Cost and MGMT Acctg I CH 5

Chapter 5
Cost allocation
1
© 2012 Pearson Prentice Hall. All rights reserved.
Meaning of cost allocation
Cost Allocation: the process of assigning or applying col-
lected indirect costs to cost objects using an allocation

base is known as cost allocation.
The following terms are to be known and they have
strong tie with the allocation of costs to products or ser-

vices. These are:
Cost object
Cost pool and
2 Cost driver © 2012 Pearson Prentice Hall. All rights reserved.

Cont…
Cost object: - is anything for which a measurement of costs is
desired.
Cost pool: is a collection of overhead costs related to a cost ob-
ject.
Cost driver: is an activity that causes the cost pool to increase
in amount as the cost driver increases in volume.

 Cost allocation requires:
 the pooling of manufacturing overhead costs that are affected by
a common activity and

 the selection of a cost driver whose activity level causes a
3 © 2012 Pearson Prentice Hall. All rights reserved.
Purposes of cost allocation
To provide information for economic deci-
sions
To motivate managers and other employees
To justify costs or compute reimbursement
To measure income and assets for reporting
to external parties
Allocating Costs of a Supporting Depart-
ment to Operating Departments
Supporting (service) department—provides the ser-
vices that assist other internal departments in the

company. Examples of support departments are in-
formation systems and plant maintenance.
Operating (production) department—directly adds
value to a product or service.

Methods to Allocate
Support Department Costs
Single-rate method—allocates costs in each cost pool
(service department) to cost objects (production depart-

ments) using the same rate per unit of a single allocation
base
 No distinction is made between fixed and variable costs in this
method.
Dual-rate method—segregates costs within each cost pool
into two segments: a variable-cost pool and a fixed-cost

© 2012 Pearson Prentice Hall. All rights reserved. 6
Allocation Method Trade-Offs
Single-rate method is simple to implement, but
treats fixed costs in a manner similar to variable
costs.
Dual-rate method treats fixed and variable costs
7
more realistically, but is more complex to imple-
Allocation Bases
When using either the single-rate method or the dual-rate
method, managers can allocate support-department costs

to operating divisions based on either a budgeted rate or
the eventual actual cost rate.
The latter approach is neither conceptually preferred nor
widely used in practice.

Accordingly, we illustrate the single rate and dual-rate
methods next based on the use of budgeted rates.

Example
Consider the central computer department of SHC. This sup-
port department has two users, both operating divisions: the

microcomputer division and the peripheral equipment division.
The following data relate to the 2012 budget:

Allocation Based on the Usage of Computer Services
Single-Rate Method
In this method, a combined budgeted rate is used for fixed and
variable costs. The rate is calculated as follows:
Under the single-rate method, divisions are charged the bud-

geted rate for each hour of actual use of the central facility. The
support costs allocated to the two divisions under this method
are as follows:

Dual-Rate Method
As in the single-rate method, variable costs are assigned
based on the budgeted variable cost per hour of $200 for
actual hours used by each division.
However, fixed costs are assigned based on budgeted fixed
costs per hour and the budgeted number of hours for
each division.
Given the budgeted usage of 8,000 hours for the microcom-
puter division and 4,000 hours for the peripheral equipment

division, the budgeted fixed-cost rate is $250 per hour
Cont…
The costs allocated to the microcomputer division in 2012 un-
der the dual-rate method would be as follows:
The costs allocated to the peripheral equipment division in
2012 would be as follows:

Methods of Allocating Costs of Multiple
Support Departments
1. Direct
2. Step-down
3. Reciprocal

Direct Method
Allocates support costs only to operating depart-
ments.
Direct method does not allocate support-depart-
ment costs to other support departments.

Direct Method
Support Departments Production Departments
Information Systems
Manufacturing
Packaging

Accounting
Data Used in Cost Allocation Illustrations

Cont…
The base used to allocate plant maintenance costs
to the operating departments is the budgeted total

maintenance labour-hours worked in the operating
departments: 6,000 + 10,000 = 16,000 hours.
Similarly, the base used for allocation of informa-
tion systems costs to the operating departments is

4,000 + 500 = 4,500 budgeted hours of computer
time.
Direct Allocation Method Illustrated

18
Direct Allocation Method Illustrated

Step-Down Method
Also called the sequential allocation method
Allocates support-department costs to other support de-
partments and to operating departments in a sequential

manner
Partially recognizes the mutual services provided among all
support departments
The latter slides shows the step-down method. Assume
that the plant maintenance

20 costs of $6,300,000 are allo-
Step-Down Method
Information Systems
Manufacturing
Packaging
Accounting
Step-Down Allocation Method Illus-
trated

Step-Down Allocation Method Illus-
trated

Reciprocal Method
Allocates support-department costs to operating
departments by fully recognizing the mutual ser-

vices provided among all support departments.
Reciprocal method fully incorporates interdepart-
mental relationships into the support-department

cost allocation.

Reciprocal Method
Information Systems
Manufacturing
Packaging
Accounting
Reciprocal Allocation Method Illustrated

Choosing Between Methods
Reciprocal is the most precise.
Direct and step-down are simple to compute and understand.
Direct method is widely used.

Cost Allocation:
Joint Products and Byproducts

Joint Cost Terminology
Joint costs—costs of a single production process that yields
multiple products simultaneously.

Splitoff point—the place in a joint production process where
two or more products become separately identifiable.

