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Chapter 6: Problem 12

Describe how nonoutput-based cost drivers can be incorporated into budgeting.

Short Answer

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Non-output-based cost drivers are indirect costs that are not directly proportional to the quantity of output produced and cannot be directly traced to specific products or processes. To incorporate them into budgeting, identify these cost drivers, allocate indirect costs to appropriate cost objects using allocation methods such as departmental nurturing or activity-based costing, and review and adjust these allocations periodically. Use the allocated indirect costs along with direct costs to create accurate budget projections, and monitor and control costs regularly to identify areas for cost control or reduction. This ensures a more detailed and accurate budget for better decision-making and resource allocation.

Step by step solution

01

1. Define Non-Output-Based Cost Drivers

Non-output-based cost drivers are factors that contribute to the cost of production, but are not directly proportional to the quantity of output produced. These drivers are associated with the utilization of resources that do not vary with the level of production and cannot be directly traced to specific products or processes. In other words, non-output-based cost drivers are indirect costs that are not tied to the level of production, and hence, these costs are fixed or semi-fixed in nature. Examples of non-output-based cost drivers include the number of employees working for a company, facility square footage, or the number of investments made.
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2. Differentiate Non-Output-Based Cost Drivers from Output-Based Cost Drivers

Output-based cost drivers, as the name suggests, are the factors that drive the cost of production based on the quantity of output produced. They are directly proportional to the level of production, which means that when the level of output increases, the associated costs will also increase. This relationship helps businesses in attributing the costs incurred to specific products or processes, resulting in more reliable data for cost and budget estimations. Examples of output-based cost drivers include labor hours or materials required for production.
03

3. Incorporating Non-Output-Based Cost Drivers into Budgeting

To effectively integrate non-output-based cost drivers into the budgeting process, the following steps should be taken: (i) Identify Non-Output-Based Cost Drivers: Recognize the cost drivers that fall under this category through careful analysis of the company's operations, expenses, and resource utilization patterns. (ii) Allocate Indirect Costs: Allocate indirect costs to appropriate cost objects (particular products, services, departments, or projects) using appropriate cost allocation methods. Common methods include departmental nurturing (allocating costs based on defined departments) or activity-based costing (allocating costs based on the activities that consume resources). (iii) Review and Adjust: Review the allocation of indirect costs periodically to ensure their accuracy and relevance. Make necessary adjustments based on business requirements and any changes in cost driver factors that may have occurred. (iv) Create Budget Projections: Use the allocated indirect costs, along with direct costs, to create accurate and comprehensive budget projections for the company. (v) Monitor and Control Costs: Monitor costs regularly and evaluate variances between the budgeted and actual figures to identify areas where costs can be controlled or reduced. Incorporating non-output-based cost drivers into budgeting ensures a more detailed and accurate budget, which ultimately supports better decision-making and resource allocation.

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Key Concepts

These are the key concepts you need to understand to accurately answer the question.

