The arbitrary nature of overhead apportionments
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In the Intermediate Standards
http://www.aat.org.uk/servlet/file/Intermediate.pdf?ITEM_ENT_ID=56796&COLLSPEC_ENT_ID=34
for Unit 6 Recording and Evaluating Costs and Revenues
on page 29 in the Knowledge and Understanding section - Accounting Techniques
K&U 10 is the expectation that exam candidates will know and understand the arbitrary nature of overhead apportionments.
http://www.aat.org.uk/servlet/file/Intermediate.pdf?ITEM_ENT_ID=56796&COLLSPEC_ENT_ID=34
for Unit 6 Recording and Evaluating Costs and Revenues
on page 29 in the Knowledge and Understanding section - Accounting Techniques
K&U 10 is the expectation that exam candidates will know and understand the arbitrary nature of overhead apportionments.
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Re:The arbitrary nature of overhead apportionmentsar·bi·trar·y /ˈɑrbɪˌtrɛri/ Pronunciation Key - Show Spelled Pronunciation[ahr-bi-trer-ee] Pronunciation Key - Show IPA Pronunciation adjective, noun, plural -trar·ies.
–adjective
1. subject to individual will or judgment without restriction; contingent solely upon one's discretion: an arbitrary decision.
from
http://dictionary.reference.com/browse/arbitrary0 -
Re:The arbitrary nature of overhead apportionments
So an arbitrary decision can be taken without looking at the facts.
In the question of what method of valuation to use for raw materials,-
some businesses may look at how they will use the value the stock as it goes into to production and want a method that gives a very close approximation to the cost of replacing the material used,
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others may want a method that gives a closing stock value which is a close approximation to the cost of replacing it (both of these are reasonably thought out decisions
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yet more firms may not be interested at all, and just pick a method because a metod is needed such firms would be making the decision about which stock valuation method to use in an
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Re:The arbitrary nature of overhead apportionments
Arbitrary decision making in overhead apportionments.
Example Eastern Bus Company plc (EBC)
This was the June 2007 ECR exam paper example
http://www.aat.org.uk/other_files/exam-answers-07/intermediate_and_advanced/ECR-questions.pdf
You are told there are 3 service departments
• Vehicle Maintenance and Repairs
• Fuel and Parts Store
• General Administration
And the following budgeted overhead costs
Rent and rates of premises.............. £418,000
Light, heat and power at premises......£92,400
And that the Floor space (square metres)of each departments is:-
• Vehicle Maintenance and Repairs 14,000
• Fuel and Parts Store ..........................8,400
• General Administration.......................5,600
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Re:The arbitrary nature of overhead apportionments
As part of the preparation for the exam we know that when the examiner says
We are expected to apportion the Rent and rates of premises and the Light, heat and power at premises on the basis of how much floor space each takes up.Overheads are allocated or apportioned on the most appropriate basis.
And when we do we apportion
................................Basis of .............. Vehicle Maintenance ...Fuel and Parts Store..... General Admin ..............Totals
................................apportionment ....and Repairs ..............
Rent and ........................Floor
rates of premises ........Space..............£209,000........................£125,400........................£83,600........................£418,000
Light, heat and................Floor
power at premises ........Space................£46,200........................£27,720........................£18,480..........................£92,400
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Re:The arbitrary nature of overhead apportionments
But following the rules laid down by Eastern Bus Company plc (EBC), or apportioning on the most appropriate basis may not be providing the management with an accurate cost for each department as far as the rent and rates and light heat and power costs are concerned.
We have made arbitrary apportionment decisions
What is the department where the Vehicle Maintenance and Repairs are carried out like?
Is it an open air piece of land, which would have a pretty low rent if rented separately, and does it include a workshop area where engineers go into pits so they can worked on the underneath parts of the buses?
Is the majority of work carried out in daylight outside with a small amount of specific light in the workshop?
Of course we don't know. The question doesn't tell us. But we can begin to question whether Vehicle Maintenance and Repairs is carrying more of the overhead costs than it causes.
And, if management are using this information in decision making we can wonder whether those decisions are reliable if they have been made based on such arbitrary assumptions.0 -
Re:The arbitrary nature of overhead apportionments
Great thread Sandy - very helpful.0