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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 Department B Department C Total

Budgeted Numberof Quality Checks

50 30 20 100

Budgeted Cost perQuality Check

$10 $10 $10

Budget Cost forQuality Control

$500 $300 $200 $1000

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 Department B Department C Total

Actual Number ofQuality Checks

50 50 15 115

Actual Cost perQuality Check

$11 $11 $11

Actual Costs forQuality Control

$550 $550 $165 $1265

To assess the managers claims, the variance of the quality control costs must be

analyzed. This requires total flexible budget costs.

Department A Department B Department C Total

Actual Number ofQuality Checks

50 50 15 115

Budgeted Cost perQuality Check

$10 $10 $10

Flexible BudgetCosts for QualityControl

$500 $500 $150 $1150

Actual Costs forQuality Control

$550 $550 $165 $1265

Variance(unfavourable)

($50) ($50) ($15) ($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 additionalwork for the company.

o By evaluating managers based on the number of quality checks used, managerswould 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 andits corresponding expenses.

o The motivation to decrease the number of quality checks by the quality controldepartment 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 agreater duration. Thus, this method better reflects the costs of quality control for eachdepartment.

o Managers would be motivated to ensure high quality in the gizmos produced by theirrespective 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 eachquality 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 moresubjective 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.