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Chapter Seven
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Learning Objectives
department.
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Producing departments are units within an organization that are directly responsible for creating the products or services sold to customers.
Examples: Services: auditing, tax, management advisory Manufacturing: grinding and assembly PPT 7 -5
Definitions
Mutually beneficial costs, which occur when the same resource is used in the output of two or more services or products, are common costs.
Example: security guard wages at a factory
Causal factors are variables or activities within a producing department that provoke the incurrence of service costs.
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1. Departmentalize the firm. 2. Classify each department as a support or a producing department. 3. Trace all overhead costs in the firm to a support or producing department.
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4. Allocate support-department costs to the producing departments. 5. Calculate predetermined overhead rates for producing departments. 6. Allocate overhead costs to the units of individual products through the predetermined overhead rates.
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Objectives of Allocation
Objectives
To obtain a mutually agreeable price. To compute product-line profitability. To predict the economic effects of planning
and control.
To value inventory.
To motivate managers.
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Possible Driver
Number of transactions Number of employees Number of change orders Machine hours Number of employees Number of new hires
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to serve its three producing departments (audit, tax, and management advisory systems or MAS).
The costs of the photocopying department include fixed
costs of $26,190 per year and variable costs of $0.023 per page copied.
Estimated usage in pages by the three producing
departments is as follows:
Audit department Tax department MAS department Total 94,500 67,500 108,000 270,000 ======
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When we allocate support-department costs to the producing departments, should we allocate actual or budgeted costs? Budgeted costs
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*For a producing department, direct costs refer only to overhead costs that are directly traceable to the department.
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Reciprocal Method
The reciprocal method of allocation recognizes all interactions among support departments.
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Direct Costs:
Fixed Variable Total $200,000 50,000 $250,000 ======= Power Allocation Ratios:
Power
Maintenance
--0.10
0.20
---
0.60
0.45
0.20
0.45
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The cost equation for each support department can be expressed as follows: P = Direct costs + Share of Maintenances cost
P = $250,000 + 0.1(M)
M = Direct costs + Share of Powers costs M = $160,000 + 0.2P
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Substituting the Power equation into the Maintenance equation, we get: M = $160,000 + 0.2 ($250,000 + 0.1M)
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Substituting the value for M into the Power equation we get: P = $250,000 + 0.1 ($214,286) P = $250,000 + $21,429
P = $271,429
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Support Departments Producing Departments Power Direct Costs Power $250,000 (271,429) Maint. $160,000 54,286 Grinding $100,000 162,857 Assembly $ 60,000 54,286
Maintenance
Total
21,429
$ 0 =======
(214,286)
$ 0 =======
96,429
$359,286 =======
96,429
$210,715 =======
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End of Chapter 7
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