Fundamentals of Cost Accounting 3rd Edition by William N. Lanen, Shannon W. Anderson, Michael Maher

Exercise 21

Why Are Costs Allocated?—Ethical Issues

I You are the division president of Stable Division of Giga-Corp. Your friend, Ligia, is the division president of Giga-Corp.’s Turmoil Division. These are the only divisions. Each division has 5,000 employees. Last year, Stable Division had a turnover of 1,000 employees (1,000 employees left and 1,000 were hired). Turmoil Division had a turnover of 4,000 employees. There were no transfers between divisions.

Giga-Corp.’s Personnel Department only provides services to Stable and Turmoil and only when an employee leaves or is hired. The total cost of the Personnel Department last year was $100,000.

Required

a.As the Stable Division president, how would you recommend the cost of the Personnel Department be allocated? What arguments would you use to support your claim?

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b.As the Turmoil Division president, how do you think Ligia will recommend allocating the cost of the Personnel Department? Why?

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c.You are going to be transferred to Turmoil Division, but before the transfer, Giga-Corp.’s CEO asks you to recommend an allocation method. How would you recommend the cost of the Personnel Department be allocated? What arguments would you use?

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d.Is it ethical to recommend different allocation methods depending on which division you will be heading?

Step 1 of 5

Cost accounting system

This is a system designed for inhouse or internal managers and their decision making. Cost accounting information is not needed for comparison with other companies. This information is commonly used in financial accounting also, but it is primarily used by company managers for their decision making. It is important that cost accounting information is relevant for the decision making of the manager.

Cost allocation of service departments

Service departments like human resource, administration, accounts, IT etc. render their services to other user departments which may include production or other service departments also. The costs of these service departments also need to be allocated among other user departments for product and departmental costing purposes. There are different methods used for service costs allocation like direct method, step method and reciprocal method.