allocation of cost

8/21/2019 Allocation of Cost

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Allocation and Apportionment ofOverhead costs

Abhay Kumar


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Apportionment of Overhead costs

Supporting (Service) Departmentprovides

the services that assist other internal

departments in the company

Operating (Production) Departmentdirectly

adds value to a product or service


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Apportionment of Overhead costs

Primary Distribution:

Apportionment of Overhead costs to different

departments (Production and service both)

Secondary Distribution

Apportionment of service departments Overhead

costs to Productiondepartment.


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Methods to Allocate

Support Department Costs

Single-rate methodallocates costs in

each cost pool (service department) to

cost objects (production departments)using the same rate per unit of a single

allocation base

No distinction is made between fixedand variable costs in this method


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Methods to Allocate

Support Department Costs

Dual-Rate methodsegregates costs

within each cost pool into two segments:

a variable-cost pool and a fixed-cost pool. Each pool uses a different cost-allocation

base


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Allocation Method Tradeoffs

Single-Rate method is simple to implement,

but treats fixed costs in a manner similar to

variable costs

Dual-Rate method treats fixed and variable

costs more realistically, but is more complex to

implement


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Allocation ofSupport Department Costs


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Methods of Allocating Support Costs

to Production Departments

1. Direct

2. Step-Down

3. Reciprocal4. Simultaneous equation


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Direct Method

Allocates support costs only to Operating

departments

No Interaction between Support Departments

prior to allocation


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Direct Method

Manufacturing

Information Systems

Accounting

Packaging

Support Departments Production Departments


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Cost Allocation -Illustrations


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Direct Method


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Direct Method


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Step-Down Method

Allocates support costs to other support

departments and to operating departments

that partially recognizes the mutual services

provided among all support departments

One-Way Interaction between Support

Departments prior to allocation


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Step-Down Method

Manufacturing

Information Systems

Accounting

Packaging



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Step-Down Method


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Step-Down Method


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Reciprocal Method

Allocates support department costs to

operating departments by fully recognizing

the mutual services provided among all

support departments

Full Two-Way Interaction between Support

Departments prior to allocation


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Reciprocal Method

Manufacturing

Information Systems

Accounting

Packaging



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Reciprocal Method


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Reciprocal Method


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Illustration -Allocation of cost

Support Department Operating Department

Total Maintenance HR Deptt. Processing Assembly

Facility Mgt

Cost

12,60,000 12,60,000

Human

Resource Cost

240,000 240,000

square

footage

27000 9000 15000 3000

Employees in

production

16 64


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Allocation of cost

Facilities management cost = $1,260,000

Human resources cost = $240,000

Total square footage in productiondepartments: 15,000 processing + 3,000

assembly = 18,000

Total employees in production departments

16 processing + 64 assembly = 80

Square footage in human resources = 9,000


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Direct Method

Facilities management cost allocated to

processing = (15,000 18,000) $1,260,000 =

$1,050,000

Facilities management cost allocated to assembly= (3,000 18,000) $1,260,000 = $210,000

Human resources cost allocated to processing =

(16 80) $240,000 = $48,000 Human resources cost allocated to assembly =

(64 80) $240,000 = $192,000


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Step-Down Method

To human resources: (9 27) $1,260,000 =$420,000

To processing:(15 27) $1,260,000 = $700,000 To assembly: (3 27) $1,260,000 = $140,000

$240,000 + $420,000 = $660,000

To processing:(16 80) $660,000 = $132,000

To assembly: (64 80) $660,000 = $528,000


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Step-Down Method

Processing department Direct Step-Down

Direct department costs $1,000,000 $1,000,000

From facilities management 1,050,00 700,000

From Personnel 48,000 132,000

Total costs $2,098,000 $1,832,000


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Step-Down Method

Assembly department

Direct Step-Down

Direct department costs $1,600,000 $1,600,000

From facilities management 210,0 00 140,000

From personnel 192,000 528,000 Total costs $2,002,000 $2,268,000


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Choosing Between Methods

Direct and Step-Down are simple to compute

and understand.

Direct Method is widely used.

Reciprocal method is more accurate to

ascertain cost.


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Allocation of Joint Costs

Two conventional ways of allocating joint costs

to products are widely used:

Physical units

Relative sales values

Joint costs include all inputs of material, labor,

and overhead costs that are incurred before

the split-off point.


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The physical-units method requires a commonphysical unit for measuring the output of eachproduct.

The joint costs are allocated based on eachproducts percentage of the total physical unitsproduced.

Allocation of joint costs should not affectdecisions about the individual products.


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Physical unitsRelative sales values

Dow Chemical produces two chemicals, X andY. The joint cost is $100,000. X sells for $.09per liter and Y for $.06.Production of X & Y is1000,000 & 500,000 liters respectively.Allocate the Joint Cost on each product byPhysical units & Relative sales values methods.


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Allocation Sales Value at

Liters Weighting of Joint Costs Split-off Point

X 1,000,000 (10/15)X$100,000 $ 66,667 $ 90,000

Y 500,000 (5/15)X$100,000 33,333 30,0001,500,000 100,000 120,000


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The joint costs are allocated based on each

products sales value as a percentage of the

total sales value at split-off.


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Relative-Sales-Value Method

When weighting is based on the sales value of

the individual products, the allocation of a

cost to one product depends upon the sales

value of both products.

Physical units


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Physical unitsRelative sales values

Relative Sales

Value at Allocation

Spit-off Point Weighting of Joint Costs

X $ 90,000 (90/120)X$100,000 $ 75,000

Y 30,000 (30/120X$100,000 25,000

$120,000


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By-product Cost

A by-product is not individually identifiable untilmanufacturing reaches a split-off point.

They have relatively insignificant sales value.

If an item is accounted for as a by-product, onlyseparable costs are allocated to it.

All joint costs are allocated to the main products.

Any revenues from by-products, less theirseparable costs, are deducted from the cost ofthe main products.


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