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Allocation of Support Department Costs, Common Costs, and Revenues

Allocation of Support Department Costs, Common Costs, and Revenues. Chapter 15 . Single-Rate and Dual-Rate Methods. The single-rate cost allocation method pools together all costs in a cost pool. The dual-rate cost allocation method classifies costs in each cost pool into

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Allocation of Support Department Costs, Common Costs, and Revenues

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  1. Allocation of Support DepartmentCosts, Common Costs, and Revenues Chapter 15

  2. Single-Rate andDual-Rate Methods The single-rate cost allocation method pools together all costs in a cost pool. The dual-rate cost allocation method classifies costs in each cost pool into two cost pools – a variable-cost cost pool and a fixed-cost cost pool.

  3. Budgeted versus Actual Rates Budgeted rates let the user department know in advance the cost rates they will be charged. During the budget period, the supplier department, not the user departments, bears the risk of any unfavorable cost variances. Why?

  4. Budgeted versus Actual Rates – because the user departments do not pay for any costs that exceed the budgeted rates When actual rates are used for cost allocation, managers do not know the rates to be used until the end of the budget period.

  5. Budgeted versus ActualUsage Allocation Bases Organizations commit to infrastructure costs on the basis of a long-run planning horizon. The use of budgeted usage to allocate these fixed costs is consistent with the long-run horizon.

  6. Allocating SupportDepartments Costs An operating department(a production department in manufacturing companies) adds value to a product or service. A support department(service department) provides the services that assist other operating and support departments in the organization.

  7. Allocating SupportDepartments Costs Direct method: Allocates support department costs to operating departments only. Step-down (sequential allocation) method: Allocates support department costs to other support departments and to operating departments. Reciprocal allocation method: Allocates costs by services provided among all support departments.

  8. Allocating SupportDepartments Costs The Canton Division of Smith Corporation has two operating departments and two support departments. Assembly and Finishing Maintenance and Human Resources

  9. Allocating SupportDepartments Costs Total square feet = 255,000 Total number of employees = 95 Maintenance is allocated using square feet. Human Resources is allocated using number of employees.

  10. Human MaintenanceResources Budgeted costs before allocations: $300,000 $2,160,000 Square feet: 5,000 30,000 Number of employees: 8 15 Allocating SupportDepartments Costs

  11. AssemblyFinishing Budgeted costs before allocations: $1,700,000 $900,000 Square feet: 110,000 110,000 Number of employees: 48 24 Allocating SupportDepartments Costs

  12. Direct Method Support Departments Operating Departments Maintenance $300,000 $1,700,000 Assembly 110/220 0% 0% 110/220 48/72 Human Resources $2,160,000 $900,000 Finishing 24/72

  13. Direct Method Support Departments Operating Departments Maintenance $300,000 $1,700,000 Assembly $150,000 0% 0% $150,000 $1,440,000 Human Resources $2,160,000 $900,000 Finishing $720,000

  14. AssemblyFinishing Original costs: $1,700,000 $ 900,000 Maintenance Allocated:150,000 150,000 Human Resources Allocated: 1,440,000 720,000 Total $3,290,000 $1,770,000 Direct Method

  15. Step-Down Method Which support department should be allocated first? Maintenance provides 12% of its services to Human Resources. Human Resources provides 10% of its services to Maintenance. Maintenance to Human Resources: 30,000 ÷ 250,000 (or 12%) × $300,000 = $36,000

  16. Step-Down Method Maintenance to Assembly: 110,000 ÷ 250,000 (or 44%) × $300,000 = $132,000 Maintenance to Finishing: 110,000 ÷ 250,000 (or 44%) × $300,000 = $132,000

  17. Costs before Allocated allocationcosts Maintenance: $ 300,000 ($300,000) Human Resources: $2,160,000 $ 36,000 Assembly: $1,700,000 $132,000 Finishing: $ 900,000 $132,000 Step-Down Method

  18. Step-Down Method Human Resources costs to be allocated become $2,160,000 + $36,000 = $2,196,000. Human Resources to Assembly: 48 ÷ 72 × $2,196,000 = $1,464,000 Human Resources to Finishing: 24 ÷ 72 × $2,196,000 = $732,000

  19. Costs before Allocated Allocated allocationcostscosts Human Resources: $2,160,000 $ 36,000 ($2,196,000) Assembly: $1,700,000 $132,000 $ 1,464,000 Finishing: $ 900,000 $132,000 $ 732,000 Step-Down Method

  20. Step-Down Method Total cost after allocation: Assembly Department: $1,700,000 + $132,000 + $1,464,000 = $3,296,000 Finishing Department: $900,000 + $132,000 + $732,000 = $1,764,000

  21. Reciprocal MHRAF Maintenance – 12% 44% 44% Human Resources 10% – 60% 30% Maintenance cost = $300,000 + .10P Human Resource cost = $2,160,000 + .12M

  22. Reciprocal Maintenance cost (M) = $300,000 + .10($2,160,000 + .12M) M = $300,000 + $216,000 + .012M .988M = $516,000  M = $522,267 HR = $2,160,000 + .12($522,267) HR = $2,160,000 + $62,672 = $2,222,672

  23. Reciprocal MHRAF Before allocation: $300,000 $2,160,000 $1,700,000 $ 900,000 Allocation: (522,267) 62,672 229,797 229,797 Allocation: 222,267 ($2,222,672) 1,333,603 666,802 Total $3,263,400 $1,796,599 Total cost Assembly Department: $3,263,400 Total cost Finishing Department: $1,796,599

  24. Overview of Methods Overhead rate for the Assembly Department is determined using direct labor cost as a denominator. Overhead rate for the Finishing Department is determined using machine-hours as the denominator.

