Chap018 TNx2

Chapter Eighteen
Allocation of Support Activity Costs and Joint Costs
McGraw-Hill/Irwin
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Learning Objective 1
McGraw-Hill/Irwin
Service Department Cost Allocation

How are service department costs charged to production departments? First, we identify the factor that drives costs in the service department.
This cost driver is called the allocation base.

Service Departments
support
Production Departments
Provide support that facilitates the activities of production departments.
Carry out the central purposes of an organization.

How are service department costs charged to production departments? Well, we measure the consumption of the allocation base in the production departments.

How are service department costs charged to production departments?
Third, we allocate the service department cost based on the relative amount of the allocation base consumed in each production department.

What happens to service department costs after they are allocated to production departments? Allocated service department costs become a part of the manufacturing overhead in each production department.

I get it. They become a part of the overhead that is applied to products with a predetermined overhead rate. Allocated service department costs become a part of the manufacturing overhead in each production department.

So, the costs become a part of the finished product via the application of the predetermined factory overhead rate. Exactly. Take a look at this flow chart. I think it will summarize our discussion of the allocation process.

Service Department (Cafeteria)
Service Department (Accounting) Service Department (Personnel)
First Stage Allocations Service department costs are allocated to production departments.
Production Department (Machining) Production Department (Assembly) The Product

Service Department (Accounting) Production Department (Machining) Production Department (Assembly) Second Stage Allocations The Product
Service Department Production department overhead costs, plus allocated service (Personnel) department costs, are applied to products using
departmental predetermined overhead rates.
Selecting Allocation Bases

Personnel: Number of employees Receiving: Units handled Security: Square footage Accounting: Staff hours
Typical Allocation Bases
Custodial: Square footage Cafeteria: Number of employees Power: Kilowatt hours

Personnel: Number of employees Receiving: Units handled Security: Square footage
Criteria for selection
Simplicity
Accounting:
Staff hours


Availability of space or equipment
Accounting: Staff hours


Benefits received by the production department
Accounting: Staff hours
Interdepartmental Services
Service Department (Cafeteria) Production Department (Machining)
POWER DEPARTMENT
Service Department (Custodial)
Production Department (Assembly)
Interdepartmental Services
Problem Allocating costs when service departments provide services to each other
Solutions
Direct Method
Step Method
Direct Method
Cost of services between service departments are ignored and all costs are allocated directly to production departments.
Production Department (Machining)
Direct Method Example

Service Departments Cafeteria Departmental costs before allocation Number of employees Square feet occupied $ 360,000 15 5,000 Custodial $ 90,000 10 2,000 Production Departments Machining $ 400,000 20 25,000 Assembly $ 700,000 30 50,000
Service Department Cafeteria Custodial
Allocation Base Number of employees Square feet occupied

Service Departments Cafeteria Departmental costs before allocation Cafeteria allocation Custodial allocation Total after allocation $ 0 $ 360,000 (360,000) ? Custodial $ 90,000 Production Departments Machining $ 400,000 144,000 ? Assembly $ 700,000 ? ?
20 $360,000 = $144,000 20 + 30
Allocation base: Number of employees

Service Departments Cafeteria Departmental costs before allocation Cafeteria allocation Custodial allocation Total after allocation $ 0 $ 360,000 (360,000) ? Custodial $ 90,000 Production Departments Machining $ 400,000 144,000 ? Assembly $ 700,000 216,000 ?
30 $360,000 = $216,000 20 + 30

Service Departments Cafeteria Departmental costs before allocation Cafeteria allocation Custodial allocation Total after allocation $ 0 $ $ 360,000 (360,000) (90,000) 0 Custodial $ 90,000 Production Departments Machining $ 400,000 144,000 30,000 $ 574,000 Assembly $ 700,000 216,000 ?
25,000 $90,000 25,000 + 50,000
= $30,000
Allocation base: Square feet occupied

Service Departments Cafeteria Departmental costs before allocation Cafeteria allocation Custodial allocation Total after allocation $ 0 $ $ 360,000 (360,000) (90,000) 0 Custodial $ 90,000 Production Departments Machining $ 400,000 144,000 30,000 $ 574,000 Assembly $ 700,000 216,000 60,000 $ 976,000
50,000 $90,000 25,000 + 50,000
= $60,000
Step Method
Service department costs are allocated to other service departments and to production departments, usually starting with the service department that serves the largest number of other service departments.
Step Method
Once a service departments costs are allocated, other service departments costs are not allocated back to it.
Step Method
Custodial will have a new total to allocate to production departments: its own costs plus those costs allocated from the cafeteria.
Step Method Example

