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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 resour...
Selecting Allocation Bases The allocation bases used should “drive” the cost being allocated. For example, when allocating...
Selecting Allocation Bases A service department’s costs may be allocated using more than one base. For example, a portion ...
Examples of Allocation Bases Exh. 15-1
Interdepartmental Services Problem Allocating costs when service departments provide services to each other Solutions Dire...
Direct Method Service  Department (Cafeteria) Service  Department (Custodial) Operating  Department (Machining) Operating ...
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  De...
Step Method <ul><li>There are three key points to understand regarding the step method: </li></ul><ul><li>   In both the ...
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) Operat...
Revenue Producing  Service Departments If a service department generates revenue, such as a cafeteria that charges for the...
Quick Check Data for Direct and Step Methods <ul><li>Allocation bases: </li></ul><ul><ul><li>Business school administratio...
Quick Check   <ul><li>How much cost will be allocated from Administration to Accounting? </li></ul><ul><li> a. $  36,000 ...
<ul><li>How much cost will be allocated from Administration to Accounting? </li></ul><ul><li> a. $  36,000 </li></ul><ul><...
Quick Check   <ul><li>How much total cost will be allocated from ADMIN and BACS combined to the Accounting Department? </...
Quick Check   <ul><li>How much total cost will be allocated from ADMIN and BACS combined to the Accounting Department? </...
Quick Check Data <ul><li>Allocation bases: </li></ul><ul><ul><li>Business school administration costs (ADMIN):   Number of...
Quick Check   <ul><li>How much total cost will be allocated from ADMIN and BACS combined to the Accounting Department? </...
<ul><li>How much total cost will be allocated from ADMIN and BACS combined to the Accounting Department? </li></ul><ul><ul...
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 ...
Allocating Costs by Behavior Allocate  fixed  service department costs to  consuming departments in predetermined lump-sum...
Allocating Costs by Behavior Budgeted  variable and fixed service department costs should be allocated to operating depart...
Allocating Costs by Behavior If  variable  cost allocations are made at the beginning  of the year, the  budgeted  variabl...
Allocating Costs by Behavior If  variable   cost allocations are made at the end   of the year, the   budgeted  variable r...
SimCo:  An Example SimCo has a maintenance department and two operating departments:  cutting and assembly.  Variable main...
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...
SimCo: Comparison of Results Only budgeted variable and fixed service department costs were allocated to the  two operatin...
Quick Check: Allocating Costs by Behavior Foster City has an ambulance service that is used by the two public hospitals in...
Quick Check   <ul><li>How much ambulance service cost will be allocated to Mercy Hospital at the  beginning  of the year?...
<ul><li>How much ambulance service cost will be allocated to Mercy Hospital at the  beginning  of the year? </li></ul><ul>...
Quick Check   <ul><li>How much ambulance service cost will be allocated to Mercy Hospital at the  end  of the year? </li>...
<ul><li>How much ambulance service cost will be allocated to Mercy Hospital at the  end  of the year? </li></ul><ul><ul><l...
Effect of Allocations on Operating Departments Once service department cost allocations are completed, they are included i...
Effect of Allocations on Operating Departments Service  Department (Cafeteria) Service  Department (Accounting) Service  D...
Effect of Allocations on Operating Departments Service  Department (Cafeteria) Service  Department (Accounting) Service  D...
Allocation Pitfalls to Avoid Pitfall 1 Allocating fixed  costs using a variable allocation base Result Fixed costs allocat...
Kolby Products:  An Example Kolby Products has two sales territories, the Eastern Territory and the Western Territory.  Bo...
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 mile...
Kolby Products: Second–year Allocation Western territory has the same number of miles as last year, but $15,000 more cost ...
Allocation Pitfalls to Avoid Pitfall 2 Using sales dollars as an allocation base Result Sales of one department influence ...
Clothier Inc.  –  An Example Clothier Inc., a men’s clothing store has one service department and three sales departments,...
Clothier Inc.  –  First-year Allocation In the next year, the manager of the Suit Department increased sales by $100,000. ...
Clothier Inc.  –  Second-year Allocation If you were the suit department manager, would you be happy with the increased se...
