chapter 21
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Chapter 21. Cost Allocation and Performance Measurement. Conceptual Learning Objectives. C1: Explain departmentalization and the role of departmental accounting C2: Distinguish between direct and indirect expenses C3: Identify bases for allocating indirect expenses to departments - PowerPoint PPT PresentationTRANSCRIPT
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Chapter 21
Cost Allocation and Performance Measurement
© The McGraw-Hill Companies, Inc., 2007McGraw-Hill/Irwin
Conceptual Learning Objectives
C1: Explain departmentalization and the role of departmental accounting
C2: Distinguish between direct and indirect expenses
C3: Identify bases for allocating indirect expenses to departments
C4: Explain controllable costs and responsibility accounting
C5: Appendix 21A: Describe allocation of joint costs across products
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A1: Analyze investment centers using return on total assets
P1: Assign overhead costs using
two-stage cost allocation
P2: Assign overhead costs using activity-based
costing
P3: Prepare departmental income statements
P4: Prepare departmental contribution reports
Analytical Learning Objectives
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One of the most difficult tasks in
computing accurate unit costs lies in determining the
proper amount of overhead cost to
assign to each job.
Assigningoverhead is
difficult. I agree!
Overhead Cost Allocation Methods
P1
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A two-stage process maybe used because different
departments may have different allocation bases.
A two-stage process maybe used because different
departments may have different allocation bases.
Finishing Department
Shipping Department
Painting Department
Two-Stage Cost AllocationP1
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IndirectMaterials
OtherOverhead
IndirectLabor
Department1
Department2
Department3
Stage One:Costs assignedto departments
Two-Stage Cost AllocationP1
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Stage One:Costs assignedto departments
Two-Stage Cost AllocationIndirect
MaterialsOther
OverheadIndirectLabor
Department1
Department2
Department3
P1
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Stage One:Costs assignedto departments
Two-Stage Cost AllocationIndirect
MaterialsOther
OverheadIndirectLabor
Department1
Department2
Department3
P1
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Stage Two:Costs applied
to jobs
Stage One:Costs assignedto departments
Jobs
Two-Stage Cost AllocationIndirect
MaterialsOther
OverheadIndirectLabor
Department1
Department2
Department3
P1
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Jobs
Direct Labor Hours
MachineHours
RawMaterials
Cost
Departmental Allocation Bases
Stage Two:Costs applied
to jobs
Stage One:Costs assignedto departments
Two-Stage Cost AllocationIndirect
MaterialsOther
OverheadIndirectLabor
Department1
Department2
Department3
P1
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Level of C
omplexity
Level of C
omplexity
Overhead Allocation
Plantwide Overhead
Rate
DepartmentalOverhead
Rates
Activity BasedCosting
Activity-Based Cost AllocationP2
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In the ABC method, we recognize that many
activities within a department drive overhead costs.
In the ABC method, we recognize that many
activities within a department drive overhead costs.A
B CA
CB
P2
Activity-Based Cost Allocation
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Identify activities and assign indirect costs to those activities.
Central idea . . . Products require activities. Activities consume resources. A
B CA
CB
Activity-Based CostingP2
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More detailed measures of costs. Better understanding of activities. More accurate product costs for . . .
Pricing decisions. Product elimination decisions. Managing activities that cause costs.
Benefits should always be comparedto costs of implementation.
More detailed measures of costs. Better understanding of activities. More accurate product costs for . . .
Pricing decisions. Product elimination decisions. Managing activities that cause costs.
Benefits should always be comparedto costs of implementation.
Activity-Based Costing BenefitsP2
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Most cost drivers are related to either volume or complexity of production. Examples: machine time, machine setups, purchase
orders, production orders.
Three factors are considered in choosing a cost driver: Causal relationship. Benefits received. Reasonableness.
Most cost drivers are related to either volume or complexity of production. Examples: machine time, machine setups, purchase
orders, production orders.
Three factors are considered in choosing a cost driver: Causal relationship. Benefits received. Reasonableness.
Identifying Cost DriversP2
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Identify activities that consume resources.
Assign costs to a cost pool for each activity.
Identify cost drivers associated with each activity.
