7 1 CHAPTER Support Department Cost Allocation 7

7 -1 CHAPTER Support Department Cost Allocation

7 -2 Objectives 1. Describe the. After difference between studying this support departmentschapter, and producing departments. you should 2. Calculate single be andable multiple to: 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.

7 -3 Types of Departments Producing departments are directly responsible for creating the products or services sold to customers.

7 -4 Types of Departments Supporting departments provide essential support services for producing departments. Maintenance, grounds, engineering, personnel, storage

Steps in Allocating Support Department Costs to Producing Departments 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. Continued 7 -5

Steps in Allocating Support Department Costs to Producing Departments 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 -6

Examples of Cost Drivers for Support Departments Support Department Possible Driver 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 7 -7

7 -8 Objectives of Allocation 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.

7 -9 Note Objective 5: Allocations can be used to motivate managers.

7 -10 AND Fixed costs……………… $26, 190 Variable costs…. . $0. 023 per page

7 -11 A Single Charge Rate 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 Fixed cost Total cost for 270, 000 pages Average cost ($32, 400 ÷ 270, 000) $ 6, 210 26, 190 $32, 400 $0. 12 per page

7 -12 A Single Charge Rate Total Photocopying Department Charge Number x Charge = Total of Pages per Page Charges Audit Department 92, 000 $0. 12 $11, 040 Tax Department 65, 000 0. 12 7, 800 115, 000 0. 12 13, 800 MAS Department Total 272, 000 $32, 640

7 -13 Multiple Charging Rates Proportion of Peak Usage Total Fixed Costs Amount Allocated to Each Department 7, 875 0. 20 $26, 190 $ 5, 238 22, 500 0. 57 26, 190 14, 928 9, 000 0. 23 26, 190 6, 024 Peak Number of Pages Audit Tax MAS Total 39, 375 $26, 190

7 -14 Multiple Charging Rates Number of Pages x Fixed Cost Total $0. 023 + Allocation = 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 $6, 256 $26, 190 $32, 446 Total

Budgeted Versus Actual Usage When we allocate supportdepartment costs to the producing departments, should we allocate actual or budgeted costs? 7 -15

Budgeted Versus Actual Usage Budgeted costs. 7 -16

Budgeted Versus Actual Usage 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 -17

7 -18 Use of Budgeted Data for Product Costing Number of x Copies Total Rate Allocated = Charges Audit Department 94, 500 $0. 12 $11, 340 Tax Department 67, 500 0. 12 8, 100 108, 000 0. 12 12, 960 MAS Department Total 270, 000 $32, 400

Use of Actual Data for Performance Evaluation Purposes Number of x Copies Total Rate Allocated = Charges Audit department 92, 000 $0. 12 $11, 040 Tax department 65, 000 0. 12 7, 800 115, 000 0. 12 13, 800 MAS department Total 272, 000 7 -19 $32, 640

Choosing A Service Department Cost Allocation Method The three methods for allocating service department costs to producing departments are: § The Direct Method § The Sequential Method § The Reciprocal Method 7 -20

Data for Illustrating Allocation Methods Support Departments Power Direct costs* 60, 000 $250, 000 Producing Departments Maintenance $160, 000 Grinding Assembly $100, 000 $ Normal activity: Kilowatt-hours ----- 200, 000 600, 000 200, 000 Maintenance hours 1, 000 *For a ----- 4, 500 producing department, direct costs refer only to overhead costs that are directly traceable to the department. 7 -21

7 -22 Direct Method of Allocation Power Maintenance Grinding Assembly

7 -23 Direct Method of Allocation Power Maintenance Grinding Assembly

7 -24 STEP 1—CALCULATE ALLOCATION RATIOS Grinding 600, 000 Power = (600, 000 + 200, 000) 0. 75 200, 000 (600, 000 + 200, 000) Maintenance = 4, 500 (4, 500 + 4, 500) Direct Method Assembly 0. 25 0. 50

7 -25 STEP 2—ALLOCATE SUPPORTS DEPARTMENT COSTS USING THE ALLOCATION RATIOS Direct costs Power a Support Departments Producing Departments Power Maintenance Grading Assembly $250, 000 $160, 000 $100, 000 $ 60, 000 -250, 000 --- 187, 500 62, 500 --- -160, 000 80, 000 Maintenance b $ 0 $367, 500 $202, 500 a 0. 75 x $250, 000 = $187, 500; 0. 25 x $250, 000 = $62, 500 b 0. 50 x $160, 000 = $80, 000 Direct Method

