Edmonds FMAC10 Chap04

CHAPTER 4
Cost Accumulation,
Tracing, and
Allocation
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Chapter Opening
Managers must have reliable cost estimates to:

• Price products.
• Evaluate performance.
• Control operations.
• Prepare financial statements..
4-2
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Cost Objects
The things for which we are trying to determine
the cost are commonly called cost objects.
Cost objects may be:

• products,
• processes,
• departments,
• services,
• activities, and so on.
4-3
Learning Objective 4-1
Identify cost objects and distinguish
between direct costs versus indirect
costs.
4-4
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Determine the Cost of Cost
Objects
Accountants use cost accumulation

to determine the cost of a particular object.
Cost accumulation begins with identifying:

1. Cost objects
2. Cost drivers
4-5
Cost Drivers and Cost
Accumulation
• Determining the costs of the secondary cost
objects requires identifying what drives those
costs.
• A cost driver has a cause-and-effect
relationship with a cost object.
4-6
Estimated versus Actual
Cost
Timely Relevant
Potential
Inaccuracies
Estimated Costs
Managers use estimated costs to
make decisions about the future.
4-7
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Income Statement for In
Style, Inc. (ISI)
4-8
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Assignments of Costs to
Objects in a Retail Business
In Style, Inc. (ISI), a retail clothing store pays a
bonus to each department manager based on a
percentage of departmental sales revenue.
In the drive to To improve the
situation, the store
maximize sales,
manager decided to
the managers base future bonuses
ignored the on each department’s
need to control contribution to
costs. profitability rather
than its sales revenue.
4-9
Identifying Direct and
Indirect Costs
• The new bonus strategy requires determining the
costs of operating each department.
• Assigning costs to the departments (cost objects)
requires cost tracing and cost allocation.
Indirect costs are also called overhead costs.
4-10
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Income Statement
Classification of Costs
4-11
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Allocate indirect costs to cost objects.
4-12
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Cost Allocation
Support multiple cost
Common Costs objects but cannot be
directly traced to any
specific object.
Costs that can be

Controllable influenced by a
Costs manager’s decisions
and actions.
Cost allocation involves dividing a

total cost into parts and assigning the
parts to designated cost objects.
4-13
Allocating Rental Costs to Objects
Step 1. Compute the allocation rate.
Step 2. Multiply the allocation rate by the

weight of the cost driver to determine the
allocation per cost object.
4-14
Allocating Utility Costs to Objects
Step 2. Multiply the allocation rate by the weight of

the cost driver to determine the allocation per cost
object.
4-15
Determining the Cost to Be
Allocated Using Cost Pools
Companies frequently accumulate many
individual costs into a single cost pool.
Pooling should be limited to costs

with common cost drivers.
4-16
Identify the most appropriate cost
driver.
4-17
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Selecting the Cost Driver
• Companies can
frequently identify more A company
than one cost driver for should use the
a particular indirect
cost. driver with the
• For example, ISI’s cost strongest
of shopping bags cause-and-
provided to customers effect
can be linked to both
the number of sales
relationship.
transactions and the
total amount of sales.
4-18
Cause and Effect versus
Availability of Information
Consider shopping bag usage for
T-shirts sold in the children’s versus the men’s
departments.
• A study of T-shirt sales is below.
4-19
Allocating Supplies Costs
to Objects Step One
Assuming that total sales for the women’s, men’s, and
children’s departments was $190,000, $110,000, and
$60,000, respectively, ISI can allocate the supplies cost as
follows.
Step 1. Compute the allocation rate by dividing the total
cost of supplies $900 to be allocated by the $360,000
total sales cost driver.
4-20
Allocating Supplies Costs
to Objects Step Two
Step 2. Multiply the allocation rate by the weight
of the cost driver to determine the
4-21
Allocating Advertising
Costs to Objects Step One
ISI also believes the amount of sales is the
appropriate allocation base for advertising costs.
Step 1. Compute the allocation rate by dividing

$7,200 total advertising cost by the $360,000 total
sales cost driver.
4-22
Allocating Advertising
Costs to Objects Step Two
4-23
Allocating Store Manager’s
Salary to Objects Step One
SI allocates the store manager’s salary arbitrarily
because there is no strong cause-and-effect
relationship between it and the departments.
Step 1. Compute the allocation rate by dividing

$9,360 manager’s monthly salary by the number
of departments.
4-24
Allocating Store Manager’s
Salary to Objects Step Two
4-25
Profit Analysis by
Department
4-26
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Costs Drivers for Variable
Overhead Costs
Increases in the volume of production will
cause variable overhead costs to increase.
Volume measures
serve as good cost drivers
for the allocation of
variable overhead.
Units Labor Direct

Produced Hours Materials
4-27
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Filmier Furniture Company
Production and Cost
Information
Product
Chairs Desks Total
Number of Units 4,000 1,000 5,000
Direct Labor Hours 2,500 3,500 6,000
Direct Materials Cost $ 500,000 $ 1,000,000 $ 1,500,000
Indirect Materials Cost $ 60,000
• Use the two-step process to allocate indirect

materials cost using the three volume measures
as cost drivers.
4-28
Using Units as the Cost Driver

weight of the cost driver.
4-29
Using Direct Labor Hours
as the Cost Driver Step One
4-30
Using Direct Labor Hours
as the Cost Driver Step Two
4-31
Using Direct Materials
Dollars as the Cost Driver

amount of the cost driver.
4-32
Selecting the Best Cost
Driver
• Which volume The most
measure should be accurate
used? allocations of
indirect costs
• Management must may require
use judgment to using multiple
decide. cost drivers.
4-33
Cost Drivers for Fixed
Overhead Costs
Volume of
production does
not drive fixed The objective of allocating
costs. fixed costs to products is
to distribute a rational
share of the overhead
cost to each product.
Selecting an allocation base that spreads

total overhead cost equally over total
production often produces a rational
distribution.
4-34
Lednicky Bottling
Company Information
Units Produced 2,000,000
Units Sold 1,800,000
Units in Ending Inventory 200,000
Fixed Rental Cost $ 28,000
Use the two-step process to allocate the fixed rental

cost to units sold and to units in ending inventory.
4-35
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Allocating Fixed Costs to
Objects

