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# Which allocation method for indirect headquarters costs

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Gether Corporation manufactures appliances. It has four division: Refrigerator, Stove, Dishwasher, and Microwave oven. Each division is located in a different city and the headquarters is located in Oakland, California. Headquarters incurs a total of \$14,255,000 in costs, none of which are direct costs of any o the divisions. Revenues, costs, and facility space for each division are as follows:

Refrigerator Stove Dishwasher Microwave Oven
Revenue \$10,900,000 \$18,800,000 \$11,500,000 \$6,780,000
Direct costs \$5,700,000 \$10,400,000 \$6,200,000 \$3,220,000
Segment margin \$5,200,000 \$8,400,000 \$5,300,000 \$3,560,000
Sq. ft. of floor space 130,000 90,000 80,000 100,000

Gether wants to allocate the indirect headquarters on the basis of either square feet or segment margin for each division.

1. Allocate the indirect headquarters costs to each division, first using square feet of space and then using segment margin as the allocation base. Calculate the division operating margins after each allocation in dollars as a percentage of revenue.
2. Which allocation base do you prefer? Why?
3. Should any of the divisions be dropped based on your calculations? Why or why not?

#### Solution Summary

This solution discusses different allocation methods and applies it to the indirect headquarters cost to each division. Calculations are also shown to determine the division operating margins and recommendations are made on which allocation method to use and if any of the divisions should be dropped.

\$2.19

## MANAGEMENT ACCOUNTING PROBLEMS.

Assume that Hillcrest placed purchase orders for \$475,000 in January, \$540,000 in February, \$525,000 in March and \$550,000 in April. Payment terms followed by Hillcrest are:

When purchases are paid % paid within this time Discount Received
Within month of purchase 50% 2%
Month following purchase 40% 1%
60 days following purchase 10% 0%

38. Calculate the cash payments in March for purchases
a) \$518,590
b) \$525,000
c) \$471,090
d) \$532,500

39. Assume that you budget for purchasing agent's salary and benefits for the next year using the following data. Activity analysis shows that each purchase order placed should require 17 minutes (both normal productive and non-productive time). Each full time worker works 2,000 hours. Hillcrest hires part-time employees only in 1000- hour increments. In 2000 if we expect 93,000 purchase orders placed, how many agents would you request in your budget?
a. 13 agents
b. 13.5 agents
c. 13.18 agents
d. 720 agents

40. Organizations often acquire more resources than they actually use productively in the short-term. Why do they do this?
a) To make budget achievement easier for managers.
b) This is a normal benefit of corporate life.
c) Since most companies don't take budgeting seriously, they don't understand the resources they actually require.
d) Long-term growth and the indivisibility of many costs often make it impossible or unwise to acquire only what is necessary in the short run.

41. To prepare a manufacturing support budget using activity based budgeting, the following is done:
a) Budget each overhead account by using last year's data and adding a percent for inflation.
b) Take last year's manufacturing support rate and adjust it for production volume this year.
d) Document activities, identify drivers, estimate use of drivers, and cost the resources needed for the activities.

42. To set an appropriate budget context for the year upper management:
a) Assesses the environment using an analysis such as SWOT.
b) Update long range plans for products and profits.
c) Communicate environmental assumptions and targets for products or profits to lower levels in the organization.
d) All of the above.

43. Which is not a technical attribute of a good budgeting system?
a) Budgets improve management decisions by forcing managers to plan for uncertainly.
b) Budgets force managers to think about whether the tasks and activities planned are consistent with organizational strategy.
c) Activity budgets cause employees to better under work processes and their related costs.
d) Budgets set high expectations and cause managers to be motivated to perform.

44. Budgeting may fail to have a positive impact on perceptions, aspiration levels, morale and satisfaction when:
a) Traditional budgeting systems are used.
b) Employees don't have formal budget training.
c) A strong review and evaluation process isn't followed.
d) Budget pressure is high, employees didn't participate enough in establishing budgets or monitoring is too frequent.

45. What do budgets symbolize in US culture?
a) Corporate greed.
b) Heavy-handed control over employees.
c) Corporations need tight monitoring to assure absent owners that managers' stewardship functions are being performed.
d) They represent fiscal responsibility and that rational, calculated action plans dominate impulse.

