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Managerial Accounting by G. Norren Chap015
 

Managerial Accounting by G. Norren Chap015

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  • Most large organizations have both operating departments and service departments. The central purposes of the organization are carried out in the operating departments. In contrast, service departments do not directly engage in operating activities. This chapter discusses why and how service department costs are allocated to operating departments.
  • Service department costs are allocated to operating departments to: Encourage operating departments to wisely use service department resources. Provide operating departments with more complete cost data for making decisions. Help measure the profitability of operating departments. Create incentive for service departments to operate efficiently. Value inventory for external financial reporting purposes. Include all overhead in the cost base when cost-plus pricing is used.
  • The allocation bases used should drive the cost being allocated. For example, when allocating costs of the employee cafeteria, the number of meals served would be a good choice for the allocation base.
  • A service department’s costs may be allocated using more than one base. For example, the costs of a human resource department might be divided into two parts, with one part allocated based on number of employees in each operating department and the other part allocated on the basis of hours spent in training programs run by the human resource department.
  • Several examples of service departments and possible allocation bases are shown on your screen.
  • Service provided between service departments are known as interdepartmental or reciprocal services. Three approaches may be used to allocate the costs of service departments to other departments. These approaches are known as the direct method, the step method, and the reciprocal method.
  • The direct method is the simplest of the three cost allocation methods because it ignores the services provided by a service department to other service departments. Interactions between service departments are ignored and all costs of each service department are allocated directly to operating departments.
  • In the example shown on your screen, a company has two service departments, Cafeteria and Custodial, and two operating departments, Machining and Assembly. Cafeteria costs are allocated to the operating departments based on the number of employees in each department. Custodial costs are allocated to each operating department based on the number of square feet in each operating department.
  • How much of the Cafeteria and Custodial costs should be allocated to each operating department using the direct method of cost allocation?
  • Using the direct method of cost allocation, it doesn’t matter which service department we allocate first. We will start with cafeteria. The total number of employees in the allocation base is fifty, twenty for Machining plus thirty for Assembly. Recall that we ignore the number of employees in Custodial as it is a service department and using the direct method, we only allocate to operating departments. The allocation percentage is calculated by dividing the number of employees in an operating department by the total number of employees in the allocation base. For Machining, the allocation percentage is forty percent, obtained by dividing twenty employees by fifty employees. Next we multiply the allocation percentage times the service department cost. To allocate Cafeteria costs to Machining we multiply forty percent times three hundred sixty thousand dollars and get one hundred forty-four thousand dollars.
  • Next, let’s allocate Cafeteria costs to Assembly. The allocation percentage is calculated by dividing the number of employees in an operating department by the total number of employees in the allocation base. For Assembly, the allocation percentage is sixty percent, obtained by dividing thirty employees by fifty employees. To allocate Cafeteria costs to Assembly we multiply sixty percent times three hundred sixty thousand dollars and get two hundred sixteen thousand dollars.
  • Now let’s allocate Custodial costs. The total number of square feet in the allocation base is seventy-five thousand, twenty-five thousand for Machining plus fifty thousand for Assembly. Recall that we ignore the square feet in Cafeteria as it is a service department and using the direct method, we only allocate to operating departments. The allocation percentage is calculated by dividing the square feet in an operating department by the total number of square feet in the allocation base. For Machining, the allocation percentage is thirty-three and one-third percent, obtained by dividing twenty-five thousand square feet by seventy-five thousand square feet. Next we multiply the allocation percentage times the service department cost. To allocate Custodial costs to Machining we multiply thirty-three and one-third percent times ninety thousand dollars and get thirty thousand dollars.
  • Next, let’s allocate Custodial costs to Assembly. The total number of square feet in the allocation base is seventy-five thousand, twenty-five thousand for Machining plus fifty thousand for Assembly. The allocation percentage is calculated by dividing the square feet in an operating department by the total number of square feet in the allocation base. For Assembly, the allocation percentage is sixty-six and two-thirds percent, obtained by dividing fifty thousand square feet by seventy-five thousand square feet. Next we multiply the allocation percentage times the service department cost. To allocate Custodial costs to Assembly we multiply sixty-six and two-thirds percent times ninety thousand dollars and get sixty thousand dollars.
