Chapter 17

Allocation of Support
Activity Costs and
Joint Costs

McGraw-Hill/Irwin Copyright © 2014 by The McGraw-Hill Companies, Inc. All rights reserved.
Learning Objective 17-1 – Allocate service
department costs using the direct method and the
step-down method.

17-2
 Service Department Cost Allocation
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.

17-3
 Service Department Cost Allocation
Service Production
Departments Departments

support
Provide support Carry out the
that facilitates the central purposes
activities of production of an organization.
departments.

17-4
 Service Department Cost Allocation

How are service Well, we measure the

department costs consumption of the
charged to production allocation base in the
departments? production departments.

17-5
 Service Department Cost Allocation

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.

17-6
 Service Department Cost Allocation
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.

17-7
 Service Department Cost Allocation
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.

17-8
 Service Department Cost Allocation
So, the costs become
a part of the finished Exactly. Take a look at
product via the this flow chart.
application of the pre-
determined factory I think it will summarize
overhead rate. our discussion of the
allocation process.

17-9
 Service Department Cost Allocation
First Stage Allocations
Service department costs are allocated
Service to production departments.
Department
(Cafeteria) Production
Department
Service (Machining)
The
Department
Product
(Accounting) Production
Department
Service
(Assembly)
Department
(Personnel)
Second Stage Allocations
Production department overhead costs, plus allocated service department costs,
are applied to products using departmental predetermined overhead rates. 17-10
 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
17-11
 Selecting Allocation Bases
Criteria for
Personnel:
selection Custodial:
Number of Square
employees Simplicity footage
Availability
Receiving: of space or Cafeteria:
equipment
Units Number of
handled Benefits received employees
by the production
department

Security: Power:
Accounting:
Square Kilowatt
footage Staff hours
hours
17-12
 Interdepartmental Services
Service
Department Production
(Cafeteria) Department
(Machining)

POWER DEPARTMENT

Production
Service Department
Department (Assembly)
(Custodial)

17-13
 Interdepartmental Services
Problem
Allocating costs when service departments
provide services to each other

Solutions
Direct Method
Step-Down Method

17-14
 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)

For an example please see the textbook.

17-15
 Step-Down 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.

17-16
 Step-Down 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
Department Department
(Custodial) (Assembly)

17-17
 Step-Down Method
Service Production
Department Department
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)

For an example please see the textbook.

17-18
Learning Objective 17-2 - Use the dual
approach to service department cost allocation.

17-19
 Fixed Versus Variable Costs
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.

17-20
 Fixed Versus Variable Costs
Problem
Allocating common
fixed costs using a
variable activity
allocation base
Solution
Use dual allocation
method, allocating
fixed and variable
costs separately.

17-21
 Dual Cost Allocation

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.

Budgeted costs should be allocated to avoid passing on inefficiencies

from the service departments. 17-22
 Dual Cost Allocation
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.

17-23
 Dual Cost Allocation Example

Cutting Assembly
Department Department
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.
17-24
 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.

17-25
Learning Objective 17-3 – Explain the difference
between two-stage cost allocation with departmental
overhead rates and activity-based costing (ABC).

17-26
The New Manufacturing Environment

More accurate cost tracing systems

reduce the need for allocation
of indirect costs.

17-27
 The Rise of Activity-Based Costing
Service First stage allocations are to
Department activities, not departments.
(Cafeteria)
Activity
Service
One
The
Department
Product
(Accounting)
Activity
Two
Service
Department
(Personnel)
17-28
Learning Objective 17-4 – Allocate joint costs among joint
products using each of the following techniques: physical-units
method, relative-sales-value method, and the net-realizable-value
method.

17-29
 Joint Product Cost Allocation
Product

Joint Product Product

Costs

Product
17-30
 Joint Product Cost Allocation
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. 17-31
Joint Product Cost Allocation

Consider the following

example of an oil
refinery.
We will assume only
two products,
gasoline and oil.

17-32
 Joint Product Cost Allocation
Joint
Product
Separate Final
Costs Oil
Processing Sale

Joint Separate
Joint
Production Processing Costs
Input
Process

Gasoline Separate Final

Processing Sale

Split-Off Separate
Point Processing Costs
17-33
Learning Objective 17-5 – Describe the
purposes for which joint cost allocation is useful and
those for which it is not.

17-34
 Allocating Joint Costs
Physical-Units
Method

Relative-
Joint Product Sales-Value
Costs Method

Net-Realizable-
Value Method
17-35
 Allocating Joint Costs
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.
17-36
Allocating Joint Costs

Let’s look at an
example illustrating
the joint cost
allocation methods.

17-37
 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
17-38
 Physical-Units Method
Product
Oil Gasoline Total
Output quantities in gallons 240,000 360,000 600,000
Proportionate share:
240,000 ÷ 600,000 40%
360,000 ÷ 600,000 60%
Allocated joint costs:
$500,000 × 40% $ 200,000
$500,000 × 60% $ 300,000

$225,000 joint conversion cost plus

$275,000 joint material cost
17-39
 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
17-40
 Relative-Sales-Value Method
Product
Oil Gasoline Total
Sales value at split-off point $ 200,000 $ 600,000 $ 800,000
Proportionate share:
$200,000 ÷ $800,000 25%
$600,000 ÷ $800,000 75%
Allocated joint costs:
$500,000 × 25% $ 125,000
$500,000 × 75% $ 375,000

$225,000 joint conversion cost plus

$275,000 joint material cost
17-41
 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
17-42
 Net-Realizable-Value Method
Joint conversion Sales
cost = $225,000 Separate
Oil 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

17-43
 Net-Realizable-Value Method
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
Proportionate share:
$300,000 ÷ $1,000,000 30%
$700,000 ÷ $1,000,000 70%
Allocated joint costs:
$500,000 × 30% $ 150,000
$500,000 × 70% $ 350,000

17-44
 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
17-45
 By-Products
Two commonly used
methods of accounting for
by-products are . . .

2
1
1. By-product NRV is
deducted from cost of
joint process before
allocation.
2. By-product NRV is
deducted from cost of
main product. 17-46
Learning Objective 17-6 – Allocate service
department costs using the reciprocal-services
method (appendix).

17-47
 Reciprocal-Services Method

• Fully accounts for reciprocal services

• More accurate

• Can be combined with dual allocation

17-48
End Chapter 17

17-49