Cost Allocation Lesson

8/19/2019 Cost Allocation Lesson

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Copyright © 2006, The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin

11th EditionChapter 15


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Service DepartmentCosting: An Activity

Approach

Chapter Fifteen


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Reasons for Allocating ServiceDepartment Costs

To encourage operatingdepartments to wisely

use service departmentresources.

To encourage operatingdepartments to wisely

use service departmentresources.

To provide operatingdepartments with more

complete cost datafor making decisions.

To provide operatingdepartments with more

complete cost datafor making decisions.

To help measure theprofitability of operating

departments.

To help measure theprofitability of operating

departments.

To create incentivefor service departments

to operate efficiently.

To create incentivefor service departments

to operate efficiently.

To value inventory for external financial

reporting purposes.

To value inventory for external financial

reporting purposes.

To include all overheadin the cost base when

costplus pricing is used.

To include all overheadin the cost base when

costplus pricing is used.


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Selecting Allocation Bases

OperatingDepartments

ServiceDepartments

$

$ service department%s costs may beallocated using more than one base.

For example# a portion of the human resource departmentcosts might be allocated based on the number of employeesin each operating department and another portion might be

allocated based on hours spent in training employees ineach operating department.

$ service department%s costs may beallocated using more than one base.

For example# a portion of the human resource departmentcosts might be allocated based on the number of employeesin each operating department and another portion might be

allocated based on hours spent in training employees ineach operating department.


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Examples of Allocation Bases

Service Department Allocation BasesLaunry !ouns of launry

Airport "roun Services #umer of flights

Cafeteria #umer of meals

%eical &acilities Cases hanle' numer of employees'

hours (or)e

%aterials *anling *ours of service' volume hanle

+nformation ,echnology #umer of personal computers'

applications installe

Custoial Services S-uare footage occupie

Cost Accounting Laor hours' customers serve

!o(er ./* use' capacity of machines*uman Resources #umer of employees' training hours

Receiving0 Shipping0 an Stores 1nits hanle' numer of re-uisitions'

space occupie

&actory Aministration ,otal laor hours

%aintenance %achine hours

Exh.

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+nterepartmental Services

!rolem

Allocating costs (hen service epartments

provie services to each other

!rolem

Allocating costs (hen service epartments

provie services to each other

Solutions

Direct %ethoStep %etho

Reciprocal %etho



Direct %etho

&ervice'epartment(Cafeteria)

&ervice

'epartment(Custodial)

*perating'epartment(+achining)

*perating

'epartment($ssembly)

,nteractionsbetween servicedepartments areignored and all

costs areallocated directly

to operating

departments.



Direct %etho Example

Service Departments Operating Departments

Cafeteria Custoial %achining Assemly

Departmental costs

efore allocation 2340444$ 540444$ 6440444$ 7440444$#umer of employees 89 84 4 24

S-uare feet occupie 90444 0444 90444 940444

Service Department Allocation Base

Cafeteria #umer of employees

Custoial S-uare feet occupie






Direct %etho Example



Departmental costs

efore allocation 2340444$ 540444$ 6440444$ 7440444$

Cafeteria allocation ; ; ;

Custoial allocation ; ; ;

,otal after allocation ; ; ; ;





Departmental costs


Cafeteria allocation 44 ? 24

@ $8660444





Departmental costs


Cafeteria allocation 244 ? 24

@ $830444





Departmental costs


Cafeteria allocation




*perating


Step %etho

*nce a servicedepartment%s costs

are allocated#other service

department costsare not allocated

back to it.


&ervice




Step %etho

,here are three )ey points to unerstanregaring the step metho:

,n both the direct and step methods# any amount of the allocation base attributable to the service

department whose cost is being allocated is always ignored.

$ny amount of the allocation base that is

attributable to a service department whose cost has already been allocated is ignored.

Each service department assigns its own costs to operating departments plus the costs that have

been allocated to it from other service departments.



Step %etho Example


Cafeteria Custoial %achining AssemlyDepartmental costs


#umer of employees 89 84 4 24

S-uare feet occupie 90444 0444 90444 940444




/e (ill use the same ata use in the irect metho example



Step %etho Example



Departmental costs


Cafeteria allocation ; ; ; ;

Custoial allocation ; ; ;

,otal after allocation ; ; ; ;

$llocate Cafeteria costs first sinceit provides more service than Custodial.

