Chapter 4 Cost Accumulation, Tracing, and Allocation
Answers to Questions
1.A cost object is something for which one is trying to determine the cost. Cost objects that accountants would need to know the cost of would include products, activities, services, and departments.
2.Managers need timely cost information. They may have to sacrifice accuracy in order to get the information in time for decision making. For instance, managers need cost information for planning (budgeting) before the activities that cause the costs have occurred. Consequently, they rely on estimates and judgment that are not as precise as actual cost data.
3.For product costing one needs to accumulate the costs necessary to produce the product, which are direct materials, direct labor, and overhead.
4.A direct cost is a cost that is easily traceable to a cost object. A cost-benefit analysis is necessary to determine if a cost is easily traceable to a cost object. If the costs or sacrifices to trace a cost are small in relation to the informational benefits, the cost is easily traceable.
5.A direct cost can be either a fixed or variable cost and an indirect cost can be either a fixed or variable cost. For example, supervisor salaries are usually fixed costs but they are direct or indirect depending on the cost object. If the cost object is the product, supervisor salaries are indirect costs; whereas, if the cost object is the department, supervisor salaries are direct costs.
6.The depreciation on machinery used in only one department is a direct cost to that department but the depreciation is not avoidable if the activities of the department are eliminated.
7.The cost driver chosen to use in allocating a cost should be some activity that drives the cost. In other words, the cost driver should be the activity responsible for changes in the cost. The best cost driver is not only the one that drives the cost to be allocated but the activity that accomplishes the intended goals in allocating the cost. In other words, the cost driver should provide an assignment of costs such that the allocation motivates behavior toward intended objectives.
8.To determine an allocation rate divide the total cost to be allocated by the total cost driver for that cost. To make an allocation to a cost object multiply the allocation rate by the weight (the actual amount) of the cost driver for that object.
9.Direct material and direct labor costs are direct costs of the product. Overhead costs are indirect costs of the product. Overhead is composed of a myriad of costs that have the common property of being indirect costs of the product.
10.It is not possible to trace some costs, such as the utility cost of heating a factory, to individual products. It is not cost effective to trace other manufacturing costs to products. In other words, the costs to trace these costs would outweigh the benefits. In addition, the amounts of some costs are unknown at the time products are made. An example would be manufacturing supplies under the periodic inventory system. Finally some fixed costs do not change with changes in production volume; therefore, these costs cannot be traced to any specific product or level of production.
11.Overhead costs are allocated to the product in order to estimate the total cost of manufacturing the product and to evenly spread overhead costs over the units produced in a period. This smoothing will assign an equal amount of indirect cost to each unit of product. Smoothing is necessary for the following reasons: (1) overhead may not be easily traceable to products, (2) some overhead may be unknown when the products are produced and (3) some overhead costs are not related to the number of units produced.
12.The volume of production may vary from month to month. If an equal amount of overhead is allocated to each month, the per unit cost of the product each month varies depending on production volume. The per unit cost will be lower in months of high volume and higher in months of low volume.
13.The statement is incorrect. Choosing an inappropriate allocation base can result in inaccurate product costs which can cause poor decisions. An allocation base that does not rationally link the costs to be allocated to the cost object will assign costs arbitrarily without reasonable justification for the assignment. The allocation base chosen should be the factor that drives the allocated costs. An appropriate allocation base will result in a more accurate assignment of costs and more reasonable and productive decisions.
14.Both students are correct. Costs should be estimated beforehand to determine the project's merits and to plan expenditures. Projected costs have to be estimated costs and will not be completely accurate but these costs are relevant because of their timeliness. They are known in time to make decisions that can affect the success or failure of the project. Actual costs cannot be timely and relevant for decisions that need to be made before the project begins. Actual costs are useful for evaluating the results of the project and for the planning of future projects.
15.The three methods used for allocating service center costs are as follows:
Direct Method – The simplest method of allocating service center costs. The technique allocates accumulated service center cost pools directly to operating departments using the most appropriate allocation base. The method does not consider that service center departments render services to other service center departments.
Step Method – A two-step allocation method that considers the effect of interdepartmental services but does not consider reciprocal allocations between service departments. In the first-stage allocation process, pooled service center costs are distributed to other service departments and to operating departments in a sequence of step-down allocations. The service center cost pool that represents resources used by the largest number of departments is first allocated to the other service centers and to operating departments. Next, allocations are made from the service center cost pool that represents resources used by the second largest number of departments. This first-stage allocation process continues until all service center costs have been distributed to the operating departments. Finally in a second stage, costs are allocated from the operating departments to the company’s products. The method eliminates many of the distortions that result when interdepartmental services are ignored as in the direct method and provides a more accurate product cost.
