To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com CHAPTER 15 ALLOCATION OF SUPPORT-DEPARTMENT COSTS, COMMON COSTS, AND REVENUES 15-1 The single-rate (cost-allocation) method makes no distinction between fixed costs and variable costs in the cost pool It allocates costs in each cost pool to cost objects using the same rate per unit of the single allocation base The dual-rate (cost-allocation) method classifies costs in each cost pool into two pools—a variable-cost pool and a fixed-cost pool—with each pool using a different cost-allocation base 15-2 The dual-rate method provides information to division managers about cost behavior Knowing how fixed costs and variable costs behave differently is useful in decision making 15-3 Budgeted cost rates motivate the manager of the supplier department to improve efficiency because the supplier department bears the risk of any unfavorable cost variances 15-4 Examples of bases used to allocate support department cost pools to operating departments include the number of employees, square feet of space, number of hours, and machine-hours 15-5 The use of budgeted indirect cost allocation rates rather than actual indirect rates has several attractive features to the manager of a user department: a the user knows the costs in advance and can factor them into ongoing operating choices, b the cost allocated to a particular user department does not depend on the amount of resources used by other user departments, and c inefficiencies at the department providing the service not affect the costs allocated to the user department 15-6 Disagree Allocating costs on ―the basis of estimated long-run use by user department managers‖ means department managers can lower their cost allocations by deliberately underestimating their long-run use (assuming all other managers not similarly underestimate their usage) 15-7 The three methods differ in how they recognize reciprocal services among support departments: a The direct (allocation) method ignores any services rendered by one support department to another; it allocates each support department’s costs directly to the operating departments b The step-down (allocation) method allocates support-department costs to other support departments and to operating departments in a sequential manner that partially recognizes the mutual services provided among all support departments c The reciprocal (allocation) method allocates support-department costs to operating departments by fully recognizing the mutual services provided among all support departments 15-1 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 15-8 The reciprocal method is theoretically the most defensible method because it fully recognizes the mutual services provided among all departments, irrespective of whether those departments are operating or support departments 15-9 The stand-alone cost-allocation method uses information pertaining to each user of a cost object as a separate entity to determine the cost-allocation weights The incremental cost-allocation method ranks the individual users of a cost object in the order of users most responsible for the common costs and then uses this ranking to allocate costs among those users The first-ranked user of the cost object is the primary user and is allocated costs up to the costs of the primary user as a stand-alone user The second-ranked user is the first incremental user and is allocated the additional cost that arises from two users instead of only the primary user The third-ranked user is the second incremental user and is allocated the additional cost that arises from three users instead of two users, and so on The Shapley Value method calculates an average cost based on the costs allocated to each user as first the primary user, the second-ranked, the third-ranked user, and so on 15-10 All contracts with U.S government agencies must comply with cost accounting standards issued by the Cost Accounting Standards Board (CASB) 15-11 Areas of dispute between contracting parties can be reduced by making the ―rules of the game‖ explicit and in writing at the time the contract is signed 15-12 Companies increasingly are selling packages of products or services for a single price Revenue allocation is required when managers in charge of developing or marketing individual products in a bundle are evaluated using product-specific revenues 15-13 The stand-alone revenue-allocation method uses product-specific information on the products in the bundle as weights for allocating the bundled revenues to the individual products The incremental revenue allocation method ranks individual products in a bundle according to criteria determined by management—such as the product in the bundle with the most sales—and then uses this ranking to allocate bundled revenues to the individual products The first-ranked product is the primary product in the bundle The second-ranked product is the first incremental product, the third-ranked product is the second incremental product, and so on 15-14 Managers typically will argue that their individual product is the prime reason why consumers buy a bundle of products Evidence on this argument could come from the sales of the products when sold as individual products Other pieces of evidence include surveys of users of each product and surveys of people who purchase the bundle of products 15-15 A dispute over allocation of revenues of a bundled product could be resolved by (a) having an agreement that outlines the preferred method in the case of a dispute, or (b) having a third party (such as the company president or an independent arbitrator) make a decision 15-2 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 