Budgeting
Budgeting is a financial plan that predicts expenses and revenues over a specified period, usually a year, to help an organization manage its finances effectively. It involves analyzing various cost drivers and estimating both the direct and indirect costs associated with products or services.
A well-prepared budget serves several purposes:
  • Setting financial goals and objectives
  • Providing a roadmap for resource allocation
  • Facilitating performance evaluation and control
To successfully incorporate non-output-based cost drivers into budgeting, organizations must first identify these indirect costs through a careful review of operations. Successfully pinpointing these costs allows the organization to create better projections that reflect the real business environment, resulting in a more reliable budgeting process.
Ultimately, a comprehensive budget helps a company allocate resources efficiently and make informed strategic decisions that align with its financial goals.
Indirect Costs
Indirect costs are those expenses that cannot be directly linked to a specific product, service, or activity because they support various departments and functions within an organization. These costs usually remain constant, regardless of output levels, and include administrative salaries, utilities, and rent.
Understanding indirect costs is vital for accurate financial planning and budgeting. Here are some key characteristics:
  • They can be fixed, such as rent, or semi-fixed, like utility bills that fluctuate with seasonal usage.
  • Indirect costs require careful allocation to ensure that each department or product bears an equitable share of expenses.
Accounting for indirect costs helps businesses avoid significant deviations between budgeted and actual figures, improving financial control and performance analysis.
Cost Allocation
Cost allocation involves distributing indirect costs across different departments, products, or services within an organization. This process is essential for accurately determining the profitability of various segments and ensuring costs are fairly assigned. Cost allocation supports effective budgeting by providing a clearer picture of how resources are consumed.
There are different methods of cost allocation, including:
  • Departmental Nurturing: Allocating costs based on the responsibilities and activities of specific departments.
  • Activity-Based Costing (ABC): Allocating costs based on the activities that actually consume resources, offering more accuracy and detail.
Regularly reviewing cost allocation ensures that cost distribution reflects current operational realities, enhancing decision-making and financial planning.
Activity-Based Costing
Activity-Based Costing (ABC) is a cost allocation method that assigns indirect costs to products or services based on the activities they require. This method provides a more accurate picture of the true costs associated with each product or service because it considers the complexity and consumption of resources involved.
Key benefits of ABC include:
  • Improved accuracy in cost allocation, leading to better product pricing and profitability analysis.
  • Enhanced understanding of the drivers behind indirect costs, leading to more informed strategic planning.
Implementing ABC can be complex due to its detailed data requirements, but the insights gained justify its complexity when accurate cost allocation and improved budgeting are priorities.

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Most popular questions from this chapter

Comprehensive problem with \(A B C\) costing. Animal Gear Company makes two pet carriers, the Cat-allac and the Dog-eriffic. They are both made of plastic with metal doors, but the Cat-allac is smaller. Information for the two products for the month of April is given in the following tables: Animal Gear uses a FIF0 cost-flow assumption for finished-goods inventory. Animal Gear uses an activity-based costing system and classifies overhead into three activity pools: Setup, Processing, and Inspection. Activity rates for these activities are \( 105\) per setup-hour, \( 10\) per machine-hour, and \( 15\) per inspection-hour, respectively. Other information follows: If necessary, round up to calculate number of batches. Nonmanufacturing fixed costs for March equal \( 32,000\), half of which are salaries. Salaries are expected to increase \(5 \%\) in April. 0 ther nonmanufacturing fixed costs will remain the same. The only variable nonmanufacturing cost is sales commission, equal to \(1 \%\) of sales revenue. Prepare the following for April: 1\. Revenues budget 2\. Production budget in units 3\. Direct material usage budget and direct material purchases budget 4\. Direct manufacturing labor cost budget 5\. Manufacturing overhead cost budgets for each of the three activities 6\. Budgeted unit cost of ending finished-goods inventory and ending inventaries budget 7\. cost of goods sold budget 8\. Nonmanufacturing costs budget 9\. Budgeted income statement (ignore income taxes) 10\. How does preparing the budget help Animal Gear's management team better manage the company?

