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CHAPTER

Support Department Cost Allocation

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Objectives
1. Describe theAfter studying this support difference between departmentschapter, you should and producing departments. 2. Calculate single be able to: changing rates and multiple for a support department. 3. Allocate support-department costs to producing departments using the direct, sequential, and reciprocal methods. 4. Calculate departmental overhead rates.

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Types of Departments
Producing departments are directly responsible for creating the products or services sold to customers.

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Types of Departments
Supporting departments provide essential support services for producing departments.
Maintenance, grounds, engineering, personnel, storage

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Steps in Allocating Support Department Costs to Producing Departments 1. Departmentalize the firm. 2. Classify each department as a support department or a producing department. 3. Trace all overhead costs in the firm to a support department or producing department. 4. Allocate supports department costs to the producing departments.
Continued

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Steps in Allocating Support Department Costs to Producing Departments

5. Calculate predetermined overhead rates for the producing departments. 6. Allocate overhead costs to the units of individual products through the predetermined overhead rates.

Examples of Cost Drivers for Support Departments

Support Department Accounting Cafeteria Engineering Maintenance Payroll Personnel Possible Driver Number of transactions Number of employees Number of change orders Machine hours; maintenance hours Number of employees Number of employees, firings, layoffs, new hires

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Objectives of Allocation
1. To obtain a mutually agreeable price.

2. To compute product-line profitability.

3. To predict the economic effects of planning and control.

4. To value inventory.
5. To motivate managers.

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Note Objective 5: Allocations can be used to motivate managers.

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AND

The firm developed in-house Photocopying Department to serve Audit, Tax & MAS Depts. The cost of Photocopying Dept: Fixed costs (salary & rental)........$26,190 per year Variable costs (paper & toner)..$0.023 per page

A Single Charge Rate

Estimated usage (in pages) by the three producing departments is as follows:
Audit Department Tax Department MAS Department Total Variable cost: 270,000 x $0.023 Fixed cost Total cost for 270,000 pages Average cost ($32,400 270,000) 94,500 67,500 108,000 270,000

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$ 6,210 26,190 $32,400 $0.12 per page

A Single Charge Rate

Total Photocopying Department Charge

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Number x Charge = Total of Pages per Page Charges

Audit Department Tax Department MAS Department Total 92,000 65,000 115,000 272,000 $0.12 0.12 0.12 $11,040 7,800 13,800 $32,640

Multiple Charging Rates

Peak Number of Pages Audit Tax MAS Total 7,875 22,500 9,000 39,375 Proportion of Peak Usage 0.20 0.57 0.23 Total Fixed Costs $26,190 26,190 26,190

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Amount Allocated to Each Department $ 5,238 14,928 6,024 $26,190

Multiple Charging Rates

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Number of Pages x Fixed Cost Total $0.023 + Allocation = Charges Audit department Tax department MAS department Total $2,116 1,495 2,645 $6,256 $ 5,238 14,928 6,024 $26,190 $ 7,354 16,423 8,669 $32,446

Budgeted Versus Actual Usage

When we allocate supportdepartment costs to the producing departments, should we allocate actual or budgeted costs?

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Budgeted Versus Actual Usage

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Budgeted costs.

Budgeted Versus Actual Usage

A general principle of performance evaluation is that managers should not be held responsible for costs or activities over which they have no control.

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Use of Budgeted Data for Product Costing

Number of x Copies Audit Department Tax Department MAS Department Total 94,500 67,500 108,000 270,000 Total Rate $0.12 0.12 0.12 Allocated = Charges $11,340 8,100 12,960 $32,400

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Use of Actual Data for Performance Evaluation Purposes

Number of x Copies Audit department Tax department MAS department Total 92,000 65,000 115,000 272,000 Total Rate $0.12 0.12 0.12 Allocated = Charges $11,040 7,800 13,800 $32,640

Choosing A Service Department Cost Allocation Method

The three methods for allocating service department costs to producing departments are: The Direct Method The Sequential Method The Reciprocal Method

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Data for Illustrating Allocation Methods

Support Departments Producing Departments Power Direct costs* Normal activity: Kilowatt-hours Maintenance hours ----1,000 200,000 ----600,000 4,500 200,000 4,500 $250,000 Maintenance Grinding $160,000 $100,000 Assembly $ 60,000

*For a producing department, direct costs refer only to

overhead costs that are directly traceable to the department.

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Direct Method of Allocation

Power Maintenance

Grinding

Assembly

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Direct Method of Allocation

Power Maintenance

Grinding

Assembly

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STEP 1CALCULATE ALLOCATION RATIOS

Grinding 600,000 Power = (600,000 + 200,000) 200,000 (600,000 + 200,000) Maintenance = 4,500 (4,500 + 4,500) 4,500 (4,500 + 4,500) 0.50 0.50 Assembly

0.75
0.25

Direct Method

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STEP 2ALLOCATE SUPPORTS DEPARTMENT COSTS USING THE ALLOCATION RATIOS

Support Departments Producing Departments Direct costs Power a

Power Maintenance Grading Assembly $250,000 $160,000 $100,000 $ 60,000

-250,000 --187,500 62,500

Maintenance b
$
a b

--0

-160,000
$ 0

80,000

80,000

$367,500 $202,500

0.75 x $250,000 = $187,500; 0.25 x $250,000 = $62,500

0.50 x $160,000 = $80,000 Direct Method

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Sequential Method of Allocation

