MGMT 122 (T,Th 11:00~12:30)

-Management Accounting-

CASE 1

Edward An (803-411-052) Sangho Kim (003-918-781) Jason Kim Jonghyun Kim (503-993-773) Younghyun Yi (204-072-092) Phillip Nguyen

Introduction
DSL Company manufactures and sells specialized tools and dies for other manufacturers. The company has two departments; operating departments which are responsible for the major activities that ultimately generate revenue; and service departments which support the operating departments. DSL Company wants to allocate the overhead costs and determine the total departmental costs using different methods. Itll help the company to develop overhead rates based on determined departmental costs after the allocations. It also helps managers of operating departments to make better decisions since allocating costs of service provided by service departments using different method will give them more options. This Chart is based on DSL Companys cost report.
power (S1) Engineering (S2) Machining Assembly Total budget overhead Budget before allocations 320,000 180,000 120,000 80,000 700,000 Service Provided by Power (s1) Kilowatt Hours 100,000 480,000 220,000 800,000 Percentage 12.50% 60.00% 27.50% 100.00% Engineering (S2) Engineering hours 1,000 2,000 2,000 5,000 Percentage 20% 0% 40% 40% 100% Activity Driver (DLHs) 1,750 2,500

Well be using three types of allocation methods for the allocation of service department costs; The Direct Method, The Step Method, and The Reciprocal Method.

1. The Direct Method.

The Direct Method ignores interdepartmental services. Service department costs are directly allocated to operating departments-by passing other service departments. Service department costs are allocated directly to the operating departments without any allocation to other service department.
po wer (S1) Eng ineeringMa chining As s e mbly To tal budg et 320,000 180,000 120,000 80,000 700,000

o verhead Budg et befo re a llo catio ns Service Pro vided by Po wer (s 1) Allo cat ed Kilo wat t Ho urs Percenta g e Eng ineering (S2) Allo cat ed Eng ineering ho urs Percenta g e To ta l Allo catio n Activity Driver (DLHs ) O verhea d Rate

- - 320,000 0.00% - 180,000 0% 0% -

219,429 60.00% 90,000 40% 429,430 1,750 245.39

100,571 27.50% 90,000 40% 270,572 2,500 108.23

87.50% 80% 700,002

Costs of Power service center allocated directly to operating departments, machining and assembly departments. Costs of Engineering service center also allocated directly to operating departments. As a result, machining department received $219,429 from power service center and $90,000 from engineering service center. Therefore, the total allocation is $429,429. Assembly department received $100,571 from power service center and $90,000 from engineering service center. Therefore, the total allocation is $270,571. Of course, the sum of both operating departments is the same as the total overhead budget before allocation. This method gives us overhead rates of $245.39 and $108.23, respectively for machining and assembly departments.

2. The Step Method Power service center

The step method recognizes interdepartmental services, but does not account all of them. The step method allocates service department costs to other services departments as well as operating departments.
po wer (S1) Eng ineering Machining As s embly To tal budg et o verhead Budg et befo re allo cations 320,000 180,000 120,000 80,000 700,000 Service Pro vided by Po wer (s 1) Allo cated Kilo watt Ho urs - 320,000 40,000 192,000 88,000 Percentag e 12.50% 60.00% 27.50% Eng ineering (S2) Allo cated Eng ineering hours - - 220,000 110,000 110,000 Percentag e 40% 40% To tal allo catio n 0 422,000 278,000 700,000 Activity Driver (DLHs ) 1,750 2,500 Overhead Rate 241.14 111.2

As first step, power service center (s1) is allocated to each department, including other service department, engineering service center (s2). Next, engineering department (2) is allocated to operating departments, Machining and Assembly departments. As a result, Machining department receives $192,000 from power service center and $ 110,000 from engineering service center, which gives the total allocation costs of $422,000. Assembly department also receives $88,000 from power service center and $ 110,000 from engineering service center. The Assembly departments total allocation cost is $278,000. With this method, we have the overhead rate of $241.14 and $111.20, respectively for Machining and Assembly departments. However, if Engineering service center has more significance in terms of service each service center offers to operating departments, then we can choose to allocate costs of Engineering service center first, which will give us different numbers.