We will use the same data used in the direct method example.
Service Departments Cafeteria Departmental costs before allocation Number of employees Square feet occupied $ 360,000 15 5,000 Custodial $ 90,000 10 2,000 Production Departments Machining $ 400,000 20 25,000 Assembly $ 700,000 30 50,000
Service Department Cafeteria Custodial
Allocation Base Number of employees Square feet occupied
Step Method Example

Service Departments Cafeteria Departmental costs before allocation Cafeteria allocation Custodial allocation Total after allocation $ 0 $ 360,000 (360,000) Custodial $ 90,000 60,000 ? Production Departments Machining $ 400,000 ? ? Assembly $ 700,000 ? ?
10 $360,000 10 + 20 + 30
= $60,000
Step Method Example

Service Departments Cafeteria Departmental costs before allocation Cafeteria allocation Custodial allocation Total after allocation $ 0 $ 360,000 (360,000) Custodial $ 90,000 60,000 ? Production Departments Machining $ 400,000 120,000 ? Assembly $ 700,000 ? ?
20 $360,000 10 + 20 + 30
= $120,000
Step Method Example

Service Departments Cafeteria Departmental costs before allocation Cafeteria allocation Custodial allocation Total after allocation $ 0 $ 360,000 (360,000) Custodial $ 90,000 60,000 ? Production Departments Machining $ 400,000 120,000 ? Assembly $ 700,000 180,000 ?
30 $360,000 10 + 20 + 30
= $180,000
Step Method Example

Service Departments Cafeteria Departmental costs before allocation Cafeteria allocation Custodial allocation Total after allocation $ 0 $ 360,000 (360,000) Custodial $ 90,000 60,000 (150,000) $ 0 Production Departments Machining $ 400,000 120,000 ? Assembly $ 700,000 180,000 ?
New total = $90,000 original custodial cost plus $60,000 allocated from the cafeteria.
Step Method Example

Service Departments Cafeteria Departmental costs before allocation Cafeteria allocation Custodial allocation Total after allocation $ 0 $ 360,000 (360,000) Custodial $ 90,000 60,000 (150,000) $ 0 Production Departments Machining $ 400,000 120,000 50,000 $ 570,000 Assembly $ 700,000 180,000 ?
25,000 $150,000 25,000 + 50,000
= $50,000
Step Method Example

Service Departments Cafeteria Departmental costs before allocation Cafeteria allocation Custodial allocation Total after allocation $ 0 $ 360,000 (360,000) Custodial $ 90,000 60,000 (150,000) $ 0 Production Departments Machining $ 400,000 120,000 50,000 $ 570,000 Assembly $ 700,000 180,000 100,000 $ 980,000
50,000 $150,000 25,000 + 50,000
= $100,000
Comparison of Methods
Totals after allocation Method Direct Step Machining Department $ 574,000 570,000 Assembly Department $ 976,000 980,000
McGraw-Hill/Irwin
Fixed Versus Variable Costs

Are fixed and variable costs allocated differently?

Problem
Allocating common fixed costs using a variable activity allocation base
Result
When one department decreases activity to reduce allocations, all departments are penalized because the charge per use increases.
Remember, total fixed costs do not change as activity changes.

Problem
Allocating common fixed costs using a variable activity allocation base
Solution
Use dual allocation method, allocating fixed and variable costs separately.
Dual Cost Allocation

Variable Costs Fixed Costs
Charge to production departments at a budgeted rate times actual short-run usage of the allocation base.
Allocate budgeted amounts to operating departments in proportion to the long-run average usage of the allocation base.
Dual Cost Allocation

Variable Costs Fixed Costs
Allocate Charge to budgeted amounts production to operating departments departments at a in proportion to the budgeted rate times long-run average actual short-run usage of usage of the Budgeted costs should be allocated the allocation base. allocation base.
to avoid passing on inefficiencies from the service departments.
Dual Cost Allocation Example

SimCo has a maintenance department and two production departments: cutting and assembly. Variable maintenance costs are budgeted at $0.60 per machine hour. Fixed maintenance costs are budgeted at $200,000 per year. Data relating to the current year are:
Long-run Maintenance Usage as a % of Total 60% 40% 100% Actual Hours Used 80,000 40,000 120,000
Production Departments Cutting Assembly Total
Allocate maintenance costs to the two operating departments.

