Accounting Business Reporting for Decision Making

476 Accounting: Business Reporting for Decision Making

(continued)

objects, the number and type of cost pools, and the appropriate cost drivers by which to allocate the

indirect costs. An overview of the costing system is detailed in figure 11.7. The cost objects are the

three operating departments: home insurance, car insurance, and life insurance. In order to determine

the full cost for each of the operating departments, it is necessary to assign the indirect costs, which

are the total costs of each of the three service departments (i.e. finance, personnel, and computer ser-

vices). Therefore, we have three indirect cost pools classified on a departmental basis measuring costs

on an actual basis. Figure 11.7 highlights the second stage of the allocation process and the one-to-one

relationship that exists between the direct costs and the cost objects, and the one-to-many relationship

between the indirect costs and the cost objects.

Home insurance

department

Car insurance

department

Life insurance

department

Finance department

costs

Cost driver: invoices

Personnel department

costs

Cost driver: employees

Computer services

department costs

Cost driver: computers

Life insurance

direct cost

Car insurance

direct cost

Home insurance

direct cost

F I G U R E 11.7 Second stage allocation — relationships between costs and cost objects

The cost drivers identified to allocate the indirect costs are the number of invoices (finance depart-

ment), the number of employees (personnel department), and the number of computers (computer ser-

vices department). The actual usage of the cost driver is used to allocate indirect costs. The next stage

in the allocation process is calculating the indirect cost rate for each cost pool.

Step 2: Determining indirect cost rates for each cost pool

In this example, there are three cost allocation formulas — one for each of the three service depart-

ment cost pools. Each allocation formula will require determination of the cost to be allocated for the

accounting period, and the total use of the cost drivers. The indirect cost rate can then be calculated,

and the indirect costs allocated according to the use of the cost driver by the individual cost objects,

which in this example are the operating departments.

For the finance department, the total costs are $150 000, with 5000 invoices being processed in the current

accounting period. Each invoice paid by the finance department will lead to a $30 charge being assigned to

the operating department to cover such costs as finance staff salaries, stationery and telephone costs. Using

the same rationale for the personnel department costs and the computer services costs, charges of $1200

per employee and $5000 per computer will be used to assign costs to these operating departments.