Reciprocal Method – This allocation method gives recognition to reciprocal relationships between service centers. It requires complex mathematical computations involving the use of simultaneous linear equations. Because the results of the allocation process do not differ significantly from the step method and are difficult to interpret, the method is not widely used.
Exercise 4-1A
Step 1 is to determine the allocation rate:
Fringe benefit cost / $240,000Allocation rate / = / –––––––––––––––––––– / = / ––––––––––– / = / $6,000 per employee
No. of employees / 40
(Cost driver)
Step 2 is to assign the cost by multiplying the allocation rate by the weight of the base (i.e., cost driver) for each division:
Division / Allocation Rate / x / Weight of Base / = / Allocated CostA / $6,000 / x / 28 employees / = / $168,000
B / $6,000 / x / 12 employees / = / 72,000
Total allocated cost / $240,000
Exercise 4-2A
a.
Items / DirectCost / Indirect
Cost
Labor on a particular house / X
Salary of the supervisor of commercial construction projects / X
Supplies, such as glue and nails, used by the Home Construction Division / X
Cost of building permits / X
Materials used in commercial construction project / X
Depreciation on home building equipment (small tools such as hammers or saws) / X
Company president’s salary / X
Depreciation on crane used in commercial construction / X
Depreciation on home office building / X
Salary of corporate office manager / X
Wages of workers assigned to a specific construction project / X
Supplies used by the Commercial Construction Division / X
Exercise 4-2A (continued)
b.
Items / DirectCost / Indirect
Cost
Labor on a particular house / X
Salary of the supervisor of commercial construction projects / X
Supplies, such as glue and nails, used by the Home Construction Division / X
Cost of building permits / X
Materials used in commercial construction project / X
Depreciation on home-building equipment (small tools such as hammers or saws) / X
Company president’s salary / X
Depreciation on crane used in commercial construction / X
Depreciation on home office building / X
Salary of corporate office manager / X
Wages of workers assigned to a specific construction project / X
Supplies used by the Commercial Construction Division / X
c.
Items / DirectCost / Indirect
Cost
Labor on a particular house / X
Salary of the supervisor of commercial construction projects / X
Supplies, such as glue and nails, used by the Home Construction Division / X
Cost of building permits / X
Materials used in commercial construction project / X
Depreciation on home-building equipment (small tools such as hammers or saws) / X
Company president’s salary / X
Depreciation on crane used in commercial construction / X
Depreciation on home office building / X
Salary of corporate office manager / X
Salary of worker assigned to a specific construction project / X
Supplies used by the Commercial Construction Division / X
Exercise 4-3A
a.Step 1 is to determine the allocation rate:
Allocation rate / Overhead cost / $750,000for / = / ––––––––––––––––––– / = / ––––––––––– / = / $60 per DL hour
Overhead cost / Direct labor hours / 12,500
Step 2 is to assign the cost by multiplying the allocation rate by the weight of the base (i.e., cost driver):
Product / Allocation Rate / x / Weight of Base / = / Allocated CostVogue / $60 / x / 3,000 / = / $180,000
Beauty / $60 / x / 5,000 / = / 300,000
Deluxe / $60 / x / 4,500 / = / 270,000
Total / $750,000
b.Step 1 is to determine the allocation rate:
Allocation rate / Overhead cost / $750,000for / = / –––––––––––––––––– / = / ––––––––––– / = / $250 per machine hour
Overhead cost / Machine hours / 3,000
Step 2 is to assign the cost by multiplying the allocation rate by the weight of the base (i.e., cost driver):
Product / Allocation Rate / x / Weight of Base / = / Allocated CostVogue / $250 / x / 1,000 / = / $250,000
Beauty / $250 / x / 1,000 / = / 250,000
Deluxe / $250 / x / 1,000 / = / 250,000
Total / $750,000
c.If the manufacturing process is labor-intensive, the amount of labor used for a cost object would be a good indication of a corresponding use of indirect costs for the same object. Even if the manufacturing process is not labor-intensive, labor hours can still be a good indicator of the use of indirect costs as long as a consistent relationship between the use of direct labor and that of indirect costs can be demonstrated.
Exercise 4-3A (continued)
d.If the manufacturing process is machine-intensive, the amount of machine hours used for a cost object would be a good indication of a corresponding use of indirect costs for the same object. Even if the manufacturing process is not machine-intensive, machine hours can still be a good indicator of the use of indirect costs as long as a consistent relationship between the use of direct machine hours and that of indirect costs can be demonstrated.
Exercise 4-4A
a.
