Management Accounting: Regression Analysis and Cost Allocation Methods

This article discusses the regression analysis method for estimating overhead costs and the direct and reciprocal methods for allocating service company costs. It also provides a comparison of the two methods and recommends the use of the reciprocal method for better accuracy.

MANAGEMENT ACCOUNTING
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Question 1
(d) The data for running the regression analysis is indicated below.
Also, the factory manager is of the opinion that the overhead costs are not only dependent on
the genomes production but also on the kiln hours and direct labour hours involved. Hence, a
regression has been run with overhead costs as the dependent variable and all the other three
parameters as the independent variables. The result obtained is highlighted below.
From the above output, the equation of the regression model is indicated below.

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Monthly Overhead Costs = 36335.61 + 160.68*Genomes Produced + 4.58*Total Direct
Labour Hours + 17.87Kiln Hours
As per the flexed budget, the annual sales volume is estimated to be 761 genomes and hence
the average monthly sale/production would be (761/12) = 63.417
Total monthly direct labour hours budgeted = (12+15)*63.417 = 1712.25
Total monthly kiln hours budgeted = 8*63.417= 507.33 hours
Hence, estimated flexed monthly overhead costs = 36335.61 + 160.68*(63.417) +
4.58*(1712.25) + 17.87*(507.33) = $63,438.44
Therefore, estimated annual overhead costs for the year ending on March 31, 2019 =
63438.44*12 = $761,261.26
Estimated Annual Fixed Overhead Cost = 36335.61*12 = $ 436,027
Estimated Annual Variable Overhead Cost = 761,261 - 436,027 = $325,234
Comparison & Suggestion
The comparison of the estimated obtained from account method and regression approach is
carried out below.
From the above comparison, it is apparent that the regression method would be preferred
method since the estimated overhead cost along with the respective breakup is closer to the
actual overhead costs for this method as compared to the account method and hence it would
be preferable (Drury, 2016).

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Question 2
MEMO
To: Noah Scmid (CFO, Gnomes International Limited)
From: STUDENT NAME
Date: March 28, 2018
Subject: Allocation of service company costs
Dear Sir
In situations where there are support departments providing services to the operating
departments, it is imperative to allocate the costs of these support departments. With regards
to allocating the costs incurred on the support departments, there are two methods that can be
deployed namely the direct method and reciprocal method.
In the direct method, the costs incurred by the support departments is entirely allocated
between the operating department with no costs being allocated amongst the support
departments even though these support departments may be offering services to each other
besides the operating departments. An obvious advantage of this method is the ease of
allocation since all the support costs are allocated to only the operating departments
(Emmauel and Otley, 2010). Also, owing to this method the focus is on production of goods
as the support departments are required only because of existence of operating departments.
However, a key disadvantage of using this method is that there is over-allocation of
production costs since no support costs is apportioned to the support departments even
though they spend their resources in offering some services to each other (Heisinger, 2009).
For instance, for the company the support departments are essentially the head office,
Singapore office and India office. The operating departments are based in Mexico, US and
New Zealand. Hence as per direct method, all the costs related to the support offices in the
three locations would be apportioned to the operating offices as highlighted below.
In the reciprocal method, the cost incurred by the support departments are not only allocated
to the operating departments but also amongst the support departments in proportion to the

MANAGEMENT ACCOUNTING
resources used. Hence, the obvious advantage of this method is that it is more accurate in
comparison to the direct method and does not tend to overestimate the production costs since
the cost allocation is based on the actual consumption of resources by the various offices
(including support). One major disadvantage of this method is the complexity involved in the
computation of the same which is why some firms tend to prefer the direct method of cost
allocation (Drury, 2016).
Thus, as per the reciprocal method, the support offices cost would now not be limited to only
the operating offices (i.e. US, Mexico and New Zealand) but would also be distributed
between the support offices in accordance with the direct labour hours consumed. The first
step in this method involves support costs being distributed to the various departments in
proportion to the direct labour hours consumed as indicated below.
The costs obtained for the support offices (i.e. Head office, Singapore, India) need to be
further sub-divided in accordance with their respective labour hour consumption across both
operating offices and support offices till the supports costs are reduced to zero. The final cost
allocation as per this method is indicated below.
It is apparent that the given process is complicated owing to iterations required but yields to
better accuracy.
Recommendation
From the above, it is apparent that the accuracy associated with the reciprocal method of cost
allocation is higher and hence it should be preferred despite the iterations required for
completely allocating the support costs. In order to facilitate the computation, technological
aids can also be used but accurate costing is pivotal espeically in the competitive business
environment that exists (Kinney and Rainborn, 2012).
Yours Sincerely
STUDENT NAME

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References
Drury, C. (2016) Cost and Management Accounting: An Introduction. 6th ed. New York:
Cengage Learning.
Emmauel, R.C. and Otley, T.D. (2010) Accounting for Management Control. 8th ed. London:
Cengage Learning.
Heisinger, K. (2009) Essentials of Managerial Accounting. 4th ed. London: Cengage
Learning.
Kinney, R. M. and Rainborn , A. C. (2012) Cost Accounting: Foundations and Evolutions.
9th ed. New York: Cengage Learning.