Eng ineeringpo wer (S1) Machining As s embly To tal budg et o verhead Budg et befo re allo cations 180,000 320,000 120,000 80,000 700,000 Service Pro vided by Eng ineering (s 2) Allocated Kilo watt Ho urs - 180,000 36,000 72,000 72,000 Percentag e 0.00% 20.00% 40.00% 40.00% Po wer (S1) Allo cated Eng ineering hours - - 356,000 244,114 111,886 Percentag e 0.00% 0.00% 60.00% 27.50% To tal allo catio n 436,114 263,886 700,000 Activity Driver (DLHs ) 1,750 2,500 Overhead Rate 249.21 105.55

In this case, Machining department will end up with total departmental costs of $436,114 as a result of allocations ($72,000 from Engineering and $244,114 from Power), and Assembly department will have total departmental costs of $263,886 ($72,000 from Engineering and $111,886 from Power). This numbers lead us to overhead rates of $249.21 and $105.55 for Machining and Assembly respectively.

3. The Reciprocal Method (simultaneous method)

The reciprocal method takes into account all of the interdepartmental service relationships. The reciprocal method does not require any more information than the step method, but it uses more sophisticated mathematics to do the allocations.
power (S1) Engineering Machining Assembly Total budget overhead Budget before allocations 320,000 180,000 120,000 80,000 700,000 Service Provided by Power (s1) Kilowatt Hours 100,000 480,000 220,000 800,000 Percentage 12.50% 60.00% 27.50% 100.00% Allocation 365,128 45,641 219,077 100,410 Engineering (S2) Engineering hours 1,000 2,000 2,000 5,000 Percentage 20% 0% 40% 40% 100% Allocation 45,128 225,641 90,256 90,256 Total Allocation 429,333 270,667 700,000 Activity Driver (DLHs) 1,750 2,500 Activity Driver Overhead Rate 245.33 108.27

First, we need to figure out the reciprocal relationship between the service departments. Power Cost (P) = 320,000 + 0.2 E Engineering Cost (E) = 180,000 + 0.125 E Through the formula, we could find P and E. P = 320000 + 0.2 (180000 +0.125 P) P = 320000 + 36000 + 0.025 P 0.975 P = 356000

P = 365,128 E = 180000 + 0.125 * 365128 E = 180000 + 45641 E = 225,641 On the next step, we allocated the reciprocally allocated service departmental costs to operating departments; machining and assembly departments. Consequently, Machining department receives $219,077 from power department and $90,256 from engineering department. Therefore, the total departmental cost for Machining department is $429,333. Assembly department receives $100,410 from power department, and $90,256 from engineering department. The total departmental cost for Assembly department is $270,667. These numbers give us the overhead rate of $245.33 and $108.27 for Machining and Assembly departments respectively.

(Reference. Using matrix Algebra) Departments Linear Equations S1 S2 PreAllocatio n Dollars $320,000 180,000

Power(S1) 1.00 -0.125

Engineering(S2) -0.20 1.00

Machining(P1) 0.00 0.00

Assembly(P2) 0.00 0.00

P1 P2

-0.60 -0.275 S1 1.02564102 6 0.12820512 8 0.66666666 7 0.33333333 3 Post Allocation Cost $365,128.21 $225,641.03 $429,333.33 $270,666.67

-0.40 -0.40 S2 0.205128205 1.025641026 0.533333333 0.466666667

1.00 0.00 P1 0 0 1 0

0.00 1.00 P2 0 0 0 1

120,000 80,000

S1 S2 P1 P2

Departmen t S1 S2 P1 P2

Explanation total cost of S1 Total cost of S2 Post Allocation cost of P1 Post allocation costs of P2

Conclusion
Each allocation method gives us different results. Even though services offered by service departments such as power, engineering, human resource, purchasing, building maintenance, etc. arent easily traceable, its clear that they are part of the manufacturing overhead, and should be allocated. Hence, allocation is important to companies. As we stated earlier, it can help evaluate performance in the operating department, measure profitability in the operating department, develop overhead rates in the operating department, and encourage managers of operating departments to make wise use of services provided by service department. DSL Company can choose any one method of them, because it is not depending on Generally Accepted Accounting Principle (GAAP), but depending on companies.