Reference no: EM132486738

Topic - Product Costing

Learning objectives - After studying this presentation, you should be able to:

- Describe the role of cost objects and how they support decision making;

- Explain and compare indirect and direct costs;

- Discuss the process of indirect cost allocation;

- Apply and evaluate the costing framework in service entity settings and support department settings;

- Critically analyse the limitations of cost allocation data.

Questions -

Q1. What is a cost object? Give 3 examples.

Q2. Explain the difference between a direct cost and indirect cost.

Q3. Discuss the importance of selecting an appropriate cost driver for cost allocation.

Q4. What should determine the choice of cost allocation method (direct, step-down and reciprocal) discussed in this chapter?

Q5. What factors should be considered when choosing allocation bases?

Q6. What are the advantages and disadvantages of using estimated support cost allocation rates?

Q7. Direct and indirect costs

Frida's Tax Practice has two departments, tax and audit. The tax department has two product lines, business returns and individual returns. A list of costs and three cost objects from Frida's Tax Practice follow.

Required - For each cost, identify whether it is direct or indirect for each cost object.

Cost -

a. Subscription to personal tax law updates publication

b. Ink supplies for tax department photocopy machine

c. Portion of total rent for tax department office space

d. Wages for tax department administrative assistant

e. Tax partner's salary

f. Charges for long distance call to Mr Gruper about personal tax return questions

g. Tax partner lunch with Mr Gruper; the tax partner has lunch with each client at least once per year

Q8. Direct and indirect costs; fixed, variable, and mixed costs

Your sister turned her hobby into a small business called Glazed Over. She is a potter and manufactures and sells bowls that can be used for decoration or for birdbaths. She has one employee who works 40 hours a week no matter how many bowls are made. She has asked your advice in developing a cost function for the bowls so that she can estimate costs for the next period.

Required - The following list of costs comes from your sister's general ledger. Assume the cost object is an individual unit (i.e. bowl). Categorise each cost as direct or indirect (D or I), and as fixed, variable or mixed (F, V or M).

(a) Employee wages

(b) Clay used to make bowls

(c) Depreciation on the kilns

(d) Glaze (the finish painted on the bowls)

(e) Brushes for the glaze

(f) Electricity

(g) Business licence

(h) Advertising

(i) Pottery studio maintenance (cost of weekly cleaning service)

(j) Packing materials for the bowls

Q9. Cost driver selection

For each of the following activities undertaken to bake pastries and cakes, identify a suitable cost driver to allocate costs.

(a) Mixing ingredients

(b) Baking pastries and cakes

(c) Decorating cakes

(d) Packing pastries and cakes on trays

(e) Sales

(f) Dispatch to customers

Q10. Allocation rates

A housekeeping support department budgets its costs at $40 000 per month plus $12 per hour. For November the following were the estimated and actual hours provided by the housekeeping support department to three operating departments.

	Estimated hours spent cleaning	Actual hours spent cleaning
Department A	1600	1500
Department B	1400	1600
Department C	2000	1800
Total	5000	4900

Required -

(a) What is the support department's allocation rate if estimated activity is the allocation base?

(b) What is the support department's allocation rate if actual activity is the allocation base?

(c) List one advantage and one disadvantage for each type of allocation rate.

Q11. Direct method using estimated costs, benchmarking

Devon Ltd allocates support department costs using the direct method and estimated costs. The support department costs are budgeted at $88 000 for department A, $63 000 for department B, and $40 000 for department C. These costs are allocated using the proportion of total cost the firm would pay to an outside service provider.

	Support			Operating
	Dept. A	Dept. B	Dept. C	Casting	Machine
Direct costs	$88,000	$63,000	$40,000	-	-
Labour hours				6,000	4,000
Machine hours				2,000	10,000
Costs if support services were purchased outside:
Department A				$50,000	$60,000
Department B				$40,000	$30,000
Department C				$20,000	$30,000

Required -

(a) Allocate budgeted support department costs using the direct method, first using labour hours and then with the outside cost proportions as the allocation bases.

(b) Could Devon Ltd use the cost of purchasing outside as an efficiency benchmark for the cost of both the support departments and the user departments? List several advantages and disadvantages of this approach.

Q12. Reciprocal method

The Brown and Brinkley Brokerage firm is organised into two major sales divisions: institutional clients and retail clients. The firm also has two support departments: research and administration. The research department's costs are allocated to the other departments based on a log of hours spent on tasks for each user. The administration department's costs are allocated based on the number of employees in each department.

Records are available for last period as follows.

	Support departments		Operating departments
	Research	Administration	Institutional	Retail
Payroll costs	$350,000	$300,000	$400,000	$550,000
Other costs	$230,000	$150,000	$120,000	$240,000
Research hours	100	200	500	300
Number of employees	7	10	8	10

Required - Using the reciprocal method, determine the total cost of operations for each sales division. Use either simultaneous equations or Excel Solver.

Q13. Step-down, direct, and reciprocal methods; accuracy of allocation

Software Plus Ltd produces flight and driving simulations and games for personal computers. The company's president has a complaint about the accounting for support department costs. He points to the following table describing the use of various support departments in the company and says, 'According to this table, every department receives services from all the support departments. But I understand that only some of the support departments are bearing costs from the other support departments. Why is that?'

Support department	Cost	Administration	Percentage use of services			Simulation manufacturing
			Maintenance	Information systems	Games manufacturing
Administration	$40,000	0%	10%	50%	10%	30%
Maintenance	20,000	20	0	10	40	30
Information systems	50,000	35	5	0	40	20

Required -

(a) What method has Software Plus Ltd been using to allocate support costs? Explain how you know.

(b) Which method would ignore all interactions among support departments? Explain.

(c) Which method would consider all interactions among support departments? Explain.

(d) Allocate the support department costs to Games and Simulations using the step-down method. Explain how you decided which department's costs to allocate first.

(e) Allocate the support department costs using the direct method.

(f) Allocate the support department costs using the reciprocal method.

(g) In your own words, explain how the step-down method improves upon the direct method.

(h) In your own words, explain how the reciprocal method improves upon the step-down method.

Q14. Direct, step-down, and reciprocal methods; assign costs to departments. Cost information for Lake County Library is as follows.

Direct costs	Support maintenance	Administration	Operating books	Other media	Total
Salaries	$20,000	$40,000	$50,000	$70,000	$180,000
Supplies	5,000	5,000	15,000	25,000	50,000
Allocation base volumes
Square meters	500	500	1,200	300	2,500
Employees	1	1	2	1	5

In addition to directly traceable costs, the library incurred $24,000 for a building lease.

Required -

(a) Allocate to departments any costs that have not been traced, and then calculate total costs assigned to each department.

(b) Allocate the support department costs to the operating departments using the direct method.

(c) Allocate the support department costs to the operating departments using the step-down method. Allocate first the costs for the support department having the largest direct costs.

(d) Allocate the support department costs to the operating departments using the reciprocal method. Use either simultaneous equations or Excel Solver.