Step 1 is to determine the allocation rate:
Allocation rate / Overhead cost / $250,000for / = / ––––––––––––––– / = / ––––––––––– / = / $100 per machine hour
Overhead cost / Machine hours / 2,500
Step 2 is to assign the cost by multiplying the allocation rate by the weight of the base (i.e., cost driver):
Product / Allocation Rate / x / Weight of Base / = / Allocated CostCups / $100 / x / 500 / = / $ 50,000
Tablecloths / $100 / x / 800 / = / 80,000
Bottles / $100 / x / 1,200 / = / 120,000
Total / $250,000
b.Flemming may have chosen machine hours as the cost driver because the manufacturing process could be machine-intensive, or a clear relationship between machine hours and the use of indirect costs could exist.
Exercise 4-5A
There is a logical cause and effect relationship between the fringe benefits cost and the direct labor hours. The more labor employed the more fringe benefit cost incurred. In other words, the labor is driving the fringe benefits cost. Accordingly, labor hours is a rational allocation base for fringe benefit cost. Similarly, direct materials is a rational cost driver for indirect materials. The more direct materials (e.g., lumber) used, the more indirect materials (e.g., nails, glue) used. Accordingly, direct materials cost is a rational base for the allocation of indirect materials. The computations for the allocations and the total cost figures are shown below:
Step 1 is to determine the allocation rates:
Allocation rate / Fringe benefit cost / $40,000for / = / –––––––––––––––––––– / = / ––––––––––– / = / $0.125 per labor $
fringe benefits / Direct Labor Dollars / $320,000
Allocation rate / Indirect mater. cost / $20,000
for / = / ––––––––––––––––––––– / = / ––––––––––– / = / $0.05 Per material $
indirect mater. / Direct mater. dollars / $400,000
Step 2 is to assign the costs by multiplying the allocation rate by the weight of the base (i.e., cost driver) for each home:
Fringe Benefits
House / Allocation Rate / x / Weight of Base / = / Allocated Cost1 / $0.125 / x / $ 60,000 / = / $ 7,500
2 / $0.125 / x / $ 90,000 / = / 11,250
3 / $0.125 / x / $170,000 / = / 21,250
Total / $40,000
Exercise 4-5A (continued)
Indirect Materials
House / Allocation Rate / x / Weight of Base / = / Allocated Cost1 / $0.05 / x / $ 90,000 / = / $ 4,500
2 / $0.05 / x / $130,000 / = / 6,500
3 / $0.05 / x / $180,000 / = / 9,000
Total / $20,000
Step 3 sums the cost components to determine the total cost of each house:
Expected Costs / House 1 / House 2 / House 3 / TotalDirect labor / $ 60,000 / $ 90,000 / $170,000 / $320,000
Direct materials / 90,000 / 130,000 / 180,000 / 400,000
Fringe benefits / 7,500 / 11,250 / 21,250 / 40,000
Indirect materials / 4,500 / 6,500 / 9,000 / 20,000
Total cost / $162,000 / $237,750 / $380,250 / $780,000
Exercise 4-6A
There is a logical relationship between the amount of labor and the level of production. The more man hours worked, the more products produced. In order to spread indirect costs (i.e., rental costs) evenly over the total number of products made, more rental costs should be assigned to the months in which more labor is used. This objective can be accomplished by allocating the total annual rental cost on the basis of direct labor hours.
Step 1 is to determine the allocation rate:
Annual rent / $86,400*Allocation rate / = / –––––––––––––––––––– / = / ––––––––––– / = / $21.60 per labor hour
Annual labor hours / 4,000
(Cost driver)
*$7,200 x 12 = $86,400
Step 2 is to assign the cost by multiplying the allocation rate by the weight of the base (i.e., cost driver) for each month:
Month / Allocation Rate / x / Weight of Base / = / Allocated CostJan. / $21.60 / x / 320 hours / = / $ 6,912
Feb. / $21.60 / x / 480 hours / = / 10,368
Exercise 4-7A
A problem exists because the insurance premium is paid only in July. If all of the cost is assigned to the July production, the cost of the goods made in July would be high relative to the cost of goods made in other months. Allocating the cost on the basis of annual direct labor hours will assign appropriate portions of the cost to the units produced in each month.
