Allocation of Support-Department

Costs
 Allocating Costs of a Supporting Department to
Operating Departments
 Supporting (Service) Department – provides the services that assist
other internal departments in the company

 Operating (Production) Department – directly adds value to a product

or service

 Two Questions:
 Should the Fixed Cost of Support Department, be allocated to
operating Departments?
 If the Fixed Cost is allocated, Should the Fixed cost and Variable
cost be allocated in the same way?
Methods to Allocate Support Department Costs

 Single-rate method – allocates costs in each cost pool

(service department) to cost objects (production
departments) using the same rate per unit of a single
allocation base

No distinction is made between fixed and variable costs

in this method
 Methods to Allocate Support Department Costs

 Dual-Rate method – segregates costs within each cost

pool into two segments: a variable-cost pool and a fixed-
cost pool.

 Each pool uses a different cost-allocation base

 Allocation Bases

 Under either method, allocation of support costs can be based on

one of the three following scenarios:
Budgeted overhead rate and budgeted hours
Budgeted overhead rate and actual hours
Actual overhead rate and actual hours

 Choosing between actual and budgeted rates: budgeted is known at

the beginning of the period, while actual will not be known with
certainty until the end of the period
 Two Operating Departments: Machining Department and Assembly Department
 Service Department: Materials Management Department
 The cost of Materials Management Department to be allocated to Operating
Departments: Machining and Assembly
 The Budget of the Materials Management Department for 2017 as follows:
 Practical capacity: 4000 Hrs
 Fixed Cost of the Materials Management Department in 3000-4000 Labour Hrs
relevant range- Rs. 14,40,000
 Budgeted Usage(quantity) in Labour Hrs:
 Machining Department-800 Hrs
 Assembly Departmnet-2800 Hrs
 Total - 3600 Hrs
 Variable Cost per material handling hrs- Rs. 300 per hrs
 Actual Usage(quantity) in Labour Hrs required to support the Operating
Departments:
 Machining Department-1200 Hrs
 Assembly Departmnet-2400 Hrs
 Total - 3600 Hrs
 Methods of Allocating Support Costs to
Production Departments(Multiple Departments)

 Direct

 Step-Down

 Reciprocal
 Direct Method

Allocates support costs only to Operating

Departments

No Interaction between Support Departments

prior to allocation
 Direct Method
Support Departments Production Departments

Information Systems

Manufacturing

Packaging

Accounting
 Data Used in Cost Allocation Illustrations
Support Departments Operating Departments Total
Engineering and Materials Machining Assembly
Production Management
Control
Budgeted Overhead Cost 30,00,000 26,40,000 32,90,000 22,70,000 112,00,000
before any inter-
department Cost
allocation
Support Work Done:
By Engineering and - 6000 10,000 4000 20,000
Production Control (Hrs)
As Percent - 30% 50% 20% 100%
By Materials Management 400 - 800 2800 4000
(Hrs)
As Percent 10% - 20% 70% 100%
 Direct Allocation Method

Engineering and 5/7

Production Control Machining
30,00,000

Materials Management 7/9

Assembly
26,40,000
 Step-Down Method

 Allocates support costs to other support departments

and to operating departments that partially recognizes
the mutual services provided among all support
departments

 One-Way Interaction between Support Departments

prior to allocation
 Step-Down Method
Support Departments Production Departments

Information Systems

Manufacturing

Packaging

Accounting
 Step-Down Allocation Method

5/10
Engineering and Production Control
Machining
30,00,000

3/10 2/9 2/10

Materials Management
{26,40,000 +(3/10)x Assembly
7/9
30,00,000}
 Reciprocal Method

 Allocates support department costs to operating

departments by fully recognizing the mutual services
provided among all support departments

 Full Two-Way Interaction between Support Departments

prior to allocation
 Reciprocal Method

Support Departments Production Departments

Information Systems

Manufacturing

Packaging

Accounting
 Step-Down Allocation Method

Engineering and Production Control

EPC= 30,00,000 +0.1 MM 5/10 Machining
33,64,950

3/10 1/10

2/10 2/10

Materials Management
MM=26,40,000+0.3 EPC Assembly
36,49,485 7/10
 Choosing Between Methods

 Reciprocal is the most precise

 Direct and Step-Down are simple to compute and understand

 Direct Method is widely used