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Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

McGraw-Hill/Irwin
Allocation of
Support Activity
Costs and Joint
Costs
Chapter
Eighteen
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin
Learning
Objective
1
First, we identify the factor
that drives costs in the
service department.
This cost driver is called
the allocation base.
How are service
department costs
charged to production
departments?
Service Department Cost
Allocation
Production
Departments
Service
Departments
Carry out the
central purposes
of an organization.
Provide support
that facilitates the
activities of production
departments.
Service Department Cost
Allocation
support
Well, we measure the
consumption of the
allocation base in the
production departments.
Service Department Cost
Allocation
How are service
department costs
charged to production
departments?
Third, we allocate the service
department cost based on
the relative amount of the
allocation base consumed in
each production department.
Service Department Cost
Allocation
How are service
department costs
charged to production
departments?
Allocated service department
costs become a part of the
manufacturing overhead in
each production department.
Service Department Cost
Allocation
What happens to
service department
costs after they are
allocated to
production
departments?
Allocated service department
costs become a part of the
manufacturing overhead in
each production department.
I get it. They become
a part of the overhead
that is applied to
products with a
predetermined
overhead rate.
Service Department Cost
Allocation
So, the costs become
a part of the finished
product via the
application of the pre-
determined factory
overhead rate.
Exactly. Take a look at
this flow chart.
I think it will summarize
our discussion of the
allocation process.
Service Department Cost
Allocation
Service
Department
(Cafeteria)
Service
Department
(Accounting)
Service
Department
(Personnel)
Production
Department
(Machining)
Production
Department
(Assembly)
The
Product
Service Department Cost
Allocation
First Stage Allocations
Service department costs are allocated
to production departments.
Service
Department
(Cafeteria)
Service
Department
(Accounting)
Service
Department
(Personnel)
Production
Department
(Machining)
Production
Department
(Assembly)
The
Product
Second Stage Allocations
Production department overhead costs, plus allocated service
department costs, are applied to products using
departmental predetermined overhead rates.
Service Department Cost
Allocation
Selecting Allocation Bases
Personnel:
Number of
employees
Receiving:
Units
handled
Security:
Square
footage
Power:
Kilowatt
hours
Cafeteria:
Number of
employees
Custodial:
Square
footage
Accounting:
Staff
hours
Typical
Allocation
Bases
Selecting Allocation Bases
Criteria for
selection
Personnel:
Number of
employees
Receiving:
Units
handled
Security:
Square
footage
Power:
Kilowatt
hours
Cafeteria:
Number of
employees
Custodial:
Square
footage
Accounting:
Staff
hours
Simplicity
Selecting Allocation Bases
Personnel:
Number of
employees
Security:
Square
footage
Power:
Kilowatt
hours
Custodial:
Square
footage
Accounting:
Staff
hours
Availability
of space or
equipment
Receiving:
Units
handled
Cafeteria:
Number of
employees
Criteria for
selection
Selecting Allocation Bases
Personnel:
Number of
employees
Security:
Square
footage
Power:
Kilowatt
hours
Custodial:
Square
footage
Accounting:
Staff
hours
Benefits received
by the production
department
Receiving:
Units
handled
Cafeteria:
Number of
employees
Criteria for
selection
Interdepartmental Services
Service
Department
(Cafeteria)
Service
Department
(Custodial)
Production
Department
(Machining)
Production
Department
(Assembly)
POWER DEPARTMENT
Interdepartmental Services
Problem
Allocating costs when service departments
provide services to each other
Solutions
Direct Method
Step Method
Direct Method
Service
Department
(Cafeteria)
Service
Department
(Custodial)
Production
Department
(Machining)
Production
Department
(Assembly)
Cost of services
between service
departments are
ignored and all
costs are
allocated directly
to production
departments.
Direct Method Example
Service Departments Production Departments
Cafeteria Custodial Machining Assembly
Departmental costs
before allocation 360,000 $ 90,000 $ 400,000 $ 700,000 $
Number of employees 15 10 20 30
Square feet occupied 5,000 2,000 25,000 50,000
Service Department Allocation Base
Cafeteria Number of employees
Custodial Square feet occupied
Direct Method Example
Service Departments Production Departments
Cafeteria Custodial Machining Assembly
Departmental costs
before allocation 360,000 $ 90,000 $ 400,000 $ 700,000 $
Cafeteria allocation (360,000) 144,000 ?
Custodial allocation ? ? ?
Total after allocation $ 0
$360,000
20
20 + 30
= $144,000
Allocation base: Number of employees
Direct Method Example
Service Departments Production Departments
Cafeteria Custodial Machining Assembly
Departmental costs
before allocation 360,000 $ 90,000 $ 400,000 $ 700,000 $
Cafeteria allocation (360,000) 144,000 216,000
Custodial allocation ? ? ?
