AK0038

MANAGEMENT ACCOUNTING
CHAPTER 7
Support Department Cost Allocation

ACCOUNTING PROGRAM
 Overview
Describe the difference between support departments
and producing departments
 Objectives
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.
Contents
1. An overview of Cost Allocation
2. Allocating One Departments Cost to Another
Departement.
3. Choosing a Support-Department Cost Allocation Method
Types of Departments

Producing
departments are
directly responsible for
creating the products or
services sold to
customers.
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
 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.
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
 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.
Note Objective 5: Allocations can
be used to motivate managers.
 AND

Fixed costs……………… $26,190

Variable costs….. $0.023 per page
 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 $ 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
Total Photocopying Department Charge

Number Charge Total

x =
of Pages per Page 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
 Multiple Charging Rates
Amount
Peak Proportion Total Allocated to
Number of Peak Fixed Each
of Pages Usage Costs 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
 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
Total $6,256 $26,190 $32,446
 Budgeted Versus Actual Usage
•When we allocate support-
department costs to the producing
departments, should we allocate
actual or budgeted costs?
Budgeted Versus Actual Usage

Budgeted costs.
 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.
 Use of Budgeted Data for
Product Costing
Number of Total Allocated
x Rate = Charges
Copies
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
 Use of Actual Data for
Performance Evaluation Purposes
Number of Total Allocated
x Rate = Charges
Copies
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
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
Data for Illustrating Allocation Methods

• Support Departments Producing Departments

• Power Maintenance 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.
 Direct Method of Allocation

Power Maintenance

Grinding Assembly
 Direct Method of Allocation

Power Maintenance

Grinding Assembly
 STEP 1—CALCULATE ALLOCATION RATIOS

Grinding Assembly
600,000
Power = 0.75
(600,000 + 200,000)
200,000 0.25
(600,000 + 200,000)
4,500
Maintenance = 0.50
(4,500 + 4,500)
4,500 0.50
(4,500 + 4,500)

Direct Method
STEP 2—ALLOCATE SUPPORTS DEPARTMENT COSTS USING THE ALLOCATION RATIOS

Support Departments Producing Departments

Power Maintenance Grading Assembly
Direct costs $250,000 $160,000 $100,000 $ 60,000
Power a -250,000 --- 187,500 62,500
Maintenance b --- -160,000 80,000 80,000
$ 0 $ 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
Sequential Method of Allocation
STEP 1: Rank service departments

1 2

Power Maintenance
 Sequential Method of Allocation

Power STEP 2

Maintenance Grinding Assembly

 Sequential Method of Allocation

Maintenance STEP 2

Grinding Assembly
 STEP 1—CALCULATE ALLOCATION RATIOS

Maint. Grinding Assembly

200,000 0.20
Power =
(200,000 + 600,000 +
200,000)
600,000 0.60
(200,000 + 600,000 +
200,000)

Sequential Method
 STEP 1—CALCULATE ALLOCATION RATIOS

Maint. Grinding Assembly

Mainte- = 4,500 0.50

nance (4,500 + 4,500)

4,500
0.50
(4,500 + 4,500)

Sequential Method
STEP 2—ALLOCATE SUPPORT DEPARTMENT COSTS USING THE ALLOCATION RATIOS

Support Departments Producing Departments

Power Maintenance Grading Assembly
Direct costs $250,000 $160,000 $100,000 $ 60,000
Power a -250,000 50,000 150,000 50,000
Maintenance b --- -210,000 105,000 105,000
$ 0 $ 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
•The reciprocal method
of allocation recognizes
all interactions among
support departments.
 Reciprocal Method
Support Departments Producing Departments
Power Maintenance Grading Assembly
Direct costs:
Normal activity:
Kilowatt-hours --- 200,000 600,000 200,000
Maintenance
hours 1,000 --- 4,500 4,500
Proportion of Output Used by Departments
Power Maintenance Grading Assembly
Allocated ratios:
Power --- 0.20 0.60 0.20
Maintenance 0.10 --- 0.45 0.45
 M = Direct costs + Share of Power’s costs
M = $160,000 + $50,000 + 0.02M
0.98M = $210,000
M = $214,286
P = Direct cost + Share of Maintenance’s cost
P = $250,000 + 0.1($214,286)
P = $250,000 + $21,429
P = $271,429
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 $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 from
Slide 7-35 Slide 7-34
 Comparison of Support Department Cost
Allocations Using the Direct, Sequential, and
Reciprocal Methods
Direct Method
Grinding Assembly

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 Return to
Click on button to compare with reciprocal method show
 Comparison of Support Department Cost
Allocations Using the Direct, Sequential, and
Reciprocal Methods
Sequential Method
Grinding Assembly

Direct costs $100,000 $ 60,000

Allocated from power 150,000 50,000
Allocated from maintenance 105,000 105,000
Total cost $355,000 $215,000
Click on button to compare with direct method Return to
Click on button to compare with reciprocal method show
 Comparison of Support Department Cost
Allocations Using the Direct, Sequential, and
Reciprocal Methods
Reciprocal Method
Grinding Assembly

Direct costs $100,000 $ 60,000

Allocated from power 162,857 54,286
Allocated from maintenance 96,429 96,429
Total cost $359,286 $210,715
Click on button to compare with direct method Return
Click on button to compare with sequential method 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
 Product 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
Chapter Seven

The End