support department cost allocation

7 -1

Support Support Department Department

Cost Cost AllocationAllocation

CHAPTERCHAPTER

7 -2

1. Describe the difference between support departments and producing departments.

2. Calculate single and multiple changing rates for a support department.

3. Allocate support-department costs to producing departments using the direct, sequential, and reciprocal methods.

4. Calculate departmental overhead rates.

ObjectivesObjectivesObjectivesObjectives

After studying this After studying this chapter, you should chapter, you should

be able to:be able to:

After studying this After studying this chapter, you should chapter, you should

be able to:be able to:

7 -3

Types of DepartmentsTypes of Departments

Producing departments are

directly responsible for creating the products or

services sold to customers.

7 -4

Types of DepartmentsTypes of Departments

Supporting departments provide

essential support services for producing

departments.

Maintenance, grounds, engineering, personnel, storage

7 -5

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.

Steps in Allocating Support Department Steps in Allocating Support Department Costs to Producing DepartmentsCosts to Producing Departments


ContinuedContinuedContinuedContinued

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5. Calculate predetermined overhead rates for the producing departments.

6. Allocate overhead costs to the units of individual products through the predetermined overhead rates.



7 -7

Examples of Cost Drivers forExamples of Cost Drivers forSupport DepartmentsSupport Departments

Accounting Number of transactions

Cafeteria Number of employees

Engineering Number of change orders

Maintenance Machine hours; maintenance hours

Payroll Number of employees

Personnel Number of employees, firings, layoffs, new hires

Support Department Possible DriverSupport Department Possible Driver

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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.

Objectives of AllocationObjectives of AllocationObjectives of AllocationObjectives of Allocation

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

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

7 -10

AND

Fixed costs………………$26,190Variable costs….. $0.023 per page

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Estimated usage (in pages) by the three producing departments is as follows:

Audit Department 94,500

Tax Department 67,500

MAS Department 108,000

Total 270,000

Variable cost: 270,000 x $0.023 $ 6,210

Fixed cost 26,190

Total cost for 270,000 pages $32,400

Average cost ($32,400 ÷ 270,000) $0.12 per page

A Single Charge Rate

7 -12

A Single Charge RateTotal Photocopying Department Charge

Number of Pages

Charge per Page

Total Charges

x =

Audit Department 92,000 $0.12 $11,040

Tax Department 65,000 0.12 7,800

MAS Department 115,000 0.12 13,800

Total 272,000 $32,640

7 -13

Multiple Charging Rates

Peak Number of Pages

Proportion of Peak Usage

Total Fixed Costs

Amount Allocated to

Each Department

Audit 7,875 0.20 $26,190 $ 5,238

Tax 22,500 0.57 26,190 14,928

MAS 9,000 0.23 26,190 6,024

Total 39,375 $26,190

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Multiple Charging Rates

Number of Pages x $0.023

Fixed Cost Allocation

Total Charges

Audit department $2,116 $ 5,238 $ 7,354

Tax department 1,495 14,928 16,423

MAS department 2,645 6,024 8,669

Total $6,256 $26,190 $32,446

+ =

7 -15

Budgeted Versus Actual Usage

When we allocate support-department costs to the producing departments, should we allocate

actual or budgeted costs?

When we allocate support-department costs to the producing departments, should we allocate

actual or budgeted costs?

7 -16


Budgeted costs.Budgeted costs.

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A general principle of performance evaluation is that managers should not be held responsible for

costs or activities over which they have no control.

A general principle of performance evaluation is that managers should not be held responsible for

costs or activities over which they have no control.

7 -18

Use of Budgeted Data for Product Costing

Number of Copies

Total Rate

Allocated Charges

Audit Department 94,500 $0.12 $11,340

Tax Department 67,500 0.12 8,100

MAS Department 108,000 0.12 12,960

Total 270,000 $32,400

x =

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Use of Actual Data for Performance Evaluation Purposes

Number of Copies

Total Rate

Allocated Charges

Audit department 92,000 $0.12 $11,040

Tax department 65,000 0.12 7,800

MAS department 115,000 0.12 13,800

Total 272,000 $32,640

x =

7 -20

Choosing A Service Department Choosing A Service Department Cost Allocation MethodCost Allocation Method

Choosing A Service Department Choosing A Service Department Cost Allocation MethodCost 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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Support Departments Producing Departments

Direct costs* $250,000 $160,000 $100,000 $ 60,000

Normal activity:

Kilowatt-hours ----- 200,000 600,000 200,000

Maintenance hours 1,000 ----- 4,500 4,500

*For a producing department, direct costs refer only to overhead costs that are directly traceable to the department.