Separable costs—all costs incurred beyond the splitoff point
that are assignable to each of the now-identifiable specific

products.
29
Joint Cost Terminology
Joint products—outputs of a joint production process that
yields two or more products with a high sales value com-

pared to the sales values of any other outputs.
Byproducts—outputs of a joint production process that
have low sales values compare to the sales values of the

other outputs.
30
Joint Process Overview
Steam:
An Output with Zero Sales Value
Joint Product #1
Single Production
Process
Joint Product #2
Byproduct
31
Joint Cost Allocation Methods
 Market-based—allocate using market-derived data (dol-
lars):
1. Sales value at splitoff
2. Net realizable value (NRV)
3. Constant gross-margin percentage NRV
 Physical measures—allocate using tangible attributes of
the products, such as pounds, gallons, barrels, and so on
32
Sales Value at Splitoff Method
Uses the sales value of the entire production of the
accounting period to calculate allocation percent-

age
Ignores inventories
33
Joint Cost Illustration Overview
34
Cont…
The selling price per gallon
For cream is $8
For liquid skim is $4
35
Sales Value at Splitoff Illustration
Allocation of Joint Costs Using Liquid
Sales Value at Splitoff Method Cream Skim Total
Sales value of total production at splitoff
point: (25,000*$8; 75,000*$4) $200,000 $300,000 $500,000
Weighting ($200,000/$500,000;
$300,000/$500,000) 0.40 0.60
Joint costs allocated:
(0.40*$400,000; 0.60*$400,000) $160,000 $240,000 $400,000
36
Net Realizable Value Method
Allocates joint costs to joint products on the basis
of relative NRV of total production of the joint

products.
NRV = Final Sales Value – Separable Costs
37
Net Realizable Value Method Over-
view

39
Cont…
Solution:
40
Constant Gross Margin NRV Method
Allocates joint costs to joint products in a way that
the overall gross-margin percentage is identical for
the individual products.
Joint costs are calculated as a residual amount.
41
Cont…
 Step 1: Compute overall gross margin percentage
This is based on the final sales value of total production during the
accounting period.
 Step 2: Compute total production costs for each product.
The difference between the final sales value of total production and the
gross margin then yields the total production costs that the product must
bear.
 Step 3: Compute allocated joint costs.
As the final step, the separable costs for each product are deducted from
the total production costs that the product must bear to obtain the joint-
cost allocation for that product.
42
Cont…
Solution:
43
Physical-Measure Method
Allocates joint costs to joint products on the basis of
the relative weight, volume, or other physical measure

at the splitoff point of total production of the products.
44
Physical Measures Illustration
Allocation of Joint Costs Using Liquid
Physical Measure Method Cream Skim Total
Physical Measure of total production
(gallons) 25,000 75,000 100,0000
Weighting (25,000/100,000;
75,000/100,000) 0.25 0.75
Joint costs allocated (0.25*$400,000;
0.75*$400,000) $100,000 $300,000 $400,000
45
Byproducts
Two methods for accounting for byproducts
Production method—recognizes byproduct inventory as it is
created, and sales and costs at the time of sale.

Sales method—recognizes no byproduct inventory, and rec-
ognizes only sales at the time of sales: byproduct costs are

not tracked separately.
46
The End!

Cost and MGMT Acctg I CH 5

Uploaded by

Document Information

Original Description:

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Cost and MGMT Acctg I CH 5

Uploaded by

Copyright:

Available Formats

Chapter 5

lected indirect costs to cost objects using an allocation

strong tie with the allocation of costs to products or ser-

Cost pool and

2 Cost driver © 2012 Pearson Prentice Hall. All rights reserved.

in amount as the cost driver increases in volume.

 the pooling of manufacturing overhead costs that are affected by

a common activity and

To justify costs or compute reimbursement

To measure income and assets for reporting

Supporting (service) department—provides the ser-

vices that assist other internal departments in the

value to a product or service.

5 © 2012 Pearson Prentice Hall. All rights reserved.

(service department) to cost objects (production depart-

Dual-rate method—segregates costs within each cost pool

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

Single-rate method is simple to implement, but

treats fixed costs in a manner similar to variable

Dual-rate method treats fixed and variable costs

method, managers can allocate support-department costs

widely used in practice.

methods next based on the use of budgeted rates.

port department has two users, both operating divisions: the

9 © 2012 Pearson Prentice Hall. All rights reserved.

Under the single-rate method, divisions are charged the bud-

© 2012 Pearson Prentice Hall. All rights reserved. 10

puter division and 4,000 hours for the peripheral equipment

der the dual-rate method would be as follows:

The costs allocated to the peripheral equipment division in

2012 would be as follows:

12 © 2012 Pearson Prentice Hall. All rights reserved.

13 © 2012 Pearson Prentice Hall. All rights reserved.

Allocates support costs only to operating depart-

Direct method does not allocate support-depart-

ment costs to other support departments.

14 © 2012 Pearson Prentice Hall. All rights reserved.

15 © 2012 Pearson Prentice Hall. All rights reserved.

16 © 2012 Pearson Prentice Hall. All rights reserved.

to the operating departments is the budgeted total

tion systems costs to the operating departments is

© 2012 Pearson Prentice Hall. All rights reserved.

19 © 2012 Pearson Prentice Hall. All rights reserved.

Allocates support-department costs to other support de-

partments and to operating departments in a sequential

that the plant maintenance

© 2012 Pearson Prentice Hall. All rights reserved. 22

23 © 2012 Pearson Prentice Hall. All rights reserved.

departments by fully recognizing the mutual ser-

mental relationships into the support-department

24 © 2012 Pearson Prentice Hall. All rights reserved.

© 2012 Pearson Prentice Hall. All rights reserved. 26

Reciprocal is the most precise.

Direct and step-down are simple to compute and understand.

Direct method is widely used.

27 © 2012 Pearson Prentice Hall. All rights reserved.

© 2012 Pearson Prentice Hall. All rights reserved. 28

multiple products simultaneously.

two or more products become separately identifiable.

that are assignable to each of the now-identifiable specific

yields two or more products with a high sales value com-

have low sales values compare to the sales values of the