Managerial Accounting (lesson 15)

Slide 1: Chapter 15 Service Department Costing: An Activity Approach

Slide 2: The Need for Cost Allocations Operating Service Departments Departments Carry out the Provide support central purposes to the of an organization operating departments © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin

Slide 3: The Need for Cost Allocations First, we identify the factor How are service that drives costs in the department costs service department. charged to operating departments? This cost driver is used as the allocation base. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin

Slide 4: The Need for Cost Allocations Second, we measure the consumption of the allocation base in the operating departments. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin

Slide 5: The Need for Cost Allocations Third, we allocate the service department cost based on the relative amount of the allocation base used in each operating department. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin

Slide 6: The Need for Cost Allocations Allocated service department What happens to costs become a part of service department the overhead in each costs after they operating department. are allocated to operating departments? © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin

Slide 7: The Need for Cost Allocations I get it. They become a part of the overhead that is applied to That’s right. Take a look products with a at this flow chart. predetermined overhead rate. I think it will summarize our discussion of the allocation process. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin

Slide 8: The Need for Cost Allocations First Stage Allocations Service department costs are Service allocated to operating departments. Department (Cafeteria) Operating Department (Machining) Service The Department Products (Accounting) Operating Department (Assembly) Service Department (Personnel) © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin

Slide 9: The Need for Cost Allocations Second Stage Allocations Operating department overhead costs and allocated service department costs are Service applied to products. Department (Cafeteria) Operating Department (Machining) Service The Department Products (Accounting) Operating Department (Assembly) Service Department (Personnel) © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin

Slide 10: Guidelines for Cost Allocation $ Service Operating Departments Departments 1. Allocation bases 2. Interdepartmental services 3. Allocating costs by behavior 4. Allocation pitfalls to avoid 5. Allocation of actual or budgeted costs © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin

Slide 11: Selecting Allocation Bases Personnel: Custodial: Number of Square Criteria employees footage Receiving: Cafeteria: Easiest Units Number of handled employees Security: Accounting: Power: Square Staff Kilowatt footage hours hours © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin

Slide 12: Selecting Allocation Bases Personnel: Custodial: Number of Square Criteria employees footage Receiving: Cafeteria: Availability Units Number of of space or handled employees equipment Security: Accounting: Power: Square Staff Kilowatt footage hours hours © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin

Slide 13: Selecting Allocation Bases Personnel: Custodial: Number of Square Criteria employees footage Benefits received Receiving: Cafeteria: by the operating Units Number of department handled employees Security: Accounting: Power: Square Staff Kilowatt footage hours hours © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin

Slide 14: Selecting Allocation Bases Personnel: Custodial: Number of Square Criteria employees footage Consumption of Receiving: Cafeteria: resources Units Number of handled employees Security: Accounting: Power: Square Staff Kilowatt footage hours hours © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin

Slide 15: Interdepartmental Services Problem Allocating costs when service departments provide services to each other Solutions Direct Method Step method Reciprocal method © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin

Slide 16: Direct Method Service Operating Department Department Interactions (Cafeteria) (Machining) between service departments are ignored and all costs are allocated directly to operating Service Operating departments. Department Department (Custodial) (Assembly) © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin

Slide 17: Direct Method Example Service Departments Operating 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 © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin

Slide 18: Direct Method Example Service Departments Operating Departments Cafeteria Custodial Machining Assembly Departmental costs before allocation $ 360,000 $ 90,000 $ 400,000 $ 700,000 Cafeteria allocation ? ? ? Custodial allocation ? ? ? Total after allocation ? ? ? ? © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin

Slide 19: Direct Method Example Service Departments Operating 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 ? ? ? 20 $360,000 × = $144,000 20 + 30 Allocation base: Number of employees © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin

Slide 20: Direct Method Example Service Departments Operating 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 ? ? ? 30 $360,000 × = $216,000 20 + 30 Allocation base: Number of employees © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin

Slide 21: Direct Method Example Service Departments Operating 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 ? 25,000 $90,000 × = $30,000 25,000 + 50,000 Allocation base: Square feet occupied © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin

Slide 22: Direct Method Example Service Departments Operating 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 50,000 $90,000 × = $60,000 25,000 + 50,000 Allocation base: Square feet occupied © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin

Slide 23: Step Method Service Operating Department Department Once a service (Cafeteria) (Machining) department’s costs are allocated, other service department costs are not allocated Service Operating back to it. Department Department (Custodial) (Assembly) © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin

Slide 24: Step Method Service Operating Department Department Custodial will (Cafeteria) (Machining) have a new total to allocate to operating departments; its own costs plus Service Operating those costs Department Department allocated from (Custodial) (Assembly) the cafeteria. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin

Slide 25: Step Method Example We will use the same data used in the direct method example. Service Departments Operating 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 © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin

Slide 26: Step Method Example Service Departments Operating Departments Cafeteria Custodial Machining Assembly Departmental costs before allocation $ 360,000 $ 90,000 $ 400,000 $ 700,000 Cafeteria allocation ? ? ? ? Custodial allocation ? ? ? Total after allocation ? ? ? ? Allocate Cafeteria costs first since it provides more service than Custodial. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin

Slide 27: Step Method Example Service Departments Operating 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 ? ? ? 10 $360,000 × = $60,000 10 + 20 + 30 Allocation base: Number of employees © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin

Slide 28: Step Method Example Service Departments Operating 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 ? ? ? 20 $360,000 × = $120,000 10 + 20 + 30 Allocation base: Number of employees © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin

Slide 29: Step Method Example Service Departments Operating 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 ? ? ? 30 $360,000 × = $180,000 10 + 20 + 30 Allocation base: Number of employees © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin

Slide 30: Step Method Example Service Departments Operating 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. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin

Slide 31: Step Method Example Service Departments Operating 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 ? 25,000 $150,000 × = $50,000 25,000 + 50,000 Allocation base: Square feet occupied © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin

Slide 32: Step Method Example Service Departments Operating 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 50,000 $150,000 × = $100,000 25,000 + 50,000 Allocation base: Square feet occupied © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin

Slide 33: Reciprocal Method Service Operating Department Department (Cafeteria) (Machining) Interdepartmental services are given full recognition rather than partial recognition as with the step method. Service Operating Department Department (Custodial) (Assembly) Because of its mathematical complexity, the reciprocal method is rarely used. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin

Slide 34: Comparison of Methods Totals after allocation Machining Assembly Method Department Department Direct $ 574,000 $ 976,000 Step 570,000 980,000 Reciprocal Results are similar to step method © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin

Slide 35: Quick Check Data Service Departments Operating Departments ADMIN BACS Accounting Others Departmental costs before allocation $ 180,000 $ 90,000 $ 190,000 $ 900,000 Number of employees 15 5 20 80 Number of PCs 12 20 18 102 The direct method of allocation is used. Allocation bases: Business school administration costs (ADMIN): Number of employees Business administration computer services (BACS): Number of personal computers © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin

Slide 36: Quick Check  How much cost will be allocated from Administration to Accounting? a. $ 36,000 b. $144,000 c. $180,000 d. $ 27,000 © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin

Slide 37: Quick Check  How much cost will be allocated from Administration to Accounting? a. $ 36,000 b. $144,000 Service Departments Operating Departments c. $180,000 d. $ 27,000 ADMIN BACS Accounting Others Departmental costs before allocation $ 180,000 $ 90,000 $ 190,000 $ 900,000 ADMIN allocation (180,000) 36,000 144,000 20 $180,000 × = $36,000 20 + 80 © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin

Slide 38: 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 © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin

Slide 39: Service Departments Operating Departments Quick Check  ADMIN BACS Accounting Others Departmental costs before allocation $ 180,000 $ 90,000 $ 190,000 $ 900,000 How much total(180,000) be allocated from 144,000 cost will ADMIN allocation 36,000 BACS allocationand BACS - combined to the13,500 (90,000) 76,500 ADMIN Accounting Total after allocation $ - $ - $ 239,500 $ 1,120,500 Department? a. $ 52,500 b. $135,000 c. $270,000 d. $ 49,500 18 $90,000 × = $13,500 18 + 102 © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin

Slide 40: Quick Check Data Service Departments Operating Departments ADMIN BACS Accounting Others Departmental costs before allocation $ 180,000 $ 90,000 $ 190,000 $ 900,000 Number of employees 15 5 20 80 Number of PCs 12 20 18 102 The step method of allocation is used. Allocation bases: Business school administration costs (ADMIN): Number of employees Business administration computer services (BACS): Number of personal computers © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin

Slide 41: 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 © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin

Slide 42: 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 Service Departments Operating Departments d. $26,333 ADMIN BACS Accounting Others Departmental costs before allocation $ 180,000 $ 90,000 $ 190,000 $ 900,000 ADMIN allocation (180,000) 8,571 34,286 137,143 BACS allocation - (98,571) 14,786 83,786 Total after allocation $ - $ - $ 239,071 $ 1,120,929 © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin

Slide 43: Allocating Fixed Costs My performance looked But that would not be good until they beneficial to the company; allocated those service most of those costs are department costs, so fixed. I’m not going to use What if we charged a flat the service again. annual fee for the service? © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin

Slide 44: Allocating Fixed Costs That sounds better. If the fee is fixed, the more I use the service the lower my average cost per use will be. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin

Slide 45: Allocating Costs by Behavior Variable Fixed Costs Costs Allocate Charge to budgeted amounts operating to operating departments departments at a in proportion to the budgeted rate times peak-period capacity the usage of the required by the allocation base. operating department. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin

Slide 46: Allocating Costs by Behavior Variable Fixed Costs Costs Allocate Charge to budgeted amounts operating to operating departments departments at a in proportion to the budgeted rate times peak-period capacity the usage of the required by the allocation base. should be operating department. Budgeted costs allocated to avoid passing on inefficiencies from the service departments. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin

Slide 47: Allocating Costs by Behavior Allocations are made at the beginning of the period to provide data for predetermined overhead rates and flexible budgets. Allocations are made at the end of the period to provide data for comparing actual performance to planned performance. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin

Slide 48: Allocating Costs by Behavior 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: Percent of Peak-Period Operating Capacity Hours Hours Departments Required Planned Used Cutting 60% 75,000 80,000 Assembly 40% 50,000 40,000 Total hours 100% 125,000 120,000 Allocate maintenance costs to the two operating departments. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin

Slide 49: Allocating Costs by Behavior Example: Beginning of the Period Hours planned Cutting Assembly Department Department Variable cost allocation: $0.60 × 75,000 hours $ 45,000 $0.60 × 50,000 hours $ 30,000 Fixed cost allocation Total allocated cost © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin

Slide 50: Allocating Costs by Behavior Example: Beginning of the Period Cutting Assembly Department Department Variable cost allocation: $0.60 × 75,000 hours $ 45,000 $0.60 × 50,000 hours $ 30,000 Fixed cost allocation 60% of $200,000 120,000 40% of $200,000 80,000 Total allocated cost $ 165,000 $ 110,000 Percent of peak-period capacity. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin

Slide 51: Allocating Costs by Behavior Example: End of the Period Hours used Cutting Assembly Department Department Variable cost allocation: $0.60 × 80,000 hours $ 48,000 $0.60 × 40,000 hours $ 24,000 Fixed cost allocation Total allocated cost © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin

Slide 52: Allocating Costs by Behavior Example: End of the Period Cutting Assembly Department Department Variable cost allocation: $0.60 × 80,000 hours $ 48,000 $0.60 × 40,000 hours $ 24,000 Fixed cost allocation 60% of $200,000 120,000 40% of $200,000 80,000 Total allocated cost $ 168,000 $ 104,000 Percent of peak-period capacity. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin

Slide 53: Allocating Costs by Behavior Example Allocation Based on Allocation Based on Cost Beginning-of-Period End-of-Period Type Planned Activity Actual Activity Cutting Assembly Cutting Assembly Variable $ 45,000 $ 30,000 $ 48,000 $ 24,000 Fixed 120,000 80,000 120,000 80,000 $ 165,000 $ 110,000 $ 168,000 $ 104,000 Fixed cost allocations are the same at the end and at the beginning because they are based on capacity instead of usage. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin

Slide 54: Quick Check Data 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: Percent of Peak-Period Capacity Miles Miles Hospitals Required Planned Used Mercy 45% 15,000 16,000 Northside 55% 17,000 17,500 Total 100% 32,000 33,500 © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin

Slide 55: 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 © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin

Slide 56: 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 Mercy Northside c. $114,480 Variable cost allocation: $4.20 × 15,000 miles $ 63,000 d. $119,250 miles $4.20 × 17,000 $ 71,400 Fixed cost allocation 45% of $120,000 54,000 55% of $120,000 66,000 Total allocated cost $ 117,000 $ 137,400 © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin

Slide 57: 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 © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin

Slide 58: Quick Check  Mercy Northside Variable cost allocation: $4.20 × 16,000 miles $ 67,200 How$4.20 × 17,500 miles much ambulance service cost will be $ 73,500 Fixed cost allocation allocated to Mercy Hospital at54,000end of the the 45% of $120,000 year? of $120,000 55% 66,000 Total allocated cost $ 121,200 $ 139,500 a. $114,000 b. $118,800 c. $110,400 d. $121,200 © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin

Slide 59: Allocation Pitfalls to Avoid Pitfall 1 Using sales dollars as an allocation base Result Departments that increase revenues are penalized by receiving more allocated costs. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin

Slide 60: Allocation Pitfalls to Avoid Pitfall 2 Allocating fixed costs using a variable Result activity allocation Total fixed costs do not base change, but departments that increase activities to support increased revenues are penalized by receiving more allocated costs. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin

Slide 61: End of Chapter 15 © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin