Budgeted Cost Rates, Rather Than

¶ … budgeted cost rates, rather than actual cost rates, be used for allocating the variable costs of service departments? When allocating for costs of service departments, organizations are better off using budgeted cost rates rather than actual cost rates. There are two reasons for using budgeted cist rates. The first is that the use of budgeted cost rates instead of actual cost rates protects the user departments from intervening price fluctuations.

The second reason is that using budgeted cost rates can also protect the larger organization from the inherent inefficiencies in the service departments. If a company allocates actual total service department cost, the result is that user department managers are become unwittingly responsible for costs beyond their control. The service departments also have much less of an incentive to ramp up their efficiency if their costs are being attributed elsewhere.

This can lead to tension between user and service departments and complaints from user department managers over the uncertainty of allocations. Service department managers need to have budget responsibility and the user departments are protected. Student 2: Every organization has to make the choice of whether or not to use actual cost rates or budgeted cost rates when allocating the variable costs of service departments.

The wise choice is to use budgeted cost rates, as it is the fairest system and protects user departments from the fluctuations and inefficiencies in service department budgets. An example in the text illustrates how actual cost rates can be detrimental.

If variable costs are allocated to a department that uses 600 hours of computer time but inefficiencies in the department caused variable costs to be $20,000 greater than anticipated, using a budgeted cost scheme would allocate only the original amount to the consuming departments and leave the $-20,000 unallocated -- an unfavorable budget variance of the computer department. The service department is held responsible for the variance, not the department managers. Question 2.

What are some reasons for differences between the amounts of incurred and applied overhead? Student 1: There is usually a difference between incurred and applied overhead. A normal costing approach uses an annual average overhead rate consistently throughout the year, without accounting for day-to-day and month to month fluctuations. This average overhead rate is applied to the cost of a manufactured product, along with actual direct material and actual direct labor.

Because the amount of overhead is computed as an average over the year, a department's applied overhead will rarely, if ever, be equal the actual incurred overhead. A department's applied overhead will rarely equal the actual overhead incurred. Why the reason for the variance? The most common reason is that the department is operating at a different level of volume than the level used in calculating the budgeted overhead rate.

This can be the result of an over- or under-estimation of the hours which will be needed to produce goods or unexpected events like plant shutdowns. Still, even with the variances, companies prefer to use an annual budgeted overhead rate, despite the month-to-month variances. Student 2. Managers often find themselves in the position of having to analyze the difference between the annual overhead rate budgeted for their.