March 3, 2012

Sparky Inc.: Cost Allocation The key problem in this case is the current method of Sparkys cost allocation for quality control among its three departments. Currently, Sparky allocates costs based on a rate equivalent to the total quality control costs per quality control check and the expected number of quality control checks for each department.
Department A Budgeted Number 50 of Quality Checks Budgeted Cost per $10 Quality Check Budget Cost for $500 Quality Control Department B 30 $10 $300 Department C 20 $10 $200 $1000 Total 100

However, the total cost of quality control increased due to an increase in overtime expenses. Based on the current method, this is how the costs were reallocated. The manager of department A finds the reallocation unfair as his department incurs an increase in costs in spite of only using the budgeted number of quality checks.
Department A Actual Number of 50 Quality Checks Actual Cost per $11 Quality Check Actual Costs for $550 Quality Control Department B 50 $11 $550 Department C 15 $11 $165 $1265 Total 115

To assess the managers claims, the variance of the quality control costs must be analyzed. This requires total flexible budget costs.
Department A Actual Number of 50 Quality Checks Budgeted Cost per $10 Quality Check Flexible Budget $500 Costs for Quality Control Actual Costs for $550 Quality Control Variance ($50) (unfavourable) Department B 50 $10 $500 Department C 15 $10 $150 $1150 Total 115

$550 ($50)

$165 ($15)

$1265 ($165)

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It is evident that there is an unfavourable variance in the budget allocation for the current budget allocation for all the departments. Assuming that quality control costs are expected to grow in the future, the current cost allocation system may not accurately indicate the true costs of quality control for each department and the performance of the managers for each department. Alternative 1: Continue to budget and allocate costs based on the number of quality checks each department needs and evaluate performances of each department manager by the actual versus budgeted number of quality checks for each department. - Advantages: o This method would be a lot easier to implement as it does not require any additional work for the company. o By evaluating managers based on the number of quality checks used, managers would be motivated to meet/decrease the budgeted quality checks. This would likely ensure that the quality of gizmos in each department is high without the oversight of the quality control department. - Disadvantages: o The company would not be able to recognize the duration of each quality check and its corresponding expenses. o The motivation to decrease the number of quality checks by the quality control department may lead to a greater lack of control for product quality. Managers may be more reluctant to request a quality control check. Alternative 2: Budget and allocate costs based on the number of hours the quality control department spends on each department and evaluate the performance of department managers based on the actual versus budgeted costs spent on quality control for their department. - Advantages: o This method would recognize which department have quality checks that require a greater duration. Thus, this method better reflects the costs of quality control for each department. o Managers would be motivated to ensure high quality in the gizmos produced by their respective department in order to minimize the number of hours spent on quality checks. This effectively minimizes costs while maximizing quality.

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- Disadvantages: o The company would now have to keep track of the number of hours spent on each quality check and budget the number of hours each department should need for quality control checks. o The estimate for the number of hours each department needs is likely to be more subjective when compared to the estimates for the number of quality checks each department needs. Given the inaccuracy of the current allocation method used by Sparky for quality control, it is recommended that the company should budget and allocate costs based on the total number of hours spent on quality checks during the year. This would better represent the quality control costs of each department and be a better way of evaluating the management performance of each department.