2. PPT 7 -2
Learning Objectives
Describe the difference between support
departments and producing departments.
Calculate single charging rates for a support
department.
3. PPT 7 -3
Learning Objectives (continued)
Allocate support-department costs to producing
departments using the direct, sequential, and
reciprocal methods.
Calculate departmental overhead rates.
4. PPT 7 -4
Support and Producing Departments
Support departments are units within an organization
that provide essential support services for producing
departments.
Examples: maintenance, grounds, engineering,
housekeeping, personnel, and stores
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
5. 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.
6. PPT 7 -6
Steps in Allocating Support Department
Costs to Producing Departments
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.
7. PPT 7 -7
Steps in Allocating Support Department
Costs to Producing Departments
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.
8. PPT 7 -8
Objectives
Objectives of Allocation
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.
9. PPT 7 -9
Examples of Cost Drivers for
Support Departments
Accounting Number of transactions
Cafeteria Number of employees
Engineering Number of change orders
Maintenance Machine hours
Payroll Number of employees
Personnel Number of new hires
Support Department Possible Driver
10. PPT 7 -10
A Single Charging Rate Example
A firm developed an in-house photocopying department 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 94,500
Tax department 67,500
MAS department 108,000
Total 270,000
======
11. PPT 7 -11
A Single Charging Rate (continued)
Total costs = $26,190 + (270,000 x $0.023) = $32,400
Overhead rate = $32,400 270,000 = $0.12 per page
Suppose the actual usage per department is:
Audit department 92,000
Tax department 65,000
MAS 115,000
12. PPT 7 -12
A Single Charging Rate (continued)
The total photocopying department charges would
be as shown:
Total
# of Pages OH rate Charges
Audit 92,000 $0.12 $11,040
Tax 65,000 $0.12 7,800
MAS 115,000 $0.12 13,800
Total 272,000 $32,640
====== ======
13. PPT 7 -13
Budgeted Versus Actual Usage
When we allocate support-department costs to the
producing departments, should we allocate actual or
budgeted costs?
Budgeted costs
14. PPT 7 -14
Budgeted Versus Actual Usage
(continued)
There are two basic reasons for allocating support-
department costs.
1. To calculate unit costs
2. For performance evaluations
15. PPT 7 -15
Choosing A Service Department Cost
Allocation Method
The three methods for allocating service department
costs to producing departments are:
The Direct Method
The Sequential Method
The Reciprocal Method
16. PPT 7 -16
Service Department Allocation
An Example
Support Departments Producing Departments
Power Maint. Grinding Assembly
Direct Costs* $250,000 $160,000 $100,000 $ 60,000
Normal Activity:
Kilowatt-hours ----- 200,000 600,000 200,000
Maintenance hours 1,000 ----- 4,500 4,500
*For a producing department, direct costs refer only to overhead costs
that are directly traceable to the department.
17. PPT 7 -17
Service Department Allocation
Direct Method
Support Departments Producing Departments
Power Maint. Grinding Assembly
Direct Costs $250,000 $160,000 $100,000 $ 60,000
Power (250,000 ) -------- 187,500 62,500
Maintenance -------- (160,000 ) 80,000 80,000
Total $ 0 $ 0 $367,500 $202,500
======= ======= ======= =======
18. PPT 7 -18
Service Department Allocation
Sequential Method
Support Departments Producing Departments
Power Maint. Grinding Assembly
Direct Costs $250,000 $160,000 $100,000 $ 60,000
Power (250,000 ) 50,000 150,000 50,000
Maintenance --- (210,000 ) 105,000 105,000
Total $ 0 $ 0 $355,000 $215,000
======= ====== ======= =======
19. PPT 7 -19
Reciprocal Method
The reciprocal method of
allocation recognizes all
interactions among support
departments.
20. PPT 7 -20
Reciprocal Method (continued)
Support Departments Producing Departments
Power Maint. Grinding Assembly
Direct Costs:
Fixed $200,000 $100,000 $ 80,000 $50,000
Variable 50,000 60,000 20,000 10,000
Total $250,000 $160,000 $100,000 $60,000
======= ======= ======= ======
Proportion of Output Used by
Power Maint. Grinding Assembly
Allocation Ratios:
Power --- 0.20 0.60 0.20
Maintenance 0.10 --- 0.45 0.45
21. PPT 7 -21
Reciprocal Method (continued)
The cost equation for each support department can be
expressed as follows:
P = Direct costs + Share of Maintenance’s cost
P = $250,000 + 0.1(M)
M = Direct costs + Share of Power’s costs
M = $160,000 + 0.2P
22. PPT 7 -22
Reciprocal Method (continued)
Substituting the Power equation into the Maintenance
equation, we get:
M = $160,000 + 0.2 ($250,000 + 0.1M)
M = $160,000 + $50,000 + 0.02M
0.98M = $210,000
M = $214,286
23. PPT 7 -23
Reciprocal Method (continued)
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
24. PPT 7 -24
Reciprocal Method (continued)
Support Departments Producing Departments
Power Maint. Grinding Assembly
Direct Costs $250,000 $160,000 $100,000 $ 60,000
Power (271,429) 54,286 162,857 54,286
Maintenance 21,429 (214,286) 96,429 96,429
Total $ 0 $ 0 $359,286 $210,715
======= ======= ======= =======
25. PPT 7 -25
Departmental Overhead Rates
The overhead rate for the grinding department is computed
as follows (assuming the normal level of activity is 71,000
MH):
OH rate = $359,286 71,000 = $5.06 per MH
The overhead rate for the assembly department is computed
as follows (assuming the normal level of activity is 107,500
DLH):
OH rate = $210,715 107,500 = $1.96 per DLH
