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DQ52 - Essay Example

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“Managers want to know total costs, both producing-department costs and the costs of using resources from other departments” (Horngren,…
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Cost Allocation The goal of analyzing this type of allocation method is to ensure that profit (or at least the reporting of profitability) is maximized. “Managers want to know total costs, both producing-department costs and the costs of using resources from other departments” (Horngren, Sundem, Stratton, Burgstahler, and Shatzberg, 2008, p.701). If wage rates vary, then it would be difficult to apply this to a cost allocation base which is typically meant for fixed cost environments. For example, if the manager is looking to understand total costs, they are going to review the manufacturing environment, assuming this is a product oriented company. The business needs to understand its overhead and should be looking at this from a fixed cost perspective. If the wage rates are fluctuating in this or different departments, the element of fixed costs is removed and makes this practice unpredictable for maximizing the reporting of financial health.
Measuring overhead has to do with the health of the operating environment which relies on understanding costs that are generally not variable. These costs can include administration, groundskeeping, machining and assembly (Horngren et al, 2008). When looking at administration overhead, it is going to be practical to want to know if their wages are fixed. If wage rates continue to fluctuate, deciding where to allocate the total overhead costs is going to be highly difficult if the goal is to maximize financial reporting data to show better corporate health at the accounting level. For example, the monthly or weekly groundskeeping maintenance required could be looked at as a fixed cost, especially if contracted at x dollars per month/week. This overhead cost would be a necessity as part of operations and could be predicted for financial reporting based on the contract cost negotiated throughout the business operating year. Direct-labor cost would be an appropriate cost allocation option here if the wages, such as for administration, remained constant. This method would also give the senior business leaders more accurate overhead costs, if they were needed, for strategic review or for assessing the health of certain divisions.
Direct labor costs should be seen as costs which are directly incurred by the organization and should have an element of predictability surrounding them. It would be a guess that most real-life organizations do not have varying wages for certain things such as administration, unless they had structured some sort of bonus system where wages were subject to bi-annual pay increases. Even in this situation, it would be relatively easy to predict where future wages are going to be when assessing overhead. However, administration might be on an hourly pay basis, therefore making them subject to monthly or weekly declines in man-hours worked. This would make it difficult to use this type of cost allocation method when overhead costs continue to be unpredictable and changing. It would seem that the predictability and stability of wages would be connected with the method of cost allocation used.
Horngren, Sundem, Stratton, Burgstahler, and Shatzberg. 2008. Introduction to Management Accounting, 14th ed. Pearson Education. Read More
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