15 - 1 allocation of support department costs, common costs, and revenues chapter 15
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15 - 1
Allocation of Support DepartmentCosts, Common Costs, and
Revenues
Allocation of Support DepartmentCosts, Common Costs, and
RevenuesChapter 15
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Learning Objective 1Learning Objective 1
Differentiate the single-rate
from the dual-rate
cost-allocation method.
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Single-Rate andDual-Rate Methods
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.
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Learning Objective 2Learning Objective 2
Understand how the uncertainty
user managers face is affected
by the choice between budgeted
and actual cost-allocation rates.
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Budgeted versus Actual RatesBudgeted 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?
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Budgeted versus Actual RatesBudgeted 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.
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Budgeted versus ActualUsage Allocation BasesBudgeted 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.
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Learning Objective 3Learning Objective 3
Allocate support department costs
using the direct, step-down,
and reciprocal methods.
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Allocating SupportDepartments CostsAllocating 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 operating
and support departments in the organization.
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Allocating SupportDepartments CostsAllocating SupportDepartments Costs
Direct method:Allocates support department costs to operating
departments only.
Step-down (sequential allocation) method:Allocates support department costs to other support
departments and to operating departments.
Reciprocal allocation method:Allocates costs by services provided among all
support departments.
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Allocating SupportDepartments CostsAllocating SupportDepartments Costs
The Canton Division of Smith Corporation has twooperating departments and two support departments.
Assemblyand
Finishing
Maintenanceand
Human Resources
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Allocating SupportDepartments CostsAllocating SupportDepartments Costs
Total square feet = 255,000
Total number of employees = 95
Maintenance is allocated using square feet.
Human Resources is allocated usingnumber of employees.
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Allocating SupportDepartments CostsAllocating SupportDepartments Costs
Human Maintenance Resources Budgeted costs before allocations: $300,000 $2,160,000 Square feet: 5,000 30,000 Number of employees: 8 15
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Allocating SupportDepartments CostsAllocating SupportDepartments Costs
Assembly Finishing Budgeted costs before allocations: $1,700,000 $900,000 Square feet: 110,000 110,000 Number of employees: 48 24
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Direct MethodDirect Method
Support 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
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Direct MethodDirect Method
Support 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
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Direct MethodDirect 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
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Step-Down MethodStep-Down Method
Which support department should be allocated first?
Maintenance provides 12% of its servicesto Human Resources.
Human Resources provides 10% of itsservices to Maintenance.
Maintenance to Human Resources:30,000 ÷ 250,000 (or 12%) × $300,000 = $36,000
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Step-Down MethodStep-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
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Step-Down MethodStep-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
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Step-Down MethodStep-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
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Step-Down MethodStep-Down Method
Costs before Allocated Allocated allocation costs costs
HumanResources: $2,160,000 $ 36,000 ($2,196,000)Assembly: $1,700,000 $132,000 $ 1,464,000Finishing: $ 900,000 $132,000 $ 732,000
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Step-Down MethodStep-Down Method
Total cost after allocation:
Assembly Department:$1,700,000 + $132,000 + $1,464,000 = $3,296,000
Finishing Department:$900,000 + $132,000 + $732,000 = $1,764,000
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ReciprocalReciprocal
M HR A FMaintenance – 12% 44% 44%Human Resources 10% – 60% 30%
Maintenance cost = $300,000 + .10P
Human Resource cost = $2,160,000 + .12M
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ReciprocalReciprocal
Maintenance cost (M)= $300,000 + .10($2,160,000 + .12M)
M = $300,000 + $216,000 + .012M
.988M = $516,000 M = $522,267
HR = $2,160,000 + .12($522,267)
HR = $2,160,000 + $62,672 = $2,222,672
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ReciprocalReciprocal
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
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Overview of MethodsOverview 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.
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Comparison of MethodsComparison 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?