$llocate Cafeteria costs first sinceit provides more service than Custodial.





Departmental costs


Cafeteria a llocation 8484 ? 4 ? 24

@ $340444

Allocation ase: #umer of employees





Departmental costs



@ $840444






Departmental costs


Cafeteria a llocation





Departmental costs




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Step %etho Example



Departmental costs




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Reciprocal %etho

,nterdepartmentalservices are given

full recognitionrather than partialrecognition as withthe step method.


&ervice



*perating


-ecause of its mathematical complexity#

the reciprocal method is rarely used.

Revenue !roucing


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Revenue !roucing Service Departments

,f a service departmentgenerates revenue# such as a

cafeteria that charges for the service itprovides# the revenue generated should

be offset against the costs incurred.*nly the remaining net amount

of costs should be allocated to other departments.

uic) Chec) Data


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uic) Chec) Datafor Direct an Step %ethos


AD%+# BACS Accounting Others

Departmental costs



#umer of !Cs 8 4 8 84

$llocation bases

-usiness school administration costs ($'+,/) /umber of employees

-usiness $dministration computer services

(-$C&) /umber of personal computers

,he irect metho of allocation is use


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uic) Chec)

0ow much cost will be allocated from $dministration to $ccounting

a. 2 34#

b. 2166#c. 217#

d. 2 89#


a. 2 34#

b. 2166#c. 217#

d. 2 89#


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a. 2 34#

b. 2166#c. 217#

d. 2 89#


a. 2 34#

b. 2166#c. 217#

d. 2 89#

uic) Chec)



Departmental costs

efore allocation 840444$ 540444$ 8540444$ 5440444$AD%+# allocation 4

4 ? 4

@ $230444


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uic) Chec)

0ow much total cost will be allocated from $'+,/ and -$C& combined to the $ccounting 'epartment

a. 2 58#5

b. 2135#

c. 289#

d. 2 6:#5


a. 2 58#5

b. 2135#

c. 289#

d. 2 6:#5


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uic) Chec)


a. 2 58#5

b. 2135#

c. 289#

d. 2 6:#5


a. 2 58#5

b. 2135#

c. 289#

d. 2 6:#5



Departmental costs


AD%+# allocation


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uic) Chec) Data



Departmental costs



#umer of !Cs 8 4 8 84

$llocation bases

-usiness school administration costs ($'+,/) /umber of employees

-usiness administration computer services

(-$C&) /umber of personal computers

,he step metho of allocation is use


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uic) Chec)


a. 235#85b. 26:#98

c. 217#

d. 284#333


a. 235#85b. 26:#98

c. 217#

d. 284#333


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a. 235#85b. 26:#98

c. 217#

d. 284#333


a. 235#85b. 26:#98

c. 217#

d. 284#333

uic) Chec)



Departmental costs


AD%+# allocation


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Allocating Costs y Behavior

;hen possible#variable and fixed

service department costsshould be allocated

separately.


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ariale serviceepartment costs shoul e

allocate to consuming epartmentsaccoring to the activitycausing incurrence

of the cost



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$llocate fixed service department costs toconsuming departments in predeterminedlumpsum amounts that are based on the

consuming departments% peak or longrunaverage needs. Fixed cost allocations

$llocate fixed service department costs toconsuming departments in predeterminedlumpsum amounts that are based on the

consuming departments% peak or longrunaverage needs. Fixed cost allocations

$re based on amounts of capacity each consuming

department re


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Bugete variale

an fixe service epartmentcosts shoul e allocate to

operating epartments

All i C B h i


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+f variale cost allocations are mae at theeginning of the year0 the ugete variale

rate shoul e multiplie y the ugeteactivity level of each consuming epartment

+f variale cost allocations are mae at theeginning of the year0 the ugete variale

rate shoul e multiplie y the ugeteactivity level of each consuming epartment

$llocations made

at the beginning of theyear provide data for

pricing and other decisions.

All ti C t B h i


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+f variale cost allocations are mae at theen of the year0 the ugete varialerate shoul e multiplie y the actual

activity level of each consuming epartment

+f variale cost allocations are mae at theen of the year0 the ugete varialerate shoul e multiplie y the actual

activity level of each consuming epartment

$llocations made atthe end of the year providedata for performance

evaluation.