  • The step method provides for the allocation of a service department’s costs to other service departments, as well as to operating departments. It is a sequential allocation procedure, and the sequence usually begins with the service department that provides the greatest amount of service to other service departments. Once a service department’s costs have been allocated to other departments, other service department costs are not allocated back to it.
  • There are three key points to understand regarding the step method:  In both the direct and step methods, any amount of the allocation base attributable to the service department whose cost is being allocated is always ignored.  Any amount of the allocation base that is attributable to a service department whose cost has already been allocated is ignored.  Each service department assigns its own costs to operating departments plus the costs that have been allocated to it from other service departments.
  • We will use the same information shown on your screen for the step-method example. There are two service departments, Cafeteria and Custodial, and two operating departments, Machining and Assembly. Cafeteria costs are allocated to the operating departments based on the number of employees in each department. Custodial costs are allocated to each operating department based on the number of square feet in each operating department.
  • How much of the Cafeteria and Custodial costs should be allocated to each operating department using the step method of cost allocation? We will allocate Cafeteria first since it is larger and provides more service to Custodial than Custodial provides to Cafeteria.
  • The total number of employees in the allocation base is sixty, ten for Custodial plus twenty for Machining plus thirty for Assembly. The allocation percentage is calculated by dividing the number of employees in a department by the total number of employees in the allocation base. For Custodial, the allocation percentage is sixteen and two-thirds percent, obtained by dividing ten employees by sixty employees. Next we multiply the allocation percentage times the service department cost. To allocate Cafeteria costs to Custodial, we multiply sixteen and two-thirds percent times three hundred sixty thousand dollars and get sixty thousand dollars.
  • Next, let’s allocate Cafeteria costs to Machining. The allocation percentage is calculated by dividing the number of employees in a department by the total number of employees in the allocation base. For Machining, the allocation percentage is thirty-three and one-third percent, obtained by dividing twenty employees by sixty employees. Next we multiply the allocation percentage times the service department cost. To allocate Cafeteria costs to Machining, we multiply thirty-three and one-third percent times three hundred sixty thousand dollars and get one hundred twenty thousand dollars.
  • Next, let’s allocate Cafeteria costs to Assembly. The allocation percentage is calculated by dividing the number of employees in a department by the total number of employees in the allocation base. For Assembly, the allocation percentage is fifty percent, obtained by dividing thirty employees by sixty employees. Next we multiply the allocation percentage times the service department cost. To allocate Cafeteria costs to Assembly, we multiply fifty percent times three hundred sixty thousand dollars and get one hundred eighty thousand dollars.
  • Now, we can allocate Custodial costs. The costs in Custodial are now $150,000. This amount includes the department’s own costs of $90,000 plus the $60,000 allocated from Cafeteria. None of the $150,000 will be allocated back to Cafeteria. How much of the Custodial costs should be allocated to each operating department using the step method of cost allocation?
  • The total number of square feet in the allocation base is seventy-five thousand, twenty-five thousand for Machining plus fifty thousand for Assembly. The allocation percentage is calculated by dividing the square feet in a department by the total number of square feet in the allocation base. For Machining, the allocation percentage is thirty-three and one-third percent, obtained by dividing twenty-five thousand square feet by seventy-five thousand square feet. Next we multiply the allocation percentage times the service department cost. To allocate Custodial costs to Machining we multiply thirty-three and one-third percent times one hundred fifty thousand dollars and get fifty thousand dollars.
  • Next, let’s allocate Custodial costs to Assembly. The total number of square feet in the allocation base is seventy-five thousand, twenty-five thousand for Machining plus fifty thousand for Assembly. The allocation percentage is calculated by dividing the square feet in an operating department by the total number of square feet in the allocation base. For Assembly, the allocation percentage is sixty-six and two-thirds percent, obtained by dividing fifty thousand square feet by seventy-five thousand square feet. Next we multiply the allocation percentage times the service department cost. To allocate Custodial costs to Assembly we multiply sixty-six and two-thirds percent times one hundred fifty thousand dollars and get one hundred thousand dollars.
  • The reciprocal method gives full recognition to interdepartmental services. While the step method only allocates forward – never backwards – the reciprocal method allocates service department costs in both directions. Reciprocal allocation requires the use of simultaneous linear equations and is beyond the scope of our discussion. The reciprocal method is rarely used in practice because of its complexity and because the results are usually close to the step method results.
