Cost Management: A Strategic Emphasis 5th Edition by David Stout, Edward Blocher, Gary Cokins

Exercise 51

Performance Measurement; Cost Accounting Standards; Ethics Callum Corporation is a diversified manufacturing company with corporate headquarters in St. Louis. The three operating divisions are the aerospace division, the ceramic products division, and the glass products division.

Much of the manufacturing activity of the aerospace division is related to work performed for the National Aeronautics and Space Administration (NASA) under negotiated contracts. The contracts provide that cost shall be allocated to the contracts in accordance with the federal government’s Cost Accounting Standards (as promulgated by the Cost Accounting Standards Board and administered by the General Accounting Office).

Callum Corporation headquarters provide general administrative support and computer services to each of the three operating divisions. The Cost Accounting Standards provide that the cost of general administration may be allocated to negotiated defense contracts. Further, the standards provide that in institutions where computer services are provided by corporate headquarters, the actual costs (fixed and variable) of operating the computer department may be allocated to the defense division based on a reasonable measure of computer usage.

Another provision of the Cost Accounting Standards deals with the situation in which a defense division acquires noncommercial components from a sister division. The standards provide that when there is no established market price for the component, the component must be transferred to the defense division at cost without a markup for profit. This provision of the standards applies to Callum Corporation because the aerospace division purchases custom designed ceramic components from the ceramic products division. There is no established market price for these custom components.

The general managers of the three divisions are evaluated as profit center managers based on the before-tax profit of the division. The November 2010 performance evaluation reports for each of the divisions (in millions of dollars) are shown in the following table:

	Aerospace	Ceramic Products	Glass Products
	Division	Division	Division
Sales	$23.0	$15.0*	$55.0
Cost of goods sold	13.0	7.0	38.0
Gross profit	$10.0	$ 8.0	$17.0
Selling and administration:
Division selling and administration	$ 5.0	$ 5.0	$ 8.0
Corporate—general administration	1.0	—	—
Corporate—computing	1.0	—	—
Total selling and administration	$ 7.0	$ 5.0	$ 8.0
Profit before taxes	$ 3.0	$ 3.0	$ 9.0

* Includes $3,000,000 of custom ceramic products sold to aerospace division at cost and the remainder ($12,000,000) sold to the glass products division and outside customers at established market prices.

Required

1. Review the November performance evaluation reports for the three operating divisions of Callum Corporation.

a. Identify specific instances where the federal government’s Cost Accounting Standards have influenced Callum’s divisional performance reporting.

b. For each specific instance identified, discuss whether the use of accounting practices based on Cost Accounting Standards is desirable for internal reporting and performance evaluation.

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2. Considering the accounting practices and reporting methods currently employed by Callum Corporation, describe the improper decision making that could result for the company as a whole if the demand for commercial (nondefense related) ceramic products is equal to or greater than the productive capacity of the ceramic products division.

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3. Without a charge for computing services, the operating divisions may not make the most cost-effective use of the resources of the computer systems department of Callum Corporation. Outline and discuss methods for charging the operating divisions for the use of computer services that would promote cost consciousness by the operating divisions and operating efficiency by the computer systems department.

Step 1 of 3

Performance Measurement; Cost Accounting Standards; Ethics (20 min)

1.?Performance Reporting Influenced by CAS

•?The government’s Cost Accounting Standards (CAS) allow allocation of general administration cost to negotiated defense contracts. Thus, Callum has allocated cost of general administration to the Aerospace Division, but not to its other divisions.

•?Computer services provided by corporate headquarters have been allocated to Aerospace as allowed by CAS, but not to other benefiting divisions.

•?CAS provide that when there is no established market price, components transferred between divisions are to be made at cost, without mark-up for profit.

Are Cost Accounting Standards Desirable for Internal Reporting and Performance Evaluation?

•?By allocating the cost of general administration to the Aerospace Division, but not to its other divisions, Callum has overstated the results of these other divisions in comparison to the Aerospace Division.

•?Allocation of the cost of general administration should be made to all the corporation’s facilities based on the estimated benefit received by the individual facility. If the basis for allocation is questionable or arbitrary, then no allocation should be made to any division for internal reporting purposes.

•?As with general administration, computer services should be allocated to all divisions benefiting from use of the central facility. Without uniformity in treatment of all overhead costs, Aerospace Division is being evaluated on a different basis from the other divisions.

•?The $3,000,000 transfer of cost, without mark-up, from Ceramic Products Division to Aerospace understates the operating results of Ceramic Products and renders inter-divisional performance measures incomparable.

Ethical Issues with Current Practice

?The current practice of allocating administrative and computing costs directly to the federal government contracts (the Aerospace Division), while in compliance with federal cost accounting standards, could conflict with the management accountant’s ethical obligation of credibility (Exhibit 1-10). Credibility requires the management accountant to reflect all relevant information fairly and objectively.