PART 4

Cost Allocation and Performance Measurement

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 Content

Departmentalization and the role of departmental

accounting
Distinguish between direct and indirect expenses
Bases for allocating indirect expenses to
department
Activities based costing

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Departmental Accounting
Primary
goals

Provide information Assign costs to

for managers to use managers who are
in performance responsible for
evaluation. controlling the costs.

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Departmental Accounting

Large complex businesses are

divided into departments
enabling managers to have a
smaller effective span of
control.

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Departmental Accounting
Departments are
established for
specialized functions.

Production Sales Service

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Information for
Departmental Evaluation
The accounting system provides information
about resources used and outputs achieved.
Managers use this information to:
Control operations
Appraise performance
Allocate resources.
Plan strategy
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Information for
Departmental
The type of accounting information Evaluation
provided depends on whether
the department is a . . .

Cost Profit
center center

Evaluated on Evaluated on ability

ability to to generate revenues
control costs. in excess of expenses.

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Information for
Departmental Evaluation
Customer
Quality
Satisfaction
Information must
support these
four pillars of
any successful
business

Cost
Profitability
Effectiveness
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 Departmental Expense Allocation
C2

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.

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Illustration of Indirect Exh.
21-7

Expense Allocation
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.

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Exh.

Illustration of Indirect 21-7

Expense
Classic Jewelry pays its janitorialAllocation
service $300 per month to clean its
store. Management allocates this cost to its three departments
according to the floor space each occupies.

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Illustration of Indirect Exh.
21-7

Expense Allocation
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.

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Bases for Allocating Exh.
21-8

Service Department Costs

Service department costs are shared, indirect expenses that
support the activities of two or more production departments.

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Service Department Costs

Question
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. $100,000
b. $120,000
c. $150,000
d. $180,000

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Service Department Costs

Question
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. $100,000
b. $120,000 Assembly percentage
= 100 (100 + 150) = 40%
c. $150,000
40% of $300,000 = $120,000
d. $180,000

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Preparing Departmental
Income Statements

Lets prepare departmental income statements

using the following steps:
Direct expense accumulation.
Indirect expense allocation.
Service department expense allocation.
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Step 1: Direct Expense
Accumulation
Direct expenses are traced to each
department without allocation.

Service Service
Dept. One Dept. Two

Operating Operating
Dept. One Dept. Two

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Step 2: Indirect Expense Allocation

Indirect expenses are allocated to all departments
using appropriate allocation bases.

Allocation Allocation Allocation Allocation

Service Service
Dept. One Dept. Two

Operating Operating
Dept. One Dept. Two

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Step 3: Service Department

Expense Allocation
Service department total expenses (original direct
expenses + allocated indirect expenses) are
allocated to operating departments.

Service Service
Dept. One Dept. Two

Allocation Allocation

Operating Operating
Dept. One Dept. Two

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Departmental Expense
Allocation Spreadsheet

Lets examine this three-step

allocation procedure for
Owl Company.

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Departmental Expense
Allocation Spreadsheet
Expense Allocation to Departments
Service 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.

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 Of a total of 2,000 square feet, the service departments
occupy 200Departmental
square feet each,Expense
P3
sales department one
occupies 600 Allocation
square feet,Spreadsheet
and sales department two
occupies 1,000 square feet.
Expense Allocation to Departments
Service 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.

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 Step 3: Service department total expenses (original direct
P3expenses + allocated indirect expenses) are allocated to
sales departments.
Sales department one has $40,000 in sales and sales
department two has $48,000 in sales.
Expense Allocation to Departments
Service 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
Total expenses $ 32,500 $ 0 $ 3,400 $ 10,700 $ 18,400

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 Step 3: Service department total expenses (original direct
P3expenses + allocated indirect expenses) are allocated to
sales departments.
Sales department one has 28 employees and sales
department two has 40 employees.
Expense Allocation to Departments
Service 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

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Departmental Expense
Allocation Spreadsheet
Expense Allocation to Departments
Service 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

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Departmental
Income Statements

Now that we have the costs,

lets do an income statement.

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Departmental
Income Statements
Sales Sales
Combined 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

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Departmental
Income Statements
Sales Sales
Combined 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

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Departmental Contribution
to Overhead
Departmental revenue
Direct expenses
= Departmental contribution

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.

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Eliminating an
Unprofitable Department
As a general rule, a department can
be considered a candidate for
elimination if its revenues are less
than its escapable expenses.

Direct expenses are usually escapable.

Indirect expenses are usually inescapable.

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Departmental Contribution
to Overhead

Lets recast Owl Companys income

statement using the departmental
contribution approach where indirect
expenses are not allocated.

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Departmental Contribution
to Overhead

Net income for

the company is
still $17,500.

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Departmental Contribution
to Overhead

Departmental contributions
to indirect expenses
(overhead) are emphasized.

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Departmental Contribution
to Overhead

Departmental contributions are

positive so neither department
is a candidate for elimination.

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 Controllable Costs
C4

Costs are controllable Im in

if the manager
control
has the power to
determine, or strongly
influence, the amounts
incurred.
A managers performance
evaluation should be
based on controllable
costs.

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Distinguishing Controllable
and Direct Costs
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.

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Responsibility Accounting
An accounting system that
provides information . . .

Relating to the To evaluate

responsibilities of managers on
individual managers. controllable items.

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Successful implementation
Responsibility of responsibility
Accounting
accounting may use organization charts with
clear lines of authority and clearly defined
levels of responsibility.
Board of Directors

President

Vice President Vice President Vice President

of Finance of Operations of Marketing

Store Manager

Department Manager
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Responsibility Accounting
Performance Reports
Amount of detail varies according
to level in organization.

A store manager receives

A department manager summarized information
receives detailed reports. from each department.
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Responsibility Accounting
Performance Reports
Amount of detail varies according
to level in organization.
Management by exception:
Upper-level management
does not receive operating
detail unless problems arise.

The vice president of operations

receives summarized information
from each store.
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Responsibility Accounting
Performance Reports
To be of maximum benefit, responsibility reports should . .
.
Be timely.
Be issued regularly.
Be understandable.
Compare budgeted
and actual amounts.

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Joint Costs
A single cost incurred in producing or purchasing two or more
different products.
Similar to an indirect expense
since it is shared among more
than one cost object.

Example: The cost of crude

oil is a joint cost for many
petrochemical products.

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Joint Costs and Their Allocation

Joint
costs

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?
Hamburger, because there is more of it.
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Joint Costs and Their Allocation

Joint
costs

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.
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Value Basis Allocation of Joint Costs

Product One
Sales value = $80,000

$200,000 Product Two

Joint Cost Sales value = $200,000

Product Three
Sales value = $120,000

Allocate the $200,000 joint cost based on sales value.

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 C5

Value Basis Allocation of Joint Costs

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