Chapter 12 – Cost Accumulation, Tracing, and Allocation
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Teaching Notes for Chapter 12
The topics in this chapter are critical. The need to make allocations causes widespread
problems. A parent with one candy bar and two children has an allocation problem.
While allocation is nothing more than dividing a total into parts and assigning those parts
to different objects, the human effort to be fair in the division complicates this simple
process. Consider the above candy bar example. Suppose one child doesn’t like candy
as much as the other. Should the parent give that child a smaller portion or give each
child an equal share? Suppose both children like candy. How does the parent assure an
equal distribution? You have surely seen the discord generated by an unequal break.
Who hasn’t heard (or said) at one time or another, “it’s not fair, her piece is bigger!”
Given this human characteristic, it is little wonder that bitter disputes erupt among adults
over who gets what share of a raise pool or how costs are assigned to different
departments. Starting your class with a discussion involving the human side of making
allocations can motivate students to get involved in the material.
Chapter 12 provides the foundation necessary to understand cost objects and cost
drivers necessary for efficient and effective cost accumulation.
Detailed Outline of a Lesson Plan for Chapter 12
I. Distribute Demonstration Problem 12-1 (My House / Your House) to the
class.
We have provided two versions of Demonstration Problem 12-1. If you want to
use this problem as a problem-based learning exercise, either distribute the version
labeled “problem–based learning format” or put the following information on the
board:
House 1
House 2
House 3
Direct Materials
$140,000
$ 70,000
$90,000
Direct Labor
210,000
130,000
60,000
Overhead
?
?
?
Total overhead (indirect cost) is $84,000.
If you prefer to work the problem in a lecture-based format, use the other version,
labeled “traditional format.”
We recommend the problem-based learning approach. Begin by identifying
House 1 as yours and House 3 as the student’s. Then suggest that the overhead
cost ($84,000) be divided equally among the three houses. In other words, assign
each house $28,000 ($84,000 ÷ 3) of overhead cost. Usually, students object
immediately. If they fail to respond, prod them by asking if the allocation seems
Chapter 12 – Cost Accumulation, Tracing, and Allocation
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fair. Once they recognize that equal allocation is unfair, ask them to allocate the
overhead in a way that they consider more fair. Require them to provide a
specific amount of overhead cost for each house and give them time to compute
the amounts. Put students in their groups to reach consensus on their answers.
If you are using the traditional format version, work requirement a. Even with
the lecture approach we recommend that you keep students actively involved by
giving them time to attempt a solution to each requirement before you provide the
answer.
II. Point out that different mathematical approaches to solving allocation
problems can lead to the same result. Point out, also, that with respect to
Demonstration Problem 12-1, total direct cost dollars (direct materials plus direct
labor cost) is a rational allocation base (cost driver).
If you are using the traditional format, complete requirement b at this point.
III. Once students understand the math used in making allocations, focus your
discussion on how to select the most appropriate allocation base (identify the
cost driver). The equal share allocation (the first approach suggested in the
demonstration problem) was based on the number of units. That method was
flawed because it allocated equal amounts of overhead cost to different-sized
houses. Number of units sometimes is an appropriate base. It may be suitable
when the units produced are homogenous. If the three houses were identical, then
number of units would be a rational allocation base. Given that the houses were
different sizes, we determined that a measure of size (direct cost dollars) would
be a more reasonable allocation base (see requirement b).
IV. Extend the logic further by using two different bases to allocate the total
overhead cost. Tell the students that the total overhead cost ($84,000) consists of
two components, $63,000 of indirect materials cost and $21,000 of fringe benefits
Problem-Based Learning Exercise
My House Your House
I think an equal amount of overhead cost should be allocated
to each house. Do you agree?
Chapter 12 – Cost Accumulation, Tracing, and Allocation
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cost. Now use direct materials dollars to allocate the indirect materials cost and
direct labor dollars to allocate the fringe benefits cost. After completing this
problem you will have allocated the same overhead cost in three different ways
(equally, based on total direct costs, and using 2 separate cost drivers) using three
different allocation bases (cost drivers).