Sweatshirts, Inc. Makes two types of sweatshirts: plain and deluxe. Both types of sweatshirts go through two operations: cutting and sewing. The deluxe sweatshirts go through a third operation that prints emblems and words on them. The deluxe sweatshirts also have more expensive material used on them. After manufacture, sweatshirts are warehoused for sale to department stores.
The following data is available for a one month period:
Deluxe Plain
Quantity produced 10,000 12,000
Direct materials \$50,000 \$48,000
Conversion Costs:
Cutting \$22,000
Sewing \$22,000
Printing \$ 5,000
Total \$ 49,000

46. How much does a Deluxe sweatshirt cost to manufacture?
A. \$7.50
B. \$6.68
C. \$5.00
D. \$9.90

47. Sweatshirts, Inc. uses what kind of production cost system?
A. Job order costing system
B. Process costing system
C. Back or forward flush system
A. Operations costing system.

Watermark Paper co. produces white paper used for computer printers, copy machines, and fax machines. produced 140,000 complete rolls of paper and 5,000 incomplete rolls (50% complete). Direct materials, which are added at the beginning of the process, cost \$217,500 and conversion costs were \$71,250. There were no beginning inventories.

48. How many equivalent units are complete relative to the conversion costs?
A. 72,500
B. 140,000
C. 142,500
D. 145,000

49. How many equivalent units are complete relative to direct materials?
A. 145,000
B. 142,500
C. 140,000
D. 135,000

50. What is the total cost per equivalent unit (roll of paper)?
A. \$2.00
B. \$1.58
C. \$1.50
D. \$1.00

51. What kind of product does Watermark produce?
A. processed
B. fabricated
C. assembled
D. extracted

Englewood Hospital uses a job cost system for all patients who have surgery. In March the pre-operating room (PRE-OP) and operating room (OR) had budgeted allocation bases of 2,000 nursing hours and 1000 nursing hours, respectively. The budgeted nursing overhead charges for each department for the month were \$84,000 and \$66,000, respectively. The hospital floor for surgery patients had budgeted overhead costs of \$600,000 and 7,500 nursing hours for the month. For patient R.J. Welborn the actual hours incurred in PRE-OP were 8 and in OR, 4. He was in the hospital for 4 days or 96 hours. Other costs related to Welborn were:

PRE-OP costs OR Costs In-room Cost
Patient Medicine \$100 \$250 \$1,200
Direct nursing time 2,400 3,500 5400
Indirect nursing time 400 0 600
Room usage charges 1000 2000 1600
Nursing station supplies \$200 \$800 \$1100
Utilities for room occupied \$50 \$100 \$75

The hospital charges patients for medicine, direct nursing time and room usage, but uses budgeted overhead rates for charging overhead to patient stays (as opposed to the actual costs incurred or indirect nursing time, supplies, utilities, meals, etc.).
52. What is the budgeted nursing overhead rate for PRE-OP?
A. \$80/Hour
B. \$66/Hour
C. \$188/Hour
E. \$42/Hour

53. What is the Nursing overhead rate for OR?
A. \$80/Hour
B. \$66/Hour
C. \$188/Hour
D. \$42/Hour

54. How much would the Patient, R.J. Welborn be charged for his use of PRE-OP?
A. \$2,836
B. \$3,836
C. \$4,150
A. \$4,486

55. Product cost information derived using traditional process costing provides good technical information for:
A. Companies with high product variety manufactured on sophisticated machinery in production cells.
B. Companies to use for their make or buy decisions.
C. A company to use to forecast profits resulting from receiving a contract which triples their sales volume and requires major expansion of productive facilities.
D. Companies that produce in traditional manufacturing environments where cost is largely a function of the volume of homogeneous products produced.

56. A job order costing system would be most applicable for a:
a) Ice cream producer
b) Flour mill
c) bicycle manufacturer
d) Custom furniture manufacturer

57. Which one of the following examples normally could be classified as a direct cost?
A. The costs of electricity; the product line is the cost object.
B. Printing costs incurred for payroll checks; the activity, payroll check processing is the cost object.
C. The salary of a maintenance supervisor, the product is the cost object.
D. The space charge for the space used by the personnel office within the facility of headquarters: the personnel department is the cost object.