15-16 (20 min.) Single-rate versus dual-rate methods, support department Bases available (kilowatt hours): Rockford Practical capacity 10,000 Expected monthly usage 8,000 1a Rockford 10,000 $3,000 Peoria Hammond Kankakee Total 20,000 12,000 8,000 50,000 $6,000 $3,600 $2,400 $15,000 Single-rate method based on expected monthly usage: Total costs in pool = $6,000 + $9,000 = $15,000 Expected usage = 30,000 kilowatt hours Allocation rate = $15,000 ÷ 30,000 = $0.50 per hour of expected usage Expected monthly usage in hours Costs allocated at $0.50 per hour Total 50,000 30,000 Single-rate method based on practical capacity: Total costs in pool = $6,000 + $9,000 = $15,000 Practical capacity = 50,000 kilowatt hours Allocation rate = $15,000 ÷ 50,000 = $0.30 per hour of capacity Practical capacity in hours Costs allocated at $0.30 per hour 1b Peoria Hammond Kankakee 20,000 12,000 8,000 9,000 7,000 6,000 Variable-Cost Pool: Total costs in pool Expected usage Allocation rate Fixed-Cost Pool: Total costs in pool Practical capacity Allocation rate Rockford Peoria Hammond Kankakee Total 8,000 9,000 7,000 6,000 30,000 $4,000 $4,500 $3,500 $3,000 $15,000 = = = $6,000 30,000 kilowatt hours $6,000 ÷ 30,000 = $0.20 per hour of expected usage = = = $9,000 50,000 kilowatt hours $9,000 ÷ 50,000 = $0.18 per hour of capacity Rockford Variable-cost pool $0.20 × 8,000; 9,000; 7,000, 6,000 Fixed-cost pool $0.18 × 10,000; 20,000; 12,000, 8,000 Total Peoria Hammond Kankakee Total $1,600 $1,800 $1,400 $1,200 $ 6,000 1,800 $3,400 3,600 $5,400 2,160 $3,560 1,440 9,000 $2,640 $15,000 The dual-rate method permits a more refined allocation of the power department costs; it permits the use of different allocation bases for different cost pools The fixed costs result from decisions most likely associated with the practical capacity level The variable costs result from decisions most likely associated with monthly usage 15-3 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 15-17 (20–25 min.) Single-rate method, budgeted versus actual costs and quantities a Budgeted rate = Budgeted indirect costs $575,000 = = $2,300 per round-trip Budgeted trips 250 trips Indirect costs allocated to Juices Division = $2,300 per round-trip = $345,000 150 budgeted round trips Indirect costs allocated to Preserves Division = $2,300 per round-trip = $230,000 100 budgeted round trips b Budgeted rate = $2,300 per round-trip Indirect costs allocated to Juices Division = $2,300 per round-trip = $345,000 Indirect costs allocated to Preserves Division = $2,300 per round-trip = $172,500 c Actual rate = 150 actual round trips 75 actual round trips Actual indirect costs $483,750 = = $2,150 per round-trip Actual trips 225 trips Indirect costs allocated to Juices Division = $2,150 per round-trip = $322,500 Indirect costs allocated to Preserves Division = $2,150 per round-trip = $161,250 150 actual round trips 75 actual round trips When budgeted rates/budgeted quantities are used, the Juices and Preserves Divisions know at the start of 2007 that they will be charged a total of $345,000 and $230,000 respectively for transportation In effect, the trucking resource becomes a fixed cost for each division Then, each may be motivated to over-use the trucking fleet, knowing that their 2007 transportation costs will not change When budgeted rates/actual quantities are used, the Juices and Preserves Divisions know at the start of 2007 that they will be charged a rate of $2,300 per round trip, i.e., they know the price per unit of this resource This enables them to make operating decisions knowing the rate they will have to pay for transportation Each can still control its total transportation costs by minimizing the number of round trips it uses Assuming that the budgeted rate was based on honest estimates of their annual usage, this method will also provide an estimate of the excess trucking capacity (the portion of trucking costs not charged to either division) In contrast, when actual costs/actual quantities are used, the two divisions must wait until year-end to know their transportation charges The use of actual costs/actual quantities makes the costs allocated to one division a function of the actual demand of other users In 2007, the actual usage was 225 trips, which is 25 trips below the 250 trips budgeted The Juices Division used all the 150 trips it had budgeted The Preserves Division used only 75 of the 100 trips budgeted When costs are allocated based on actual costs and actual quantities, the same fixed costs are spread over fewer trips resulting in 15-4 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com a higher rate than if the Preserves Division had used its budgeted 100 trips As a result, the Juices Division bears a proportionately higher share of the fixed costs Using actual costs/actual rates also means then any efficiencies or inefficiencies of the trucking fleet get passed along to the user divisions In general, this will have the effect of making the trucking fleet less careful about its costs, although in 2007, it appears to have managed its costs well, leading to a lower actual cost per roundtrip relative to the budgeted cost per round trip For the reasons stated above, of the three single-rate methods suggested in this problem, the budgeted rate and actual quantity may the best one to use (The management of Sunrise would have to ensure that the managers of the Juices and Preserves divisions not systematically overestimate their budgeted use of the trucking division, in an effort to drive down the budgeted rate) 15-18 (20 min.) Dual-rate method, budgeted versus actual costs, and practical capacity vs actual quantities (continuation of 15-17) Charges