COST MANAGEMENT

Accounting & Control

Hansen▪Mowen▪Guan

Chapter 7
Allocating Costs of
Support Departments
and Joint Products
COPYRIGHT © 2009 South-Western Publishing, a division of Cengage Learning. 1
Cengage Learning and South-Western are trademarks used herein under license.
 Study Objectives
1. Describe the difference between support departments
and producing departments.
2. Calculate charging rates, and distinguish between
single and dual charging rates.
3. Allocate support center costs to producing departments
using the direct method, the sequential method, and
the reciprocal method.
4. Calculate departmental overhead rates.
5. Identify the characteristics of the joint production
process, and allocate joint costs to products.

2
 An Overview of Cost Allocation
• Allocation is dividing a pool of costs and
assigning those costs to subunits
• The cost objects must be determined
• Cost objects are usually departments
– Producing: creating products sold to
customers
– Support: provide essential services for
producing departments

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Departmentalization:
Manufacturing Firm

4
Departmentalization:
Service Firm

5
 Allocating Support Department
Costs to Producing Departments
Steps:
• Departmentalize the firm
• Classify each department as support or producing
• Trace all overhead costs in the firm to the appropriate
department
• Allocate support department costs to producing
departments
• Calculate predetermined overhead rate for producing
departments
• Allocate overhead to units produced

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An Overview of Cost Allocation

7
Allocating One Department’s Costs
to Another Department
• The costs of a support department are
often allocated through the use of a
charging rate.
• Major factors of rate selection:
– Choice of single or dual rate
– Use of budgeted or actual support department
costs.

8
Allocating One Department’s Costs
to Another Department
Single = Fixed costs + estimated variable costs
rate estimated usage

Dual rate: Fixed rate and a variable rate

• Developing a fixed rate
– Determine budgeted fixed costs
– Compute allocation ratio
– Allocate
• Developing the variable rate
– Depends on the costs that change as the activity
driver changes 9
Allocating One Department’s Costs
to Another Department
When allocating support department costs,
should actual or budgeted costs be
allocated?
Answer: Budgeted – to prevent the
transfer of efficiencies or inefficiencies
from one department to another.

10
Allocating One Department’s Costs
to Another Department

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Allocating One Department’s Costs
to Another Department

12
 Choosing a Support Department
Cost Allocation Method
• Direct method
– Costs are allocated only to producing
departments
• Sequential (step) method
– Costs allocations are performed in a step-
down fashion, using predetermined ranking
procedures (e.g., degree of support)
• Reciprocal method
– Recognizes interactions of support
departments prior to allocation to producing
departments 13
Choosing a Support Department
Cost Allocation Method

14
 Direct allocation
Allocate Power Dept costs based on kilowatt-
hours:
600,000
Grinding  $250,000 = $187,500
 600,000 + 200,000
200,000
Assembly  $250,000 = $62,500
 600,000 + 200,000 
Allocate Maintenance Dept costs based on
maintenance-hours:
4,500
Grinding  $160,000 = $80,000
 4,500 + 4,500
4,500
Assembly  $160,000 = $80,000
 4,500 + 4,500 15
Direct allocation

16
 Sequential allocation
• Rank support departments by their direct costs
• Allocate
– First support department’s direct cost to all other
support departments and producing departments
– Next support department’s costs (direct + previously
allocated) to subsequent support and producing
– Etc.
• Once a support department’s costs are allocated
it never receives a subsequent allocation

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 Sequential allocation
Step 1: Allocate Power Dept costs based on
kilowatt-hours:
200,000 Maint kWh
 $250,000 = $50,000
 200,000 + 600,000 + 200,000
Maint kWh Grinding kWh Assembly kWh  To Maintenance

600,000 Grinding kWh

 $250,000 = $150,000
 200,000 + 600,000 + 200,000
Maint kWh Grinding kWh Assembly kWh  To Grinding

200,000 Assembly kWh

 $250,000 = $50,000
 200,000 + 600,000 + 200,000
Maint kWh Grinding kWh Assembly kWh  To Assembly
18
 Sequential allocation
Step 2: Allocate Maintenance Dept costs (direct
+ allocated) based on maintenance-hours:
Costs to allocate: $160,000 direct + $50,000 allocated = $210,000

4,500 Grinding
 $210,000 = $105,000
 4,500 + 4,500
Grinding Assembly  To Grinding

4,500 Assembly
 $210,000 = $105,000
 4,500 + 4,500
Grinding Assembly  To Assembly
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Sequential allocation

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Reciprocal allocation

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 Reciprocal allocation
Utilize a series of simultaneous linear equations

M = $160,000 + .2P
M = $160,000 + .2(250,000 + .1M)
M = $160,000 + 50,000 + .02M
.09M = $210,000
M = $214,286

P = $250,000 + .1P
P = $250,000 + .1(214,286)
P = $250,000 + 21,429
P = $271,429 22
 Reciprocal allocation
Utilize a series of simultaneous linear equations

M = $160,000 + .2P
M = $160,000 + .2(250,000 + .1M)
M = $160,000 + 50,000 + .02M
.98M = $210,000
M = $214,286

P = $250,000 + .1P
P = $250,000 + .1(214,286)
P = $250,000 + 21,429
P = $271,429 23
 Reciprocal allocation
Utilize a series of simultaneous linear equations