4-36
Allocating Fixed Costs When the
Volume of Production Varies
Step One
Monthly fluctuations in production volume complicate
fixed cost allocations.
• To illustrate, assume Grave Manufacturing pays its
production supervisor a yearly salary of $36,000.
Assume Grave makes 800 units of product in January
and 1,875 in February and expects to produce 18,000
units during the year.
4-37
Allocating Fixed Costs When the
Volume of Production Varies Step
Two
Step 2. Multiply the rate by the weight of the base
(number of units per month) to determine how
much of the salary cost to allocate to each month’s
production.
Because the overhead allocation rate is determined before

actual cost and volume data are available, it is called the
predetermined overhead rate. 4-38
Allocate joint costs to joint products.
4-39
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Allocating Joint Costs
Assume Westar Chemical Company produces from
common raw materials the joint products Compound
AK and Compound AL. Compound AL requires further
processing before Westar can sell it.
• Joint costs are common costs incurred in the process of making

two or more joint products.
• The point in the production process at which products become
separate and identifiable is the split-off point. 4-40
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Allocating Joint Costs to
Objects by Volume

weight of the base.
4-41
Relative Sales Value as the
Allocation Base
Gross margin with and without Compound
AL.
4-42
Relative Sales Value as the
Allocation Base Continued
Westar Chemical would allocate all of the
joint costs to Compound AK because
Compound AL has no market value at the
split-off point.
4-43
Recognize the effects of cost
allocation on employee motivation.
4-44
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Cost Allocation—The
Human Factor
Cost allocations significantly affect
individuals.
• They can influence managers’
performance evaluations and pay.
• They may dictate the amount of
resources various organizational
subunits receive.
4-45
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Cost Allocation at a Major
State University
Academic Number of Number of Actual Cost
Departments Faculty Students Prior Year
Management 29 330 $ 12,000
Accounting 16 360 10,000
Finance 12 290 8,000
Marketing 15 220 6,000
Totals 72 1,200 36,000
4-46
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Allocating Copying Costs to
Objects by Number of Faculty

4-47
Allocating Copying Costs to
Objects by Number of Students

4-48
Controlling Emotions
• Technical expertise in computing numbers
is of little use without the interpersonal
skills to persuade others.
• Accountants may provide numerical
measurements, but they should never
forget the impact of their reports on the
people in the organization.
4-49
Allocate service department costs to
operating departments (Appendix).
4-50
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Allocating Service Center
Costs
Most organizations establish departments
responsible for accomplishing specific tasks.
• Departments that are assigned tasks leading to
the accomplishment of the primary objectives
of the organization are called operating
departments.
• Those that provide support to operating
departments are called service departments.
4-51
Direct Method
The direct method allocates service department
costs directly to operating department cost pools.
To illustrate, assume that Candler & Associates is a
law firm that desires to determine the cost of
handling each case. The firm has two operating
departments, one that represents clients in civil suits
and the other that defends clients in criminal cases.
The two operating departments are supported by
two service departments—personnel and secretarial
support. Candler uses a two-stage allocation system
to allocate the service centers’ costs to the firm’s
legal cases.
4-52
Determination of
Allocation Rates
4-53
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First-Stage Allocation –
Direct Method
4-54
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Step Method
A service that is performed by one service
department for the benefit of another
service department is called an
interdepartmental service.
The step method is a cost approach that

recognizes interdepartmental service
activity.
4-55
Comparison of the Direct
and Step Allocation
Methods
4-56
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Step Method – Allocation
Rate Personnel Department
4-57
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Step Method – Allocation
Rate Secretarial Department
4-58
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First-Stage Allocations –
Step Method
4-59
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Reciprocal Method
• Two-way associations in
which departments
• Note that the step provide and receive
method is limited services from one
to one-way another are called
interdepartmental reciprocal
relationships.
relationships.
• The results attained with
• In practice, many the reciprocal method
departments have are not significantly
two-way working different from those
relationships. attained through the step
method.
• As a result, the reciprocal
method is rarely used in
practice. 4-60

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CHAPTER 4

Managers must have reliable cost estimates to:

Cost objects may be:

Accountants use cost accumulation

Cost accumulation begins with identifying:

Indirect costs are also called overhead costs.

Costs that can be

Cost allocation involves dividing a

Step 2. Multiply the allocation rate by the

Step 2. Multiply the allocation rate by the weight of

Pooling should be limited to costs

• A study of T-shirt sales is below.

Step 1. Compute the allocation rate by dividing

Step 1. Compute the allocation rate by dividing

Units Labor Direct

• Use the two-step process to allocate indirect

Step 2. Multiply the allocation rate by the

Step 1. Compute the allocation rate.

Step 2. Multiply the allocation rate by the

Selecting an allocation base that spreads

Use the two-step process to allocate the fixed rental

Step 2. Multiply the allocation rate by the

Step 1. Compute the allocation rate.

Because the overhead allocation rate is determined before

• Joint costs are common costs incurred in the process of making

Step 2. Multiply the allocation rate by the

Step 2. Multiply the allocation rate by the

Step 2. Multiply the allocation rate by the

The step method is a cost approach that

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