Cu-Later, Inc., produces bug spray. The budgeted cost of inserting spray nozzles is \$300,000. This amount includes the costs of insertion equipment depreciation, operating expenses and supplies for insertion equipment, and a portion of the salary of a machine operator who operates a control panel controlling this and other equipment. Bug spray bottles have a variety of spray nozzle assemblies, depending on their design. Insertion of the spray assemblies requires a different amount of equipment time.
58. The cost of inserting spray nozzles is a:
A. Direct Cost
B. Indirect Cost
C. Marketing Cost
D. Direct Materials Cost

59. The best method for assigning insertion costs to products is:
A. Based on time on the insertion equipment. Technically this is good because the kinds of cost, depreciation, operating expenses of running the machine, supplies used, and control operator salary are driven by time spent. Behaviorally it encourages the design of spray nozzles easy to insert. Culturally it is fair.
B. Based on weight of the bug spray bottles. Technically, it is easy to measure. Behaviorally, it encourages selling smaller bottles of bug spray, where there is more profit. Culturally this is fair because larger bottles can bear more cost.
C. Based on the selling price of the spray bottles. Technically, selling prices are in the information system, and additional data does not have to be collected. Behaviorally, it encourages designing bottles that cost customers less. Culturally this is fair because more expensive bottles can bear more cost.
D. Based on cost of spray nozzles inserted. Technically, cost of spray nozzles drives costs of inserting them by the machine operation. Behaviorally this encourages designers to design less expensive spray nozzles. Culturally, this would be perceived as fair.

60. If a company provides health insurance for a limited number of employees. The coverage is the same for all people insured. The best cost driver for insurance costs is
A. The total number of employees in the company.
B. Salary dollars for all employees in the company.
C. The total number of employees covered by the insurance.
D. The salary of the employees who qualify for the insurance.

61. Which one of the following examples is a direct cost, given the specified cost object?
a) The costs of factory tools & supplies; a product is the cost object.
c) The salary of a maintenance supervisor, a product line is the cost object.
d) The space charge for the space used by the personnel office within the administrative office's facility; the personnel department is the cost object.

62. Yamazoo makes two models of waverunners: Sharks and Sting-rays. These products differ by color combinations, trim, mirrors, and seat style. The products are shipped by common carrier to dealers. What allocation base would you use to allocate common carrier delivery charges to Sharks and Sting-rays, given the following options:
a) Direct materials cost; it is fair because it represents the two products' ability to bear.
b) Units of product shipped, it is fair because it represents benefits received by each product line.
c) Direct materials costs, because technically direct materials drives shipment costs.
d) Evenly between the two products, because culturally it is fair to share evenly.

63. Many Japanese companies allocate all indirect costs to products based on the number of unique parts in the product. Why might US companies consider doing this?
a. It is considered fair in the US culture, since number of unique parts reflects products' ability to bear cost.
b. Unique parts have been shown statistically to drive or cause all indirect costs, and is thus good technical information.
c. There is a belief in Japanese companies that fewer parts ultimately result in lower costs, fewer quality problems, and more rapid production. By assigning indirect costs based on parts, managers are encouraged to reduce the number of parts in products. This is a behavioral reason that might benefit any company.
d. Generally accepted accounting principles in the US require this method since it is easily verifiable.

Four divisions operated by a US parent company have headquarter's costs allocated to them based on sales revenue dollars. The US parent allocates \$.12 per sales revenue dollar. The Southeastern Asia Division, with sales revenue of \$22,500,000, reported a \$1,200,000 loss after this allocation, and the parent company is considering closing it.

64. How much profit/loss did the Southeastern Asia Division have before this allocation?
a) A loss of \$500,000
b) A profit of \$1,500,000
c) A profit of \$3,900,000
d) A loss of \$1,500,000

65. How much headquarters' cost was allocated to the Southeastern Asia Division under this scheme?
a) \$300,000
b) \$2,464,000
c) \$700,000
d) \$2,700,000

66. Which of the following statements are true about the allocation to the Southeastern Asia Division?
a) It is a good idea to close the division since they are operating at a loss; overall profits would increase.
b) If Southeastern Asia would lower sales revenue next year, they would receive a smaller allocation and operate at a greater profit.
c) It is not a good idea to sell this division unless the cost of headquarters can be reduced by the amount allocated to the division or the company, as a whole, will be worse off.
d) Since the amounts allocated to Southeastern Asia are controllable by it, the division should reduce the headquarters' cost to an amount they can afford to pay.

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