Eighteen: Allocation of Support Activity Costs and Joint Costs

18-1
18 Chapter
Eighteen
Allocation of Support
Activity Costs and
Joint Costs
McGraw-Hill/Irwin
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Service Department Cost Allocation

Production Service
Departments Departments
Carry out the Provide support

central purposes that facilitates the
of an organization. activities of production
departments.
McGraw-Hill/Irwin
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First, we identify the factor

How are service that drives costs in the
department costs service department.
charged to production This cost driver is called
departments? the allocation base.
McGraw-Hill/Irwin
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How are service Second, we measure the

department costs consumption of the
charged to production allocation base in the
departments? production departments.
McGraw-Hill/Irwin
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Third, we allocate the service

How are service department cost based on
department costs the relative amount of the
charged to production allocation base consumed in
departments? each production department.
McGraw-Hill/Irwin
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What happens to
service department
costs after they are Allocated service department
allocated to costs become a part of the
production manufacturing overhead in
departments? each production department.
McGraw-Hill/Irwin
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I get it. They become
a part of the overhead
that is applied to Allocated service department
products with a costs become a part of the
predetermined manufacturing overhead in
overhead rate. each production department.
McGraw-Hill/Irwin
18-8

I get it. They become
a part of the overhead That’s right. Take a look at
that is applied to this flow chart.
products with a
predetermined I think it will summarize
overhead rate. our discussion of the
allocation process.
McGraw-Hill/Irwin
18-9

First Stage Allocations
Service Service department costs are allocated
to production departments.
Department
(Cafeteria) Production
Department
Service (Machining)
The
Department
Product
(Accounting) Production
Department
Service (Assembly)
Department
(Personnel)
McGraw-Hill/Irwin
18-10

Service
Department
(Cafeteria) Production
Department
Service (Machining)
The
Department
Product
(Accounting) Production
Department
Service (Assembly)
Second Stage Allocations
Department
Production department overhead costs, plus allocated service
(Personnel)
department costs, are applied to products using
departmental predetermined overhead rates.
McGraw-Hill/Irwin
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Selecting Allocation Bases
Personnel: Typical Custodial:

Number of Allocation Square
employees footage
Bases
Receiving: Cafeteria:
Units Number of
handled employees
Security: Accounting: Power:

Square Staff Kilowatt
footage hours hours
McGraw-Hill/Irwin
18-12
Personnel: Criteria for Custodial:

Number of selection Square
employees footage
Receiving: Cafeteria:
Units Simplicity Number of
handled employees

footage hours hours
McGraw-Hill/Irwin
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employees footage
Receiving: Availability Cafeteria:

Units of space or Number of
handled equipment employees

footage hours hours
McGraw-Hill/Irwin
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employees footage
Receiving: Benefits received Cafeteria:

Units by the production Number of
handled department employees

footage hours hours
McGraw-Hill/Irwin
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Interdepartmental Services
Problem
Allocating costs when service departments
provide services to each other
Solutions
Direct Method
Step Method
McGraw-Hill/Irwin
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Direct Method
Service Production
Cost of services Department Department
between service (Cafeteria) (Machining)
departments are
ignored and all
costs are
allocated directly
to production Service Production
departments. Department Department
(Custodial) (Assembly)
McGraw-Hill/Irwin
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Direct Method Example
Service Departments Production Departments

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

Cafeteria Number of employees
Custodial Square feet occupied
McGraw-Hill/Irwin
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Departmental costs
Cafeteria allocation (360,000) 144,000 ?
Custodial allocation ? ? ?
Total after allocation $ 0
20
$360,000 × = $144,000
20 + 30
Allocation base: Number of employees

McGraw-Hill/Irwin
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Departmental costs
Cafeteria allocation (360,000) 144,000 216,000
30
$360,000 × = $216,000
20 + 30

McGraw-Hill/Irwin
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Departmental costs
Custodial allocation (90,000) 30,000 ?
Total after allocation $ 0 $ 0 $ 574,000
25,000
$90,000 × = $30,000
25,000 + 50,000
Allocation base: Square feet occupied