  • If a service department generates revenue, such as a cafeteria that charges for the service it provides, the revenue generated should be offset against the costs incurred. Only the remaining net amount of costs should be allocated to other departments.
  • On your screen, you see information for a series of questions. The first cost allocation questions use the direct method. You will probably want to refer back to this screen as you work through the questions.
  • Here’s your first question using the direct method of service department cost allocation.
  • The total number of employees in the allocation base is one hundred, twenty in Accounting plus eighty others. Recall that we ignore the number of employees in BACS as it is a service department and using the direct method, we only allocate to operating departments. The allocation percentage is calculated by dividing the number of employees in an operating department by the total number of employees in the allocation base. For Accounting, the allocation percentage is twenty percent, obtained by dividing twenty employees by one hundred employees. Next we multiply the allocation percentage times the service department cost. To allocate ADMIN costs to Accounting we multiply twenty percent times one hundred eighty thousand dollars and get thirty-six thousand dollars.
  • Here’s your second question using the direct method of service department cost allocation.
  • We will allocate BACS costs to Accounting and add the result to the answer for the previous question. BACS is allocated on the basis of the number of personal computers in each operating department. The total number of personal computers in the allocation base is one hundred twenty, eighteen for Accounting plus one hundred two others. The allocation percentage is calculated by dividing the number of personal computers in an operating department by the total number of personal computers in the allocation base. For Accounting, the allocation percentage is fifteen percent, obtained by dividing eighteen personal computers by one hundred twenty personal computers. To allocate BACS costs to Accounting, we multiply fifteen percent times ninety thousand dollars and get thirteen thousand five hundred dollars. The total amount allocated to Accounting is the sum of thirty-six thousand dollars and thirteen thousand five hundred dollars for a total of forty-nine thousand five hundred dollars.
  • Now we will look at a question where we will use the step method of service department cost allocation. The information on your screen for this question is the same information that we used for the direct method questions.
  • Here’s your question using the step method of service department cost allocation.
  • ADMIN provides more services than BACS so we allocate it first. The total number of employees in the allocation base is one hundred five, five for BACS, plus twenty for Accounting, plus eighty others. The allocation percentage is calculated by dividing the number of employees in a department by the total number of employees in the allocation base. For Accounting, the allocation percentage is found by dividing twenty employees by one hundred five employees. Next we multiply the allocation percentage times the service department cost. To allocate ADMIN costs to Accounting we multiply the allocation percentage times one hundred eighty thousand dollars and get thirty-four thousand two hundred eighty-six dollars. We must also allocate ADMIN costs to BACS. The allocation percentage is found by dividing five employees by one hundred five employees. Next we multiply the allocation percentage times the service department cost. To allocate ADMIN costs to BACS, we multiply the allocation percentage times one hundred eighty thousand dollars and get eight thousand five hundred seventy-one dollars. The new amount to be allocated from BACS is the original ninety thousand dollars plus the eight thousand five hundred seventy-one dollars, for a total of ninety-eight thousand five hundred seventy-one dollars. Now we can allocate BACS costs to Accounting. For BACS, the allocation percentage of fifteen percent is found by dividing eighteen computers by one hundred twenty computers. Next we multiply the allocation percentage times the service department cost. To allocate BACS costs to Accounting, we multiply fifteen percent times ninety-eight thousand five hundred seventy-one dollars and get fourteen thousand seven hundred eighty-six dollars. The total amount allocated to Accounting is the sum of thirty-four thousand two hundred eighty-six dollars plus fourteen thousand seven hundred eighty-six dollars.
  • Allocating service department variable and fixed costs separately provides more useful information for planning and control of departmental operations.
  • Variable service department costs should be allocated to consuming departments according to the activity causing incurrence of the cost.
  • Fixed costs should be allocated to consuming departments in predetermined lump-sum amounts that are based on the consuming departments’ peak-period or long-run average servicing needs. Importantly, fixed cost allocations: Are based on the amount of capacity each consuming department requires. Should not vary from period to period.
  • Budgeted variable and fixed service department costs (rather than actual costs) should be allocated to operating departments. Actual costs may contain inefficiencies that should not be allocated to operating departments.
  • If variable cost allocations are made at the beginning of the year, the budgeted variable rate should be multiplied by the budgeted activity level of each consuming department. Allocations made at the beginning of the year provide data for pricing, planning, and other decisions.
