Allocation of Support Department Costs, Common Costs, and ...

15 - 1©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Allocation of Support DepartmentCosts, Common Costs, and

RevenuesChapter 15


Learning Objective 1

Differentiate the single-ratefrom the dual-rate

cost-allocation method.


Single-Rate andDual-Rate Methods

The single-rate cost allocation methodpools together all costs in a cost pool.The dual-rate cost allocation methodclassifies costs in each cost pool intotwo cost pools – a variable-cost cost

pool and a fixed-cost cost pool.



Understand how the uncertaintyuser managers face is affected

by the choice between budgetedand actual cost-allocation rates.


Budgeted versus Actual Rates

Budgeted rates let the user department know inadvance the cost rates they will be charged.

During the budget period, the supplier department,not the user departments, bears the risk of any

unfavorable cost variances.

Why?


Budgeted versus Actual Rates

– because the user departments do not pay forany costs that exceed the budgeted rates

When actual rates are used for cost allocation,managers do not know the rates to be used

until the end of the budget period.


Budgeted versus ActualUsage Allocation Bases

Organizations commit to infrastructure costs onthe basis of a long-run planning horizon.

The use of budgeted usage to allocate these fixedcosts is consistent with the long-run horizon.



Allocate support department costsusing the direct, step-down,

and reciprocal methods.


Allocating SupportDepartments Costs

An operating department (a productiondepartment in manufacturing companies)

adds value to a product or service.A support department (service department)

provides the services that assist other operatingand support departments in the organization.



Direct method:Allocates support department costs to operating

departments only.Step-down (sequential allocation) method:

Allocates support department costs to other supportdepartments and to operating departments.

Reciprocal allocation method:Allocates costs by services provided among all

support departments.



The Canton Division of Smith Corporation has twooperating departments and two support departments.

Assemblyand

Finishing

Maintenanceand

Human Resources



Total square feet = 255,000Total number of employees = 95

Maintenance is allocated using square feet.Human Resources is allocated using

number of employees.



Human Maintenance Resources Budgeted costs before allocations: $300,000 $2,160,000 Square feet: 5,000 30,000 Number of employees: 8 15



Assembly Finishing Budgeted costs before allocations: $1,700,000$900,000 Square feet: 110,000 110,000 Number of employees: 48 24


Direct MethodSupport Departments Operating Departments

$1,700,000Assembly

$900,000Finishing

110/220

48/72

24/72

0% 0% 110/220

Maintenance$300,000

HumanResources$2,160,000


Direct MethodSupport Departments Operating Departments

$1,700,000Assembly

$900,000Finishing

$150,000

$1,440,000

$720,000

0% 0% $150,000

Maintenance$300,000

HumanResources$2,160,000


Direct Method

Assembly FinishingOriginal costs: $1,700,000$ 900,000Maintenance Allocated: 150,000 150,000Human Resources Allocated: 1,440,000 720,000Total $3,290,000$1,770,000


Step-Down Method

Which support department should be allocated first?Maintenance provides 12% of its services

to Human Resources.Human Resources provides 10% of its

services to Maintenance.Maintenance to Human Resources:

30,000 ÷ 250,000 (or 12%) × $300,000 = $36,000


Step-Down Method

Maintenance to Assembly:110,000 ÷ 250,000 (or 44%) × $300,000 = $132,000

Maintenance to Finishing:110,000 ÷ 250,000 (or 44%) × $300,000 = $132,000


Step-Down Method

Costs before Allocated allocation costs

Maintenance: $ 300,000 ($300,000)Human Resources:$2,160,000$ 36,000Assembly: $1,700,000$132,000Finishing: $ 900,000$132,000


Step-Down Method

Human Resources costs to be allocated become$2,160,000 + $36,000 = $2,196,000.

Human Resources to Assembly:48 ÷ 72 × $2,196,000 = $1,464,000

Human Resources to Finishing:24 ÷ 72 × $2,196,000 = $732,000


Step-Down Method

Costs before AllocatedAllocated allocation costscosts

HumanResources: $2,160,000 $ 36,000 ($2,196,000)Assembly: $1,700,000 $132,000 $ 1,464,000Finishing: $ 900,000 $132,000 $ 732,000


Step-Down Method

Total cost after allocation:Assembly Department:

$1,700,000 + $132,000 + $1,464,000 = $3,296,000Finishing Department:

$900,000 + $132,000 + $732,000 = $1,764,000


Reciprocal

M HR A FMaintenance – 12% 44% 44%Human Resources 10% – 60% 30%

Maintenance cost = $300,000 + .10PHuman Resource cost = $2,160,000 + .12M


Reciprocal

Maintenance cost (M)= $300,000 + .10($2,160,000 + .12M)

M = $300,000 + $216,000 + .012M.988M = $516,000 M = $522,267HR = $2,160,000 + .12($522,267)

HR = $2,160,000 + $62,672 = $2,222,672


Reciprocal

M HR A FBeforeallocation: $300,000 $2,160,000 $1,700,000 $ 900,000Allocation: (522,267) 62,672 229,797 229,797Allocation: 222,267 ($2,222,672) 1,333,603 666,802Total $3,263,400 $1,796,599

Total cost Assembly Department: $3,263,400Total cost Finishing Department: $1,796,599


Overview of Methods

Overhead rate for the Assembly Department isdetermined using direct labor cost as a denominator.

Overhead rate for the Finishing Department isdetermined using machine-hours as the denominator.


Comparison of Methods

Assembly FinishingDirect labor cost: $698,880 $349,440Machine-hours: 24,000 23,500

What are the various overhead rates using the three methods?