Compute overhead rate for each cost pool:
Assign costs to products: Overhead Actual Rate Activity
×
Rate = Estimated overhead costs in activity cost pool
Estimated number of activity units
Activity-Based Costing Procedures
P2
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Let’s look at anexample comparingtraditional costing
with ABC. We will start with
traditional costing.
Activity-Based CostingP2
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Pear Company manufactures a product in regular and deluxe models. Overhead is assigned on the basis of direct labor hours. Budgeted overhead for the current year is $2,000,000. Other information:
First, determine the unit cost of each model using traditional costing methods.
Traditional Costing vs. ABCExample
P2
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Overhead Estimated overhead costs Rate Estimated activity
=
Overhead $2,000,000 Rate 40,000 DLH
= = $50 per DLH
P2
Traditional Costing
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Deluxe RegularModel Model
Direct Material 150$ 112$ Direct Labor 16 8 Manufacturing Overhead$50 per hour × 1.6 hours 80 $50 per hour × 0.8 hours 40 Total Unit Cost 246$ 160$
ABC will have differentoverhead per unit.
Traditional CostingP2
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Pear Company plans to adopt activity-based costing. Using the following activity center
data, determine the unit cost of the two products using activity-based costing.
Activity-Based CostingP2
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Overhead UnitsActivity Cost Cost for ofCenter Driver Activity Activity Rate
Purchasing Orders 84,000$ 1,200 Scrap Rework Orders 216,000 900 Testing Tests 450,000 15,000 Machine Related Hours 1,250,000 50,000 Total Overhead 2,000,000$
400 deluxe + 800 regular = 1,200 total
Activity-Based CostingP2
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Overhead UnitsActivity Cost Cost for ofCenter Driver Activity Activity Rate
Purchasing Orders 84,000$ 1,200 $ 70 per orderScrap Rework Orders 216,000 900 $240 per orderTesting Tests 450,000 15,000 $ 30 per testMachine Related Hours 1,250,000 50,000 $ 25 per hourTotal Overhead 2,000,000$
Rate = Overhead Cost for Activity ÷ Units of Activity
Activity-Based CostingP2
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Activity-Based CostingP2
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Let’s completethe table.
Activity-Based CostingP2
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Activity-Based CostingP2
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Total overhead = $720,000 + $1,280,000 = $2,000,000Recall that $2,000,000 was the original amount of
overhead assigned to the products using traditional overhead costing.
Activity-Based CostingP2
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Activity-Based CostingP2
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This result is not uncommon when activity-based costing is used. Many companies have found that low-volume, specialized products have greater overhead costs than
previously realized.
Traditional Costing ABCDeluxe Regular Deluxe RegularModel Model Model Model
Direct labor 150$ 112$ 150$ 112$ Direct material 16 8 16 8 Overhead 80 40 144 32 Total cost 246$ 160$ 310$ 152$
Traditional Costing vs. ABCP2
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Cost Cost DriverMaterials purchasing Number of purchase ordersMaterials handling Number of materials
requisitionsPersonnel processing Number of employees hired
or laid offEquipment depreciation Number of products
produced or hours of useQuality inspection Number of units inspectedIndirect labor for Number of setups required equipment setupsEngineering costs for Number of modifications product modifications
Costs and Cost Drivers inActivity-Based Costing
Exh. 21-6
P2
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Provide informationfor managers to use
in performanceevaluation.
Provide informationfor managers to use
in performanceevaluation.
Assign costs tomanagers who are
responsible forcontrolling the costs.
Assign costs tomanagers who are
responsible forcontrolling the costs.
Primarygoals
Departmental AccountingC1
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Large complex businesses are
divided into departments
enabling managers to have a smaller effective span of
control.
Departmental AccountingC1
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Departments areestablished for
specialized functions.
Departmental AccountingC1
Production Sales Service
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Managers use this information to: Control operations
Appraise performance
Allocate resources.
Plan strategy
The accounting system provides information about resources used and outputs achieved. The accounting system provides information about resources used and outputs achieved.
Information forDepartmental Evaluation
C1
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The type of accounting information provided depends on whether the department is a . . .
The type of accounting information provided depends on whether the department is a . . .
