Managerial Accounting: Allocation Of Indirect Expenses To Departments

Allocation of Salaries

As per the given information, the Vortex company has two departments has tends to operate a retail store. For each department, details have been provided with regards to the underlying revenue and direct expenses. Further, for the company as a whole, the indirect expenses are also provided.  The central objective is to allocate the indirect expenses to the two departments in accordance with the respective basis and thereby decide whether a particular department should be eliminated on account of profitability concerns.

1. a) In order to allocate the indirect expenses to the two departments, the various indirect expenses need to be allocated to the two departments in accordance with the underlying criterion. This is carried below (Drury, 2016).

Allocation of Salaries

Total indirect expenses as salaries = $ 36,000

This needs to be allocated to the two departments A and B on the basis of the underlying sales.

Based on the given information, it is known that sales of department A = $800,000 while sales of department B = $ 450,000

Ratio of sales of Department A: Department B = 80:45 = 16:9

Hence, salary expenses allocated to department A = (16/(16+9))*36000 = $ 23,040

Further, salary expenses allocated to department B = (9/(16+9))*36000 = $ 12,960

Allocation of Insurance

Total indirect expenses as insurance = $ 6,000

This needs to be allocated to the two departments A and B on the basis of the square footage area.

Based on the given information, it is known that square footage of department A = 28,000 while square footage of department B = 12,000

Ratio of square footage of Department A: Department B = 28:12 = 7:3

Hence, insurance expenses allocated to department A = (7/(7+3))*6000 = $ 4,200

Further, insurance expenses allocated to department B = (3/(7+3))*6000 = $ 1,800

Allocation of Depreciation

Total indirect expenses as depreciation= $ 15,000

This needs to be allocated to the two departments A and B on the basis of the square footage area.

Based on the given information, it is known that square footage of department A = 28,000 while square footage of department B = 12,000

Ratio of square footage of Department A: Department B = 28:12 = 7:3

Hence, depreciation expenses allocated to department A = (7/(7+3))*15000 = $ 10,500

Further, depreciation expenses allocated to department B = (3/(7+3))*15000 = $ 4,500

Allocation of office expenses

Total indirect expenses as office expenses = $ 50,000

This needs to be allocated to the two departments A and B on the basis of the number of employees

Based on the given information, it is known that number of employees in department A = 75 while number of employees in department B = 50

Ratio of number of employees of Department A: Department B = 75:50= 3:2

Hence, office expenses allocated to department A = (3/(3+2))*50000 = $ 30,000

Further, expenses allocated to department B = (2/(3+2))*50000 = $ 20,000

Departmental Contribution to Overhead

On the basis of the above allocation of various indirect overhead cost to the two departments A and B, the following overhead cost distribution may be obtained (Bhimani et. al., 2017).

Particulars	Department A	Department B
Salaries	23040	12960
Insurance	4200	1800
Depreciation	10500	4500
Office Expenses	30000	20000
Total Overhead Costs ($)	67740	39260

Hence, from the above computation, it may be concluded that the overhead costs allocated to department A is $ 67,740 while the overhead costs allocated to department B is $ 39,260.

Allocation of Insurance

The computation of the net departmental income is indicated as shown below. Besides, the direct expenses, it also includes the indirect expenses so that the net income for each of the two departments may be accurately determined. With this intention, the allocation of the overhead costs to the two departments was carried out. The requisite income statement for the two departments is shown below (Damodaran, 2015).

Particulars	Department A	Department B
Sales	800000	450000
Cost of Goods Sold	497000	291000
Direct Expenses
Salaries	125000	88000
Insurance	20000	10000
Utilities	24000	14000
Depreciation	21000	12000
Maintenance	7000	5000
Indirect Expenses
Salaries	23040	12960
Insurance	4200	1800
Depreciation	10500	4500
Office Expenses	30000	20000
Net income	38260	-9260

From the above computations, the net income for Department A is $ 38,260 while the net income for Department B is -$ 9,260. This implies that department A makes a profit while department B is making a net loss.

1. b) The negative income or net loss generated by Department B may tempt the relevant decision makers to discontinue department B. However, the significant aspect to be noted is that Department B is catering to $ 39,260 of indirect expenses which cannot be avoided if this department B is eliminated (Brealey, Myers & Allen, 2014). As a result, this would fall on Department A and hence the overall profit would be reduced by $30,000. Thus, till the time that the company comes out with some solution to avoid atleast $ 30,000 of the indirect expenses, it must continue with Department A as it is helping the company to absorb some of the indirect expenses and tends to have a profit if only direct expenses are taken into consideration (Petty et. al., 2015).