Comprehensive problem; ABC manufacturing, two products. Hazlett, Inc., operates at capacity and makes plastic combs and hairbrushes. Although the combs and brushes are a matching set, they are sold individually and so the sales mix is not 1: 1 . Hazlett's management is planning its annual budget for fiscal year \(2018 .\) Here is information for 2018 : Hazlett uses a FIF0 cost-flow assumption for finished-goods inventory. Combs are manufactured in batches of \(200,\) and brushes are manufactured in batches of \(100 .\) It takes 20 minutes to set up for a batch of combs and 1 hour to set up for a batch of brushes. Hazlett uses activity-based costing and has classified all overhead costs as shown in the following table. Budgeted fixed overhead costs vary with capacity. Hazlett operates at capacity so budgeted fixed overhead cost per unit equals the budgeted fixed overhead costs divided by the budgeted quantities of the cost allocation base. Delivery trucks transport units sold in delivery sizes of 1,000 combs or 1,000 brushes. Do the following for the year 2018 : 1\. Prepare the revenues budget. 2\. Use the revenues budget to: a. Find the budgeted allocation rate for marketing costs. b. Find the budgeted number of deliveries and allocation rate for distribution costs. 3\. Prepare the production budget in units. 4\. Use the production budget to: a. Find the budgeted number of setups and setup-hours and the allocation rate for setup costs. b. Find the budgeted total machine-hours and the allocation rate for processing costs. c. Find the budgeted total units produced and the allocation rate for inspection costs. 5\. Prepare the direct material usage budget and the direct material purchases budget in both units and dollars; round to whole dollars. 6\. Use the direct material usage budget to find the budgeted allocation rate for materials-handling costs. 7\. Prepare the direct manufacturing labor cost budget 8\. Prepare the manufacturing overhead cost budget for materials handling, setup, processing, and inspection costs 9\. Prepare the budgeted unit cost of ending finished-goods inventory and ending inventories budget 10\. Prepare the cost of goods sold budget. 11\. Prepare the nonmanufacturing overhead costs budget for marketing and distribution. 12\. Prepare a budgeted income statement (ignore income taxes). 13\. How does preparing the budget help Hazlett's management team better manage the company?

Budget schedules for a manufacturer. Hale Specialties manufactures, among other things, woolen blankets for the athletic teams of the two local high schools. The company sews the blankets from fabric and sews on a logo patch purchased from the licensed logo store site. The teams are as follows: \(\cdot\) Broncos, with red blankets and the Broncos logo \(\cdot\) Rams, with black blankets and the Rams logo Manufacturing overhead (both variable and fixed) is allocated to each blanket on the basis of budgeted direct manufacturing labor-hours per blanket. The budgeted variable manufacturing overhead rate for March 2017 is \( 17\) per direct manufacturing labor-hour. The budgeted fixed manufacturing overhead for March 2017 is \( 14,625 .\) Both variable and fixed manufacturing overhead costs are allocated to each unit of finished goods. Budgeted sales for March 2017 are 140 units of the Broncos blankets and 195 units of the Rams blankets. The budgeted selling prices per unit in March 2017 are \( 305\) for the Broncos blankets and \( 378\) for the Rams blankets. Assume the following in your answer: \(\cdot\) Work-in-process inventories are negligible and ignored. \(\cdot\) Direct materials inventory and finished-goods inventory are costed using the FIF0 method. \(\cdot\) Unit costs of direct materials purchased and finished goods are constant in March 2017 . 1\. Prepare the following budgets for March 2017: a. Revenues budget b. Production budget in units c. Direct material usage budget and direct materials purchases budget d. Direct manufacturing labor costs budget e. Manufacturing overhead costs budget f. Ending inventories budget (direct materials and finished goods) g. cost of goods sold budget 2\. Suppose Hale Specialties decides to incorporate continuous improvement into its budgeting process. Describe two areas where it could incorporate continuous improvement into the budget schedules in requirement 1.

Outline the steps in preparing an operating budget.

Sales budget, service setting. In 2017 , Hart \(\&\) Sons, a small environmental-testing firm, performed 11,400 radon tests for \(260\) each and 15,000 lead tests for \(210\) each. Because newer homes are being built with lead-free pipes, lead-testing volume is expected to decrease by \(12 \%\) next year. However, awareness of radon-related health hazards is expected to result in a \(5 \%\) increase in radon-test volume each year in the near future. Jim Hart feels that if he lowers his price for lead testing to \(200\) per test, he will have to face only a \(4 \%\) decline in lead-test sales in 2018 . 1\. Prepare a 2018 sales budget for Hart \(\&\) Sons assuming that Hart holds prices at 2017 levels. 2\. Prepare a 2018 sales budget for Hart \(\&\) Sons assuming that Hart lowers the price of a lead test to \( 200\). Should Hart lower the price of a lead test in 2018 if the company's goal is to maximize sales revenue?
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