STEP 1: Rank service departments

1
Power

2
Maintenance

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Sequential Method of Allocation

Power

STEP 2

Maintenance

Grinding

Assembly

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Sequential Method of Allocation

Maintenance

STEP 2

Grinding

Assembly

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STEP 1CALCULATE ALLOCATION RATIOS

Maint. Grinding Assembly 200,000 Power = (200,000 + 600,000 + 200,000) 600,000 (200,000 + 600,000 + 200,000) 0.20

0.60

Sequential Method

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STEP 1CALCULATE ALLOCATION RATIOS

Maint. Grinding Assembly Mainte- = nance

4,500 (4,500 + 4,500) 4,500 (4,500 + 4,500)

0.50

0.50

Sequential Method

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STEP 2ALLOCATE SUPPORT DEPARTMENT COSTS USING THE ALLOCATION RATIOS

Support Departments Producing Departments Direct costs Power a Maintenance b $
a

Power Maintenance Grading Assembly $250,000 $160,000 $100,000 $ 60,000

-250,000 --0 50,000 -210,000 $ 0 150,000 105,000 50,000 105,000

$355,000 $215,000

0.20 x $250,000 = $50,000; 0.60 x $250,000 = $150,000; 0.20 x $250,000 = $50,000 0.50 x $210,000 = $105,000 Sequential Method

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The reciprocal method of allocation recognizes all interactions among support departments.

Reciprocal Method

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Support Departments Producing Departments Power Maintenance Grading Assembly

Direct costs: $250,000 $160,000 Normal activity: Kilowatt-hours --- 200,000 Maintenance hours 1,000 ---

$100,000
600,000 4,500

$60,000
200,000 4,500

Proportion of Output Used by Departments Power Maintenance Grading Assembly Allocated ratios: Power (P) --0.20 0.60 0.20

Maintenance (M)

0.10

---

0.45

0.45

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For a Supporting Departement: Total Cost = Direct Cost + Allocated Cost

M = Direct costs + Share of Powers costs

M = $160,000 + 0.2P =$160,000 + 0.2($250,000 + 0.1M) = $160,000 + $50,000 + 0.02M 0.98M = $210,000 M = $214,286

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P = Direct cost + Share of Maintenances cost

P = $250,000 + 0.1M P = $250,000 + 0.1($214,286) P = $250,000 + $21,429 P = $271,429

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ALLOCATE SUPPORT DEPARTMENT COSTS USING THE ALLOCATION RATIOS AND THE SUPPORT-DEPARTMENT COSTS FROM RECIPROCAL METHODS EQUATIONS
Support Departments Producing Departments Power Maintenance Grading Assembly Direct costs Power Maintenance Total $ $250,000 -271,429 271,429 0 $160,000 54,286 -214,286 $ 0 $100,000 $ 60,000 162,857 96,429 54,286 96,429

$359,286 $210,715

from from Slide 7-35 Slide 7-34

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Comparison of Support Department Cost Allocations Using the Direct, Sequential, and Reciprocal Methods
Direct Method Grinding Assembly $100,000 $ 60,000 187,500 80,000 62,500 80,000

Direct costs
Allocated from power Allocated from maintenance

Total cost

$367,500

$202,500
Return to show

Click on button to compare with sequential method Click on button to compare with reciprocal method

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Comparison of Support Department Cost Allocations Using the Direct, Sequential, and Reciprocal Methods
Sequential Method Grinding Assembly $100,000 $ 60,000 150,000 105,000 50,000 105,000

Direct costs
Allocated from power Allocated from maintenance

Total cost

$355,000

$215,000
Return to show

Click on button to compare with direct method Click on button to compare with reciprocal method

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Comparison of Support Department Cost Allocations Using the Direct, Sequential, and Reciprocal Methods
Reciprocal Method Grinding Assembly $100,000 $ 60,000 162,857 96,429 54,286 96,429

Direct costs
Allocated from power Allocated from maintenance

Total cost

$359,286

$210,715
Return to show

Click on button to compare with direct method Click on button to compare with sequential method

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What does it mean?

Direct method allocated $12,500 more to the

Grinding Department ($12,500 less to the Assembly Department) than Sequential Method.
Meaning: Manager Assembly Dept prefer Direct

Method, and Manager of the Grinding Dept prefer Sequential Method

So? Accountant must consider the consequences of

the different methods and have good reasons for the eventual choice (consider cost-benefits)

Departmental Overhead Rates

Under Sequential Method:
The overhead rate for the grinding department is computed

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as follows (assuming the normal level of activity is 71,000 MH): OH rate = $355,000 71,000 = $5 per MH
The overhead rate for the assembly department is

computed as follows (assuming the normal level of activity is 107,500 DLH):

OH rate = $215,000 107,500 = $2 per DLH

Product Unit Cost

A product requires two machine hours of grinding per unit and one hour of assembly. Overhead cost assigned: 2 x $5 1 x $2 Total assigned

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$10 2 $12

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Chapter Seven

The End

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