M = $160,000 + .2P
M = $160,000 + .2(250,000 + .1M)
M = $160,000 + 50,000 + .02M
.98M = $210,000
M = $214,286

P = $250,000 + .1P
P = $250,000 + .1(214,286)
P = $250,000 + 21,429
P = $271,429 24
Reciprocal allocation

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Choosing a Support Department
Cost Allocation Method

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 Departmental Overhead Rates
and Product Costing
After allocating all support service costs to
producing departments, an overhead rate is
calculated for each department

 Allocated   Producing 
 service    department 
 costs   overhead costs 
   
Measure of activity

27
 Departmental Overhead Rates
and Product Costing
A product cost can now be determined:

Direct materials
+ Direct labor
+ Assigned overhead
Product cost

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 Accounting for Joint
Production Processes
• Joint products are two or more products
produced simultaneously by the same
process up to a “split-off” point.
– The split-off point is the point at which the joint
products become separate and identifiable.
• Separable costs are easily traced to
individual products and offer no particular
problem.

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 Accounting for Joint
Production Processes

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 Accounting for Joint
Production Processes

31
 Accounting for Joint
Production Processes
• The distinction between joint and by-
products rests solely on the relative
importance of their sales value.
• A by-product is a secondary product
recovered in the course of manufacturing
a primary product.
– Joint costs are not typically allocated
– Sales revenue is classified as “other income”
– Post-split-off processing costs are deducted
from sales revenue
32
 Joint Cost Allocation Methods
• Physical Units Method
– Presumes that each unit of the final product
costs as much to produce as any other
• Weighted Average Method
– Applies weight factors to reflect differing
materials, complexity, time, etc.

33
 Joint Cost Allocation:
Physical Units Method
A sawmill processes logs into four grades of lumber
and incurs total joint costs of $186,000:
Percent Joint Cost
Grades Board Feet of Units Allocation
First and second 450,000 15.00% $ 27,900
No. 1 common 1,200,000 40.00% 74,400
No. 2 common 600,000 20.00% 37,200
No. 3 common 750,000 25.00% 46,500
3,000,000 $ 186,000

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 Joint Cost Allocation:
Weighted Average Method
A peach canning factory purchases $5,000 of peaches
and grades and cans them by quality.
Weighted Joint
Number Weight Number Cost
Grades of Cases Factor of Cases Percent Allocation
Fancy 100 1.30 130 21.67% $ 1,083
Choice 120 1.10 132 22.00% 1,100
Standard 303 1.00 303 50.50% 2,525
Pie 70 0.50 35 5.83% 292
600 $ 5,000

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 Joint Cost Allocation Methods
• Sales-Value-at-Split-Off-Method
– Allocates joint cost based on each product’s
proportionate share of sales value at split-off
• Net Realizable Value Method
– Allocates joint cost based on hypothetical market price
(eventual market value minus processing costs beyond
split-off)
• Constant Gross Margin Percentage Method
– Allocates joint costs such that the gross margin is the
same for each product

36
 Joint Cost Allocation:
Sales-Value-at-Split-Off Method
A sawmill processes logs into four grades of lumber
and incurs total joint costs of $186,000:
Price at
Split-Off
(per 1,000 Sales Value Joint Cost
Grades Board Feet board ft.) at Split-Off Percent Allocation
First and second 450,000 $ 300 135,000 26.99% $ 50,201
No. 1 common 1,200,000 200 240,000 47.99% 89,261
No. 2 common 600,000 121 72,600 14.52% 27,007
No. 3 common 750,000 70 52,500 10.50% 19,530
3,000,000 500,100 $ 185,999
does not sum to $186,000 due to rounding

37
 Joint Cost Allocation:
Net Realizable Value Method
A company manufactures two products, Alpha and Beta, from a
joint process. One production run costs $5,750 and results in
1,000 gallons of Alpha and 3,000 gallons of Beta. The separable
cost for Alpha is $1 per gallon and for Beta is $2 per gallon.

Further
Mark et Processing Hypothetical Number Hypothetical Allocated
Price Cost Mark et Price of Units Mark et Value Percent Joint Cost
Alpha $5 $1 $4 1,000 $ 4,000 40.0% $ 2,300
Beta 4 2 2 3,000 6,000 60.0% 3,450
$ 10,000 $ 5,750

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 Joint Cost Allocation:
Constant Gross Margin Method
Revenue:
Alpha ($5 × 1,000) $ 5,000
Beta ($4 × 3,000) 12,000 $ 17,000 100%
Costs
Alpha ($1 × 1,000) $ 1,000
Determine gross
Beta ($2 × 3,000) 6,000 margin percentage
Joint costs 5,750 12,750 75%
Gross Margin $ 4,250 25%

Alpha Beta
Eventual market value $ 5,000 $ 12,000
Joint cost Less: Gross margin at 25% (1,250) (3,000)
allocation Cost of goods sold $ 3,750 $ 9,000
Less: seperable costs (1,000) (6,000)
Allocated joint costs $ 2,750 $ 3,000
39
COST MANAGEMENT
Accounting & Control
Hansen▪Mowen▪Guan

End Chapter 7

COPYRIGHT © 2009 South-Western Publishing, a division of Cengage Learning. 40

Cengage Learning and South-Western are trademarks used herein under license.