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Overhead Rates Direct MethodOverhead Rates Direct Method
Assembly:$3,290,000 ÷ $698,880 direct labor costs
= 471% of direct labor costs
Finishing:$1,770,000 ÷ 23,500 = $75.32 per machine-hour
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Overhead RatesStep-Down Method
Overhead RatesStep-Down Method
Assembly:$3,296,000 ÷ $698,880 direct labor costs
= 472% of direct labor cost
Finishing:$1,764,000 ÷ 23,500 = $75.06 per machine-hour
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Overhead Rates ReciprocalOverhead Rates Reciprocal
Assembly:$3,263,400 ÷ $698,880 direct labor costs
= 467% of direct labor cost
Finishing:$1,796,599 ÷ 23,500 = $76.45 per machine-hour
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Comparison of RatesComparison of Rates
Assembly FinishingDirect method: 471% $75.32Step-down method: 472% $75.06Reciprocal method: 467% $76.45
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Learning Objective 4Learning Objective 4
Allocate common costs
using either the stand-alone
or incremental method.
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Allocating Common CostsAllocating Common Costs
Two methods for allocating common cost are:
1. Stand-alone costallocation method
2. Incremental costallocation method
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Stand-Alone ExampleStand-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.
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Stand-Alone ExampleStand-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.
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Stand-Alone ExampleStand-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
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Incremental Cost ExampleIncremental 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
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Learning Objective 5Learning Objective 5
Explain the importance of
explicit agreement between
contracting parties when
reimbursement is based
on costs incurred.
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Cost Allocation and ContractsCost 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 aspossible (and in writing).
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Learning Objective 6Learning Objective 6
Understand how bundling
of products gives rise to
revenue-allocation issues.
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Revenues and Bundled ProductsRevenues 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.
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Revenues and Bundled ProductsRevenues 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
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Learning Objective 7Learning Objective 7
Allocate the revenues of
a bundled package to
the individual products
in that package.
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Revenue Allocation MethodsRevenue 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 Composition
These programs are offered stand-aloneor in a bundle.
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Revenue Allocation MethodsRevenue Allocation Methods
Stand-alone PriceGrammar $255Translation $ 85Composition $185
Purchasing these softwareprograms costs English
the following:Grammar $180Translation $ 45Composition $ 95
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Revenue Allocation MethodsRevenue Allocation Methods
Bundle (Suites) PriceGrammar + Translation $290Grammar + Composition $350Grammar + Translation + Composition $410
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Revenue Allocation MethodsRevenue Allocation Methods
The two main revenue allocation methods are:
1. The stand-alonemethod
2. The incrementalmethod
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Stand-Alone RevenueAllocation Method
Stand-Alone RevenueAllocation Method
There are four types of weights for thestand-alone revenue allocation method.
1. Selling prices 2. Unit costs
3. Physical units4. Stand-alone
product revenues
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Stand-Alone RevenueAllocation Method
Stand-Alone RevenueAllocation Method
Consider the Grammar and Translationsuite, which sells for $290 per day.
How much weight should EnglishLanguages Institute assign to each item?
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Stand-Alone RevenueAllocation Method
Stand-Alone RevenueAllocation Method
Selling prices:The individual selling prices are $255 for
Grammar and $85 for Translation.
Grammar:$255 ÷ $340 = 0.75, $290 × 0.75 = $217.50
Translation:$85 ÷ $340 = 0.25, $290 × 0.25 = $72.50
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Stand-Alone RevenueAllocation Method
Stand-Alone RevenueAllocation Method
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
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Stand-Alone RevenueAllocation Method
Stand-Alone RevenueAllocation Method
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, eachproduct is allocated 50% of suite revenues.
1 ÷ (1 + 1) = 0.50$290 × 0.50 = $145
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Stand-Alone RevenueAllocation Method
Stand-Alone RevenueAllocation Method
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 Grammarand Translation suite?
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Stand-Alone RevenueAllocation Method
Stand-Alone RevenueAllocation Method
Grammar:$734,400 ÷ $816,000 = 0.90, $290 × 0.90 = $261
Translation:$81,600 ÷ $816,000 = 0.10, $290 × 0.10 = $29
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Stand-Alone RevenueAllocation Method
Stand-Alone RevenueAllocation Method
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
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Incremental RevenueAllocation Method
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.
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Incremental RevenueAllocation Method
Incremental RevenueAllocation Method
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.
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Incremental RevenueAllocation Method
Incremental RevenueAllocation Method
Grammar and Translation suite selling price= $290 per day
Allocated to Grammar: $255
Remaining to be allocated: ($290 – $255) = $35
Allocated to Translation: $35
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End of Chapter 15End of Chapter 15