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Allocate Single Cost Pool to Users
Principles of Cost Analysis and Management
© Dale R. Geiger 2011 1
Have you ever been here?
2© Dale R. Geiger 2011
Terminal Learning Objective
• Task: Allocate Single Cost Pool to Users• Condition: You are a cost advisor technician with access
to all regulations/course handouts, and awareness of Operational Environment (OE)/Contemporary Operational Environment (COE) variables and actors.
• Standard: with at least 80% accuracy• Explain how poor cost information encourages undesired
behaviors• Calculate driver rate• Calculate proportion
© Dale R. Geiger 2011 3
A Broad Definition of Managerial Costing
raw accounting data
managerial costing
translation
managerially useful information
© Dale R. Geiger 2011 4
Why Is This Translation Needed?
• Accounting Systems usually measure input or source costs• Labor, overhead, materials• Salaries, benefits, supplies, contracts
• Managers want measurements based on output or consumption • Product, service, project• Consuming organization, customer
© Dale R. Geiger 2011 5
Managerial Costing Terms
raw accounting data
managerial costing
translation
managerially useful information
=
cost pool
method of
distribution
cost object
© Dale R. Geiger 2011 6
Terminology
• Cost pool: • An aggregation of incurred or
source costs to be distributed• Examples:
• Salary and benefits, supplies, travel, etc. in an airfield operations center
• Utility bills for a garrison
cost pool
© Dale R. Geiger 2011 7
Terminology
• Method of distribution:• The mechanics of deriving
management information from the cost pool
• Example:• Determine unit cost by
adding all input costs and dividing by number of units
method of
distribution
© Dale R. Geiger 2011 8
Terminology
• Cost Object: • A view of cost needed by
management • Examples:
• 120mm tube product cost• Morale, welfare, recreation cost• Armor school cost
cost object
© Dale R. Geiger 2011 9
What is Allocation?
• Allocation: • A method of distribution that
distributes cost pool to cost objects in the same proportion as cost driver
• Example:• Distributing the cost of utilities
to occupants in the same proportion as space occupied
allocation based on
cost driver
© Dale R. Geiger 2011 10
The Mechanics of Allocation
• Allocation is a basic technique of activity based costing (ABC)
• Becoming an expert is required but easy
• Allocation mechanics excel spreadsheet makes it even easier
allocation based on
cost driver
© Dale R. Geiger 2011 11
Two Allocation Methods
• Rate Method: • Uses a computed rate per driver unit
• Proportion Method: • Computes a proportional share of the total cost
based on driver usage• Both Methods
• Yield same results• Represent the same underlying algebra
© Dale R. Geiger 2011 12
Reconciling the Two Methods
Total Cost PoolTotal Number of Driver Units
* Number of Driver Units Used
Number of Driver Units Used Total Number of Driver Units
* Total Cost Pool
Number of Driver Units Used * Total Cost PoolTotal Number of Driver Units
Equals
Equals
Rate Method
ProportionMethod
© Dale R. Geiger 2011 13
Reconciling the Two Methods
Total Cost PoolTotal Number of Driver Units
* Number of Driver Units Used
Number of Driver Units Used Total Number of Driver Units
* Total Cost Pool
Number of Driver Units Used * Total Cost PoolTotal Number of Driver Units
Equals
Equals
Rate Method
ProportionMethod
© Dale R. Geiger 2011 14
Split the Dinner Check
Thank You
Fillet and Lobster 35.00Chicken Kiev 15.00Top Sirloin 20.00Caesar Salad 9.00Coffee 2 @1.00 2.00House Wine 4 @5.00 20.00Champagne 24.00Ice Cream 4.00Chocolate Cheesecake 6.00Sampler 10.00Soup/Salad 8.00Aperitif 7 .00
Total $160.00
Chez Paris
Bob
Carol
Ted
Alice
© Dale R. Geiger 2011 15
Identifying Key Information
• What is the cost pool?• The dinner check of $160
• What are the cost objects?• Bob, Carol, Ted and Alice
• What is the cost driver?• Number of persons (or eaters)
© Dale R. Geiger 2011 16
Identifying Key Information
• What is the cost pool?• The dinner check of $160
• What are the cost objects?• Bob, Carol, Ted and Alice
• What is the cost driver?• Number of persons (or eaters)
© Dale R. Geiger 2011 17
Identifying Key Information
• What is the cost pool?• The dinner check of $160
• What are the cost objects?• Bob, Carol, Ted and Alice
• What is the cost driver?• Number of persons (or eaters)
© Dale R. Geiger 2011 18
Identifying Key Information
• What is the cost pool?• The dinner check of $160
• What are the cost objects?• Bob, Carol, Ted and Alice
• What is the cost driver?• Number of persons (or eaters)
© Dale R. Geiger 2011 19
Allocation Mechanics.xls
Enter the Name of the Cost Pool to be Allocated here:dinner check 0
Enter the Total Cost of dinner check here:160$
Enter the Names of the Cost Objects here:
Bob Ted Carol Alice 0 ?
Enter the Name of the Cost Driver here:eaters 0
Reset
© Dale R. Geiger 2011 20
Allocation by Rate Method
• First, calculate the driver rate:Total cost pool
Total driver units
Cost pool = $160Total driver units = 4 eaters
Rate = $40/eater© Dale R. Geiger 2011 21
Allocation by Rate Method
• First, calculate the driver rate:Total cost pool
Total driver units
Cost pool = $160Total driver units = 4 eaters
Rate = $40/eater© Dale R. Geiger 2011 22
Allocation by Rate Method
• First, calculate the driver rate:Total cost pool
Total driver units
Cost pool = $160Total driver units = 4 eaters
Rate = $40/eater© Dale R. Geiger 2011 23
Allocation by Rate Method
• Second, multiply by driver units used by each cost object:• Bob = 1 eater * $40/eater = $40• Carol = 1 eater * $40/eater = $40• Ted = 1 eater * $40/eater = $40• Alice = 1 eater * $40/eater = $40• What if Bob and Carol are a couple and Bob is
paying for them both?