7 -26 Sequential Method of Allocation STEP 1: Rank service departments 1 2 Power Maintenance

7 -27 Sequential Method of Allocation STEP 2 Power Maintenance Grinding Assembly

7 -28 Sequential Method of Allocation STEP 2 Maintenance Grinding Assembly

7 -29 STEP 1—CALCULATE ALLOCATION RATIOS Maint. Grinding Assembly 200, 000 Power = (200, 000 + 600, 000 + 200, 000) 600, 000 (200, 000 + 600, 000 + 200, 000) 0. 20 Sequential Method 0. 60

7 -30 STEP 1—CALCULATE ALLOCATION RATIOS Maint. Grinding Assembly Mainte- = nance 4, 500 (4, 500 + 4, 500) Sequential Method 0. 50

7 -31 STEP 2—ALLOCATE SUPPORT DEPARTMENT COSTS USING THE ALLOCATION RATIOS Direct costs Power a Support Departments Producing Departments Power Maintenance Grading Assembly $250, 000 $160, 000 $100, 000 $ 60, 000 -250, 000 150, 000 --- -210, 000 105, 000 Maintenance b $ 0 $355, 000 $215, 000 a 0. 20 x $250, 000 = $50, 000; 0. 60 x $250, 000 = $150, 000; 0. 20 x $250, 000 = $50, 000 b 0. 50 x $210, 000 = $105, 000 Sequential Method

7 -32 The reciprocal method of allocation recognizes all interactions among support departments.

Reciprocal Method 7 -33 Support Departments Producing Departments Power Maintenance Grading Assembly Direct costs: Normal activity: Kilowatt-hours Maintenance hours --- 200, 000 600, 000 200, 000 1, 000 --- 4, 500 Proportion of Output Used by Departments Power Maintenance Grading Assembly Allocated ratios: Power Maintenance --- 0. 20 0. 60 0. 20 0. 10 --- 0. 45

7 -34 M = Direct costs + Share of Power’s costs M = $160, 000 + $50, 000 + 0. 02 M 0. 98 M = $210, 000 M = $214, 286

7 -35 P = Direct cost + Share of Maintenance’s cost P = $250, 000 + 0. 1($214, 286) P = $250, 000 + $21, 429 P = $271, 429

7 -36 ALLOCATE SUPPORT DEPARTMENT COSTS USING THE ALLOCATION RATIOS AND THE SUPPORT-DEPARTMENT COSTS FROM RECIPROCAL METHODS EQUATIONS Support Departments Producing Departments Power Maintenance Grading Assembly Direct costs Power $250, 000 $160, 000 -271, 429 54, 286 162, 857 54, 286 271, 429 -214, 286 96, 429 Maintenance Total $ 0 from Slide 7 -35 7 -34 $100, 000 $ 60, 000 $359, 286 $210, 715

7 -37 Comparison of Support Department Cost Allocations Using the Direct, Sequential, and Reciprocal Methods Direct costs Allocated from power Allocated from maintenance Total cost Direct Method Grinding Assembly $100, 000 $ 60, 000 187, 500 62, 500 80, 000 $367, 500 $202, 500 Click on button to compare with sequential method Click on button to compare with reciprocal method Return to show

7 -38 Comparison of Support Department Cost Allocations Using the Direct, Sequential, and Reciprocal Methods Direct costs Sequential Method Grinding Assembly $100, 000 $ 60, 000 Allocated from power 150, 000 Allocated from maintenance 105, 000 $355, 000 $215, 000 Total cost Click on button to compare with direct method Click on button to compare with reciprocal method Return to show

7 -39 Comparison of Support Department Cost Allocations Using the Direct, Sequential, and Reciprocal Methods Direct costs Allocated from power Allocated from maintenance Total cost Reciprocal Method Grinding Assembly $100, 000 $ 60, 000 162, 857 54, 286 96, 429 $359, 286 $210, 715 Click on button to compare with direct method Click on button to compare with sequential method Return to show

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 -40

7 -41 Product Unit Cost A product requires two machine hours of grinding per unit and one hour of assembly. Overhead cost assigned: 2 x $5 1 x $2 Total assigned $10 2 $12

7 -42 Chapter Seven The End

7 -43