  • If variable cost allocations are made at the end of the year, the budgeted variable rate should be multiplied by the actual activity level of each consuming department. Allocations made at the end of the year provide data for comparing actual performance to planned performance.
  • Let’s look at an example of allocating costs by behavior. SimCo has one service department, maintenance, and two operating 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. Both planned and actual hours are given. We will allocate variable costs at the beginning of the year using planned hours and then we will allocate variable costs at the end of the year using actual hours. We will allocate fixed costs based on percent of peak capacity required.
  • Variable cost allocations are made at the beginning of the year by multiplying the budgeted variable rate of sixty cents per machine hour times the planned hours for each operating department.
  • Fixed service department costs are allocated to the operating departments by multiplying the percent of peak-period capacity required by each department times the two hundred thousand dollars of budgeted fixed costs.
  • Variable cost allocations are made at the end of the year by multiplying the budgeted variable rate of sixty cents per machine hour times the actual hours for each operating department.
  • There is no change in the allocation procedure for fixed costs at the end of the year. Fixed service department costs are allocated to the operating departments by multiplying the percent of peak-period capacity required by each department times the two hundred thousand dollars of budgeted fixed costs.
  • The variable cost allocations differ because the budgeted activity level is used at the beginning of the year and the actual activity level is used at the end of the year. Fixed cost allocations are the same at the end and at the beginning because they are both based on peak-period capacity rather than usage.
  • The two operating departments were charged for budgeted costs not for the actual costs of the maintenance service departments. The budgeted rate of sixty cents per machine hour was used to allocate variable maintenance costs, and the budgeted lump-sum fixed maintenance cost of two hundred thousand dollars was allocated. Allocating actual service department costs would pass on service department inefficiencies to the operating departments. The inefficiencies are beyond the control of managers in the operating departments.
  • Now we will look at a couple of questions where we will allocate costs by behavior. On your screen, you see information for both questions. You will probably want to refer back to this screen as you work through the questions.
  • Here is your first question asking for allocations at the beginning of the year.
  • Variable cost allocations are made at the beginning of the year by multiplying the budgeted variable rate of four dollars twenty cents per mile times the planned number of miles for each hospital. Fixed service department costs are allocated to the hospitals by multiplying the percent of peak-period capacity required by each hospital times the one hundred twenty thousand dollars of budgeted fixed costs.
  • Here is your second question asking for allocations at the end of the year.
  • Variable cost allocations are made at the end of the year by multiplying the budgeted variable rate of four dollars twenty cents per mile times the actual number of miles for each hospital. Fixed service department costs are again allocated to the hospitals by multiplying the percent of peak-period capacity required by each hospital times the one hundred twenty thousand dollars of budgeted fixed costs.
  • Once service department costs are allocated to operating departments, they are typically included in the: Performance evaluations of operating departments. Determination of the operating departments’ profitability. Overhead rate computations of the operating departments.
  • In the first stage of cost allocations, service department costs are allocated to operating departments and then become a part of the overhead costs of those operating departments. The ultimate objective is to determine the costs of products and services.
  • In the second stage of cost allocations, operating department overhead costs and allocated service department costs become the total amount of overhead that is applied to products and services using departmental predetermined overhead rates.
  • Rather than allocating service department fixed costs to operating departments in predetermined lump-sum amounts, some companies allocate them using a variable allocation base that fluctuates from period to period. This is a pitfall because it creates a situation where the fixed costs allocated to one operating department are heavily influenced by what happens in other operating departments.
  • Let’s look at an example to illustrate the pitfalls of allocating fixed costs using a variable allocation base. Kolby Products has two sales territories, the Eastern Territory and the Western Territory. Both sales territories are serviced by one auto service center whose costs are all fixed. Contrary to good practice, Kolby allocates the fixed service center costs to the sales territories on the basis of actual miles driven (a variable base).
  • On your screen, you see data for miles driven in each sales territory and the service center’s one hundred twenty thousand dollar fixed cost. The Western territory maintained an activity level of one million five hundred thousand miles in both years. The Eastern division dropped from one million five hundred thousand miles driven in year one to nine hundred thousand miles driven in year two. Allocation rates based on total miles driven are shown for both years. The total number of miles driven in year two is less, so the allocation rate per mile in year two is higher.
  • We allocate the one hundred twenty thousand dollars service center cost by multiplying the allocation rate per mile times the number of miles driven in each territory. The two sales territories share the service center’s costs equally because the miles driven in each territory are equal in the first year.