Total after allocation $ 0
$360,000
30
20 + 30
= $216,000
Allocation base: Number of employees
Service Departments Production Departments
Cafeteria Custodial Machining Assembly
Departmental costs
before allocation 360,000 $ 90,000 $ 400,000 $ 700,000 $
Cafeteria allocation (360,000) 144,000 216,000
Custodial allocation (90,000) 30,000 ?
Total after allocation $ 0 $ 0 574,000 $
Direct Method Example
$90,000
25,000
25,000 + 50,000
= $30,000
Allocation base: Square feet occupied
Service Departments Production Departments
Cafeteria Custodial Machining Assembly
Departmental costs
before allocation 360,000 $ 90,000 $ 400,000 $ 700,000 $
Cafeteria allocation (360,000) 144,000 216,000
Custodial allocation (90,000) 30,000 60,000
Total after allocation $ 0 $ 0 574,000 $ 976,000 $
Direct Method Example
$90,000
50,000
25,000 + 50,000
= $60,000
Allocation base: Square feet occupied
Step Method
Service
Department
(Cafeteria)
Service
Department
(Custodial)
Production
Department
(Machining)
Production
Department
(Assembly)
Service department
costs are allocated
to other service
departments and
to production
departments, usually
starting with the
service department
that serves the
largest number of
other service
departments.
Step Method
Service
Department
(Cafeteria)
Service
Department
(Custodial)
Production
Department
(Machining)
Production
Department
(Assembly)
Once a service
departments costs
are allocated,
other service
departments costs
are not allocated
back to it.
Step Method
Service
Department
(Cafeteria)
Service
Department
(Custodial)
Production
Department
(Machining)
Production
Department
(Assembly)
Custodial will
have a new
total to allocate
to production
departments: its
own costs plus
those costs
allocated from
the cafeteria.
Step Method Example
Service Departments Production Departments
Cafeteria Custodial Machining Assembly
Departmental costs
before allocation 360,000 $ 90,000 $ 400,000 $ 700,000 $
Number of employees 15 10 20 30
Square feet occupied 5,000 2,000 25,000 50,000
Service Department Allocation Base
Cafeteria Number of employees
Custodial Square feet occupied
We will use the same data used in the direct method example.
Step Method Example
Service Departments Production Departments
Cafeteria Custodial Machining Assembly
Departmental costs
before allocation 360,000 $ 90,000 $ 400,000 $ 700,000 $
Cafeteria allocation (360,000) 60,000 ? ?
Custodial allocation ? ? ?
Total after allocation $ 0
$360,000
10
10 + 20 + 30
= $60,000
Allocation base: Number of employees
Step Method Example
Service Departments Production Departments
Cafeteria Custodial Machining Assembly
Departmental costs
before allocation 360,000 $ 90,000 $ 400,000 $ 700,000 $
Cafeteria allocation (360,000) 60,000 120,000 ?
Custodial allocation ? ? ?
Total after allocation $ 0
$360,000
20
10 + 20 + 30
= $120,000
Allocation base: Number of employees
Step Method Example
Service Departments Production Departments
Cafeteria Custodial Machining Assembly
Departmental costs
before allocation 360,000 $ 90,000 $ 400,000 $ 700,000 $
Cafeteria allocation (360,000) 60,000 120,000 180,000
Custodial allocation ? ? ?
Total after allocation $ 0
$360,000
30
10 + 20 + 30
= $180,000
Allocation base: Number of employees
Step Method Example
Service Departments Production Departments
Cafeteria Custodial Machining Assembly
Departmental costs
before allocation 360,000 $ 90,000 $ 400,000 $ 700,000 $
Cafeteria allocation (360,000) 60,000 120,000 180,000
Custodial allocation (150,000) ? ?
Total after allocation $ 0 $ 0
New total = $90,000 original custodial cost
plus $60,000 allocated from the cafeteria.
Step Method Example
Service Departments Production Departments
Cafeteria Custodial Machining Assembly
Departmental costs
before allocation 360,000 $ 90,000 $ 400,000 $ 700,000 $
Cafeteria allocation (360,000) 60,000 120,000 180,000
Custodial allocation (150,000) 50,000 ?
Total after allocation $ 0 $ 0 570,000 $
$150,000
25,000
25,000 + 50,000
= $50,000
Allocation base: Square feet occupied
Step Method Example
Service Departments Production Departments
Cafeteria Custodial Machining Assembly
Departmental costs
before allocation 360,000 $ 90,000 $ 400,000 $ 700,000 $
Cafeteria allocation (360,000) 60,000 120,000 180,000
Custodial allocation (150,000) 50,000 100,000
Total after allocation $ 0 $ 0 570,000 $ 980,000 $
$150,000
50,000
25,000 + 50,000
= $100,000
Allocation base: Square feet occupied
Comparison of Methods
Totals after allocation
Machining Assembly
Method Department Department
Direct 574,000 $ 976,000 $
Step 570,000 980,000
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin
Learning
Objective
2
Fixed Versus Variable Costs
Are fixed
and variable
costs allocated
differently?
Result
When one department
decreases activity to
reduce allocations, all
departments are penalized
because the charge
per use increases.