with dual rate method Variable indirect cost rate = Fixed indirect cost rate = = Juices Division Variable indirect costs, $1,500 × 150 Fixed indirect costs, $800 × 150 Preserves Division Variable indirect costs, $1,500 × 75 Fixed indirect costs, $800 × 100 $1,500 per trip $200,000 budgeted costs 250 round trips budgeted $800 per trip $225,000 120,000 $345,000 $112,500 80,000 $192,500 The dual rate changes how the fixed indirect cost component is treated By using budgeted trips made, the Juices Division is unaffected by changes from its own budgeted usage or that of other divisions 15-5 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 15-19 (30 min.) Support department cost allocation; direct and step-down methods a Direct Method Costs Alloc of AS costs (40/75, 35/75) Alloc of IS costs (30/90, 60/90) AS IS Govt $600,000 $2,400,000 (600,000) $ b Step-Down (AS first) Costs Alloc of AS costs (0.25, 0.40, 0.35) Alloc of IS costs (30/90, 60/90) $ $600,000 (600,000) $ c Step-Down (IS first) Costs Alloc of IS costs (0.10, 0.30, 0.60) Alloc of AS costs (40/75, 35/75) $ $600,000 240,000 $ (840,000) $ $ 320,000 (2,400,000) $ 280,000 800,000 $1,120,000 1,600,000 $1,880,000 $2,400,000 150,000 $ 240,000 (2,550,000) $ 210,000 850,000 $1,090,000 1,700,000 $1,910,000 $2,400,000 (2,400,000)$ 720,000 $1,168,000 Govt Direct method Step-Down (AS first) Step-Down (IS first) Corp $1,440,000 448,000 $1,832,000 Corp $1,120,000 1,090,000 1,168,000 $1,880,000 1,910,000 1,832,000 The direct method ignores any services to other support departments The step-down method partially recognizes services to other support departments The information systems support group (with total budget of $2,400,000) provides 10% of its services to the AS group The AS support group (with total budget of $600,000) provides 25% of its services to the information systems support group 15-6 392,000 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Three criteria that could determine the sequence in the step-down method are: a Allocate support departments on a ranking of the percentage of their total services provided to other support departments Administrative Services 25% Information Systems 10% b Allocate support departments on a ranking of the total dollar amount in the support departments Information Systems $2,400,000 Administrative Services $ 600,000 c Allocate support departments on a ranking of the dollar amounts of service provided to other support departments Information Systems (0.10 $2,400,000) = Administrative Services (0.25 $600,000) = $240,000 $150,000 The approach in (a) above typically better approximates the theoretically preferred reciprocal method It results in a higher percentage of support-department costs provided to other support departments being incorporated into the step-down process than does (b) or (c), above 15-20 (50 min.) Support-department cost allocation, reciprocal method (continuation of 15-19) 1a Costs Alloc of AS costs (0.25,0.40, 0.35) Alloc of IS costs (0.10, 0.30, 0.60) Support Departments AS IS $600,000 $2,400,000 (861,538) 215,385 Operating Departments Govt Corp $ 344,615 $ 301,538 261,538 (2,615,385) 784,616 $ $ $1,129,231 Reciprocal Method Computation AS = $600,000 + 0.10 IS IS = $2,400,000 + 0.25AS IS = $2,400,000 + 0.25 ($600,000 + 0.10 IS) = $2,400,000 + $150,000 + 0.025 IS 0.975IS = $2,550,000 IS = $2,550,000 ÷ 0.975 = $2,615,385 AS = $600,000 + 0.10 ($2,615,385) = $600,000 + $261,538 = $861,538 1,569,231 $1,870,769 15-7 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 1b Costs 1st Allocation of AS (0.25, 0.40, 0.35) 1st Allocation of IS (0.10, 0.30, 0.60) nd Allocation of AS (0.25, 0.40, 0.35) 2nd Allocation of IS (0.10, 0.30, 0.60) 3rd Allocation of AS (0.25, 0.40, 0.35) rd Allocation of IS (0.10, 0.30, 0.60) 4th Allocation of AS (0.25, 0.40, 0.35) 4th Allocation of IS (0.10, 0.30, 0.60) th Allocation of AS (0.25, 0.40, 0.35) th Allocation of IS (0.10, 0.30, 0.60) Total allocation Support Departments AS IS $600,000 $2,400,000 Operating Departments Govt Corp (600,000) 150,000 2,550,000 $ 240,000 255,000 (2,550,000) 210,000 765,000 1,530,000 63,750 102,000 89,250 6,375 (63,750) 19,125 38,250 (6,375) 1,594 2,550 2,231 160 (1,594) 478 956 40 64 56 (40) 12 24 (4) $1,129,231 $1,870,769 (255,000) (160) $ $ 0 (1) $ a b c d e Direct Step-Down (AS first) Step-Down (IS first) Reciprocal (linear equations) Reciprocal (repeated iterations) Govt Consulting $1,120,000 1,090,000 1,168,000 1,129,231 1,129,231 Corp Consulting $1,880,000 1,910,000 1,832,080 1,870,769 1,870,769 The four methods differ in the level of support department cost allocation across support departments The level of reciprocal service by support departments is material Administrative Services supplies 25% of its services to Information Systems Information Systems supplies 10% of its services to Administrative Services The Information Department has a budget of $2,400,000 that is 400% higher than Administrative Services The reciprocal method recognizes all the interactions and is thus the most accurate It is especially clear from looking at the repeated iterations calculations 15-8 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 15-21 (40 min.) Direct and step-down allocation Support Departments HR Info Systems $72,700 $234,400 Costs Incurred Alloc of HR costs (42/70, 28/70) Alloc of Info Syst costs (1,920/3,520, 1,600/3,520) (72,700) $ Operating Departments Corporate Consumer $ 998,270 $489,860 $ (234,400) 43,620 29,080 127,855 $1,169,745 106,545 $625,485 Total $1,795,230 $1,795,230 Rank on percentage of services rendered to other support departments Step 1: HR provides 23.077% of its services to information systems: 21 21 = = 91 42 28 21 