Allocation of

Support Department Costs,

Common Costs,
and Revenues

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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

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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.

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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.

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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 more
realistically, but is more complex to implement.

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Allocation Bases
 Under either method, allocation of support costs
can be based on one of the three following
scenarios:
1. Budgeted overhead rate and budgeted hours
2. Budgeted overhead rate and actual hours
3. Actual overhead rate and actual hours
 Choosing between actual and budgeted rates:
budgeted is known at the beginning of the period,
whereas actual will not be known with certainty
until the end of the period

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Comparative Allocation Bases
Illustrated

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Methods of Allocating Support Costs to
Production Departments

1. Direct
2. Step-down
3. Reciprocal

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

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Direct Method
Support Departments Production Departments

Information Systems

Manufacturing

Packaging

Accounting

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Data Used in Cost Allocation
Illustrations

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Direct Allocation Method Illustrated

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Direct Allocation Method Illustrated

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Step-Down Method
Also called the sequential allocation method
Allocates support-department costs to other support
departments and to operating departments in a
sequential manner
Partially recognizes the mutual services provided
among all support departments

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Step-Down Method
Support Departments Production Departments

Information Systems

Manufacturing

Packaging

Accounting

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Step-Down Allocation Method
Illustrated

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Step-Down Allocation Method
Illustrated

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Reciprocal Method
Allocates support-department costs to operating
departments by fully recognizing the mutual services
provided among all support departments.
Reciprocal method fully incorporates interdepartmental
relationships into the support-department cost
allocation.

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Reciprocal Method
Support Departments Production Departments

Information Systems

Manufacturing

Packaging

Accounting

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Reciprocal Allocation Method
(Repeated Iterations) Illustrated

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Reciprocal Allocation Method
(Linear Equations) Illustrated

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

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Allocating Common Costs
Common cost—the cost of operating a facility,
activity, or like cost object that is shared by two or
more users at a lower cost than the individual cost of
the activity to each user.

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Methods of Allocating
Common Costs
Stand-alone cost-allocation method—uses
information pertaining to each user of a cost object as
a separate entity to determine the cost-allocation
weights.
Individual costs are added together and allocation
percentages are calculated from the whole, and
applied to the common cost.

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Methods of Allocating
Common Costs
Incremental cost-allocation method ranks the individual users
of a cost object in the order of users most responsible for a
common cost and then uses this ranking to allocate the cost
among the users.
 The first ranked user is the primary user and is allocated costs up
the cost as a stand-alone user (typically gets the highest allocation
of the common costs).
 The second ranked user is the first incremental user and is
allocated the additional cost that arises from two users rather than
one.
 Subsequent users are handled in the same manner as the second
ranked user.

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Revenue Allocation and
Bundled Products
Revenue allocation occurs when revenues are
related to a particular revenue object but cannot be
traced to it in an economically feasible manner.
Revenue object—anything for which a separate
measurement of revenue is desired.
Bundled product—a package of two or more
products or services that are sold for single price,
but individual components of the bundle also may
be sold as separate items at their own “stand-alone”
prices.
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Methods to Allocate Revenue to Bundled
Products
 Stand-alone (separate) revenue allocation method
uses product-specific information on the products
in the bundle as weights for allocating the bundled
revenues to the individual products. Three types of
weights may be used:
1. Selling prices
2. Unit costs
3. Physical units

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Methods to Allocate Revenue to Bundled
Products
Incremental revenue-allocation method ranks
individual products in a bundle according to criteria
determined by management and then uses this
ranking to allocate bundled revenues to individual
products (similar to earlier discussed incremental
cost-allocation method).
 The first-ranked product is the primary product.
 The second-ranked product is the first incremental product.
 The third-ranked product is the second incremental product,
and so on.

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