Allocation of Support Department Costs, Common Costs, and Revenues

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Allocation of Support DepartmentCosts, Common
Costs, and Revenues

• Chapter 15

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Learning Objective 1
Differentiate the single-rate from the dual-rate
cost-allocation method when allocating costs of
a support department to operating divisions
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Single-Rate andDual-Rate Methods
The single-rate cost allocation method pools
together all costs in a cost pool.
The dual-rate cost allocation method classifies
costs in each cost pool into two cost pools a
variable-cost cost pool and a fixed-cost cost
pool.
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Learning 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 Rates
Budgeted rates let the user department know
in advance 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 Rates
because the user departments do not pay for any
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 Bases
Organizations commit to infrastructure costs
on the basis of a long-run planning horizon.
The use of budgeted usage to allocate these
fixed costs is consistent with the long-run
horizon.
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Learning Objective 3
Allocate support department costs using the
direct, step-down, and reciprocal methods.
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Allocating SupportDepartments Costs
An operating department (a production department
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 Costs
(1) Direct method Allocates support department
costs to operating departments only.
(2) Step-down (sequential allocation)
method Allocates support department costs to
other support departments and to operating
departments.
(3) Reciprocal allocation method Allocates costs
by services provided among all support
departments.
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Allocating SupportDepartments Costs
The Canton Division of Smith Corporation has
two operating departments and two support
departments.
Assembly and Finishing
Maintenance and Human Resources
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Allocating SupportDepartments Costs
Total square feet 255,000
Total number of employees 95
Maintenance is allocated using square feet.
Human Resources is allocated using number of
employees.
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Allocating 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 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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(1)Direct Method
Support Departments
Operating Departments
1,700,000 Assembly
Maintenance 300,000
110/220
0
0
110/220
48/72
900,000 Finishing
Human Resources 2,160,000
24/72
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(1)Direct Method
Support Departments
Operating Departments
1,700,000 Assembly
Maintenance 300,000
110/220
150,000
0
0
1,440,000
110/220
48/72
150,000
900,000 Finishing
Human Resources 2,160,000
24/72
720,000
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(3)Direct Method

• Assembly Finishing
• Original costs 1,700,000 900,000
• Maintenance Allocated 150,000
  150,000
• Human Resources
• Allocated 1,440,000 720,000
• Total 3,290,000 1,770,000

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(2)Step-Down Method
Which support department should be allocated
first?
Answer The one that provides the greatest
support to other support departments
Maintenance provides 12 of its external
services to Human Resources.
Human Resources provides 10 of its external
services services to Maintenance.
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(2)Step-Down Method
Maintenance will go first
Maintenance to Human Resources 30,000 250,000
(or 12) 300,000 36,000
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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(2)Step-Down Method

• Costs before
  Allocated
• allocation costs
• Maintenance 300,000 (300,000)
• Human Resources 2,160,000 36,000
• Assembly 1,700,000 132,000
• Finishing 900,000 132,000

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(2)Step-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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(2)Step-Down Method

• Costs before Allocated Allocated
• allocation costs costs
• Human
• Resources 2,160,000 36,000 (2,196,000)
• Assembly 1,700,000 132,000 1,464,000
• Finishing 900,000 132,000 732,000

