ACCT20001 Cost Management

Department of Accounting

Tutorial Week 4 Solutions

REQUIREMENT 1:

To ensure that an accurate allocation of indirect cost occurs, the choice of allocation
base is important.

Where possible, we want to choose an allocation base which is the cost driver of the
indirect cost i.e., an increase in the allocation base (cost driver) leads to an increase in
an increase in the indirect cost and vice versa.

The choice of such an allocation base ensures that the amount of indirect cost
allocated to the cost object reflects (as much as possible) the amount of cost that is
‘caused’ by that cost object

REQUIREMENT 2:

Job Costing – Complete Bhimani et al. (5th Ed. or 6th Ed.) Ex. 3.16

1. Direct job costs must be the same under both actual and normal costing. Thus, they
must be (€55 x 70 hours) = €3,850. The direct rate or actual hours cannot be different
across the two methods.

Likewise, the actual hours must be used for both methods, so the different rates can be
computed from the costs given divided by the 70 actual hours, or 2660/70 = €38/hr
and 2800/70 = €40/hr.

Clearly the totals are 3,850+2,660 = €6,510 and 3,850+2,800 = €6,650.

2. Use the overhead allocation rates from part 1 with the given amounts to fill in the
blanks in part 2.

Budgeted consulting support costs = 18,000 hours * €40/hour = €720,000

Actual consulting labour hours = €798,000 ÷ 38/hour = 21,000 hours
Actual consulting labour compensation = 21,000 * 55 = €1,155,000

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Note that budgeted consulting labour compensation cannot be determined from
the information provided – we don’t know what the budgeted CL cost per hour
is (which may not be the same as the actual CL cost per hour).

3. Additional questions

(i) Eldorado has chosen consulting labour hours worked to allocate consulting
support cost. The consulting support cost pool consist of the following:
o Printing costs
o IT Support costs
o Telecommunication costs
o Stationery costs

Consider the following statement: “Given that there are 4 cost items, Eldorado
should not have a single indirect cost pool. It should have 4 different cost
pools.” Do you agree with it? Explain.

Disagree. Whether or not Eldorado should have a single cost pool or otherwise
does not depend on the number of indirect cost items. It is ok to have a single
cost pool (and a single allocation base) if all the cost items are influenced /
driven by the same cost driver. Therefore, if the printing, IT support, telecom
and stationery cost incurred by a job increases as the number of consulting
hours increase, then Eldorado’s current approach of allocating indirect costs
(using a single pool with consulting labour hours as the allocation base) is
appropriate.

Having 4 separate cost pools would result in more accurate / reliable allocation
of indirect cost if each cost item is influenced / driven by different cost
drivers. However this would make the allocation process more complicated
(i.e., need to decide on each allocation base separately, keep records of all 4
allocation bases, do the allocation separately).

(ii) What are the benefits of Normal Costing for Eldorado? What are is
disadvantages (relative to Actual Costing)

 Disadvantage: Timely allocation of indirect costs. Normal costing results in

allocation of estimated indirect costs to the cost object (e.g., the job) as the job
is being worked on.

 The predetermined (or estimated) allocation rate used to allocate indirect cost
is unlikely to be equal to the actual allocation rate. As a result, the total
indirect cost allocated (to all jobs) will not be the same as the total indirect

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 cost incurred. Therefore an adjustment to the amounts allocated is required at
the end of the period.

(iii) Is Job Costing suitable for Eldorado SA? Explain.

Organizational characteristics consistent with job costing:

 Relatively high product/service variety. Unique, custom products/services
 Relatively low volume of such products/services

Eldorado is a consulting firm which most probably provides tailored services based on
their individual client needs. Therefore, job costing would be appropriate for them.

REQUIREMENT 3:

Bhimani et al. (5th Ed. or 6th Ed.) Ex. 3.20

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