End of Chapter 15
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Managerial Accounting by G. Norren Chap015

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Managerial Accounting by G. Norren Chap015

  1. 1. 11 th Edition Chapter 15
  2. 2. Service Department Costing: An Activity Approach Chapter Fifteen
  3. 3. 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.
  4. 4. 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
  5. 5. 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 $
  6. 6. Examples of Allocation Bases Exh. 15-1
  7. 7. Interdepartmental Services Problem Allocating costs when service departments provide services to each other Solutions Direct Method Step Method Reciprocal Method
  8. 8. 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.
  9. 9. Direct Method Example
  10. 10. Direct Method Example
  11. 11. Direct Method Example Allocation base: Number of employees $360,000 × 20 20 + 30 = $144,000
  12. 12. Direct Method Example Allocation base: Number of employees $360,000 × 30 20 + 30 = $216,000
  13. 13. Direct Method Example Allocation base: Square feet occupied $90,000 × 25,000 25,000 + 50,000 = $30,000
  14. 14. Direct Method Example Allocation base: Square feet occupied 50,000 25,000 + 50,000 $90,000 × = $60,000
  15. 15. 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.
  16. 16. Step Method <ul><li>There are three key points to understand regarding the step method: </li></ul><ul><li> 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. </li></ul><ul><li> Any amount of the allocation base that is attributable to a service department whose cost has already been allocated is ignored. </li></ul><ul><li> Each service department assigns its own costs to operating departments plus the costs that have been allocated to it from other service departments . </li></ul>
  17. 17. Step Method Example We will use the same data used in the direct method example.
  18. 18. Step Method Example Allocate Cafeteria costs first since it provides more service than Custodial.
  19. 19. Step Method Example $360,000 × 10 10 + 20 + 30 = $60,000 Allocation base: Number of employees
  20. 20. Step Method Example $360,000 × 20 10 + 20 + 30 = $120,000 Allocation base: Number of employees
  21. 21. Step Method Example $360,000 × 30 10 + 20 + 30 = $180,000 Allocation base: Number of employees
  22. 22. Step Method Example New total = $90,000 original Custodial cost plus $60,000 allocated from the Cafeteria.
  23. 23. Step Method Example $150,000 × 25,000 25,000 + 50,000 = $50,000 Allocation base: Square feet occupied
  24. 24. Step Method Example $150,000 × 50,000 25,000 + 50,000 = $100,000 Allocation base: Square feet occupied
  25. 25. 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.
  26. 26. 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.
  27. 27. Quick Check Data for Direct and Step Methods <ul><li>Allocation bases: </li></ul><ul><ul><li>Business school administration costs (ADMIN): Number of employees </li></ul></ul><ul><ul><li>Business Administration computer services (BACS): Number of personal computers </li></ul></ul>The direct method of allocation is used.
  28. 28. Quick Check  <ul><li>How much cost will be allocated from Administration to Accounting? </li></ul><ul><li> a. $ 36,000 </li></ul><ul><ul><li>b. $144,000 </li></ul></ul><ul><ul><li>c. $180,000 </li></ul></ul><ul><ul><li>d. $ 27,000 </li></ul></ul>
  29. 29. <ul><li>How much cost will be allocated from Administration to Accounting? </li></ul><ul><li> a. $ 36,000 </li></ul><ul><ul><li>b. $144,000 </li></ul></ul><ul><ul><li>c. $180,000 </li></ul></ul><ul><ul><li>d. $ 27,000 </li></ul></ul>Quick Check  $180,000 × 20 20 + 80 = $36,000
  30. 30. Quick Check  <ul><li>How much total cost will be allocated from ADMIN and BACS combined to the Accounting Department? </li></ul><ul><ul><li>a. $ 52,500 </li></ul></ul><ul><ul><li>b. $135,000 </li></ul></ul><ul><ul><li>c. $270,000 </li></ul></ul><ul><ul><li>d. $ 49,500 </li></ul></ul>
  31. 31. Quick Check  <ul><li>How much total cost will be allocated from ADMIN and BACS combined to the Accounting Department? </li></ul><ul><ul><li>a. $ 52,500 </li></ul></ul><ul><ul><li>b. $135,000 </li></ul></ul><ul><ul><li>c. $270,000 </li></ul></ul><ul><ul><li>d. $ 49,500 </li></ul></ul>$90,000 × 18 18 + 102 = $13,500
  32. 32. Quick Check Data <ul><li>Allocation bases: </li></ul><ul><ul><li>Business school administration costs (ADMIN): Number of employees </li></ul></ul><ul><ul><li>Business administration computer services (BACS): Number of personal computers </li></ul></ul>The step method of allocation is used.