Data for Illustrating Allocation MethodsData for Illustrating Allocation MethodsData for Illustrating Allocation MethodsData for Illustrating Allocation Methods

Power Maintenance Grinding Assembly

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Direct Method of AllocationDirect Method of Allocation

Power Maintenance

Grinding Assembly

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Direct Method of AllocationDirect Method of Allocation

Power Maintenance

Grinding Assembly

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STEP 1—CALCULATE ALLOCATION RATIOSSTEP 1—CALCULATE ALLOCATION RATIOS Grinding AssemblyGrinding Assembly

Power =600,000

(600,000 + 200,000)0.75

200,000

(600,000 + 200,000)0.25

Maintenance =4,500

(4,500 + 4,500)0.50

4,500

(4,500 + 4,500)0.50

Direct MethodDirect MethodDirect MethodDirect Method

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STEP 2—ALLOCATE SUPPORTS DEPARTMENT STEP 2—ALLOCATE SUPPORTS DEPARTMENT COSTS USING THE ALLOCATION RATIOSCOSTS USING THE ALLOCATION RATIOS

Power Maintenance Grading AssemblyPower Maintenance Grading Assembly

Support Departments Producing DepartmentsSupport Departments Producing Departments

Direct costs $250,000 $160,000 $100,000 $ 60,000

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

Maintenance --- -160,000 80,000 80,000

$ 0 $ 0 $367,500 $202,500

a

b

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

0.50 x $160,000 = $80,000 b

Direct MethodDirect MethodDirect MethodDirect Method

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Sequential Method of AllocationSequential Method of Allocation

STEP 1: Rank service departments

Power

11

Maintenance

22

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Power

Maintenance AssemblyGrinding

STEP 2

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Maintenance

AssemblyGrinding

STEP 2

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STEP 1—CALCULATE ALLOCATION RATIOSSTEP 1—CALCULATE ALLOCATION RATIOS Maint. Grinding AssemblyMaint. Grinding Assembly

Power =200,000

(200,000 + 600,000 + 200,000)

0.20

600,000

(200,000 + 600,000 + 200,000)

0.60

Sequential MethodSequential MethodSequential MethodSequential Method

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STEP 1—CALCULATE ALLOCATION RATIOSSTEP 1—CALCULATE ALLOCATION RATIOS Maint. Grinding AssemblyMaint. Grinding Assembly

4,500

(4,500 + 4,500)0.50

Mainte- nance

4,500

(4,500 + 4,500)0.50=


7 -31

STEP 2—ALLOCATE SUPPORT DEPARTMENT STEP 2—ALLOCATE SUPPORT DEPARTMENT COSTS USING THE ALLOCATION RATIOSCOSTS USING THE ALLOCATION RATIOS



Direct costs $250,000 $160,000 $100,000 $ 60,000

Power -250,000 50,000 150,000 50,000

Maintenance --- -210,000 105,000 105,000

$ 0 $ 0 $355,000 $215,000

a

b

a 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 b


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

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Normal activity:Kilowatt-hours --- 200,000 600,000 200,000Maintenance

hours 1,000 --- 4,500 4,500

Reciprocal Method


Proportion of Output Used by DepartmentsProportion of Output Used by Departments

Allocated ratios:

Power --- 0.20 0.60 0.20

Maintenance 0.10 --- 0.45 0.45

Direct costs:

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M = Direct costs + Share of Power’s costs

M = $160,000 + $50,000 + 0.02M

0.98M = $210,000

M = $214,286

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P = Direct cost + Share of Maintenance’s cost

= $250,000 + 0.1($214,286) P

= $250,000 + $21,429P

= $271,429P

7 -36

ALLOCATE SUPPORT DEPARTMENT COSTS ALLOCATE SUPPORT DEPARTMENT COSTS USING THE ALLOCATION RATIOS AND THE USING THE ALLOCATION RATIOS AND THE

SUPPORT-DEPARTMENT COSTS FROM SUPPORT-DEPARTMENT COSTS FROM RECIPROCAL METHODS EQUATIONSRECIPROCAL METHODS EQUATIONS



Direct costs $250,000 $160,000 $100,000 $ 60,000

Power -271,429 54,286 162,857 54,286

Maintenance 271,429 -214,286 96,429 96,429

Total $ 0 $ 0 $359,286 $210,715

from Slide 7-34

from Slide 7-35

7 -37

Direct MethodDirect Method

Grinding AssemblyGrinding Assembly

Comparison of Support Department Cost Allocations Using the Direct, Sequential, and

Reciprocal Methods


Reciprocal Methods

Direct costs $100,000 $ 60,000

Allocated from power 187,500 62,500

Allocated from maintenance 80,000 80,000

Total cost $367,500 $202,500

Click on button to compare with sequential method

Click on button to compare with reciprocal method Return Return to showto show

7 -38

Sequential MethodSequential Method



Reciprocal Methods


Reciprocal Methods

Direct costs $100,000 $ 60,000



Total cost $355,000 $215,000

Click on button to compare with direct method

Click on button to compare with reciprocal method Return Return to showto show

7 -39

Reciprocal MethodReciprocal Method



Reciprocal Methods


Reciprocal Methods

Direct costs $100,000 $ 60,000



Total cost $359,286 $210,715

Click on button to compare with direct method

Click on button to compare with sequential method

Return Return to to

showshow

7 -40

Departmental Overhead Rates

The overhead rate for the grinding department is computed 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

7 -41

Product Unit CostProduct Unit Cost

A product requires two machine hours of grinding per unit and one hour of assembly.

Overhead cost assigned:

2 x $5 $10

1 x $2 2

Total assigned $12

7 -42

The EndThe EndThe EndThe End

Chapter SevenChapter Seven

support department cost allocation

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