Don R. Hansen

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COST MANAGEMENT

• Don R. Hansen
• Maryanne M. Mowen

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Chapter Six
Support Department Cost Allocation
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Learning Objectives

• Describe the difference between support
  departments and producing departments.
• Explain five reasons why support costs, may be
  assigned to producing departments.
• Calculate charging rates, and distinguish between
  single and dual charging rates.

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Learning Objectives (continued)

• Allocate support center costs to producing
  departments using the direct method, the
  sequential method, and the reciprocal method.
• Calculate departmental overhead rates.

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Support and Producing Departments

• Support departments are units within an
  organization that provide essential support
  services for producing departments.
• Examples maintenance, grounds, engineering,
  housekeeping, personnel, and stores
• Producing departments are units within an
  organization that are directly responsible for
  creating the products and services sold to
  customers.
• Examples Services auditing, tax, management
  advisory Manufacturing grinding and assembly

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Steps in Allocating Support Department Costs to
Producing Departments
1. Departmentalize the firm. 2. Classify each
department as a support or a producing
department. 3. Trace all overhead costs in the
firm to a support or producing department.
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Steps in Allocating Support Department Costs to
Producing Departments
4. Allocate support department costs to the
producing departments. 5. Calculate predetermined
overhead rates for producing departments. 6. Alloc
ate overhead costs to the units of individual
product through the predetermined overhead rates.
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Examples of Cost Drivers forSupport Departments
Support Department Possible Driver
Accounting
Number of transactions Cafeteria
Number of
employees Engineering
Number of change orders Maintenance
Machine
hours Payroll
Number of employees Personnel
Number of new hires
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Objectives of Allocation
Objectives

• To obtain a mutually agreeable price
• To compute product-line profitability
• To predict the economic effects of planning and
  control
• To value inventory
• To motivate managers

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Allocation of Variable Costs(Dual Rates)

• Rate Determination At the beginning of the
  year, the company determines what the variable
  cost per unit of service should be (a budgeted
  rate, not an actual rate, is used to assign
  variable costs).
• Budgeted Usage Each producing department
  determines its expected or budgeted usage of the
  service for the year.
• Actual Usage Measurement The actual units of
  service used by each producing department are
  measured.

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Allocation of Variable Costs(Dual Rates)

• Allocation Variable support costs are allocated
  by multiplying the budgeted rate by the usage
• a. Product costing
• Allocation Budgeted Rate x Budgeted Usage
• b. Performance evaluation
• Allocation Budgeted Rate x Actual Usage

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Allocation of Fixed Costs(Dual Rates)

• Determination of Budgeted Fixed Support Service
  Costs The fixed support service costs that
  should be incurred for a period need to be
  identified.
• Computation of Allocation Ratio Using practical
  or normal capacity of each producing department,
  compute an allocation ratio as follows
• Allocation ratio Production department
  capacity/Total capacity
• Allocation The fixed support costs are allocated
  in proportion to each producing departments
  original support service need
• Allocation Allocation Ratio x Budgeted Fixed
  Support Service Costs
• Note Fixed costs are allocated the same way for
  product costing and performance evaluation.

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Allocation of Variable and Fixed Costs An Example

Dept. A
Dept. B Total Budgeted Machine Hours
40,000 60,000 Actual Machine Used
45,000 58,000 Budgeted Fixed Costs
------- ------- 350,000 Budgeted Variable Costs
------- ------- 180,000 Variable Cost Rate
1.80 1.80 Fixed Costs Allocation
Ratio 40 60
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Allocation of Variable and Fixed Costs An
Example (continued)

Dept. A Dept. B Variable
Cost allocated (product costing)
72,000 108,000 Variable Cost Allocated
(performance eval.) 81,000
104,400 Fixed Cost Allocated
140,000 210,000

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Choosing A Support Department Cost Allocation
Method

• The three methods for allocating support
  department costs to producing departments are
• The Direct Method
• The Sequential Method
• The Reciprocal Method

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Support Department AllocationAn Example

• 
  Support Departments Producing Departments
• Power Maint. Grinding Assembly
• 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.

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Support Department AllocationDirect Method

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  Support Departments Producing
  Departments Power Maint. Grinding Assembly
• 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
  

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Support Department AllocationSequential Method

• 
  Support Departments Producing
  Departments Power Maint. Grinding Assembly
• 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
  

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Reciprocal Method

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

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Reciprocal Method (continued)

• 
  Support Departments Producing
  Departments Power Maint. Grinding Assembly
• Direct Costs
• Fixed 200,000 100,000 80,000 50,000
• Variable 50,000 60,000 20,000 10,000
• Total 250,000 160,000 100,000 60,000
• 
  Proportion of Output
  Used by Power Maint. Grinding Assembly
• Allocation ratios
• Power --- 0.20 0.60 0.20
• Maintenance 0.10 --- 0.45 0.45

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Reciprocal Method (continued)

• The cost equation for each support department can
  be expressed as follows
• P Direct costs Share of Maintenances cost
• P 250,000 0.1(M)
• M Direct costs Share of Powers costs
• M 160,000 0.2P

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Reciprocal Method (continued)

• Substituting the Power equation into the
  Maintenance equation, we get
• M 160,000 0.2 (250,000 0.1M)
• M 160,000 50,000 0.02M
• 0.98M 210,000
• M 214,286

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Reciprocal Method (continued)

• Substituting the value for M into the Power
  equation we get
• P 250,000 0.1 (214,286)
• P 250,000 21,429
• P 271,429

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Reciprocal Method (continued)

• 
  Support Department Producing
  Department Power Maint. Grinding Assembly
• Direct Costs 250,000 160,000 100,000
  60,000
• Power (271,429 ) 54,286 162,857 54,286
• Maintenance 21,429 (214,286 ) 96,429
  96,429
• 0 0 359,286 210,715

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Departmental Overhead RatesUsing the Reciprocal
Method

• The overhead rate for the grinding department is
  computed as follows (assuming the normal level of
  activity is 71,000 MH)
• OH rate 359,286 ? 71,000 5.06 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 210,715 ? 107,500 1.96 per DLH

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End of Chapter 6