Evaluated on ability to
control costs.
Evaluated on ability to
control costs.
Evaluated on abilityto generate revenues
in excess of expenses.
Evaluated on abilityto generate revenues
in excess of expenses.
Costcenter
Profitcenter
Information forDepartmental Evaluation
C1
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Quality CustomerSatisfaction
ProfitabilityCost
Effectiveness
Information must support these four pillars of
any successful business
Information forDepartmental Evaluation
C1
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Direct expenses are incurred for the sole benefit of a specific
department.
Indirect expenses benefit more than one department and are
allocated among departments benefited.
Departmental Expense Allocation
C2
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Classic Jewelry pays its janitorial service $300 per month to clean its store. Management allocates this cost to its three departments according to the floor space each occupies.
Illustration of IndirectExpense Allocation
Exh. 21-7
C2
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Classic Jewelry pays its janitorial service $300 per month to clean its store. Management allocates this cost to its three departments according to the floor space each occupies.
Exh. 21-7
Illustration of IndirectExpense Allocation
C2
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Classic Jewelry pays its janitorial service $300 per month to clean its store. Management allocates this cost to its three departments according to the floor space each occupies.
Exh. 21-7
Illustration of IndirectExpense Allocation
C2
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Service department costs are shared, indirect expenses that support the activities of two or more production departments.
Bases for AllocatingService Department Costs
Exh. 21-8
C3
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ABCO allocates its $300,000 personnel cost to operating departments based on the number of employees in each department. The assembly department has 100 employees and the packing department has 150 employees. What amount of cost is allocated to assembly?a. $100,000b. $120,000c. $150,000d. $180,000
ABCO allocates its $300,000 personnel cost to operating departments based on the number of employees in each department. The assembly department has 100 employees and the packing department has 150 employees. What amount of cost is allocated to assembly?a. $100,000b. $120,000c. $150,000d. $180,000
Service Department CostsQuestion
C3
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ABCO allocates its $300,000 personnel cost to operating departments based on the number of employees in each department. The assembly department has 100 employees and the packing department has 150 employees. What amount of cost is allocated to assembly?a. $100,000b. $120,000c. $150,000d. $180,000
ABCO allocates its $300,000 personnel cost to operating departments based on the number of employees in each department. The assembly department has 100 employees and the packing department has 150 employees. What amount of cost is allocated to assembly?a. $100,000b. $120,000c. $150,000d. $180,000
Assembly percentage= 100 ÷ (100 + 150) = 40%
40% of $300,000 = $120,000
Service Department CostsQuestion
C3
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Preparing DepartmentalIncome Statements
P3
Let’s prepare departmental income statements using the following steps:
Direct expense accumulation. Indirect expense allocation. Service department expense allocation
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Service Dept. One
Service Dept. Two
Operating Dept. One
Direct expenses are traced to eachdepartment without allocation.
Operating Dept. Two
Step 1: Direct Expense Accumulation
P3
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Service Dept. One
Service Dept. Two
Operating Dept. One
Indirect expenses are allocated to all departmentsusing appropriate allocation bases.
Allocation Allocation Allocation Allocation
Step 2: Indirect Expense Allocation
Operating Dept. Two
P3
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Operating Dept. One
Operating Dept. Two
Service department total expenses (original direct expenses + allocated indirect expenses) are
allocated to operating departments.
Allocation Allocation
Service Dept. One
Service Dept. Two
Step 3: Service Department Expense Allocation
P3
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Departmental ExpenseAllocation Spreadsheet
P3
Let’s examine this three-step allocation procedure forOwl Company.
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Departmental ExpenseAllocation Spreadsheet
Expense Allocation to DepartmentsService Service Sales Sales
Allocation Total Dept. Dept. Dept. Dept.Base Expense One Two One Two
Direct expenses Salaries Payroll 20,000$ 1,000$ 2,000$ 6,000$ 11,000$ Supplies Requisitions 1,500 100 300 400 700
Step 1: Direct expenses are traced to service departments and sales departments without allocation.
