Allocating Costs of Support Departments and Joint Products

1. Allocating Costs of SupportDepartments and JointProducts Chapter 7

2. Chapter 7 Objectives • Describe the difference between support departments and producing departments • Calculate charging rates, and distinguish between single and dual charging rates • Allocate support center costs to producing departments using the direct method, the sequential method, and the reciprocal method

3. Chapter 7 Objectives Calculate departmental overhead rates Identify the characteristics of the joint production process, and allocate joint costs to products

4. An Overview of Cost Allocation Common costs are mutually beneficial costs • Occur when the same resource is used in the output of two or more services or products • May pertain to periods of time, individual responsibilities, sales territories and classes of customers LO-1

5. An Overview of Cost Allocation A means of dividing a pool of costs and assigning those costs to various subunits Does not affect the total cost Amount of cost assigned to the subunits can be affected by the allocation procedure chosen LO-1

6. An Overview of Cost Allocation Types of Departments Producing departments: directly responsible for creating the products or services sold to customers Support departments: provide essential services for producing departments First step in cost allocation is to determine what the cost objects are • Usually the cost objects are departments LO-1

7. EXHIBIT 7.1—Examples of Departmentalization for a Manufacturing Firm and a Service Firm LO-1

8. EXHIBIT 7.1—Examples of Departmentalization for a Manufacturing Firm and a Service Firm (continued) LO-1

9. Exhibit 7.2—Steps in Allocating Support Department Costs to Producing Departments LO-1

10. Exhibit 7.3—Examples of Possible Activity Drivers for Support Departments LO-1

11. An Overview of Cost Allocation Objectives of Allocation To obtain a mutually agreeable price To compute a product line profitability To predict the economic effects of planning and control To value inventory To motivate managers LO-1

12. Allocating One Department’s Costs to Other Departments The costs of a support department are often allocated to other departments through the use of a charging rate Two major factors in determining charging rate • The choice of a single or dual charging rate • The use of budgeted or actual support department costs LO-2

13. Allocating One Department’s Costs to Other Departments Fixed Costs + Estimated Variable Costs Single rate = Estimated Usage A Single Charging Rate Similar in concept to a plant wide overhead rate All support department costs are accumulated in the numerator and some measure of usage in the denominator in the denominator LO-2

14. Allocating One Department’s Costs to Other Departments Multiple Charging Rates Single charging rate masks the causal factors that lead to a support department’s total costs • Companies develop a dual rate with a fixed component and a variable component LO-2

15. Allocating One Department’s Costs to Other Departments Multiple Charging Rates The allocation of fixed costs follows a three step procedure • Determination of budgeted fixed support service costs • Computation of the allocation ratio Allocation ratio = Production department capacity/Total capacity Allocation = Allocation ratio × Budgeted fixed support service costs LO-2

16. Allocating One Department’s Costs to Other Departments Budgeted versus Actual Usage By allocating budgeted costs instead of actual costs of a support department to producing departments, no inefficiencies or efficiencies are transferred from one department to another For product costing, the allocation is done at the beginning of the year on the basis of budgeted usage so that a predetermined overhead rate can be computed As the causal factors can differ for fixed and variable costs, these types of costs should be allocated separately LO-2

17. EXHIBIT 7.4—Use of Budgeted Data for Product Costing: Comparison of Single- andDual-Rate Methods LO-2

18. EXHIBIT 7.5—Use of Actual Data for Performance Evaluation Purposes: Comparison of Single and Dual Rate methods LO-2

19. EXHIBIT 7.6—Data for Support and Producing Departments LO-3

20. Choosing a Support Department Cost Allocation Method Direct Method of Allocation All costs of the support departments are allocated directly to producing departments in proportion to each producing department’s usage of the service Does not allocate any support department cost to another support department, even if other support departments use the services of a support department LO-3

21. EXHIBIT 7.7—Allocation of Support Department Costs to Producing Departments Using the Direct Method LO-3

22. EXHIBIT 7.7—Allocation of Support Department Costs to Producing Departments Using the Direct Method (continued) LO-3

23. EXHIBIT 7.7—Allocation of Support Department Costs to Producing Departments Using the Direct Method (continued) LO-3

24. Choosing a Support Department Cost Allocation Method Sequential Method of Allocation Recognizes that interactions among the support departments do occur • Takes only partial account of this interaction Performed in a step down fashion, following a predetermined ranking procedure LO-3