McGraw-Hill/Irwin
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Departmental costs
Custodial allocation (90,000) 30,000 60,000
Total after allocation $ 0 $ 0 $ 574,000 $ 976,000
50,000
$90,000 × = $60,000
25,000 + 50,000

McGraw-Hill/Irwin
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Step Method
Service department
costs are allocated
Service Production
to other service Department Department
departments and (Cafeteria) (Machining)
to production
departments, usually
starting with the
service department
that serves the Service Production
largest number of Department Department
other service (Custodial) (Assembly)
departments.
McGraw-Hill/Irwin
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Step Method
Service Production
Department Department
Once a service (Cafeteria) (Machining)
department’s costs
are allocated,
other service
departments’ costs
are not allocated
back to it. Service Production
(Custodial) (Assembly)
McGraw-Hill/Irwin
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Step Method
Service Production
Custodial will (Cafeteria) (Machining)
have a new
total to allocate
to production
departments: its
own costs plus
those costs Service Production
allocated from Department Department
the cafeteria. (Custodial) (Assembly)
McGraw-Hill/Irwin
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Step Method Example

We will use the same data used in the direct method example.

Departmental costs
Number of employees 15 10 20 30
Square feet occupied 5,000 2,000 25,000 50,000
Service Department Allocation Base

Cafeteria Number of employees
Custodial Square feet occupied
McGraw-Hill/Irwin
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Step Method Example

Departmental costs
Cafeteria allocation (360,000) 60,000 ? ?
10
$360,000 × = $60,000
10 + 20 + 30

McGraw-Hill/Irwin
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Step Method Example

Departmental costs
Cafeteria allocation (360,000) 60,000 120,000 ?
20
$360,000 × = $120,000
10 + 20 + 30

McGraw-Hill/Irwin
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Step Method Example

Departmental costs
Cafeteria allocation (360,000) 60,000 120,000 180,000
30
$360,000 × = $180,000
10 + 20 + 30

McGraw-Hill/Irwin
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Step Method Example

Departmental costs
Custodial allocation (150,000) ? ?
Total after allocation $ 0 $ 0
New total = $90,000 original custodial cost

plus $60,000 allocated from the cafeteria.
McGraw-Hill/Irwin
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Step Method Example

Departmental costs
Custodial allocation (150,000) 50,000 ?
Total after allocation $ 0 $ 0 $ 570,000
25,000
$150,000 × = $50,000
25,000 + 50,000

McGraw-Hill/Irwin
18-31
Step Method Example

Departmental costs
Custodial allocation (150,000) 50,000 100,000
Total after allocation $ 0 $ 0 $ 570,000 $ 980,000
50,000
$150,000 × = $100,000
25,000 + 50,000

McGraw-Hill/Irwin
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Comparison of Methods
Totals after allocation

Machining Assembly
Method Department Department
Direct $ 574,000 $ 976,000
Step 570,000 980,000
McGraw-Hill/Irwin
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Fixed Versus Variable Costs

Are fixed
and variable
costs allocated
differently?
McGraw-Hill/Irwin
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Problem
Result
Allocating common
fixed costs using a When one department
variable activity decreases activity to
allocation base reduce allocations, all
departments are penalized
because the charge
per use increases.
Remember, total fixed
costs do not change as
activity changes.
McGraw-Hill/Irwin
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Problem
Allocating common
fixed costs using a
variable activity
allocation base
Solution
Use dual allocation
method, allocating
fixed and variable
costs separately.
McGraw-Hill/Irwin
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Dual Cost Allocation

Variable Fixed
Costs 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
the allocation base. allocation base.
McGraw-Hill/Irwin
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Variable Fixed
Costs 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
the allocation costs should be allocated
base. allocation base.
to avoid passing on inefficiencies
from the service departments.
McGraw-Hill/Irwin
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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 Actual
Production Usage as a Hours
Departments % of Total Used
Cutting 60% 80,000
Assembly 40% 40,000
Total 100% 120,000
Allocate maintenance costs to the two operating departments.