This 23.077% of $72,700 HR department costs is $16,777 23.077% Step 2: Information systems provides 8.333% of its services to HR: 1,920 320 1,600 320 = 320 3,840 = 8.333% This 8.333% of $234,400 information systems department costs is $19,533 Costs Incurred Alloc of HR costs (21/91, 42/91, 28/91) Alloc of Info Syst costs (1,920/3,520, 1,600/3,520) Support Departments HR Info Systems $72,700 $234,400 (72,700) $ Operating Departments Corporate Consumer $ 998,270 $489,860 16,777 251,177 33,554 22,369 (251,177) $ 137,006 $1,168,830 114,171 $626,400 Total $1,795,230 $1,795,230 An alternative ranking is based on the dollar amount of services rendered to other support departments Using numbers from requirement 2, this approach would use the following sequence: Step 1: Allocate Information Systems first ($19 533 provided to HR) Step 2: Allocate HR second ($16 777 provided to Information Systems) 15-9 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 15-22 (30 min.) Reciprocal cost allocation (continuation of 15-21) The reciprocal allocation method explicitly includes the mutual services provided among all support departments Interdepartmental relationships are fully incorporated into the support department cost allocations HR = $72,700 + 08333IS IS = $234,400 + 23077HR HR = $72,700 + [.08333($234,400 + 23077HR)] = $72,700 + [$19,532.55 + 0.01923HR] 0.98077HR = $92,232.55 HR = $92,232.55 0.98077 = $94,041 IS = $234,400 + (0.23077 $94,041) = $256,102 Costs Incurred Alloc of HR costs (21/91, 42/91, 28/91) Support Depts HR Info Systems $72,700 $234,400 (94,041) Alloc of Info Syst costs (320/3,840, 1,920/3,840, 1,600/3,840) $ 21,341 $ Operating Depts Corporate Consumer $ 998,270 $489,860 21,702 43,404 28,935 (256,102) 128,051 $1,169,725 106,710 $625,505 15-10 Total $1,795,230 $1,795,230 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com At first glance, it appears that the cost of power is $40 per unit plus the material handling costs If so, Manes would be better off by purchasing from the power company However, the decision should be influenced by the effects of the interdependencies and the fixed costs Note that the power needs would be less (students frequently miss this) if they were purchased from the outside: Outside Power Units Needed X 100 Y 400 A (500 units minus 20% of 500 units, because there is no need to service the nonexistent power department) 400 Total units 900 Total costs, 900 $40 = $36,000 In contrast, the total costs that would be saved by not producing the power inside would depend on the effects of the decision on various costs: Avoidable Costs of 1,000 Units of Power Produced Inside Variable indirect labor and indirect material costs Supervision in power department Materials handling, 20% of $70,000* Probable minimum cost savings Possible additional savings: a Can any supervision in materials handling be saved because of overseeing less volume? Minimum savings is probably zero; the maximum is probably 20% of $10,000 or $2,000 b Is any depreciation a truly variable, wear-and-tear type of cost? Total savings by not producing 1,000 units of power $10,000 10,000 14,000 $34,000 ? ? _ $34,000 + ? * Materials handling costs are higher because the power department uses 20% of materials handling Therefore, materials-handling costs will decrease by 20% In the short run (at least until a capital investment in equipment is necessary), the data suggest continuing to produce internally because the costs eliminated would probably be less than the comparable purchase costs 15-30 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 15-33 (25 min.) Common costs 900 $1.00 × ($0.80 × 1,500) (900 $1.00) (600 $1.00) $900 = × $1,200 = $720 $900 $600 Miller = Jackson = 600 $1.00 × ($0.80 × 1,500) (600 $1.00) (900 $1.00) $600 = × $1,200 = $480 $600 $900 With Miller as the primary party: Party Miller Jackson Total Costs Allocated $ 900 300 ($1,200 – $900) $1,200 Cumulative Costs Allocated $ 900 $1,200 With Jackson as the primary party: Party Jackson Miller Total Costs Allocated $ 600 600 ($1,200 – $600) $1,200 Cumulative Costs Allocated $ 600 $1,200 To use the Shapley value method, consider each party as first the primary party and then the incremental party The average of the two is computed to determine the allocation Miller: Allocation as the primary party Allocation as the incremental party Total Allocation ($1,500 ÷ 2) $ 900 600 $1,500 $ 750 Jackson: Allocation as the primary party Allocation as the incremental party Total Allocation ($900 ÷ 2) $ 600 300 $ 900 $ 450 Using this approach, Miller is allocated $750 and Jackson is allocated $450 of the total costs of $1,200 Miller and Jackson could also use the stand-alone cost allocation method to allocate the rent: Miller, $720; Jackson, $480 15-31 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com The results of the four cost-allocation methods are shown below Direct method Incremental (Miller primary) Incremental (Jackson primary) Shapley Miller $720 900 600 750 Jackson $480 300 600 450 The allocations are very sensitive to the method used The direct method is simple and fair since it allocates the rent based on need or benefit received The Shapley values are also fair They result in very similar allocations and any one of them can be chosen In this case, the direct method is likely more acceptable If they used the incremental cost-allocation method, Miller and Jackson would probably have disputes over who is the primary party because the primary party gets allocated all costs first 15-34 (20–25 min.) Revenue allocation, bundled products 1.a The stand-alone revenues (using unit selling prices) of the three components of the $700 package are: Lodging $320 × = $ 640 Recreation $150 × = 300 Food $ 80 × = 160 $1,100 Lodging $640 × $700 $1,100 = 0.582 × $700 = $407 Recreation $300 × $700 $1,100 = 0.273 × $700 = $191 Food $160 × $700 $1,100 = 0.145 × $700 = $102 b Product Recreation Lodging Food Revenue Allocated $300 400 ($700 – $300) $700 15-32 Cumulative Revenue Allocated $300 $700 $700 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com The pros of the stand-alone-revenue-allocation method include the following: a Each item in the bundle receives a positive weight, which means the resulting allocations are more likely to be accepted by all parties than a method allocating zero revenues to one or more products b It uses market-based evidence (unit selling prices) to decide the revenue allocations— unit prices are one indicator of benefits received c It is simple to implement The cons of the stand-alone revenue-allocation method include: a It ignores the relative importance of the individual components in attracting consumers to purchase the bundle b It ignores the opportunity cost of the individual components in the bundle The golf course operates at 100% capacity Getaway participants must reserve a golf booking one week in advance, or else they are not guaranteed playing time A getaway participant who does not use the golf option may not displace anyone Thus, under the stand-alone method, the golf course may be paid twice—once from the non-getaway person who does play and second from an allocation of the $700 package amount for the getaway person who does not play (either did not want to play or wanted to play but made a booking too late, or failed to show) c The weight can be artificially inflated by individual product managers setting ―high‖ list unit prices and then being willing to frequently discount these prices The use of actual unit prices or actual revenues per product in the stand-alone formula will reduce this problem d The weights may change frequently if unit prices are constantly changing This is not so much a criticism as a reflection that the marketplace may be highly competitive The pros of the incremental method include: a It has the potential to reflect that some products in the bundle are more highly valued than others Not all products in the bundle have a similar ―write-down‖ from unit list prices Ensuring this ―potential pro‖ becomes an ―actual pro‖ requires that the choice of the primary product be guided by reliable evidence on consumer preferences This is not an easy task b Once the sequence is chosen, it is straightforward to implement The cons of the incremental method include: a Obtaining the rankings can be highly contentious and place managers in a ―no-win‖ acrimonious debate The revenue allocations can be highly sensitive to the chosen rankings b Some products will have zero revenues assigned to them Consider the Food division It would incur the costs for the two dinners but receive no revenue 15-33 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 15-35 (15 mins.) Revenue allocation, bundled products, additional complexities (continuation of 15-34) Alternatives include: a Use information about how each individual package is used to make the revenue allocations Thus, if one party uses only lodging and food, the $700 is allocated among those two groups This would be the most accurate approach, as it captures actual usage and non-usage of the facilities b Use the average non-usage information to compute an ―adjusted unit selling price‖: Lodging: $640 × 1.00 Food: $160 × 0.95 Recreation: $300 × 0.90 $ 640 152 270 $1,062 These adjusted revenues can be used in either the stand-alone or incremental methods For example, the stand-alone allocations are: Lodging: $640 × $700 $1,062 = $422 Food: $152 × $700 $1,062 = $100 Recreation: $270 × $700 $1,062 = $178 $700 c Use the incremental method with Recreation first, then Lodging, and then Food Allocate an ―adjusted revenue,‖ i.e., revenue adjusted for the non-use factor, as shown in (b), above Product Recreation Lodging Food Revenue Allocated $270 430 ($700 $270) $700 15-34 Cumulative Revenue Allocated $270 $700 $700 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 15-36 (30–40 min.) Overhead-allocation disputes, ethics This problem, which is based on an actual case, shows how overhead cost allocation can affect contract pricing This is how the Navy would claim a refund of $689,658: The overhead cost would be allocated differently: Previous overhead allocation rate = Error!= $0.20 per DL$ Revised overhead allocation rate = Error!= $0.2068965 per DL$ Navy Costs Original cost assignment: Direct materials Direct labor SE group Allocated overhead (20% Total $ –– 45,000,000 5,000,000 10,000,000a $60,000,000 $ –– 100,000,000 –– 20,000,000b $120,000,000 $ –– 45,000,000 5,000,000 9,310,343c $59,310,343 $ –– 100,000,000 –– 20,689,650d $120,689,650 DL$) Revised cost assignment: Direct materials Direct labor SE group Allocated overhead Total Commercial Costs a 20% ($45,000,000 direct labor + $5,000,000 SE group classified as direct labor) = $10,000,000 20% $100,000,000 = $20,000,000 c 20.68965% $45,000,000 = $9,310,343 d 20.68965% $100,000,000 = $20,689,650 b The Navy’s claim would be: Remove the original overhead allocation of $50 million 0.20 This means that the overhead pool, which has been totally allocated to products, is now underallocated by $10 million This overhead must be reallocated in proportion to the ―corrected‖ direct labor in nuclear work and commercial work In short, if the overhead allocation base shrinks from $150 to $145 million, the overhead rate increases from 20% to 20.68965% The revised allocation is $45 million 0.2068965 $10,000,000 $ 15-35 9,310,343 689,657 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 2a Revised overhead allocation rate = Error!