[SOLVED] Learning objectives: After reading this case study

Learning objectives: After reading this case study and completing the questions you will be able to: â€¢ Explain the alternative methods of allocating joint costs to products. â€¢ Discuss the arguments for and against each of the methods of allocating joint costs to products. â€¢ Present relevant financial information for a decision as to whether a product or department should be discontinued. Introduction This is a general case relating to joint costs allocation. Although it may be difficult to determine a proper allocation basis for a common cost, the broad objectives for allocating common costs are the same as those for separate costs â€“ cost control and income measurement. A variety of estimation procedures have been proposed and used, including: â€¢ Physical measures: based on weight, volume, etc. The major advantages of physical measures are that they are easy to understand and less expensive to use. â€¢ Activity basis: this procedure involves determining what activities give rise to costs and, in turn, what drives the activities. For example, the costs of operating a purchasing department can be traced to activities such as identifying suppliers, placing orders, transportation, etc. â€¢ Relative sales value: sometimes, the 'cause and effect basis' of activities is not clear. For example, in a multi-departmental company, what is the cause of central office administrative expenditure? One suggestion is that these costs are related to size. One measure of size is each department's level of sales. The relative sales value basis allocates central administrative expenses to each department in proportion of each department's sales to the company's total sales. New business Cashgate Limited commenced business on 1st April, manufacturing chips for global positioning systems (GPS) and iPhone sockets. The company was formed by the merger of two separate businesses of Mr Paul Cashmore (which made chips for GPS) and Mr Robert Gateshead (which made iPhone sockets). The new business had hoped to spread the burden of fixed costs by jointly sharing the costs of premises, some equipment and general administration. The two sole directors have agreed that their own personal remuneration should be proportional to the pre-tax profit which their section of the business generates. Appendix A shows draft accounts for the first quarter. The accounts have been prepared by a temporary accountant recently recruited from JS Temps, a recruitment agency. A meeting was held yesterday to consider the summarised draft accounts. At the meeting, Mr Cashmore expressed unhappiness with the accounts and enquired how the joint costs had been allocated. It was explained to him that the temporary accountant had apportioned premises costs and administration costs in proportion to the floor space occupied, and equipment costs in proportion to the hours of use. The explanations were not able to convince Mr Cashmore and he insisted that he could not accept the accounts. He pointed out that not only were administration costs obviously not related to floor space, but the other bases of allocation were inaccurate. Mr Cashmore pointed out that the storage was of great importance to both departments, and that the use of cubic capacity should determine the allocation of premises costs, and that GPS chips used only half as much cubic capacity as iPhone sockets. Furthermore, he considered that as by agreement the iPhone socket department had the first claim on the use of the joint equipment, the GPS chips department should be charged only half the rate-per-hour-of-use that iPhone sockets department bore. Mr Gateshead was not impressed by Mr Cashmore's opinions and said that he already had to bear extra departmental costs because the iPhone sockets department was located in the oldest part of the premises, making efficient layout and workflow very difficult. He also reminded the meeting that the iPhone socket's department held the first claim on the use of the joint equipment because otherwise his department operations, which were labour-intensive, would be disrupted even further leading to heavy overtime payments and that the present agreement had been central to his acceptance of the combination with GPS chips. Mr Cashmore responded that the important issue was not just the remuneration of the two directors, but the need to consider whether one of the departments was making a loss. If it were, then it might be better to close it down so that both directors could concentrate their attention on the profitable operation. In his concluding remarks, Mr Cashmore said that a constructive compromise might be to allocate all the joint costs in proportion to the sales value of each department's output. At this juncture, it was resolved that the meeting be adjourned for the day, and as management accountant, you should prepare revised accounts allocating joint costs on the basis proposed by Mr Cashmore (i.e. in proportion to the sales value of each department's output). You were also asked to draft a short memorandum advising the directors on how departmental performance should be measured, and on how they might best proceed. The revised accounts and the memorandum are to be laid on the table when the meeting reconvenes tomorrow. REQUIRED: 1. Prepare departmental accounts for Cashgate Ltd, for the first quarter, allocating joint costs in proportion to the sales value of each department's output. 2. Draft a report stating how you consider that the company's departmental performance should be measured, indicating the resultant figures and advising the directors on how they might best proceed. APPENDIX A: Draft account for the first quarter

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Units GPS chips Units (000) iPhone (000) department sockets £ department Departmental costs: Materials 27 500 100 000 Labour 22 500 35 000 Overheads 20 000 12 500 70 000 147 500 Joint Costs: Premises 10 000 5000 Equipment 15 000 7500 Work Costs: 50 95 000 250 160 000 Less: Closing stock of finished goods (12.5) (23.750) (50) (32 000) Cost of sales 71 250 128 000 General administration Total cost 15 000 7.500 86 250 135 500 Revenue from Sales 37.5 75 000 200 150 000 Profit/(Loss) (11 250) 14 500

Cost Accounting Definitions

ABC Classification Method

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Activity Based Costing

Annual Percentage Rate

Annuity

Arbitrary Allocation

Question: Learning objectives: After reading this case study

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