Cost Allocation_Management

LECTURE NOTES COST ALLOCATION The cost allocation strategy has four objectives; 1. Accurately determine departmental and product costs and use them as a basis f assessing the cost efficiency and profitability, financial reporting, and tax compliance of various products in your department. Managers must also meet established financial reporting standards. 2. Motivate managers to do their best to achieve the final goal of tax management. For example, if a departmental allocation of costs for equipment maintenance is based on the number of defects, the manager is motivated to reduce those costs. 3. Provide appropriate incentives to help managers make decisions consistent with tax management objectives. In other words, it provides an incentive to manage the general expenses of each department. 4. Appropriately define cost managers who make their decision expertise and effectiveness. if managers can establish an objective basis for cost allocation, effective cost allocation can be determined. The objective of cost allocation is to require that a method of cost allocation must be sufficiently accurate to support effective product and departmental decisions. Motivating management staff, in short effective cost allocation requires department heads who appreciate to save cos expected. it provides decision-making incentives, and Cost sharing provides an effective incentive for each managers, enabling them to take action automatically independently in a manner consistent with management's objectives highest, thereby achieving decision-making incentives. Clearly fairness can be achieved by applying cost allocations objectively and consistently. The departmental approach recognizes that product operations generally include two types of operations; manufacturing and services. The service department provides personnel, maintenance, engineering and other support to the production department. The manufacturing department directly assembles and manufactures the product. The departmental method uses three cost steps for each departmental allocation. 1. Trace all direct manufacturing costs and assign operating and manufacturing departments to factory overhead costs. 2. Allocate the costs of the service department to the manufacturing department. 3. Allocate manufacturing department costs to product departments. The main problem of implementing it is choosing the most appropriate mapping method. When applying the departmental assignment method, the following three points should be considered; 1. The effect of constraints that arise when the allocation base established is not related to use. 2. Inhibition effect when classification criteria are established according to actual usage conditions. 3. Impact of barriers that arise when the cost allocation exceeds the external purchase price. Composite/combined products are products that are produced simultaneously through a common process or a series of processes, and each product produced has more than nominal value depending on the processing result. There are three ways to allocate joint costs to joint products; 1. Physical size method This method uses physical measurements (such as the number of units produced in pounds, gallons, yards, or split points) to allocate joint costs to joint products. The advantages of the physical method are :  This method mudsh used  The criteria for allocating joint costs are objective. The drawback of the physical method is that it ignores the revenue-generating ability of each product. This capability can vary between joint products and is completely independent of physical quantity. 2. Split Point Sales Method This method assigns general costs to joint products based on relative sales at the split-off point, and can only be used if the joint product can be sold at the split-off point. Weakness and strength : The advantage of the sales method is that you can easily calculate and distribute income for each product. This method is superior to physical measurement methods because it assigns total costs based on each product's cost-bearing capacity. 3. Net Realizable Esteem Strategy Not all joint items can be sold at the part point. Hence, a few items don't have a special advertise cost at the split-off point. Usually decided by deducting the extra preparing expenses from the after-sales costs of the ultimate deals esteem of the item. Advantages and disadvantages : NRV method is better than method physical measurement because it represents a predictable and win-win distribution between products, similar to the split point method. Physical measurement methods can provide senior managers with misleading guidance about product profitability. There are two ways to calculate the cost of by-products namely the acquisition of assets and the revenue approach. 1. The by-product asset validation method is recorded as net asset value so that it recorded as inventory when the by-product is produced. The two methods used are: a. Net Realizable Value Method. This method shows the net realizable value of byproducts in the balance sheet as inventories and reported in profit or loss as the current net value less the total cost of production and the combined product. b. Other Income Method at the Point of Production. This method shows the ne realizable value of by-products as other income or other sales in the income statement. The sales method does not charge by-products during the production period, but tracks the sales of by-products over the product sales period. Tw methods are used:  Other Revenue Method At the Point of Sale, this method shows net sales of by-products sold at the time of sale as other income or other sales revenue in the income statement.  How to Reduce Production Costs at the Point of Sale. This method reduces the total cost of production by showing the net sales of by-products sold at the time of sale in the Profit or Loss account.