P3
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Departmental ExpenseAllocation Spreadsheet
Expense Allocation to DepartmentsService Service Sales Sales
Allocation Total Dept. Dept. Dept. Dept.Base Expense One Two One Two
Direct expenses Salaries Payroll 20,000$ 1,000$ 2,000$ 6,000$ 11,000$ Supplies Requisitions 1,500 100 300 400 700 Indirect expenses Rent Floor space 10,000 1,000 1,000 3,000 5,000 Utilities Floor space 1,000 100 100 300 500 Total dept. expenses 32,500$ 2,200$ 3,400$ 9,700$ 17,200$
Step 2: Indirect expenses are allocated to both the service and the sales departments based on floor space occupied.
Of a total of 2,000 square feet, the service departments occupy 200 square feet each, sales department one occupies 600 square feet, and sales department two
occupies 1,000 square feet.
P3
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Expense Allocation to DepartmentsService Service Sales Sales
Allocation Total Dept. Dept. Dept. Dept.Base Expense One Two One Two
Direct expenses Salaries Payroll 20,000$ 1,000$ 2,000$ 6,000$ 11,000$ Supplies Requisitions 1,500 100 300 400 700 Indirect expenses Rent Floor space 10,000 1,000 1,000 3,000 5,000 Utilities Floor space 1,000 100 100 300 500 Total dept. expenses 32,500$ 2,200$ 3,400$ 9,700$ 17,200$
Service dept. expenses Service Dept. One Sales (2,200) 1,000 1,200 Service Dept. Two EmployeesTotal expenses 32,500$ $ 0 3,400$ 10,700$ 18,400$
Sales department one has $40,000 in sales and sales department two has $48,000 in sales.
Step 3: Service department total expenses (original direct expenses + allocated indirect expenses) are allocated to
sales departments.
Departmental ExpenseAllocation Spreadsheet
P3
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Departmental ExpenseAllocation Spreadsheet
Expense Allocation to DepartmentsService Service Sales Sales
Allocation Total Dept. Dept. Dept. Dept.Base Expense One Two One Two
Direct expenses Salaries Payroll 20,000$ 1,000$ 2,000$ 6,000$ 11,000$ Supplies Requisitions 1,500 100 300 400 700 Indirect expenses Rent Floor space 10,000 1,000 1,000 3,000 5,000 Utilities Floor space 1,000 100 100 300 500 Total dept. expenses 32,500$ 2,200$ 3,400$ 9,700$ 17,200$
Service dept. expenses Service Dept. One Sales (2,200) 1,000 1,200 Service Dept. Two Employees (3,400) 1,400 2,000 Total expenses 32,500$ $ 0 $ 0 12,100$ 20,400$
Sales department one has 28 employees and sales department two has 40 employees.
Step 3: Service department total expenses (original direct expenses + allocated indirect expenses) are allocated to
sales departments.
P3
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Expense Allocation to DepartmentsService Service Sales Sales
Allocation Total Dept. Dept. Dept. Dept.Base Expense One Two One Two
Direct expenses Salaries Payroll 20,000$ 1,000$ 2,000$ 6,000$ 11,000$ Supplies Requisitions 1,500 100 300 400 700 Indirect expenses Rent Floor space 10,000 1,000 1,000 3,000 5,000 Utilities Floor space 1,000 100 100 300 500 Total dept. expenses 32,500$ 2,200$ 3,400$ 9,700$ 17,200$
Service dept. expenses Service Dept. One Sales (2,200) 1,000 1,200 Service Dept. Two Employees (3,400) 1,400 2,000 Total expenses 32,500$ $ 0 $ 0 12,100$ 20,400$
Departmental ExpenseAllocation Spreadsheet
P3
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.