= 17.93103% Revised cost assignment: Direct materials Direct labor SE group Commercial purchasing Allocated overhead (17.93103% Navy Costs Commercial Costs – 45,000,000 5,000,000 $ – 100,000,000 – – 4,000,000 17,931,030 $121,931,030 $ DL$) 8,068,964 $58,068,964 Given that the original Navy cost was $60,000,000, and the revised cost is $58,068,964, the Navy would claim a total refund of $1,931,036 The additional refund is $1,241,379 (which is $59,310,343 – $58,068,964) 2b Although both discoveries (the $5 million of the SE group cost that is not a direct labor costs and the $4 million in general yard overhead for commercial customers) will increase the costs allocated to commercial customers and will hurt Marden’s ability to meet cost targets this year, she should not wait for the government auditors to ―discover‖ the second issue She should discuss this with her managers, explain how the situation arose, pro-actively reveal both issues and issue the appropriate refund to the US Navy Hopefully, her managers will appreciate her honesty and understand that such unexpected things can occur despite the best planning and her commercial customers will be willing to bear the extra costs as well Even if her superiors are not understanding, Marden should adhere to the standards of integrity and objectivity prescribed for management accountants and reveal the mistakes made, being prepared to suffer the consequences 15-36 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 15-37 (60–80 min.) Allocating costs of support departments; dual rates; direct, stepdown, and reciprocal methods Solution Exhibit 15-37 presents the costs allocated to each assembly department under the four service department cost allocation methods The linear equations underlying the complete reciprocated costs reported in Solution Exhibit 15-37 (in 000s) are: Fixed-Cost Pool: ES = IS = $2,700 + 0.20IS $8,000 + 0.10ES ES ES 0.98ES ES = = = = $2,700 + 0.20 ($8,000 + 0.10ES) $4,300 + 0.02ES $4,300 $4,300 ÷ 0.98 = $4,387.76 IS = = $8,000 + 0.10 ($4,387.76) $8,438.78 Variable-Cost Pool: ES = IS = $8,500 + 0.25IS $3,750 + 0.15ES ES ES 0.9625ES ES = = = = $8,500 + 0.25 ($3,750 + 0.15ES) $9,437.5 + 0.0375ES $9,437.5 $9,437.5 ÷ 0.9625 = $9,805.19 IS = = $3,750 + 0.15 ($9,805.19) $3,750 + $1,470.78 = $5,220.78 15-37 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com The repeated iterations underlying the complete reciprocated costs reported in Fixed-Cost Pool: Support Departments Dollars in thousands ES IS Costs before interdepartmental allocations $2,700.00 1st Allocation of ES (.1, 4, 5) (2,700.00) 1st Allocation of IS (.2, 3, 5) 270.00 8,270.00 1,654.00 (8,270.00) 2nd Allocation of ES (.1, 4, 5) (1,654.00) Operating Departments Home Security Business Security Systems Systems $8,000.00 $1,080.00 $1,350.00 2,481.00 4,135.00 165.40 661.60 827.00 (165.40) 49.62 82.70 2nd Allocation of IS (.2, 3, 5) 33.08 3rd Allocation of ES (.1, 4, 5) (33.08) 3.31 13.23 16.54 3rd Allocation of IS (.2, 3, 5) 0.66 (3.31) 0.99 1.66 4th Allocation of ES (.1, 4, 5) (0.66) 0.07 0.26 0.33 4th Allocation of IS (.2, 3, 5) 0.01 (0.07) 0.02 0.04 5th Allocation of ES (.1, 4, 5) (0.01) 0 0.01 $4,286.72 $6,413.28 Fixed-costs allocation $ $ 15-38 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com The reported iterations underlying the complete reciprocated costs reported in VariableCost Pool: Support Departments Operating Departments Home Security Business Security Dollars in thousands ES IS Systems Systems Costs before interdepartmental allocations $8,500.00 $3,750.00 1st Allocation of ES (.15, 30, 55) (8,500.00) 1st Allocation of IS (.25, 15, 60) 1,275.00 5,025.00 1,256.25 2nd Allocation of ES (.15, 30, 55) (1,256.25) $2,550.00 $4,675.00 (5,025.00) 753.75 3,015.00 188.44 376.87 690.94 (188.44) 28.27 113.06 2nd Allocation of IS (.25, 15, 60) 47.11 3rd Allocation of ES (.15, 30, 55) (47.11) 7.07 14.13 25.91 3rd Allocation of IS (.25, 15, 60) 1.77 (7.07) 1.06 4.24 4th Allocation of ES (.15, 30, 55) (1.77) 0.27 0.53 0.97 4th Allocation of IS (.25, 15, 60) 0.07 (0.27) 0.04 0.16 5th Allocation of ES (.15, 30, 55) (0.07) 0.03 0.04 $3,724.68 $8,525.32 Variable-cost allocation $ $ 15-39 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com SOLUTION EXHIBIT 15-37 (in thousands) Engineering Support a Direct Method Fixed-Cost Pool Eng Support (4/9, 5/9) Info Support (3/8, 5/8) Information Systems Support $ 2,700 (2,700) $ Variable-Cost Pool: Eng Support (30/85, 55/85) Info Support (15/75,60/75) b Step-down (Information First) Fixed-Cost Pool: Info Support (.2, 3, 5) Eng Support (4/9, 5/9) $ Variable-Cost Pool: Info Support (.25, 15, 60) Eng Support (30/85, 55/85) $ c Step-down (Engineering First): Fixed-Cost Pool: Eng Support (.1, 4, 5) Info Support (3/8, 5/8) $ Variable-Cost Pool: Eng Support (.15, 30, 55) Info Support (.2, 8) $1,200.00 3,000.00 $4,200.00 $1,500.00 5,000.00 $6,500.00 (3,750) $3,000.00 750.00 $3,750.00 $5,500.00 3,000.00 $8,500.00 $ 2,700 1,600 (4,300) $ 8,000 (8,000) –– $ $2,400.00 1,911.11 $4,311.11 $4,000.00 2,388.89 $6,388.89 $ 8,500 937.5 (9,437.5) 0.0 $ 3,750 (3,750) –– $ $ 562.50 3,330.88 $3,893.38 $2,250.00 6,106.62 $8,356.62 $ 2,700 (2,700) $ 8,000 270 (8,270) $ $1,080.00 3,101.25 $4,181.25 $1,350.00 5,168.75 $6,518.75 $ 3,750 1,275 (5,025) $2,550.00 1,005.00 $3,555.00 $4,675.00 4,020.00 $8,695.00 $ $ $ 8,500 (8,500) $ d Reciprocal Method Fixed-Cost Pool: Eng Support (.1, 4, 5) Info Support (.2, 3, 5) $ $ 2,700 (4,387.76) 1,687.76 0.00 $ $ 8,500.00 (9,805.19) 1,305.19 0.00 Variable-Cost Pool: Eng Support (.15, 30, 55) Info Support (.25, 15, 60) Business Security Systems $ 