© Dale R. Geiger 2011 24
Allocation by Rate Method
• Second, multiply by driver units used by each cost object:• Bob = 1 eater * $40/eater = $40• Carol = 1 eater * $40/eater = $40• Ted = 1 eater * $40/eater = $40• Alice = 1 eater * $40/eater = $40• What if Bob and Carol are a couple and Bob is
paying for them both?
© Dale R. Geiger 2011 25
Allocation by Rate Method
• Second, multiply by driver units used by each cost object:• Bob = 1 eater * $40/eater = $40• Carol = 1 eater * $40/eater = $40• Ted = 1 eater * $40/eater = $40• Alice = 1 eater * $40/eater = $40• What if Bob and Carol are a couple and Bob is
paying for them both?
© Dale R. Geiger 2011 26
Allocation by Rate Method
1. Determine Overhead Rate:
Total Cost ÷ Total eaters = Rate per eaters
160$ ÷ 4 = 40$
2. Compute Allocation:
Usage by Cost Object x Rate = AllocationBob 1 x 40$ = 40$ Ted 1 x 40$ = 40$ Carol 1 x 40$ = 40$ Alice 1 x 40$ = 40$ Total 160$
Reset
© Dale R. Geiger 2011 27
Allocation by Proportion Method
• First, calculate each cost object’s proportion:Driver units usedTotal driver units
• Bob = 1 eater/4 eaters = 25%• Carol = 1 eater/4 eaters = 25%• Ted = 1 eater/4 eaters = 25%• Alice = 1 eater/4 eaters = 25%
© Dale R. Geiger 2011 28
Allocation by Proportion Method
• First, calculate each cost object’s proportion:Driver units usedTotal driver units
• Bob = 1 eater/4 eaters = 25%• Carol = 1 eater/4 eaters = 25%• Ted = 1 eater/4 eaters = 25%• Alice = 1 eater/4 eaters = 25%
© Dale R. Geiger 2011 29
Allocation by Proportion Method
• Second, multiply each cost object’s proportion by total cost pool• Bob = 25% * $160 = $40• Carol = 25% * $160 = $40• Ted = 25% * $160 = $40• Alice = 25% * $160 = $40• What if Bob and Carol are a couple and Bob is
paying for them both?
© Dale R. Geiger 2011 30
Allocation by Proportion Method
• Second, multiply each cost object’s proportion by total cost pool• Bob = 25% * $160 = $40• Carol = 25% * $160 = $40• Ted = 25% * $160 = $40• Alice = 25% * $160 = $40• What if Bob and Carol are a couple and Bob is
paying for them both?
© Dale R. Geiger 2011 31
Allocation by Proportion Method
• Second, multiply each cost object’s proportion by total cost pool• Bob = 25% * $160 = $40• Carol = 25% * $160 = $40• Ted = 25% * $160 = $40• Alice = 25% * $160 = $40• What if Bob and Carol are a couple and Bob is
paying for them both?
© Dale R. Geiger 2011 32
Allocation by Proportion
1. Determine Proportion of ConsumptionUsage by Cost Object ÷ Total eaters = %
Bob 1 ÷ 4 = 25%
Ted 1 ÷ 4 = 25%
Carol 1 ÷ 4 = 25%
Alice 1 ÷ 4 = 25%Total 100%
2. Multiply Proportion by Total CostCost Object % x Total dinner check = Allocation
Bob 25% x 160 = 40$
Ted 25% x 160 = 40$
Carol 25% x 160 = 40$
Alice 25% x 160 = 40$ Total 160$
© Dale R. Geiger 201133
The Results
Cost Allocation for dinner check Based on eaters
$-
$10
$20
$30
$40
Bob
Ted
Carol
Alice
Reset
© Dale R. Geiger 201134
Check on Learning
• What is the rate per hour when the cost pool totals $30,000 and the total hours are 500?
• One of the cost objects uses 50 hours or resources from the cost pool described above. What is its proportion?
© Dale R. Geiger 2011 35
Cross Subsidization
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Consumption Cost allocation
Is This Fair?
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Consumption Cost allocation© Dale R. Geiger 2011
36
Incremental EffectsWhat Happens if Bob Spends $10 More?
Original
IncrementalChange
0
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70
80
90
Bob Consumes Bob Pays
© Dale R. Geiger 2011 37
Incremental EffectsWhat Happens if Bob Spends $10 Less?
0
10
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30
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50
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Bob Consumes Bob Pays
DecreasedAmountBob’s ActualConsumption And Payment
© Dale R. Geiger 2011 38
Allocation: a Zero-Sum Game
• The Total is Constant • Changing allocation basis simply redistributes cost
• Increased Allocation for One Cost Object• Decreases the allocation for other cost objects
• Sometimes called “Balloon Squeezing” or “Peanut Butter Effect”
© Dale R. Geiger 2011 39
Measurement Effects Motivation
• Managerial costing inevitably impacts behavior• Design of managerial costing systems must
recognize and anticipate this effect• Consider in this example
• What iIncentives exist to spend more?• What incentives exist to spend less?• What would you do if you went to dinner with
them tonight?
© Dale R. Geiger 2011 40
• Why did allocation based on number of eaters fail to reflect resource consumption?
• What are the effects of incorrect allocation?
• What might be a better method of allocation in the dinner check case?
© Dale R. Geiger 2011 41
Check on Learning
Practical Exercises
© Dale R. Geiger 2011 42