Remember, total fixed
costs do not change as
activity changes.
Fixed Versus Variable Costs
Problem
Allocating common
fixed costs using a
variable activity
allocation base
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.
Dual Cost Allocation
Variable
Costs
Charge to
production
departments at a
budgeted rate times
actual short-run usage of
the allocation base.
Fixed
Costs
Allocate
budgeted amounts
to operating departments
in proportion to the
long-run average
usage of the
allocation base.
Charge to
production
departments at a
budgeted rate times
actual short-run usage of
the allocation base.
Allocate
budgeted amounts
to operating departments
in proportion to the
long-run average
usage of the
allocation base.
Variable
Costs
Fixed
Costs
Budgeted costs should be allocated
to avoid passing on inefficiencies
from the service departments.
Dual Cost Allocation
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:
Allocate maintenance costs to the two operating departments.
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
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
Total allocated cost
Variable costs are allocated based on hours used.
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.
Dual Cost Allocation
Example
A Behavioral Problem
Problem
Department managers
may underestimate
long-run average usage
to reduce fixed cost
allocations.
Solution
Reward managers for
making accurate estimates
of long-run average
service department needs.
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin
Learning
Objective
3
The New Manufacturing
Environment
More accurate cost tracing systems
reduce the need for allocation
of indirect costs.
The Rise of Activity-Based
Costing
Service
Department
(Cafeteria)
Service
Department
(Accounting)
Service
Department
(Personnel)
The
Product
First stage allocations are to
activities, not departments.
Activity
One
Activity
Two
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin
Learning
Objective
4
Joint Product
Costs
Product
Product
Product
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.
Joint Product Cost Allocation
Consider the following
example of an oil
refinery.
We will assume only
two products,
gasoline and oil.
Joint Product Cost Allocation
Separate
Processing Costs
Final
Sale
Separate
Processing
Final
Sale
Separate
Processing
Separate
Processing Costs
Joint
Input
Joint
Production
Process
Split-Off
Point
Joint
Product
Costs
Oil
Gasoline
Joint Product Cost Allocation
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin
Learning
Objective
5
Allocating Joint Costs
Joint Product
Costs
Physical-Units
Method
Relative-
Sales-Value
Method
Net-Realizable-
Value Method
Allocating Joint Costs
Allocation based on
the relative values
of the products at
the split-off point.
Allocation based on a
physical measure of the
joint products at the
split-off point.
Allocation based on
final sales values less
separable processing
costs.
Relative-Sales-
Value Method
Physical-Units
Method
Net-Realizable-
Value Method
Lets look at an
example illustrating
the joint cost
allocation methods.
Allocating Joint Costs
240,000 gallons
360,000 gallons
Joint
Production
Process
Split-Off
Point
Oil
Gasoline
Joint material
cost = $275,000
Joint conversion
cost = $225,000
Physical-Units Method
Product
Oil Gasoline Total
Output quantities in gallons 240,000 360,000 600,000
Proportionate share:
?
?
Allocated joint costs:
?
?
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:
?
?
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 $
Physical-Units Method
$225,000 joint conversion cost plus
$275,000 joint material cost
$200,000
sales value at
split-off point
$600,000
sales value at
split-off point
Joint
Production
Process
Split-Off
Point
Oil
Gasoline
Joint material
cost = $275,000
Joint conversion
cost = $225,000
Relative-Sales-Value Method
Relative-Sales-Value Method
Product
Oil Gasoline Total
Sales value at split-off point 200,000 $ 600,000 $ 800,000 $
Proportionate share:
?
?
Allocated joint costs:
?
?
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:
?
?
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
Relative-Sales-Value Method
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.
Estimated
NRV
Final
Sales
Value
Added
Processing
Costs
=
Net-Realizable-Value Method
Joint
Production
Process
Oil
Gasoline
Separate
Processing
Separate
Processing
Joint material
cost = $275,000
Joint conversion
cost = $225,000
Sales
Value
$500,000
Sales
Value
$1,200,000
Split-Off
Point, Sales
Value Unknown
Separate
Processing Costs
$500,000
Separate
Processing Costs
$200,000
Product
Oil Gasoline Total
Sales value 500,000 $ 1,200,000 $ 1,700,000 $
Less additional processing costs ? ? ?
Estimated NRV at split-off point ? ? ?
Proportionate share:
?
?
Allocated joint costs:
?
?
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:
?
?
Allocated joint costs:
?
?
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:
?
?
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 $
Net-Realizable-Value Method
By-Products
Joint
Input
Joint
Production
Process
Split-Off
Point
Joint
Costs
By-products
Major
Product
Relatively low
value or quantity
when compared to
major products
Major
Product
Two commonly used
methods of accounting
for by-products are . . .
By-product NRV is
deducted from cost of joint
process before allocation.
By-product NRV is
deducted from cost of
main product.
By-Products
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin
Learning
Objective
6
Reciprocal Services Method
Fully accounts for reciprocal services
More accurate
Can be combined with dual allocation
End of Chapter 18
18

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