If you are using the traditional format, complete requirement c at this point.
V. Use Problem 12-15 from the text to demonstrate selecting an appropriate
cost driver (allocation base) and to provide practice computing allocations.
Students usually need help getting started. Give them a few minutes to
familiarize themselves with the problem. Then interrupt and work requirements
a, b, and c. Based on available time, use the remaining requirements for an in
class active learning experience or as homework. You can use Problem 12-15 as
a reinforcement exercise.
VI. Use Problem 12-20 from the text to demonstrate how self-interest can impact
the selection of an allocation base. This problem also reinforces the
mathematical computations necessary to allocate costs.
VII. The text covers joint costs, and the appendix covers allocation of service
center costs. Include these topics to the extent time permits. Information
overload, however, is a common problem in accounting principles courses. Limit
the extent of coverage to what your students can handle. Little is gained when we
rush through material at such a fast pace that we lose our audience. The issue is
not how much we can cover, but how much our students can comprehend.
Summary Outline of a Lesson Plan for Chapter 12
I. Use Demonstration Problem 12-1 as a problem-based learning exercise.
II. Point out that different mathematical approaches can lead to the same result.
III. Focus your discussion on how to select the most appropriate allocation base
(identify the cost driver). Use number of units, direct cost dollars, direct
materials dollars, and direct labor dollars as examples of allocation bases.
IV. Extend the logic further by using two different bases to allocate the total
overhead cost.
V. Use Problem 12-15 from the text to demonstrate selecting an appropriate
cost driver (allocation base) and to provide practice computing allocations.
Use Problem 12-15 as a reinforcement exercise.
VI. Use Problem 12-20 from the text to demonstrate how self-interest can impact
the selection of an allocation base.
Chapter 12 – Cost Accumulation, Tracing, and Allocation
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Quiz Questions for Chapter 12
1. The process of assigning a cost to two or more designated cost objects is
a. cost tracing
b. cost allocation
c. cost/benefit analysis
d. cost classification
2. Of the following statements, which is NOT true concerning indirect costs?
a. An allocation rate for an indirect cost is determined by dividing the total cost to be allocated by
an appropriate cost driver.
b. An indirect cost is a cost that cannot easily be traced to a cost object.
c. The informational benefits from tracing an indirect cost are not worth the economic sacrifice
incurred in tracing the cost.
d. An indirect cost can be fixed but cannot be variable.
3. Logan Corporation has 30 employees, 20 in Department A and 10 in Department B. Logan incurred
$180,000 in fringe benefits costs last year. How much in fringe benefit costs should be allocated to
Department A?
a. $ 60,000
b. $120,000
c. $180,000
d. $90,000
4. Which of the following would be classified as an indirect cost in a department store? Assume the
cost object is the children’s department.
a. sales commissions
b. cost of goods sold
c. utility costs
d. depreciation on cash registers
Use the following data to answer the next two (2) questions:
Product 1
Product 2
Product 3
$25,000
$30,000
$35,000
$30,000
$40,000
$50,000
1,200 hours
1,800 hours
2,000 hours
Factory overhead is estimated to be $40,000 and is applied based on direct labor dollars. This overhead cost
is not traceable to any particular product.
5. Factory overhead allocated to Product 2 is
a. $13,333
b. $24,000
c. $20,000
d. $14,400
6. The total cost of Product 1 is
a. $55,000
b. $62,500
c. $65,000
d. $83,333
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7. Saylind Molding paid $280,000 in rent for the year. The company’s three departments are headrests,
armrests, and air ducts. The departments occupy 5,000, 6,300, and 2,700 square feet, respectively.
How much of the rent cost should be allocated to the products made in the air ducts department?
a. $ 54,000
b. $ 72,000
c. $126,000
d. $128,000
8. Employees of DTI, Inc. worked 1,600 direct labor hours in January and 1,000 direct labor hours in
February. DTI expects to use 18,000 direct labor hours during the year, and expects to incur
$22,500 of Worker’s Compensation insurance cost for the year. The cash payment for this cost will
be paid in April. How much insurance premium should be allocated to products made in January
and February?
a. $7,200; $5,500
b. $2,000; $1,250
c. $4,000; $2,500
d. $2,000; $5,500
9. Costs that can be traced to objects in a cost-effective manner are called
a. allocated costs.
b. conversion costs.
c. direct costs.
d. indirect costs.
10. Which of the following is the most logical cost driver for allocating the telephone bill among four
departments?
a. square footage of floor space
b. direct labor hours
c. telephone usage in minutes
d. sales volume measured in dollars
11. Alpha Company is selecting a cost driver to use in allocating utilities costs to its departments. The
best cost driver
a. has a strong cause-and-effect relationship to the cost being allocated.
b. is one for which information is readily available.
c. seems acceptable and reasonable to the managers of the departments.
d. all of the above.
Solutions to Quiz Questions
Question
Answer
1
B
2
D
3
B
4
C
5
A
6
C
7
A
8
B
9
C
10
C
Chapter 12 – Cost Accumulation, Tracing, and Allocation
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11
D
Demonstration Problems for Chapter 12
Demonstration Problem 12-1 Allocating Indirect Costs
(Problem-Based Learning Format)
My House / Your House
House 1
House 2
House 3
Direct Materials
$140,000
$ 70,000
$90,000
Direct Labor
210,000
130,000
60,000
Overhead*
?
?
?
*The building contractor’s total indirect costs (such as supervisory salaries and indirect
materials) amount to $84,000.
My new house is house number one. I believe distributing the contractor’s overhead
costs equally among the three houses is a fair way to allocate them. My specific
recommendation is:
$84,000 overhead / 3 houses = $28,000 per house. Your new house is house number
three. Do you agree with this assignment of cost?
Chapter 12 – Cost Accumulation, Tracing, and Allocation
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Demonstration Problem 12-1 Allocating Indirect Costs
(Traditional Format)
Assume a builder is building three houses simultaneously. The direct materials and direct
labor costs for each house are shown below:
House 1
House 2
House 3
Direct Materials
$140,000
$ 70,000
$90,000
Direct Labor
210,000
130,000
60,000
Overhead
?
?
?
The building contractor’s total indirect costs (such as supervisory salaries and indirect
materials) are $84,000.
Required
a. Assume the builder allocates overhead (indirect) costs equally among the three
houses. Determine the amount of overhead cost allocated to each house. Comment
on whether this allocation scheme is reasonable. Explain why it may be
inappropriate to use number of units as the allocation base.
b. Assume instead that the builder allocates overhead costs based on total direct costs.
Determine the amount of overhead cost allocated to each house. Compare the
allocations determined in requirement a with the allocations determined in
requirement b. Identify who will benefit and who will suffer if the builder uses the
requirement b allocation method instead of allocating overhead equally.
c. Assume that the $84,000 of total overhead cost consists of $63,000 of indirect
materials and $21,000 of fringe benefits. Decide what you believe is the most
rational allocation scheme and use that scheme to allocate the overhead cost to the
three houses.
Demonstration Problem 12-1 Solution
a. $84,000 ÷ 3 = $28,000 of overhead cost per house.
This allocation scheme assigns more overhead than seems
reasonable to the lower cost houses. A house that requires
greater amounts of direct materials cost and direct labor cost is
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Allocations based on the number of units assign the same
b. Total direct costs are as follows:
House 1
House 2
House 3
Total
Direct Materials
$140,000
$ 70,000
$90,000
$300,000
Direct Labor
210,000
130,000
60,000
400,000
Total Direct Cost
$350,000
$200,000
$150,000
$700,000
Step 1. Determine the allocation rate:
Cost to be Allocated
⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯
=
Allocation Rate
Allocation Base
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