Si C A E l


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&imCo has a maintenance department and two operatingdepartments cutting and assembly. =ariable maintenance

costs are budgeted at 2.4 per machine hour. Fixedmaintenance costs are budgeted at 28# per year.

'ata relating to the current year are

$llocate maintenance costs to the two operating departments.

!ercent of

!ea)!erio

Operating Capacity *ours *ours

Departments Re-uire !lanne 1se

Cutting 34F 790444 B40444 Assem$ly 64F 940444 640444

,otal hours 844F 8:90444 8:40444

SimCo: An Example

Si C B i i f th G


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Cutting Assemly

Department Department

ariale cost allocation: $434 > 790444 hours 690444$

$434 > 940444 hours 240444$

&ixe cost allocation:

,otal allocate cost

Cutting Assemly



$434 > 940444 hours 240444$


,otal allocate cost

0ours planned

SimCo: Beginning of the Gear

Si C B i i f th G


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Cutting Assemly



$434 > 940444 hours 240444$


34F of $440444 840444

64F of $440444 40444 ,otal allocate cost 8390444$ 8840444$

Cutting Assemly



$434 > 940444 hours 240444$


34F of $440444 840444


>ercent of peakperiod capacity.

SimCo: Beginning of the Gear

0ours planned

Si C E f th G


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Cutting Assemly



$434 > 640444 hours 60444$


,otal allocate cost

Cutting Assemly


ariale cost allocation:

$434 > 40444 hours 60444$

$434 > 640444 hours 60444$


,otal allocate cost

0ours used

SimCo: En of the Gear

Si C E f th G


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Cutting Assemly



$434 > 640444 hours 60444$


34F of $440444 840444


Cutting Assemly



$434 > 40444 hours 60444$

$434 > 640444 hours 60444$


34F of $440444 840444


>ercent of peakperiod capacity.

SimCo: En of the Gear

0ours used

Si C C i f R lt


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Cost

,ype

Cutting Assemly Cutting Assemlyariale 690444$ 240444$ 60444$ 60444$

&ixe 840444 40444 840444 40444

8390444$ 8840444$ 830444$ 8460444$

Allocation Base on Allocation Base on

Beginningof!erio

!lanne Activity

Enof!erio

Actual Activity

&ixe cost allocations are the same at theen an at the eginning ecause they are

ase on capacity instea of usage

&ixe cost allocations are the same at theen an at the eginning ecause they are

ase on capacity instea of usage

SimCo: Comparison of Results

Si C C i f R lt


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SimCo: Comparison of Results

Only ugete variale an fixe serviceepartment costs (ere allocate to the

t(o operating epartments

,he cost of service epartment inefficiencies0containe in the actual costs0 shoul not

e passe along to operating epartments

uic) Chec):


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uic) Chec):Allocating Costs y Behavior

&oster City has an amulance service that is usey the t(o pulic hospitals in the city ariale

amulance costs are ugete at $64 per mile&ixe amulance costs are ugete at $840444

per year Data relating to the current year are:

!ercent of

!ea)!erio

Capacity %iles %iles

*ospitals Re-uire !lanne 1se%ercy 69F 890444 830444

#orthsie 99F 870444 870944

,otal 844F 20444 220944

ic) Chec)


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uic) Chec)

0ow much ambulance service cost will beallocated to +ercy 0ospital at the beginningof the year

a. 2119#b. 2856#6

c. 2116#67

d. 211:#85

0ow much ambulance service cost will beallocated to +ercy 0ospital at the beginning of the year

a. 2119#b. 2856#6

c. 2116#67

d. 211:#85

uic) Chec)


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0ow much ambulance service cost will beallocated to +ercy 0ospital at the beginningof the year

a. 2119#b. 2856#6

c. 2116#67

d. 211:#85

0ow much ambulance service cost will beallocated to +ercy 0ospital at the beginning of the year

a. 2119#b. 2856#6

c. 2116#67

d. 211:#85

uic) Chec)

%ercy #orthsie


$64 > 890444 miles 320444$

$64 > 870444 miles 780644$&ixe cost allocation

69F of $840444 960444

99F of $840444 330444

,otal allocate cost 8870444$ 8270644$

uic) Chec)


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uic) Chec)

0ow much ambulance service cost will be

allocated to +ercy 0ospital at the end of theyear

a. 2116#

b. 2117#7

c. 211#6

d. 2181#8



a. 2116#

b. 2117#7

c. 211#6

d. 2181#8

uic) Chec)