Overhead Rates Direct Method

Assembly:$3,290,000 ÷ $698,880 direct labor costs

= 471% of direct labor costsFinishing:

$1,770,000 ÷ 23,500 = $75.32 per machine-hour


Overhead RatesStep-Down Method


= 472% of direct labor costFinishing:

$1,764,000 ÷ 23,500 = $75.06 per machine-hour


Overhead Rates Reciprocal


= 467% of direct labor costFinishing:

$1,796,599 ÷ 23,500 = $76.45 per machine-hour


Comparison of Rates

Assembly FinishingDirect method: 471% $75.32Step-down method: 472% $75.06Reciprocal method: 467% $76.45



Allocate common costsusing either the stand-alone

or incremental method.


Allocating Common Costs

Two methods for allocating common cost are:

1. Stand-alone costallocation method

2. Incremental costallocation method


Stand-Alone Example

A consultant in Tampa is planning to go toChicago and meet with an international client.

The round-trip Tampa/Chicago/Tampaairfare costs $540.

The consultant is also planning to attenda business meeting with a North Carolina

client in Durham.


Stand-Alone Example

The round-trip Tampa/Durham/Tampaairfare costs $360.

The consultant decides to combine the twotrips into a Tampa/Durham/Chicago/Tampa

itinerary that will cost $760.


Stand-Alone Example

How much should the consultant chargeto the North Carolina client?$360 ÷ ($360 + $540) = .40

.40 × $760 = $304

How much to the international client?$760 – $304 = $456


Incremental Cost Example

Assume that the business meeting in Chicagois viewed as the primary party.

What would be the cost allocation?International client (primary) $540Durham client (incremental) $760 – $540 = $220



Explain the importance ofexplicit agreement betweencontracting parties whenreimbursement is based

on costs incurred.


Cost Allocation and Contracts

Many commercial contracts include clauses thatrequire the use of cost accounting information.Contract disputes arise with some regularity,

often with respect to cost allocation.Cost assignment rules should be as explicit as

possible (and in writing).



Understand how bundlingof products gives rise to

revenue-allocation issues.


Revenues and Bundled Products

A bundled product is a package of two or moreproducts (or services) sold for a single price.

Bundled product sales are also referred toas “suite sales.”

The individual components of the bundle alsomay be sold as separate items at their own

“stand-alone” prices.


Revenues and Bundled Products

What businesses provide bundled products?

Banks Hotels Tours Checking Safety deposit boxes Investment advisory

Lodging Food and beverage services Recreation

Transportation Lodging Guides



Allocate the revenues ofa bundled package to

the individual productsin that package.


Revenue Allocation Methods

English Languages Institute buys Englishlanguage software programs locally and

then sells them in Mexico and Central America.English sells the following programs:

Grammar, Translation, and CompositionThese programs are offered stand-alone

or in a bundle.



Stand-alone PriceGrammar $255Translation $ 85Composition $185

Purchasing these softwareprograms costs English

the following:Grammar $180Translation $ 45Composition $ 95



Bundle (Suites) PriceGrammar + Translation $290Grammar + Composition $350Grammar + Translation + Composition $410



The two main revenue allocation methods are:

1. The stand-alonemethod

2. The incrementalmethod


Stand-Alone RevenueAllocation Method

There are four types of weights for thestand-alone revenue allocation method.

1. Selling prices 2. Unit costs

3. Physical units 4. Stand-aloneproduct revenues



Consider the Grammar and Translationsuite, which sells for $290 per day.How much weight should English

Languages Institute assign to each item?



Selling prices:The individual selling prices are $255 for

Grammar and $85 for Translation.Grammar:

$255 ÷ $340 = 0.75, $290 × 0.75 = $217.50Translation:

$85 ÷ $340 = 0.25, $290 × 0.25 = $72.50



Unit costs:This method uses the costs of the individual

products to determine the weights for therevenue allocations.

Grammar:$180 ÷ $225 = 0.80, $290 × 0.80 = $232

Translation:$45 ÷ $225 = 0.20, $290 × 0.20 = $58



Physical units:This method gives each product unit in the

suite the same weight when allocatingsuite revenue to individual products.With two products in the suite, each

product is allocated 50% of suite revenues.1 ÷ (1 + 1) = 0.50

$290 × 0.50 = $145



Stand-alone product revenues:This method captures the quantity of eachproduct sold as well as their selling prices.

Assume that the stand-alone revenues in 2003are Grammar $734,400, Translation $81,600,

and Composition $133,200.What are the weights for the Grammar

and Translation suite?



Grammar:$734,400 ÷ $816,000 = 0.90, $290 × 0.90 = $261

Translation:$81,600 ÷ $816,000 = 0.10, $290 × 0.10 = $29



Revenue Allocation Weights Grammar Translation

Selling prices $217.50 $ 72.50Unit costs 232.00 58.00Physical units 145.00 145.00Stand-alone product revenues 261.00 29.00


Incremental RevenueAllocation Method

The first-ranked product is termed theprimary product in the bundle.

The second-ranked product is termedthe first incremental product.

The third-ranked product is the secondincremental product, and so on.



Assume that Grammar is designatedas the primary product.

If the suite selling price exceeds the stand-alone price of the primary product, the

primary product is allocated 100%of its stand-alone revenue.



Grammar and Translation suite selling price= $290 per day

Allocated to Grammar: $255Remaining to be allocated: ($290 – $255) = $35

Allocated to Translation: $35


End of Chapter 15

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