  25. Comparison of Methods AssemblyFinishing Direct labor cost: $698,880 $349,440 Machine-hours: 24,000 23,500 What are the various overhead rates using the three methods?

  26. Overhead Rates Direct Method Assembly: $3,290,000 ÷ $698,880 direct labor costs = 471% of direct labor costs Finishing: $1,770,000 ÷ 23,500 = $75.32 per machine-hour

  27. Overhead RatesStep-Down Method Assembly: $3,296,000 ÷ $698,880 direct labor costs = 472% of direct labor cost Finishing: $1,764,000 ÷ 23,500 = $75.06 per machine-hour

  28. Overhead Rates Reciprocal Assembly: $3,263,400 ÷ $698,880 direct labor costs = 467% of direct labor cost Finishing: $1,796,599 ÷ 23,500 = $76.45 per machine-hour

  29. Comparison of Rates AssemblyFinishing Direct method: 471% $75.32 Step-down method: 472% $75.06 Reciprocal method: 467% $76.45

  30. Allocating Common Costs Two methods for allocating common cost are: 1. Stand-alone cost allocation method 2. Incremental cost allocation method

  31. Stand-Alone Example A consultant in Tampa is planning to go to Chicago and meet with an international client. The round-trip Tampa/Chicago/Tampa airfare costs $540. The consultant is also planning to attend a business meeting with a North Carolina client in Durham.

  32. Stand-Alone Example The round-trip Tampa/Durham/Tampa airfare costs $360. The consultant decides to combine the two trips into a Tampa/Durham/Chicago/Tampa itinerary that will cost $760.

  33. Stand-Alone Example How much should the consultant charge to the North Carolina client? $360 ÷ ($360 + $540) = .40 .40 × $760 = $304 How much to the international client? $760 – $304 = $456

  34. Incremental Cost Example Assume that the business meeting in Chicago is viewed as the primary party. What would be the cost allocation? International client (primary) $540 Durham client (incremental) $760 – $540 = $220

  35. Cost Allocation and Contracts Many commercial contracts include clauses that require the use of cost accounting information. Contract disputes arise with some regularity, often with respect to cost allocation. Cost assignment rules should be as explicit as possible (and in writing).

  36. Revenues and Bundled Products A bundled productis a package of two or more products (or services) sold for a single price. Bundled product sales are also referred to as “suite sales.” The individual components of the bundle also may be sold as separate items at their own “stand-alone” prices.

  37. Revenues and Bundled Products What businesses provide bundled products? Banks Hotels Tours • Checking • Safety deposit boxes • Investment advisory • Lodging • Food and beverage services • Recreation • Transportation • Lodging • Guides

  38. Revenue Allocation Methods English Languages Institute buys English language software programs locally and then sells them in Mexico and Central America. English sells the following programs: Grammar, Translation, and Composition These programs are offered stand-alone or in a bundle.

  39. Revenue Allocation Methods Stand-alonePrice Grammar $255 Translation $ 85 Composition $185 Purchasing these software programs costs English the following: Grammar $180 Translation $ 45 Composition $ 95

  40. Revenue Allocation Methods Bundle (Suites)Price Grammar + Translation $290 Grammar + Composition $350 Grammar + Translation + Composition $410

  41. Revenue Allocation Methods The two main revenue allocation methods are: 1. The stand-alone method 2. The incremental method

  42. Stand-Alone RevenueAllocation Method There are four types of weights for the stand-alone revenue allocation method. 1. Selling prices 2. Unit costs 3. Physical units 4. Stand-alone product revenues

  43. Stand-Alone RevenueAllocation Method Consider the Grammar and Translation suite, which sells for $290 per day. How much weight should English Languages Institute assign to each item?

  44. Stand-Alone RevenueAllocation Method Selling prices: The individual selling prices are $255 for Grammar and $85 for Translation. Grammar: $255 ÷ $340 = 0.75, $290 × 0.75 = $217.50 Translation: $85 ÷ $340 = 0.25, $290 × 0.25 = $72.50

  45. Stand-Alone RevenueAllocation Method Unit costs: This method uses the costs of the individual products to determine the weights for the revenue allocations. Grammar: $180 ÷ $225 = 0.80, $290 × 0.80 = $232 Translation: $45 ÷ $225 = 0.20, $290 × 0.20 = $58

  46. Stand-Alone RevenueAllocation Method Physical units: This method gives each product unit in the suite the same weight when allocating suite revenue to individual products. With two products in the suite, each product is allocated 50% of suite revenues. 1 ÷ (1 + 1) = 0.50 $290 × 0.50 = $145

  47. Stand-Alone RevenueAllocation Method Stand-alone product revenues: This method captures the quantity of each product sold as well as their selling prices. Assume that the stand-alone revenues in 2003 are Grammar $734,400, Translation $81,600, and Composition $133,200. What are the weights for the Grammar and Translation suite?

  48. Stand-Alone RevenueAllocation Method Grammar: $734,400 ÷ $816,000 = 0.90, $290 × 0.90 = $261 Translation: $81,600 ÷ $816,000 = 0.10, $290 × 0.10 = $29

  49. Stand-Alone RevenueAllocation Method Revenue Allocation Weights GrammarTranslation Selling prices $217.50 $ 72.50 Unit costs 232.00 58.00 Physical units 145.00 145.00 Stand-alone product revenues 261.00 29.00

  50. Incremental RevenueAllocation Method The first-ranked product is termed the primary productin the bundle. The second-ranked product is termed the first incremental product. The third-ranked product is the second incremental product, and so on.

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