  33. 33. Quick Check  <ul><li>How much total cost will be allocated from ADMIN and BACS combined to the Accounting Department? </li></ul><ul><ul><li>a. $35,250 </li></ul></ul><ul><ul><li>b. $49,072 </li></ul></ul><ul><ul><li>c. $18,000 </li></ul></ul><ul><ul><li>d. $26,333 </li></ul></ul>
  34. 34. <ul><li>How much total cost will be allocated from ADMIN and BACS combined to the Accounting Department? </li></ul><ul><ul><li>a. $35,250 </li></ul></ul><ul><ul><li>b. $49,072 </li></ul></ul><ul><ul><li>c. $18,000 </li></ul></ul><ul><ul><li>d. $26,333 </li></ul></ul>Quick Check 
  35. 35. Allocating Costs by Behavior When possible, variable and fixed service department costs should be allocated separately.
  36. 36. Allocating Costs by Behavior Variable service department costs should be allocated to consuming departments according to the activity causing incurrence of the cost.
  37. 37. 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.
  38. 38. Allocating Costs by Behavior Budgeted variable and fixed service department costs should be allocated to operating departments.
  39. 39. 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.
  40. 40. 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.
  41. 41. 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.
  42. 42. SimCo: Beginning of the Year Hours planned
  43. 43. SimCo: Beginning of the Year Percent of peak-period capacity. Hours planned
  44. 44. SimCo: End of the Year Hours used
  45. 45. SimCo: End of the Year Percent of peak-period capacity. Hours used
  46. 46. 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.
  47. 47. 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.
  48. 48. 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:
  49. 49. Quick Check  <ul><li>How much ambulance service cost will be allocated to Mercy Hospital at the beginning of the year? </li></ul><ul><ul><li>a. $117,000 </li></ul></ul><ul><ul><li>b. $254,400 </li></ul></ul><ul><ul><li>c. $114,480 </li></ul></ul><ul><ul><li>d. $119,250 </li></ul></ul>
  50. 50. <ul><li>How much ambulance service cost will be allocated to Mercy Hospital at the beginning of the year? </li></ul><ul><ul><li>a. $117,000 </li></ul></ul><ul><ul><li>b. $254,400 </li></ul></ul><ul><ul><li>c. $114,480 </li></ul></ul><ul><ul><li>d. $119,250 </li></ul></ul>Quick Check 
  51. 51. Quick Check  <ul><li>How much ambulance service cost will be allocated to Mercy Hospital at the end of the year? </li></ul><ul><ul><li>a. $114,000 </li></ul></ul><ul><ul><li>b. $118,800 </li></ul></ul><ul><ul><li>c. $110,400 </li></ul></ul><ul><ul><li>d. $121,200 </li></ul></ul>
  52. 52. <ul><li>How much ambulance service cost will be allocated to Mercy Hospital at the end of the year? </li></ul><ul><ul><li>a. $114,000 </li></ul></ul><ul><ul><li>b. $118,800 </li></ul></ul><ul><ul><li>c. $110,400 </li></ul></ul><ul><ul><li>d. $121,200 </li></ul></ul>Quick Check 
  53. 53. 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
  54. 54. 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.
  55. 55. 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.
  56. 56. 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.
  57. 57. 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).
  58. 58. Kolby Products: An Example $120,000 ÷ 3,000,000 miles $120,000 ÷ 2,400,000 miles
  59. 59. 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.
  60. 60. 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.
  61. 61. 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.
  62. 62. 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.
  63. 63. 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
  64. 64. 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
  65. 65. End of Chapter 15

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