Step 1 is to determine the allocation rate:
Insurance cost / $45,000Allocation rate / = / –––––––––––––––––––– / = / –––––––––– / = / $1.25 per hour
No. of labor hours / 36,000
(Cost driver)
Step 2 is to assign the cost by multiplying the allocation rate by the weight of the base (i.e., cost driver) for each month:
Month / Allocation Rate / x / Weight of Base / = / Allocated CostJanuary / $1.25 / x / 3,200 hours / = / $4,000
February / $1.25 / x / 2,000 hours / = / $2,500
Exercise 4-8A
a.The annual salary of the customer relations representative could be allocated by computing an allocation rate based on the total number of complaints expected to occur during the year. A monthly charge could be determined by multiplying the rate by the weight of the base. The computations for such an allocation are shown below:
Step 1 is to determine the allocation rate:
Cost of salary / $48,000*Allocation rate / = / ––––––––––––––––––– / = / –––––––––– / = / $3 per complaint
No. of complaints / 16,000
*$4,000 x 12 = $48,000
Step 2 is to assign the cost by multiplying the allocation rate by the weight of the base (i.e., cost driver) for each month:
Month / Allocation Rate / x / Weight of Base / = / Allocated CostJanuary / $3 / x / 1,000 / = / $3,000
February / $3 / x / 1,300 / = / $3,900
b.An important question that must be addressed is why one would make such an allocation. Since you do not charge for processing customer complaints, the information would not be useful for pricing decisions. Since the representative has no control over the number of complaints received, the cost per complaint would have little relevance. Indeed, non-financial measures may be more useful for management. Information such as the average length of time used to process complaints, the level of customer satisfaction, or a record as to the types of complaints may be far more relevant than an amount of cost per complaint determined by arbitrary allocation. Understanding the reasons for allocation is even more important than learning mathematical procedures.
Exercise 4-9A
a. / Month / Jan / Feb / Mar / Apr / TotalNo. of units / 4,000 / 7,000 / 3,000 / 6,000 / 20,000
Allocation rate / Overhead cost / $50,000 x 4
for / = / ––––––––––––––– / = / –––––––––––––– / = / $10 per unit
overhead / No. units / 20,000
b.Assign the cost by multiplying the allocation rate by the weight of the base (i.e., cost driver) for each month:
Month / Allocation Rate / x / Weight of Base / = / Allocated CostJan. / $10 / x / 4,000 / = / $ 40,000
Feb. / $10 / x / 7,000 / = / 70,000
Mar. / $10 / x / 3,000 / = / 30,000
Apr. / $10 / x / 6,000 / = / 60,000
Total / $200,000
c.Computation of cost per unit:
Month / Jan. / Feb. / Mar. / Apr.No. units (a) / 4,000 / 7,000 / 3,000 / 6,000
Expected cost
Overhead (b) / $40,000 / 70,000 / $30,000 / $ 60,000
Direct costs (c=a x $7) / 28,000 / 49,000 / 21,000 / 42,000
Total cost (d) / $68,000 / $119,000 / $51,000 / $102,000
Cost per unit (d÷a) / $17.00 / $17.00 / $17.00 / $17.00
Exercise 4-10A
Cost / ÷ / Base / Computation / Allocation RateTotal overhead / ÷ / No. units / $472,800÷9,600= / $49.25 per unit
Allocation
Rate / x / Weight
of Base / = / January
Number of units (a) / 1,200
Indirect overhead costs / $49.25 / x / 1,200 / = / $ 59,100
Direct materials (a x $64) / 76,800
Direct labor (a x $52) / 62,400
Total (b) / $198,300
- The amount computed in part a is an estimated amount. Accuracy could be improved by waiting until December to determine the amount of product cost. However, a manager may need to know the cost of products in January in order to evaluate performance. It is disadvantageous to wait until the end of the year to tell a manager that he or she needs to improve. By then it is too late.
Exercise 4-11A
The allocation rate is computed below:
Cost / ÷ / Base / Computation / Allocation RateRental cost / ÷ / No. units / $120,000 ÷ 24,000= / $5 per unit
Allocation
Rate / x / Weight
of Base / = / January / February
Number of Units (a) / 4,000 / 2,000
Rental cost / $5 / x / 4,000 / = / $20,000
Rental cost / $5 / x / 2,000 / = / $10,000
Direct materials / 16,000 / 8,000
Direct labor / 24,000 / 12,000
Total (b) / $60,000 / $30,000
Cost per unit [c=(b÷a)] / $15 / $15
Price (c x 1.4) / $21 / $21
Exercise 4-12A
a.Step 1 is to determine the allocation rate.
Joint product cost / $1,800,000Allocation rate / = / ––––––––––––––––––– / = / –––––––––––– / = / $6 per pound
Total weight / 300,000
Step 2 is to assign the cost by multiplying the allocation rate times the weight of the base for each operating department.
Product / Allocation Rate / x / Weight of Base / = / Allocated CostB217 / $6 / x / 70,000 / = / $ 420,000
K360 / $6 / x / 150,000 / = / 900,000
X639 / $6 / x / 80,000 / = / 480,000
Total joint cost / $1,800,000
b.The market value of the three products:
Product / Price Per Pound / x / Weight by Pound / = / Market ValueB217 / $ 4.00 / x / 70,000 / = / $ 280,000
K360 / $ 9.60 / x / 150,000 / = / 1,440,000
X639 / $16.00 / x / 80,000 / = / 1,280,000
Total market value / $3,000,000
Step 1 is to determine the allocation rate.