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a. 2116#

b. 2117#7

c. 211#6

d. 2181#8



a. 2116#

b. 2117#7

c. 211#6

d. 2181#8

uic) Chec)

%ercy #orthsie


$64 > 830444 miles 37044$

$64 > 870944 miles 720944$

&ixe cost allocation

69F of $840444 960444 99F of $840444 330444

,otal allocate cost 88044$ 8250944$

Effect of Allocations on


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Effect of Allocations onOperating Departments

*nce service department costallocations are completed# they areincluded in operating departments%

*nce service department costallocations are completed# they areincluded in operating departments%

>erformanceevaluations

>erformanceevaluations

>rofitabilitydetermination

>rofitabilitydetermination

*verhead rate computations

*verhead rate computations



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&irst Stage AllocationsService epartment costs are

allocate to operating epartments&ervice'epartment(Cafeteria)

&ervice'epartment($ccounting)

&ervice'epartment(>ersonnel)


*perating'epartment($ssembly)

The>roducts




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&ervice'epartment($ccounting)

&ervice'epartment(>ersonnel)


*perating'epartment($ssembly)

The>roducts

Secon Stage Allocations

Operating epartment overhea costs anallocate service epartment costs are

applie to proucts


Allocation !itfalls to Avoi


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!itfall 8

Allocating fixe costs using a variale

allocation ase


Result

&ixe costsallocate to oneepartment are

heavily influence y

(hat happens in other epartments

.oly !roucts: An Example


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?olby >roducts has two sales territories#the Eastern Territory and the ;estern Territory.-oth sales territories are serviced by one auto

service center whose costs are all fixed. Contraryto good practice# ?olby allocates the fixed servicecenter costs to the sales territories on the basis

of actual miles driven (a variable base).

?olby >roducts has two sales territories#the Eastern Territory and the ;estern Territory.-oth sales territories are serviced by one auto

service center whose costs are all fixed. Contraryto good practice# ?olby allocates the fixed servicecenter costs to the sales territories on the basis

of actual miles driven (a variable base).



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Gear 8 Gear Auto service center costs


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y&irstHyear Allocations

/estern sales territory

809440444 miles I $446 per mile 340444$

Eastern sales territory

809440444 miles I $446 per mile 340444

,otal cost allocate 840444$


809440444 miles I $446 per mile 340444$


809440444 miles I $446 per mile 340444


The two sales territories share the servicecenter%s costs e


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ySeconHyear Allocation


809440444 miles I $449 per mile 790444$


5440444 miles I $449 per mile 690444



809440444 miles I $449 per mile 790444$


5440444 miles I $449 per mile 690444


;estern territory has the same number of miles aslast year# but 215# more cost allocated

because Eastern%s miles declined in year 8.



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!itfall

1sing salesollars as an

allocation ase


ResultSales of one epartment

influence the serviceepartment costs

allocate to other epartments

Clothier +nc H An Example


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Clothier +nc H An Example

Clothier ,nc.# a men%s clothing store has oneservice department and three sales departments#

&uits# &hoes# and $ccessories. &ervice department

costs total 24# for both years in the example.Contrary to good practice# Clothier allocates theservice department costs based on sales.

Clothier ,nc.# a men%s clothing store has oneservice department and three sales departments#

&uits# &hoes# and $ccessories. &ervice department

costs total 24# for both years in the example.Contrary to good practice# Clothier allocates theservice department costs based on sales.

Clothier +nc H &irstyear Allocation


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Clothier +nc H &irstyear Allocation

284# @ 26# 45A of 24#

,n the next year# the manager of the &uit 'epartmentincreased sales by 21#. &ales in the other departmentsare unchanged. Bet%s allocate the 24# service department

cost for the second year given the sales increase.

,n the next year# the manager of the &uit 'epartmentincreased sales by 21#. &ales in the other departmentsare unchanged. Bet%s allocate the 24# service department

cost for the second year given the sales increase.

Clothier +nc H Seconyear Allocation


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Clothier +nc H Seconyear Allocation

234# @ 25# 98A of 24#

,f you were the suit department manager# wouldyou be happy with the increased service department

costs allocated to your department

,f you were the suit department manager# wouldyou be happy with the increased service department

costs allocated to your department

En of Chapter 89


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En of Chapter 89

Cost Allocation Lesson

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