number of maintenance hours. However, these allocation bases are not accurate cost drivers—there are no strong causal relationships between the costs being allocated and the chosen allocation bases. For example, the cost of running the material handling department is unlikely to decrease in direct proportion to decreases in the size (area in square metres) of the various user departments. While we may prefer the allocation bases to be cost drivers, these do not always exist. However, if cost drivers are not used, the potential for arbitrary and inaccurate cost allocations increases. While we can take care in selecting cost drivers, many would argue that the traditional cost allocation methods described in this chapter are of little value because of the arbitrary nature of the allocation bases and methods that are often used. It is for these reasons that activity-based costing systems have been developed. Langfield-Smith, Kim, et al. Management Accounting : Information for Creating and Managing Value, McGraw-Hill Education (Australia) Pty Limited, 2021. ProQuest Ebook Central, http://ebookcentral.proquest.com/lib/curtin/detail.action?docID=6736469. Created from curtin on 2024-08-30 05:06:16. Copyright © 2021. McGraw-Hill Education (Australia) Pty Limited. All rights reserved. Langfield-Smith, Kim, et al. Management Accounting : Information for Creating and Managing Value, McGraw-Hill Education (Australia) Pty Limited, 2021. ProQuest Ebook Central, http://ebookcentral.proquest.com/lib/curtin/detail.action?docID=6736469. Created from curtin on 2024-08-30 05:06:16.