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(2)Step-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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(3)Reciprocal using linear equations
M HR A F Maintenance
12 44 44 Human Resources 10
60 30
Maintenance cost 300,000 .10H
Human Resource cost 2,160,000 .12M
See page 530 for the other methods. Exhibit 15-5
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(4)Reciprocal using linear equations
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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(5)Reciprocal - using linear equations
We would then allocate the total reciprocated
costs to all (other) departments
M HR A F Before allocation 300
,000 2,160,000 1,700,000
900,000 Allocation (522,267) 62,672
229,797 229,797 Allocation
222,267 (2,222,672) 1,333,603
666,802 Total 3,263,400 1,796,599 Tot
al cost Assembly Department 3,263,400 Total
cost Finishing Department 1,796,599
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Overview of Methods
Overhead rate for the Assembly Department
is determined using direct labor cost as a
denominator.
Overhead rate for the Finishing Department
is determined using machine-hours as the
denominator.
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Comparison of Methods
Assembly Finishing Direct labor
cost 698,880 349,440 Machine-hours
24,000 23,500
What are the various overhead rates using the
three methods?
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Overhead 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
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 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 Rates
Assembly Finishing Direct
method 471 75.32 Step-down
method 472 75.06 Reciprocal
method 467 76.45
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Learning Objective 4
Allocate common costs using either the
stand-alone or incremental method.
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Allocating Common Costs
Two methods for allocating common cost are
1. Stand-alone cost allocation method
2. Incremental cost allocation method
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Stand-Alone Example
A consultant in Jamaica is planning to go
to Grand Cayman to meet with a client.
The round-trip Jamaica/Grand Cayman/Jamaica airfar
e costs 540.
The consultant is also planning to attend a
business meeting with a Miami client.
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Stand-Alone Example
The round-trip Jamaica/Miami/Jamaica airfare
costs 360.
The consultant decides to combine the two trips
into a Jamaica/Grand Cayman/Miami/Jamaica itinerar
y that will cost 760.
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Stand-Alone Example
How much should the consultant charge to the
Miami client?
360 (360 540) .40
.40 760 304
How much to the Grand Cayman client?
760 304 456
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(2)Incremental Cost Example
Assume that the business meeting in Grand Cayman
is viewed as the primary party.
What would be the cost allocation?
Grand Cayman client (primary) 540 Miami
client (incremental) 760 540 220
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Learning 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 Contracts
Many commercial contracts include clauses
that require 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
as possible (and in writing).
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Learning Objective 6
Understand how bundling of products gives rise
to revenue-allocation issues.
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Revenues and Bundled Products
A bundled product is a package of two or
more products (or services) sold for a single
price.
Bundled product sales are also referred to as
suite sales.
The individual components of the bundle also may
be sold as separate items at their
own stand-alone prices.
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Revenues 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 7
Allocate the revenues of a bundled package to the
individual products in that package.
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Revenue Allocation Methods
English Languages Institute buys English language
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-alone or in a
bundle.
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Revenue Allocation Methods
Stand-alone Price Grammar 255 Translation
85 Composition 185
Purchasing these software programs costs
English the following Grammar 180 Translation
45 Composition 95
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Revenue Allocation Methods
Bundle (Suites) Price Grammar
Translation 290 Grammar
Composition 350 Grammar Translation
Composition 410
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Revenue Allocation Methods
The two main revenue allocation methods are
1. The stand-alone method
2. The incremental method
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Stand-Alone RevenueAllocation Method
There are four types of weights for
the stand-alone revenue allocation method.
1. Selling prices
2. Unit costs
3. Physical units
4. Stand-alone product revenues
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Stand-Alone RevenueAllocation Method
Consider the Grammar and Translation suite, which
sells for 290 per day.
How much weight should English Languages
Institute assign to each item?
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Stand-Alone RevenueAllocation Method
(1)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
(2)Unit costs This method uses the costs of the
individual products to determine the weights for
the revenue 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
(3)Physical units This method gives each product
unit in the suite the same weight when
allocating suite revenue to individual products.
With two products in the suite, each product is
allocated 50 of suite revenues.
1 (1 1) 0.50 290 0.50 145
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Stand-Alone RevenueAllocation Method
(4)Stand-alone product revenues This method
captures the quantity of each product sold as
well as their selling prices.
Assume that the stand-alone revenues in 2003 are
Grammar 734,400, Translation 81,600, and
Composition 133,200.
What are the weights for the Grammar and
Translation suite?
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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
Revenue Allocation Weights Grammar
Translation (1)Selling prices 217.50
72.50 (2)Unit costs 232.00
58.00 (3)Physical units 145.00
145.00 (4)Stand-alone product revenues 261.00
29.00
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Incremental RevenueAllocation Method
The first-ranked product is termed the primary
product in the bundle.
The second-ranked product is termed the first
incremental product.
The third-ranked product is the
second incremental product, and so on.
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Incremental RevenueAllocation Method
Assume that Grammar is designated as 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
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 15