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4.11. Cost allocation example (3) – cost allocation rates

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4.11. Cost allocation example (3) – cost allocation rates

Weeks 4 through 6 of the Course are devoted to the issues of managerial accounting. First, we introduce the key ideas of managerial accounting, and compare it to the financial accounting. We focus on the much closer link of managerial accounting to people. Then the core idea of managerial accounting – cost – is introduced and discussed. You will learn why it is so important to identify the total cost of any product, project, or division. We will study cost behavior, fixed and variable costs, and break-even point. The last part of Week 3 discusses cost tracing and allocation as a major task of any in-depth cost analysis. We study an example and come up with the tracing and allocation roadmap.

Core Concepts of Accounting – Numbers and People

莫斯科物理科学与技术学院

課程 3（共 5 門，Understanding Modern Finance 專項課程）

Whenever the word “accounting” is pronounced, it is immediately associated with the need to memorize endless boring numbers. However, it is the common financial statements that contain important information that provides inputs for valuation of investment projects. The only challenge is how to properly extract them. Accounting and finance are indeed intertwined. Sometimes people that are not experienced in the area even mix them up. But most often emphasis in accounting is on numbers. Still, the deep understanding of key accounting concepts helps reveal the interests and actions of people behind these numbers. And the human dimension of accounting adds invaluable insight in the potential of successful project implementation. This Course discusses core ideas and concepts of both financial and managerial accounting. It by no means pretends to be comprehensive to any extent. But, being rather an accounting overview, it focuses on the issues that are most relevant and important for effective valuation of investment projects. The learners will gain insight into the essence of accounting. They will be able to use the obtained knowledge and skills to successfully advance in their career at a financial institution, as well as in the area of financial management at non-financial businesses. To pursue a career in accounting, a more detailed study is strongly recommended.

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教學方

Konstantin Kontor
Director and Professor of Finance and Strategy

腳本

Now we're almost done, and we have to just complete this

example of this process of reallocation with the finding of cost allocation rates.

These are the things that are used here and

that are important for the future processes.

Let's see what happens.

So what is a cost allocation?

So that's cost allocation three, cost allocation rates.

Well, the process went like that.

So for all, Pools,

we select, Cost allocation basis, and

now we define the cost allocation rate as follows.

So this is the share of,

Total indirect cost for

the pool divided by the total

units of cost allocation

base associated with that.

So that's sort of a converse of definition, but

we will see in this example, how this works and that immediately becomes clear.

So in our example, we would say that let's, for

all product pools, at

the good cost allocation base would be the number of man hours of direct labor.

Because we talk about manufacturing now.

We've successfully excluded real estate in general from this consideration.

So we say that the number of man-hours,

Of direct labor, this is best

cost allocation base for

all three product pools.

For badges, for clips,

and for assembly.

And now, now we have to somehow

calculate these rates, but

before we take these number of

man-hours so we measure them.

And what are they?

Badges, 5200,

clips, 3,000, and

then assembly, 1,200.

So we say that the overall amount here is 5, 3, 1 overall.

This is 9,400 of man-hours, but that is just for us to keep in mind.

Now equipped with all that and the results that we've obtained

in our previous discussion, we'll be able to calculate these cost allocation rates.

How does this go?

So, CAR calculation.

Again, we have the following table, so here is let's say,

this is total, this is batches, clips, and assembly.

So this is the first line of the table.

Now we have direct labor in man-hours,

that's what we produced at the very bottom part of the previous page.

And this is total indirect cost that arised from our previous episode.

And then finally, all that produces the required cost allocation rate.

That's in dollars per one man-hour.

See how this goes.

So, What do we have here?

We have a total number of 9,400.

From here we have 5,200, 3,000, and then 1,200.

That's what we took from the previous page.

Now total in direct cost, that was $33,000.

And that was 19,321,

that was 10,408, and 3,271.

Well, welcome back, because remember,

these numbers were our finding from the previous episode.

Now see what we do.

We just take this total direct cost and we divide by this.

And we end up with the following numbers.

For the badge manufacturing it's $3.72 per man-hour.

Here it's 3.47, and here it's 2.73.

Well, so far, so good, but the question persists.

Why the hell are we trying to come up with these numbers?

Because it takes so much time, so much effort, it's not so trivial.

It does require a lot of work that is not even depicted here,

because I said that some numbers we take from someone else's work.

But now see what happens.

After having calculated these CARs, the cost allocation rates, we can now say,

what if we would like to find what the proper overhead is for a batch of badges?

I'll give you an example.

So we see these numbers.

Let's say that now we have a batch

and that is our final cost object.

And that requires from badges 30 hours,

from clips 25 hours, and from assembly 5 hours.

So this is our batch.

And the question is, how much that would cost in terms of indirect costs?

So remember, what is the proportional share of the direct costs

that we have to charge for this batch?

Well, now, that is very easy to do.

So the overhead for the batch.

See what we do.

We say this is the cost pool.

This is direct labor and direct labor in man-hours.

Now this is the cost allocation rate and this is overhead in dollars.

Now see what happens.

We have batches, clips, assembly, and totals.

And now we are almost all set.

I am just finishing up the table with these lines and see what we do.

So first of all these numbers go here.

So this is 30, this is 25, and this is 5, the total is here in material.

But these cost allocation rates we take from the previous page.

So this is 372, 347, and then 273.

Now we just multiply this by this, And then we arrive at these final numbers.

So here for badges, we have 111.6,

here it's 86.8,

and here it will be just 13.7.

So we add all this up and then we find that

the overall overhead is 212.1.

So this is the proportional share that we have to use here.

So that was a long example, but the idea is that the bottom line is that we,

after having calculated CARs, we now can use

only the proper cost allocation base and here it was in the number of man-hours.

And then by multiplying these inputs by CARs, we can come up with the overhead.

Now, in reality, what happens is that these CARs

they are calculated once and then used for some period of time.

Let's say for a quarter of a year.

So you do not do this work for each and every batch.

So you did that once for last year.

And then you said that this year I will apply these CARs.

And for any batch, knowing these numbers of man-hours,

you can easily come up with this number.

So that is the process how people really allocate indirect costs.

And although that was a trivial example with just three units, and

very simplistic numbers, and you can imagine how complex and

how hard, how requiring a lot of hard work it is.

If you deal with the real company with lots of pools and maybe not so

trivial, or clear links between these costs and pools.

So that is a hell of a lot of work, and that's what people are doing.

So in the next final episode,

we'll wrap things up by putting together the roadmap for cost allocation.

All these steps that people engage in, and

how that leads to the result that we here have illustrated.

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