McGraw-Hill/Irwin
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Example
Cutting Assembly
Variable cost allocation:
$0.60 × 80,000 hours used $ 48,000
$0.60 × 40,000 hours used $ 24,000
Fixed cost allocation
Total allocated cost
Variable costs are allocated based on hours used.
McGraw-Hill/Irwin
18-40
Example
Cutting Assembly
Variable cost allocation:
$0.60 × 80,000 hours used $ 48,000
$0.60 × 40,000 hours used $ 24,000
Fixed cost allocation
60% of $200,000 120,000
40% of $200,000 80,000
Total allocated cost $ 168,000 $ 104,000
Variable costs are allocated based on hours used.

Fixed costs are allocated based long-run average usage.
McGraw-Hill/Irwin
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A Behavioral Problem
Problem Solution
Department managers Reward managers for
may underestimate making accurate estimates
long-run average usage of long-run average
to reduce fixed cost service department needs.
allocations.
McGraw-Hill/Irwin
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The New Manufacturing
Environment
More
More accurate
accurate cost
cost tracing
tracing systems
systems
reduce
reduce the
the need
need for
for allocation
allocation
of
of indirect
indirect costs.
costs.
McGraw-Hill/Irwin
18-43
The Rise of Activity-Based Costing

First stage allocations are to
Service activities, not departments.
Department
(Cafeteria)
Activity
Service
One
The
Department
Product
(Accounting)
Activity
Two
Service
Department
(Personnel)
McGraw-Hill/Irwin
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Joint Product Cost Allocation

Product
Joint Product Product

Costs
Product
McGraw-Hill/Irwin
18-45

 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.
McGraw-Hill/Irwin
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Consider the following

example of an oil
refinery.
We will assume only
two products,
gasoline and oil.
McGraw-Hill/Irwin
18-47

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

Physical-Units
Method
Relative-
Joint Product Sales-Value
Costs Method
Net-Realizable-
Value Method
McGraw-Hill/Irwin
18-49

Allocation based on a
Physical-Units physical measure of the
Method joint products at the
split-off point.
Allocation based on
Relative-Sales- the relative values
Value Method of the products at
the split-off point.
Allocation based on
Net-Realizable- final sales values less
Value Method separable processing
costs.
McGraw-Hill/Irwin
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Let’s look at an
example illustrating
the joint cost
allocation methods.
McGraw-Hill/Irwin
18-51
Physical-Units Method
Joint conversion
cost = $225,000 Oil 240,000 gallons
Joint
Joint material Production
cost = $275,000 Process
Gasoline 360,000 gallons
Split-Off
Point
McGraw-Hill/Irwin
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Product
Oil Gasoline Total
Output quantities in gallons 240,000 360,000 600,000
Proportionate share:
?
?
Allocated joint costs:
?
?
McGraw-Hill/Irwin
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Product
Oil Gasoline Total
240,000 ÷ 600,000 40%
360,000 ÷ 600,000 60%
?
?
McGraw-Hill/Irwin
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Product
Oil Gasoline Total
240,000 ÷ 600,000 40%
360,000 ÷ 600,000 60%
$500,000 × 40% $ 200,000
$500,000 × 60% $ 300,000
$225,000 joint conversion cost plus

$275,000 joint material cost
McGraw-Hill/Irwin
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Relative-Sales-Value Method
Joint conversion $200,000
cost = $225,000 Oil sales value at
split-off point
Joint
Joint material Production
cost = $275,000 Process
$600,000
Gasoline sales value at
split-off point
Split-Off
Point
McGraw-Hill/Irwin
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Product
Oil Gasoline Total
Sales value at split-off point $ 200,000 $ 600,000 $ 800,000
?
?
?
?
McGraw-Hill/Irwin
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Product
Oil Gasoline Total
$200,000 ÷ $800,000 25%
$600,000 ÷ $800,000 75%
?
?
McGraw-Hill/Irwin
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Product
Oil Gasoline Total
$200,000 ÷ $800,000 25%
$600,000 ÷ $800,000 75%
$500,000 × 25% $ 125,000
$500,000 × 75% $ 375,000
$225,000 joint conversion cost plus

