Answered Essay: List some types of uncontrollable and controllable costs.

• List some types of uncontrollable and controllable costs.
• Discuss how this type of breakout could be helpful.
• Can you think of any way that this might be detrimental?

Expert Answer

 

Costs, when categorized in relation to persons regulating them, can be classified into:

  1. controllable costs and
  2. uncontrollable costs

Uncontrollable Costs

From the term itself, uncontrollable costs are those that are not under the control of a specified manager. These cannot be influenced by decisions or actions of the manager. These costs are imposed by the top management or allocated to several departments. For example, a company-wide advertising cost that is allocated by the central office to different departments is not under the control of the department heads.

Other examples include depreciation, insurance, share in rent, share in organization-wide security costs, etc.

Controllable Costs

Controllable costs are costs that can be influenced or regulated by the manager or head responsible for it.

For example: direct materials, direct labor, and certain factory overhead costs are controlled by the production manager. Another example: the sales manager has control over the salary and commission of sales personnel.

Example

To effectively evaluate the performance of the production department of ABC Company, the management accountant wants to determine the controllable and uncontrollable costs from the following items:

  1. Direct materials
  2. Direct labor
  3. Factory overhead and other charges
    1. Indirect materials
    2. Indirect labor (supervision)
    3. Depreciation
    4. Insurance
    5. Allocated repairs and maintenance
    6. Allocated rent and utilities expense

Solution: The controllable costs are: direct materials, direct labor, indirect materials, and indirect labor (supervision). Depreciation, insurance, allocated repairs and maintenance, and allocated rent and utilities expense are not under the influence of the production manager. Under responsibility accounting, managers are evaluated based on costs that they can control. Hence, uncontrollable costs are ignored in evaluating managers.

Most companies develop some type of evaluation system for their employees and managers. These systems are usually based on job performance. Managers are regularly evaluated on budgetary performance as well as the sales and income performance of their department. Most of the time these performance evaluations only take into consideration controllable costs.

Uncontrollable costs are business expenses that the manager doesn’t have direct power over. In other words, the business manager doesn’t have control over how these costs are incurred. A good example of an uncontrollable cost is insurance. A manager who runs a department on the factory floor does not have control over the liability insurance that the company buys. If several accidents happen within the company and the liability issuance increases, the manager shouldn’t be penalized for the increased cost. Upper level executives usually set this insurance policy, so the factory floor manager doesn’t have control over it.

Depreciation is another example of an uncontrollable cost. Even though a factory floor manager has control over the machines, maintenance costs, and upkeep, depreciation and accelerated depreciation is rarely set at the manager level. Depending on how much equipment was purchased for the year, depreciation can also eliminate all profits from the department. Managers’ profit performance evaluations usually do not include depreciation for this reason. It won’t be fair to count these costs against a manager who has no control over them. Instead managers’ performance is only judged based on controllable costs.

A controllable cost is an expense that a manager has the power to influence. In other words, it’s a cost that management can increase or decrease based on their business decisions. Keep in mind that this doesn’t mean that the cost can be eliminated or controlled at will. A controllable cost is just an expensethat a manager has influence over.

Control over costs is a relative term in the context of a business’ hierarchy. Management at different levels of the organization have different levels of influence and different amounts of power over spending and allocation of resources.

Example

For example, a factory floor worker probably doesn’t have control over any company expenditures. His supervisors might have control over when supplies are ordered, when maintenance is done on equipment, and how much overtime the floor workers are allowed. To the supervisors, these costs are controllable because he has the power and authority to influence them.

The supervisor doesn’t typically have the power to influence equipment purchases, building acquisitions, or business mergers. Senior management controls these costs because they make the business decisions at this level of the organization.

Also, the definition of controllable costs can depend on timing. For example, a newly hired executive in charge of insurance policies might not have control over a policy that was put in place before his or her hire date. Once the policy renews and the executive has the power and authority to influence the policy along with its benefits, the costs are deemed to be controllable to that executive.

The classification of controllable and non-controllable costs is especially important when evaluating management responsibility, performance, and compensation. Management responsible for more costs should be set to higher standards than management with fewer responsibilities. Also, management shouldn’t be blamed for cost problems when the manager has no influencing power of the cost.

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