DepartmentalIncome Statements
P3
Now that we have the costs, let’s do an income statement
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Sales SalesCombined Dept. One Dept. Two
Sales 88,000$ 40,000$ 48,000$ Cost of goods sold 38,000 20,000 18,000 Gross profit on sales 50,000$ 20,000$ 30,000$ Operating expenses Salaries 17,000$ 6,000$ 11,000$ Supplies 1,100 400 700 Rent 8,000 3,000 5,000 Utilities 800 300 500
DepartmentalIncome Statements
P3
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DepartmentalIncome Statements
Sales SalesCombined Dept. One Dept. Two
Sales 88,000$ 40,000$ 48,000$ Cost of goods sold 38,000 20,000 18,000 Gross profit on sales 50,000$ 20,000$ 30,000$ Operating expenses Salaries 17,000$ 6,000$ 11,000$ Supplies 1,100 400 700 Rent 8,000 3,000 5,000 Utilities 800 300 500 Service Department One 2,200 1,000 1,200 Service Department Two 3,400 1,400 2,000 Total operating expenses 32,500$ 12,100$ 20,400$ Net income 17,500$ 7,900$ 9,600$
P3
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Departmental contribution . . . Is used to evaluate departmental performance. Is not a function of arbitrary allocations of
indirect expenses.
A department may be eliminated when its departmental contribution is negative.
Departmental revenue– Direct expenses = Departmental contribution
Departmental revenue– Direct expenses = Departmental contribution
Departmental Contributionto Overhead
P3
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As a general rule, a department canbe considered a candidate forelimination if its revenues are lessthan its escapable expenses.
Direct expenses are usually escapable.
Indirect expenses are usually inescapable.
Eliminating anUnprofitable Department
P3
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Departmental Contributionto Overhead
P4
Let’s recast Owl Company’s income statement
using the departmental contribution approach
where indirect expenses are not allocated.
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Net income for the company is
still $17,500.
Departmental Contributionto Overhead
P4
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Departmental contributions to indirect expenses
(overhead) are emphasized.
Departmental Contributionto Overhead
P4
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Departmental contributions are positive so neither department is a candidate for elimination.
Departmental Contributionto Overhead
P4
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Costs are controllableif the manager
has the power to determine, or strongly influence, the
amounts incurred.
A manager’s performance evaluation should be based
on controllable costs.
Controllable CostsC4
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Direct costs are traced to departments, but may not be controllable by the department manager. Example: Department managers usually
have no control over their own salaries.
Controllable costs are identified with a particular manager and a definite time period. All costs are controllable at some level of
management if the time period is long enough.
Distinguishing Controllableand Direct Costs
C4
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An accounting system thatprovides information . . .
Responsibility Accounting
Relating to theresponsibilities of
individual managers.
To evaluatemanagers on
controllable items.
C4
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Responsibility Accounting Successful implementation of responsibility accounting may use organization charts with
clear lines of authority and clearly defined levels of responsibility.
Successful implementation of responsibility accounting may use organization charts with
clear lines of authority and clearly defined levels of responsibility.
Vice Presidentof F inance
D epartm ent M anager
Store M anager
V ice Presidentof O perations
V ice Presidentof M arketing
President
B oard of D irectors
C4
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Amount of detail varies according to level in organization.
A department manager receives detailed reports.
A store manager receives summarized information from each department.
Responsibility AccountingPerformance Reports
C4
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The vice president of operations receives summarized information
from each store.
Management by exception:
Upper-level management does not receive operating
detail unless problems arise.
Amount of detail varies according to level in organization.
Responsibility AccountingPerformance Reports
C4
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To be of maximum benefit, responsibility reports should . . . Be timely. Be issued regularly. Be understandable. Compare budgeted
and actual amounts.
Responsibility AccountingPerformance Reports
C4
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A single cost incurred in producing or purchasing two or more different products. Similar to an indirect expense
since it is shared among morethan one cost object.
Example: The cost of crudeoil is a joint cost for manypetrochemical products.
Joint CostsC5
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If we allocate the joint costs of raising the animal to the two products based on weight, which product
would receive the largest cost allocation?
Joint Costs and Their Allocation
Hamburger, because there is more of it.
C5
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If we allocate the joint costs of raising the animal to the two products based on sales value, would the
steak receive a greater portion of the cost allocation?
Yes, steak has a higher sales value than hamburger.
Joint Costs and Their Allocation
C5
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Allocate the $200,000 joint cost based on sales value.
Product OneSales value = $80,000
Product TwoSales value = $200,000
Product ThreeSales value = $120,000
$200,000Joint Cost
Value Basis Allocation of Joint Costs
C5
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Value Basis Allocation of Joint Costs
C5
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End of Chapter 21