$275,000 joint material cost
McGraw-Hill/Irwin
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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.
Final Added
Estimated
= Sales – Processing
NRV
Value Costs
McGraw-Hill/Irwin
18-60
Joint conversion Sales
cost = $225,000 Oil
Separate
Value
Processing
$500,000
Joint Separate
Joint material Production Processing Costs
cost = $275,000 Process $200,000
Separate Sales
Gasoline Value
Processing
Split-Off $1,200,000
Point, Sales
Value Unknown Separate
Processing Costs
$500,000
McGraw-Hill/Irwin
18-61
Product
Oil Gasoline Total
Sales value $ 500,000 $ 1,200,000 $ 1,700,000
Less additional processing costs ? ? ?
Estimated NRV at split-off point ? ? ?
?
?
?
?
McGraw-Hill/Irwin
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Product
Oil Gasoline Total
Sales value $ 500,000 $ 1,200,000 $ 1,700,000
Less additional processing costs 200,000 500,000 700,000
Estimated NRV at split-off point $ 300,000 $ 700,000 $ 1,000,000
?
?
?
?
McGraw-Hill/Irwin
18-63
Product
Oil Gasoline Total
Sales value $ 500,000 $ 1,200,000 $ 1,700,000
$300,000 ÷ $1,000,000 30%
$700,000 ÷ $1,000,000 70%
?
?
McGraw-Hill/Irwin
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Product
Oil Gasoline Total
Sales value $ 500,000 $ 1,200,000 $ 1,700,000
$300,000 ÷ $1,000,000 30%
$700,000 ÷ $1,000,000 70%
$500,000 × 30% $ 150,000
$500,000 × 70% $ 350,000
McGraw-Hill/Irwin
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By-Products
Joint
Costs Major
Product
Joint
Joint Production Major
Input Product
Process
Relatively low
value or quantity
By-products
when compared to
major products
Split-Off
Point
McGraw-Hill/Irwin
18-66
By-Products
Two commonly used

methods of accounting
for by-products are . . .
2
1
 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
18-67
End of Chapter 18
18
McGraw-Hill/Irwin

Eighteen: Allocation of Support Activity Costs and Joint Costs

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18-1

Service Department Cost Allocation

Carry out the Provide support

Service Department Cost Allocation

First, we identify the factor

Service Department Cost Allocation

How are service Second, we measure the

Service Department Cost Allocation

Third, we allocate the service

Service Department Cost Allocation

Service Department Cost Allocation

Service Department Cost Allocation

Service Department Cost Allocation

Service Department Cost Allocation

Selecting Allocation Bases

Personnel: Typical Custodial:

Security: Accounting: Power:

Selecting Allocation Bases

Personnel: Criteria for Custodial:

Security: Accounting: Power:

Selecting Allocation Bases

Personnel: Criteria for Custodial:

Receiving: Availability Cafeteria:

Security: Accounting: Power:

Selecting Allocation Bases

Personnel: Criteria for Custodial:

Receiving: Benefits received Cafeteria:

Security: Accounting: Power:

Direct Method Example

Service Departments Production Departments

Service Department Allocation Base

Direct Method Example

Allocation base: Number of employees

Direct Method Example

Allocation base: Number of employees

Direct Method Example

Allocation base: Square feet occupied

Direct Method Example

Allocation base: Square feet occupied

Step Method Example

Service Departments Production Departments

Service Department Allocation Base

Step Method Example

Allocation base: Number of employees

Step Method Example

Allocation base: Number of employees

Step Method Example

Allocation base: Number of employees

Step Method Example

New total = $90,000 original custodial cost

Step Method Example

Allocation base: Square feet occupied

Step Method Example

Allocation base: Square feet occupied

Totals after allocation

Fixed Versus Variable Costs

Fixed Versus Variable Costs

Fixed Versus Variable Costs

Dual Cost Allocation

Dual Cost Allocation

Allocate maintenance costs to the two operating departments.

Total allocated cost

Variable costs are allocated based on hours used.