Cutting Department Variable cost allocation: $0.60 80,000 hours used $0.60 40,000 hours used Fixed cost allocation $ 48,000 $ 24,000 Assembly Department
Total allocated cost
Variable costs are allocated based on hours used.

Cutting Department Variable cost allocation: $0.60 80,000 hours used $0.60 40,000 hours used Fixed cost allocation 60% of $200,000 40% of $200,000 Total allocated cost $ 48,000 $ 120,000 $ 168,000 $ 80,000 104,000 24,000 Assembly Department
Variable costs are allocated based on hours used. Fixed costs are allocated based long-run average usage.
A Behavioral Problem
Problem
Department managers may underestimate long-run average usage to reduce fixed cost allocations.
Solution
Reward managers for making accurate estimates of long-run average service department needs.
McGraw-Hill/Irwin
The New Manufacturing Environment

More accurate cost tracing systems reduce the need for allocation of indirect costs.
The Rise of Activity-Based Costing

Service Department (Cafeteria) Service Department (Accounting) Service Department (Personnel)
First stage allocations are to activities, not departments. Activity One

The Product
Activity Two
McGraw-Hill/Irwin
Joint Product Cost Allocation

Product
Joint Product Costs
Product
Product

Concept:
In some industries, a number of products are produced from a single raw material input.
Key terms:
Joint products products resulting from a process with a common input.
Split-off point the stage of processing where joint products are separated. Joint product cost costs of processing joint products prior to the split-off point.
Consider the following example of an oil refinery. We will assume only two products, gasoline and oil.

Joint Product Costs
Joint Production Process
Oil
Separate Processing
Final Sale
Joint Input
Separate Processing Costs
Gasoline
Separate Processing
Final Sale
Split-Off Point
Separate Processing Costs
McGraw-Hill/Irwin
Allocating Joint Costs

Physical-Units Method
Joint Product Costs
RelativeSales-Value Method Net-RealizableValue Method

Allocation based on a physical measure of the joint products at the split-off point. Allocation based on the relative values of the products at the split-off point. Allocation based on final sales values less separable processing costs.
Relative-SalesValue Method
Net-RealizableValue Method
Lets look at an example illustrating the joint cost allocation methods.
Joint conversion cost = $225,000
Oil
240,000 gallons
Joint material cost = $275,000
Gasoline
360,000 gallons
Split-Off Point
Product Oil Output quantities in gallons Proportionate share: 240,000 ? ? Allocated joint costs: ? ? Gasoline 360,000 Total 600,000
Product Oil Output quantities in gallons Proportionate share: 240,000 600,000 360,000 600,000 Allocated joint costs: ? ? 240,000 40% 60% Gasoline 360,000 Total 600,000
Product Oil Output quantities in gallons Proportionate share: 240,000 600,000 360,000 600,000 Allocated joint costs: $500,000 40% $500,000 60% 240,000 40% 60% $ 200,000 $ 300,000 Gasoline 360,000 Total 600,000
$225,000 joint conversion cost plus $275,000 joint material cost
Relative-Sales-Value Method
Oil
$200,000 sales value at split-off point
Gasoline
$600,000 sales value at split-off point
Split-Off Point
Product Oil Sales value at split-off point Proportionate share: Gasoline Total $ 200,000 $ 600,000 $ 800,000 ? ? Allocated joint costs: ? ?
Product Oil Sales value at split-off point Proportionate share: $200,000 $800,000 $600,000 $800,000 Allocated joint costs: ? ? Gasoline Total $ 200,000 $ 600,000 $ 800,000 25% 75%
Product Oil Sales value at split-off point Proportionate share: $200,000 $800,000 $600,000 $800,000 Allocated joint costs: $500,000 25% $500,000 75% Gasoline Total $ 200,000 $ 600,000 $ 800,000 25% 75% $ 125,000 $ 375,000
$225,000 joint conversion cost plus $275,000 joint material cost
Net-Realizable-Value Method
If products require further processing beyond the split-off point before they are marketable, it may be necessary to estimate the net realizable value (NRV) at the split-off point.
Estimated NRV Final Sales Value Added Processing Costs
Oil
Separate Processing Separate Processing Costs $200,000 Separate Processing Sales Value $1,200,000 Sales Value $500,000
Gasoline
Split-Off Point, Sales Value Unknown
Separate Processing Costs $500,000
Product Oil Sales value Less additional processing costs Estimated NRV at split-off point Proportionate share: Gasoline Total $ 500,000 $ 1,200,000 $ 1,700,000 ? ? ? ? ? ? ? ? Allocated joint costs: ? ?
Product Oil Sales value Less additional processing costs Estimated NRV at split-off point Proportionate share: Gasoline Total $ 500,000 $ 1,200,000 $ 1,700,000 200,000 500,000 700,000 $ 300,000 $ 700,000 $ 1,000,000 ? ? Allocated joint costs: ? ?
Product Oil Sales value Less additional processing costs Estimated NRV at split-off point Proportionate share: $300,000 $1,000,000 $700,000 $1,000,000 Allocated joint costs: ? ? Gasoline Total $ 500,000 $ 1,200,000 $ 1,700,000 200,000 500,000 700,000 $ 300,000 $ 700,000 $ 1,000,000 30% 70%
Product Oil Sales value Less additional processing costs Estimated NRV at split-off point Proportionate share: $300,000 $1,000,000 $700,000 $1,000,000 Allocated joint costs: $500,000 30% $500,000 70% Gasoline Total $ 500,000 $ 1,200,000 $ 1,700,000 200,000 500,000 700,000 $ 300,000 $ 700,000 $ 1,000,000 30% 70% $ 150,000 $ 350,000
By-Products
Joint Costs
Major Product
Joint Input
Major Product
By-products
Relatively low value or quantity when compared to major products
Split-Off Point
By-Products
Two commonly used methods of accounting for by-products are . . . By-product NRV is
deducted from cost of joint process before allocation.
By-product NRV is
deducted from cost of main product.
McGraw-Hill/Irwin
Reciprocal Services Method
Fully accounts for reciprocal services More accurate Can be combined with dual allocation
End of Chapter 18
18

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Chapter Eighteen

Allocation of Support Activity Costs and Joint Costs

Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

Service Department Cost Allocation

This cost driver is called the allocation base.

Service Department Cost Allocation

Provide support that facilitates the activities of production departments.

Carry out the central purposes of an organization.

Service Department Cost Allocation

Service Department Cost Allocation

Service Department Cost Allocation

Service Department Cost Allocation

Service Department Cost Allocation

Service Department Cost Allocation

Production Department (Machining) Production Department (Assembly) The Product

Service Department Cost Allocation

Selecting Allocation Bases

Typical Allocation Bases

Custodial: Square footage Cafeteria: Number of employees Power: Kilowatt hours

Selecting Allocation Bases

Criteria for selection

Custodial: Square footage Cafeteria: Number of employees Power: Kilowatt hours

Selecting Allocation Bases

Criteria for selection

Custodial: Square footage Cafeteria: Number of employees Power: Kilowatt hours

Selecting Allocation Bases

Criteria for selection

Custodial: Square footage Cafeteria: Number of employees Power: Kilowatt hours

Service Department (Custodial)

Production Department (Assembly)

Service Department (Cafeteria)

Production Department (Machining)

Service Department (Custodial)

Production Department (Assembly)

Direct Method Example

Service Department Cafeteria Custodial

Allocation Base Number of employees Square feet occupied

Direct Method Example

Allocation base: Number of employees

Direct Method Example

Direct Method Example

25,000 $90,000 25,000 + 50,000

Allocation base: Square feet occupied

Direct Method Example

50,000 $90,000 25,000 + 50,000

Allocation base: Square feet occupied

Service Department (Cafeteria)

Production Department (Machining)

Service Department (Custodial)

Production Department (Assembly)

Service Department (Cafeteria)

Production Department (Machining)

Service Department (Custodial)

Production Department (Assembly)

Service Department (Cafeteria)

Production Department (Machining)

Service Department (Custodial)

Production Department (Assembly)

Step Method Example

Service Department Cafeteria Custodial

Allocation Base Number of employees Square feet occupied

Step Method Example