  • Again we allocate the one hundred twenty thousand dollar service center cost by multiplying the allocation rate per mile times the number of miles driven in each territory. In year two, the costs allocated to the Western territory increase by fifteen thousand dollars despite the fact that the miles driven within the Western territory are the same as in year one. Western’s costs for year two increased because Eastern’s miles driven declined in year two.
  • While sales dollars is a popular allocation base for service department costs, it is a poor choice because sales dollars fluctuate from period to period, and the costs being allocated are often largely fixed. Allocation of service department costs based on sales can create a situation where the sales of one department influence the service department costs allocated to other departments.
  • Let’s look at an example to illustrate the pitfalls of allocating service department costs based on sales revenue. Clothier Inc., a men’s clothing store has one service department and three sales departments, Suits, Shoes, and Accessories. Service department costs total $60,000 for both years in the example. Contrary to good practice, Clothier allocates the service department costs based on sales.
  • Part I We will focus on the Suit Department in this example. In the first year, Suit Department sales are two hundred sixty thousand dollars of the four hundred thousand dollars of total sales. Two hundred sixty thousand dollars is sixty-five percent of four hundred thousand dollars. We allocate the service department costs to the Suit Department by multiplying sixty-five percent times sixty thousand dollars. The result is thirty-nine thousand dollars. Part II In the next year, the manager of the Suit Department increased sales by $100,000. Sales in the other departments are unchanged. Let’s allocate the $60,000 service department cost for the second year given the sales increase.
  • In the second year, Suit Department sales are three hundred sixty thousand dollars of the five hundred thousand dollars of total sales. Three hundred sixty thousand dollars is seventy-two percent of five hundred thousand dollars. We allocate the service department costs to the Suit Department by multiplying seventy-two percent times sixty thousand dollars. The result is forty-three thousand two hundred dollars. The allocation of service department costs to the Suit Department increased by four thousand two hundred dollars. The allocation of service department costs to the other two departments decreased. The Suit Department manager is likely to complain because as a result of his efforts to expand sales, his department is being forced to bear a larger share of service department costs.
  • Service department costs are allocated to operating departments. We examined the direct method and the step method of service department cost allocation in some detail. Where possible fixed and variable costs should be allocated separately. Allocating service department costs based on sales and allocating fixed service department costs using a variable activity base are two pitfalls to avoid.

Managerial Accounting by G. Norren Chap015 Managerial Accounting by G. Norren Chap015 Presentation Transcript

  • 11 th Edition Chapter 15
  • Service Department Costing: An Activity Approach Chapter Fifteen
  • Reasons for Allocating Service Department Costs To encourage operating departments to wisely use service department resources. To provide operating departments with more complete cost data for making decisions. To help measure the profitability of operating departments. To create incentive for service departments to operate efficiently. To value inventory for external financial reporting purposes. To include all overhead in the cost base when cost-plus pricing is used.
  • Selecting Allocation Bases The allocation bases used should “drive” the cost being allocated. For example, when allocating costs of the employee cafeteria, the number of meals served would be a good choice for the allocation base. $ Operating Departments Service Departments
  • Selecting Allocation Bases A service department’s costs may be allocated using more than one base. For example, a portion of the human resource department costs might be allocated based on the number of employees in each operating department and another portion might be allocated based on hours spent in training employees in each operating department. Operating Departments Service Departments $
  • Examples of Allocation Bases Exh. 15-1
  • Interdepartmental Services Problem Allocating costs when service departments provide services to each other Solutions Direct Method Step Method Reciprocal Method
  • Direct Method Service Department (Cafeteria) Service Department (Custodial) Operating Department (Machining) Operating Department (Assembly) Interactions between service departments are ignored and all costs are allocated directly to operating departments.
  • Direct Method Example
  • Direct Method Example
  • Direct Method Example Allocation base: Number of employees $360,000 × 20 20 + 30 = $144,000
  • Direct Method Example Allocation base: Number of employees $360,000 × 30 20 + 30 = $216,000
  • Direct Method Example Allocation base: Square feet occupied $90,000 × 25,000 25,000 + 50,000 = $30,000
  • Direct Method Example Allocation base: Square feet occupied 50,000 25,000 + 50,000 $90,000 × = $60,000
  • Step Method Operating Department (Machining) Operating Department (Assembly) Service Department (Cafeteria) Service Department (Custodial) Once a service department’s costs are allocated, other service department costs are not allocated back to it.