Problem 10-6A

• Three column report which represents the items and the respective amount for the given case scenarios.

Case a: Company’s total expenses which include the cost of goods sold

Case b: The expenses which would be eliminated by closing the department 200

Case c: The expenses which would be continued

Eliminated expenses are set of expenses which are eliminated in regards to the closure of the respective department. Cost of goods sold, store supplies, sales, bad debt expenses. Miscellaneous office expenses, Advertisement expenses, insurance expenses are some of key example of elimination expenses. While the continuing expenses are those which would be continued even though there is closure of the department. Sales salaries, other office salary are continuing expenses (Emmauel & Otley, 2015).

It is apparent from the case facts that closing department 200 has eliminated 70% of insurance expenses (eliminating expenses) and also, 25% of their miscellaneous office expenses (eliminating expenses). Due to this elimination, the sales salaries would also be reduced as any amount which has been paid to the two clerks would not be replaced. Further, the office salary would not be the part of elimination. However, it is essential to note that the reclassification of the sales would be done which indicates that one-half would be reported as the company’s sales and the rest one-half would be reported as office salary (Heisinger, 2014).

The three columns report is shown below.

• Forecasted annual income statement of the company which would reflect the elimination of the Department 200 by taking the assumption that it would not make any effect on the sales and the gross profit of Department 100. Further, the Forecasted annual income statement of the company would also indicate the reassignment of all the office workers to the one-half time as salesclerk (Parrino & Kidwell, 2014).

It is noteworthy that income statement is an essential financial statement as it represents that various business transactions which have been done over a defined period of time generally monthly or yearly basis. The general format of an income statement comprises the deduction of total expenses from the total revenues. The case when the total revenue is higher than the total expenses of the company in definite time then the company would get a net income. While, when the net revenue of the company is lower than the total expenses then the company would suffer a net loss (Kane & Marcus, 2013). The income statement of the company is shown below (Northington, 2015).

The revised salaries are computed based on the salary of the sales clerk, administrative worker for the reallocation of the workers to the sales department. The calculation of the revised salaries is highlighted below (Lasher, 2017).

• Reconciliation of the net income with the forecasted net income by considering the fact that Department 200 would eliminate items as well as amounts.

In this case, the combined net income would be reconciled to the forecasted net income through eliminating the lost sales on Department 200 and accumulating the eliminating expenses which has been incurred on Department 200.  The table to represent the Reconciliation of the net income with the forecasted net income is highlighted below (Damodaran, 2015).

Based on the above shown table, it can be concluded that there is significant avoidable expenses of total worth $284,00 of department 200. This amount is $5930 lower than the revenue amount which is $290,000. It indicates that annual net income of the company would be $5930 lower from eliminating department 200. Hence, it has been suggested that department should not do elimination (Ehrhardt & Brigham, 2016).

References

Bhimani, A., Horngren, C.T., Datar, S.M. & Foster, G. (2017), Management and Cost Accounting 4^th ed. Harlow: Prentice Hall/Financial Times

Brealey, R. A., Myers, S. C. & Allen, F. (2014) Principles of corporate finance, 6^th ed. New York: McGraw-Hill Publications

Damodaran, A. (2015). Applied corporate finance: A user’s manual 3rd ed. New York: Wiley, John & Sons.

Drury, C. (2016) Cost and Management Accounting: An Introduction. 6^th ed. New York: Cengage Learning

Ehrhardt, M. C. & Brigham, E. F. (2016) Corporate Finance: A Focused Approach. 6th ed. London: South- Western College Publisher

Emmauel, R.C. & Otley, T.D. (2015) Accounting for Management Control. 8^th ed. London: Cengage Learning.

Heisinger, K.(2014) Essentials of Managerial Accounting 4^th ed. London: Cengage Learning.

Kane, B.Z. and Marcus, A.J. (2013) Essentials of Investment, 9^th ed, Singapore: McGraw-Hill International

Lasher, W. R., (2017) Practical Financial Management 5th ed. London: South- Western College Publisher.

Northington, S. (2015) Finance, 4^th ed. New York: Ferguson

Parrino, R. & Kidwell, D. (2014) Fundamentals of Corporate Finance, 3rd ed. London: Wiley Publications

Petty, J.W., Titman, S., Keown, A., Martin, J.D., Martin, P., Burrow, M. & Nguyen, H. (2015). Financial Management, Principles and Applications, 6^th ed..  NSW: Pearson Education, French Forest Australia