25. EXHIBIT 7.8—Allocation of Support Department Costs to Producing Departments using the sequential methods LO-3

26. EXHIBIT 7.8—Allocation of Support Department Costs to Producing Departments using the sequential methods (continued) LO-3

27. EXHIBIT 7.8—Allocation of Support Department Costs to Producing Departments using the sequential methods (continued) LO-3

28. EXHIBIT 7.8—Allocation of Support Department Costs to Producing Departments using the sequential methods (continued) LO-3

29. Choosing a Support Department Cost Allocation Method Sequential Method of Allocation Recognizes all interactions of support departments The usage of one support department by another is used to determine the total cost of each support department • The total cost reflects interactions among the support departments Then, the new total of support department costs is allocated to the producing departments LO-3

30. Choosing a Support Department Cost Allocation Method Total Cost of Support Departments Total cost = Direct costs + Allocated costs Each equation, which is a cost equation for a support department, is the sum of the department’s direct costs plus the proportion of service received from other support departments LO-3

31. EXHIBIT 7.9—Comparison of Support Department Cost Allocations Methods Using the Direct, Sequential, and Reciprocal Methods LO-3

32. Departmental Overhead Rates and Product Costing Allocated service costs + Producing department overhead costs Measure of activity (direct labor hours, machine hours) = After allocating all support service costs to producing departments, an overhead rate is calculated for each department The accuracy of product costs depends on the accuracy of the assignment of overhead costs LO-4

33. Accounting for Joint Production Processes Joint Products are two or more products produced simultaneously by the same process up to a ‘split-off’ point The split-off point is the point at which the joint products become separate and identifiable Joint or main products have relatively significant sales value LO-5

34. exhibit 7.10—Joint Production Process LO-5

35. Accounting for Joint Production Processes Cost Separability and the Need for Allocation Separable costs are easily traced to individual products and offer no particular problem • If not separable, they are allocated to various products for various reasons Cost allocations are arbitrary LO-5

36. exhibit 7.11—Independent Multiple-Product Production Using the Same Material LO-5

37. Accounting for Joint Production Processes Accounting for Joint Product Costs Joint costs must be allocated to the individual products for purposes of financial reporting Several methods have been developed to allocate joint costs • Physical units method • Weighted average method • Sales-value-at-split-off method • Net realizable value method • Constant gross margin method LO-5

38. Accounting for Joint Production Processes Physical Units Method Joint costs distributed on the basis of a physical measure—pounds, tons, gallons, board feet, atomic weight, or heat units Weighted Average Method Uses weight factors (like amount of material used, time consumed, and size of unit) to distribute joint costs LO-5

39. Accounting for Joint Production Processes Sales-Value-at-Split-Off Method Allocates joint cost based on each product’s proportionate share of market value or sales value at the split-off point The higher the market value, the greater the share of joint cost charged against the product LO-5

40. Accounting for Joint Production Processes Net Realizable Value Method Used if there is no ready market price for the individual products at the split-off point First, a hypothetical sales value is obtained for each joint product by subtracting all separable (or further) processing costs from the eventual market value. Then, use the net realizable value method to prorate the joint costs based on each product’s share of hypothetical sales value. Useful when one or more products cannot be sold at the split-off point but must be processed further LO-5

41. Accounting for Joint Production Processes Constant Gross Margin Percentage Method Recognizes that costs incurred after the split-off point are part of the cost total on which profit is expected to be earned Allocates joint cost such that the gross margin percentage is the same for each product LO-5

42. Accounting for Joint Production Processes Accounting for By-Products A secondary product recovered in the course of manufacturing a primary product Obtained from joint production processes that have relatively little sales value Two methods of accounting for by-product sales • Credit by-product revenue to ‘Other Income’ or ‘Sale of By-Product’ • Reduction of the joint costs allocated to the main products by the amount of the by product revenue LO-5

43. End of Chapter 7