  • Step Method
    • There are three key points to understand regarding the step method:
    •  In both the direct and step methods, any amount of the allocation base attributable to the service department whose cost is being allocated is always ignored.
    •  Any amount of the allocation base that is attributable to a service department whose cost has already been allocated is ignored.
    •  Each service department assigns its own costs to operating departments plus the costs that have been allocated to it from other service departments .
  • Step Method Example We will use the same data used in the direct method example.
  • Step Method Example Allocate Cafeteria costs first since it provides more service than Custodial.
  • Step Method Example $360,000 × 10 10 + 20 + 30 = $60,000 Allocation base: Number of employees
  • Step Method Example $360,000 × 20 10 + 20 + 30 = $120,000 Allocation base: Number of employees
  • Step Method Example $360,000 × 30 10 + 20 + 30 = $180,000 Allocation base: Number of employees
  • Step Method Example New total = $90,000 original Custodial cost plus $60,000 allocated from the Cafeteria.
  • Step Method Example $150,000 × 25,000 25,000 + 50,000 = $50,000 Allocation base: Square feet occupied
  • Step Method Example $150,000 × 50,000 25,000 + 50,000 = $100,000 Allocation base: Square feet occupied
  • Reciprocal Method Service Department (Cafeteria) Service Department (Custodial) Operating Department (Machining) Operating Department (Assembly) Because of its mathematical complexity, the reciprocal method is rarely used. Interdepartmental services are given full recognition rather than partial recognition as with the step method.
  • Revenue Producing Service Departments If a service department generates revenue, such as a cafeteria that charges for the service it provides, the revenue generated should be offset against the costs incurred. Only the remaining net amount of costs should be allocated to other departments.
  • Quick Check Data for Direct and Step Methods
    • Allocation bases:
      • Business school administration costs (ADMIN): Number of employees
      • Business Administration computer services (BACS): Number of personal computers
    The direct method of allocation is used.
  • Quick Check 
    • How much cost will be allocated from Administration to Accounting?
    • a. $ 36,000
      • b. $144,000
      • c. $180,000
      • d. $ 27,000
    • How much cost will be allocated from Administration to Accounting?
    • a. $ 36,000
      • b. $144,000
      • c. $180,000
      • d. $ 27,000
    Quick Check  $180,000 × 20 20 + 80 = $36,000
  • Quick Check 
    • How much total cost will be allocated from ADMIN and BACS combined to the Accounting Department?
      • a. $ 52,500
      • b. $135,000
      • c. $270,000
      • d. $ 49,500
  • Quick Check 
    • How much total cost will be allocated from ADMIN and BACS combined to the Accounting Department?
      • a. $ 52,500
      • b. $135,000
      • c. $270,000
      • d. $ 49,500
    $90,000 × 18 18 + 102 = $13,500
  • Quick Check Data
    • Allocation bases:
      • Business school administration costs (ADMIN): Number of employees
      • Business administration computer services (BACS): Number of personal computers
    The step method of allocation is used.
  • Quick Check 
    • How much total cost will be allocated from ADMIN and BACS combined to the Accounting Department?
      • a. $35,250
      • b. $49,072
      • c. $18,000
      • d. $26,333
    • How much total cost will be allocated from ADMIN and BACS combined to the Accounting Department?
      • a. $35,250
      • b. $49,072
      • c. $18,000
      • d. $26,333
    Quick Check 
  • Allocating Costs by Behavior When possible, variable and fixed service department costs should be allocated separately.
  • Allocating Costs by Behavior Variable service department costs should be allocated to consuming departments according to the activity causing incurrence of the cost.
  • Allocating Costs by Behavior Allocate fixed service department costs to consuming departments in predetermined lump-sum amounts that are based on the consuming departments’ peak or long-run average needs. Fixed cost allocations: Are based on amounts of capacity each consuming department requires. Should not vary from period to period.
  • Allocating Costs by Behavior Budgeted variable and fixed service department costs should be allocated to operating departments.
  • Allocating Costs by Behavior If variable cost allocations are made at the beginning of the year, the budgeted variable rate should be multiplied by the budgeted activity level of each consuming department. Allocations made at the beginning of the year provide data for pricing and other decisions.
