Cost Accounting (14th Edition)

508 CHAPTER 14 COST ALLOCATION, CUSTOMER-PROFITABILITY ANALYSIS, AND SALES-VARIANCE ANALYSIS
systems using indirect-cost pools and cost drivers for different activities. A major difference
in the lower half of Exhibit 14-4 is the cost pool called Facility Costs (far right, middle
row), which accumulates all annual costs of buildings and furnishings (such as
depreciation) incurred in the division. The arrows in Exhibit 14-4 indicate that CAI allocates
facility costs to the five activity-cost pools. Recall from Exhibit 14-3 that CAI uses
square feet area required for various activities (design, setup, manufacturing, distribution,
and administration) to allocate these facility costs. These activity-cost pools then include
the costs of the building and facilities needed to perform the various activities.
The costs in the six remaining indirect-cost pools (that is, after costs of the facility
cost pool have been allocated to other cost pools) are allocated to products on the basis of
cost drivers described in Exhibit 14-3. These cost drivers are chosen as the cost-allocation
bases because there is a cause-and-effect relationship between the cost drivers and the
costs in the indirect-cost pool. A cost rate per unit is calculated for each cost-allocation
base. Indirect costs are allocated to products on the basis of the total quantity of the cost
allocation base for each activity used by the product.
Next focus on the upper half of Exhibit 14-4: how corporate costs are allocated to
divisions and then to indirect-cost pools.
Before getting into the details of the allocations, let’s first consider some broader
choices that CAI faces regarding the allocation of corporate costs.
Allocating Corporate Costs to Divisions and Products
CAI’s management team has several choices to make when accumulating and allocating
corporate costs to divisions.
1. Which corporate-cost categories should CAI allocate as indirect costs of the divisions?
Should CAI allocate all corporate costs or only some of them?
Some companies allocate all corporate costs to divisions because corporate costs
are incurred to support division activities. Allocating all corporate costs motivates
division managers to examine how corporate costs are planned and controlled.
Also, companies that want to calculate the full cost of products must allocate all
corporate costs to indirect-cost pools of divisions.
Other companies do not allocate corporate costs to divisions because these costs
are not controllable by division managers.
Still other companies allocate only those corporate costs, such as corporate human
resources, that are widely perceived as causally related to division activities or that
provide explicit benefits to divisions. These companies exclude corporate costs
such as corporate donations to charitable foundations because division managers
often have no say in making these decisions and because the benefits to the divisions
are less evident or too remote. If a company decides not to allocate some or
all corporate costs, this results in total company profitability being less than the
sum of individual division or product profitabilities.
For some decision purposes, allocating some but not all corporate costs to
divisions may be the preferred alternative. Consider the performance evaluation of
division managers. The controllability notion (see p. 200) is frequently used to justify
excluding some corporate costs from division reports. For example, salaries of
the top management at corporate headquarters are often excluded from responsibility
accounting reports of division managers. Although divisions tend to benefit
from these corporate costs, division managers argue they have no say in (“are not
responsible for”) how much of these corporate resources they use or how much
they cost. The contrary argument is that full allocation is justified because the divisions
receive benefits from all corporate costs.
2. When allocating corporate costs to divisions, should CAI allocate only costs that vary
with division activity or should the company assign fixed costs as well? Companies
allocate both variable and fixed costs to divisions and then to products, because the
resulting product costs are useful for making long-run strategic decisions, such as
which products to sell and at what price. To make good long-run decisions, managers