8,000 (8,000) $ 3,750 $ 8,500 (8,500) $ Home Security Systems 15-40 $ $ $ 8,000.00 438.78 (8,438.78) 0.00 $1,755.10 2,531.63 $4,286.73 $2,193.88 4,219.39 $6,413.27 $ $ 3,750.00 1,470.78 (5,220.78) 0.00 $2,941.56 783.12 $3,724.68 $5,392.85 3,132.47 $8,525.32 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com A summary of the costs allocated under each method from Solution Exhibit 15-37 is: (Dollars in thousands) a Direct Method: Fixed-cost pool Variable-cost pool b c d & e Step-down (Information First): Fixed-cost pool Variable-cost pool Step-down (Engineering First): Fixed-cost pool Variable-cost pool Reciprocal Method: Fixed-cost pool Variable-cost pool Home Security Systems Business Security Systems $4,200.00 3,750.00 $7,950.00 $ 6,500.00 8,500.00 $15,000.00 $4,311.11 3,893.38 $8,204.49 $ 6,388.89 8,356.62 $14,745.51 $4,181.25 3,555.00 $7,736.25 $ 6,518.75 8,695.00 $15,213.75 $4,286.73 3,724.68 $8,011.41 $ 6,413.27 8,525.32 $14,938.59 Support department costs allocated per unit: Home Security Systems (Dollars in thousands) Alloc Costs ÷ 7,950 units a Direct method $1,000 b Step-down (Information first) 1,032 c Step-down (Engineering first) 973 d & e Reciprocal method 1,008 Business Security Systems Alloc Costs ÷ 3,750 units $4,000 3,932 4,057 3,984 Factors that might explain why the reciprocal method is not more widely used in practice include: a Managers find the reciprocal method difficult to understand, especially where there are many support departments b The final cost allocations obtained from the reciprocal method differ little in some cases from those obtained from the direct or step-down methods As illustrated in requirement 2, the differences among the four methods in this problem appear small c It is costly to maintain records of the use of the support departments by other support departments The manager of the Home Security Department would prefer the step-down method with the sequence starting with Engineering Support This alternative results in the lowest amount of support departments’ costs allocated to Home Security Systems 15-41 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 15 Case The Stanford University case can only be discussed using the textbook case write-up The case questions challenge students to apply the concepts learned in the chapter to a specific business situation STANFORD UNIVERSITY: Indirect Cost Allocation, Indirect Cost Recovery Synopsis In July of 1990, Stanford University enjoyed wide praise for cutting costs Less than one year later, Stanford was at the center of a roiling dispute over indirect costs billed to the government for federally sponsored research The case introduces students to procurement and audit from several perspectives––the regulator, the purchaser, and individuals within the supplier organization The determination of costs under procurement regulations and contracts receives special attention The not-for-profit setting adds an extra dimension Principal issues for discussion are: (i) the costs and benefits of various forms of procurement contracts; (ii) the effect of the cost allocation scheme on the incentives faced by individuals within Stanford University and the government; and, (iii) the role of auditors and audited cost information in the procurement process The case also raises certain ethical and political issues The case provides institutional detail that illustrates an analytical framework Too often, students conclude that cost allocation is either straightforward or irrelevant This situation is sufficiently rich to disabuse those conclusions Issues in managerial accounting matter to senior executives In the wake of this controversy, Stanford's president, provost, chief financial officer, and controller resigned When a purchaser pays cash to a supplier in exchange for some good, the terms of the exchange depend on the nature of the good and the nature of the market for the good Two prototypes of trade are: a perfectly competitive market; and bilateral exchange under uncertainty Stanford's relationship with the government is closest to the latter For example, the government procures both pencils and research from suppliers Comparing the nature of these goods and the market for them explains why the terms of trade differ between pencils and research: Pencils Pencils are a standardized good There are many suppliers of pencils Pencils have a commonly accepted use One pencil serves this purpose as well as another The worth of a pencil is known in advance of the exchange by the purchaser (and supplier) An efficient way to procure pencils is to buy them on the open market Research Research is a singular good No piece of research is exactly like another For any given piece of research, there may be only one supplier The use of research may not be known in advance of (or even after) its production One piece of research does not easily substitute for another The worth of research is uncertain There is no spot market for research 15-42 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com at the spot price In sum, the procurement of research by the federal government is a case of bargaining and contracting over ―a non-standardized item about which information is incomplete, costs are uncertain, and observability of supplier costs by the purchaser is limited.