  • Allocating Costs by Behavior If variable cost allocations are made at the end of the year, the budgeted variable rate should be multiplied by the actual activity level of each consuming department. Allocations made at the end of the year provide data for performance evaluation.
  • SimCo: An Example SimCo has a maintenance department and two operating 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.
  • SimCo: Beginning of the Year Hours planned
  • SimCo: Beginning of the Year Percent of peak-period capacity. Hours planned
  • SimCo: End of the Year Hours used
  • SimCo: End of the Year Percent of peak-period capacity. Hours used
  • SimCo: Comparison of Results Fixed cost allocations are the same at the end and at the beginning because they are based on capacity instead of usage.
  • SimCo: Comparison of Results Only budgeted variable and fixed service department costs were allocated to the two operating departments. The cost of service department inefficiencies, contained in the actual costs, should not be passed along to operating departments.
  • Quick Check: Allocating Costs by Behavior Foster City has an ambulance service that is used by the two public hospitals in the city. Variable ambulance costs are budgeted at $4.20 per mile. Fixed ambulance costs are budgeted at $120,000 per year. Data relating to the current year are:
  • Quick Check 
    • How much ambulance service cost will be allocated to Mercy Hospital at the beginning of the year?
      • a. $117,000
      • b. $254,400
      • c. $114,480
      • d. $119,250
    • How much ambulance service cost will be allocated to Mercy Hospital at the beginning of the year?
      • a. $117,000
      • b. $254,400
      • c. $114,480
      • d. $119,250
    Quick Check 
  • Quick Check 
    • How much ambulance service cost will be allocated to Mercy Hospital at the end of the year?
      • a. $114,000
      • b. $118,800
      • c. $110,400
      • d. $121,200
    • How much ambulance service cost will be allocated to Mercy Hospital at the end of the year?
      • a. $114,000
      • b. $118,800
      • c. $110,400
      • d. $121,200
    Quick Check 
  • Effect of Allocations on Operating Departments Once service department cost allocations are completed, they are included in operating departments’: Performance evaluations Profitability determination Overhead rate computations
  • Effect of Allocations on Operating Departments Service Department (Cafeteria) Service Department (Accounting) Service Department (Personnel) Operating Department (Machining) Operating Department (Assembly) The Products First Stage Allocations Service department costs are allocated to operating departments.
  • Effect of Allocations on Operating Departments Service Department (Cafeteria) Service Department (Accounting) Service Department (Personnel) Operating Department (Machining) Operating Department (Assembly) The Products Second Stage Allocations Operating department overhead costs and allocated service department costs are applied to products.
  • Allocation Pitfalls to Avoid Pitfall 1 Allocating fixed costs using a variable allocation base Result Fixed costs allocated to one department are heavily influenced by what happens in other departments.
  • Kolby Products: An Example Kolby Products has two sales territories, the Eastern Territory and the Western Territory. Both sales territories are serviced by one auto service center whose costs are all fixed. Contrary to good practice, Kolby allocates the fixed service center costs to the sales territories on the basis of actual miles driven (a variable base).
  • Kolby Products: An Example $120,000 ÷ 3,000,000 miles $120,000 ÷ 2,400,000 miles
  • Kolby Products: First–year Allocations The two sales territories share the service center’s costs equally because the miles driven in each territory are equal.
  • Kolby Products: Second–year Allocation Western territory has the same number of miles as last year, but $15,000 more cost allocated because Eastern’s miles declined in year 2.
  • Allocation Pitfalls to Avoid Pitfall 2 Using sales dollars as an allocation base Result Sales of one department influence the service department costs allocated to other departments.
  • Clothier Inc. – An Example Clothier Inc., a men’s clothing store has one service department and three sales departments, Suits, Shoes, and Accessories. Service department costs total $60,000 for both years in the example. Contrary to good practice, Clothier allocates the service department costs based on sales.
  • Clothier Inc. – First-year Allocation In the next year, the manager of the Suit Department increased sales by $100,000. Sales in the other departments are unchanged. Let’s allocate the $60,000 service department cost for the second year given the sales increase. $260,000 ÷ $400,000 65% of $60,000
  • Clothier Inc. – Second-year Allocation If you were the suit department manager, would you be happy with the increased service department costs allocated to your department? $360,000 ÷ $500,000 72% of $60,000
  • End of Chapter 15