‖ Three considerations that underlie optimal contracting are thus: (1) relieving the supplier of risk to encourage the supplier to undertake the project; (2) requiring the supplier to bear at least some of the consequences of his actions so that the supplier takes care to manage costs; (3) using a monitor to check on the project and its costs If several researchers are capable of conducting a given sponsored project and if the bidding process is competitive, then the government could award the contract to the lowest bidder However, obtaining competitive bids for a sponsored research project is virtually impossible Multiple suppliers are not usually available and the risks of the project may be so large that even the suppliers who are available would only be willing to the project for an exorbitant price Suppliers are more willing to cost-plus contracts because it minimizes their risk Of course, cost-plus contracts raise two other issues for the government First, what costs should be included in the contract Circular A-21 is an attempt to address this problem by specifying costs that are allocable to a contract and costs that are not The second issue is monitoring and auditing the costs incurred on government contracts The Defense Contract Audit Agency (DCAA) has the responsibility of monitoring that costs are properly controlled and that only costs that are reimbursable are allocated to the contract Direct costs are costs that can be identified specifically with a particular sponsored project relatively easily with a high degree of accuracy Indirect costs are costs that are incured for common or joint objectives and therefore cannot be identified readily and specifically with a particular sponsored project Identification with a particular project rather than the nature of the goods or services is the determining factor in distinguishing direct from indirect costs Examples of direct costs are the costs of materials and the salaries paid to employees and students for the time that they are specifically working on a particular project Examples of indirect costs are general administration, operations, and maintenance costs of the University, library costs, and student administration and services A cost is allocable to a specific project if the goods or services involved are chargeable or assignable to the project based on the relative benefits received or other equitable relationship All direct costs are allocable because they are directly associated with a particular project Certain indirect costs, for example, alcoholic beverages and entertainment, are under government guidelines ineligible for reimbursement These costs are not allocable Other indirect costs, such as general administration, operations, and maintenance, which support or benefit a particular project, are allocable in proportion to the relative benefits that these costs provide to the project 15-43 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com There are four possible combinations of the terms direct and indirect, and allocable and unallocable Examples for each category follow: Direct or Indirect Direct Allocable or Unallocable Allocable Direct Unallocable Indirect Allocable Indirect Unallocable Example or Explanation Economy class air travel related to a specific research project Alcoholic beverages Entertainment Cost of books and periodicals purchased for campus libraries Operation, renovation, and depreciation of University-owned houses Organized fund-raising costs Investment management Public relations Alumni activities Advertising Depreciation on the yacht Victoria One reason the federal government pays indirect costs of sponsored research is that indirect costs are essential costs of the sponsored research activity That is, libraries, buildings, and administrative services are all necessary and essential for the conduct of the sponsored research activity Therefore, the total cost to a university of conducting sponsored research is not only the direct costs of the research but also the supporting indirect costs Another argument for the federal government paying indirect costs is that it is a form of assistance (or subsidy) for higher education and basic research Under this argument, the federal government is not signing a fee-for-service contract when it funds a research program Rather, it is funding projects and paying indirect costs to support basic research to maintain U.S competitiveness Some university administrators believe that because federally sponsored research is assistance provided to universities, sponsored research projects should not be forced to conform with federal procurement accounting regulations Epilogue In an agreement announced October 18, 1994, the U.S government said it had no claims against Stanford for fraud, misrepresentation, or other wrongdoing in connection with the university's indirect cost reimbursement submissions The agreement reached between the university and the Office of Naval Research (ONR) settles all disputed matters related to the billing and payment of indirect costs of federally-sponsored research at Stanford for the fiscal years 1981 through 1992 Under terms of the settlement, the university will pay $1.2 million to the government in a final adjustment covering indirect costs for the 1981-1992 period and withdraw its own claims that the university had been underpaid during this period The settlement will not affect the university's current budget or indirect rate 15-44 ... third-ranked user, and so on 15- 10 All contracts with U.S government agencies must comply with cost accounting standards issued by the Cost Accounting Standards Board (CASB) 15- 11 Areas of dispute... indirect cost rate = = Juices Division Variable indirect costs, $1,500 × 150 Fixed indirect costs, $800 × 150 Preserves Division Variable indirect costs, $1,500 × 75 Fixed indirect costs, $800... departments 15- 9 The stand-alone cost- allocation method uses information pertaining to each user of a cost object as a separate entity to determine the cost- allocation weights The incremental cost- allocation