Prepared by Diane Tanner University of North Florida Support Cost Allocation ACG 4361

Support Costs 2  Nature  Service costs that are incurred in activities consumed by both production and other service departments but not directly associated with production  Incurred by cost centers  Incur only costs and do not generate revenue  Such as payroll, IT, maintenance, accounting, etc.  Cost should be allocated to production departments that use the services so that the cost can ultimately be passed on to the products produced

Nature of Departments Support (service) departments  Cost centers  Provide support to other support departments and production departments 3 AccountingMaintenance PackagingShapingCuttingMaintenanceAccounting Production (operating) departments  Profit or cost centers  Add value to cost objects  Responsible for creating products or providing services to customers, i.e., Cost object generators

Stage 1 Cost Allocation Stage 1. Allocate Support Costs to Cost Pools Stage 2. Allocate Production Cost Pools to Cost Objects Support Department #2 Support Department #1 Support Department #3 Direct and Indirect Costs Production Department #1 Production Department #2 Cost Object A Cost Object B

Why Allocate Support Costs? 5 Without services provided, a manufacturing facility could not function. Purposes 1.To provide more accurate product cost information. Recognizes that services constitute an input in the production process. 2.To improve decisions about resource utilization. When the cost of the support department resources are imposed on segment managers, managers are encouraged to use these resources efficiently. 3.To ration limited resources. When ‘charged’ with using costs, production departments often use less than if the resource were “free”.

Measuring Support Cost Allocations  Can be allocated based on actual rates or budgeted rates  Variable costs  Best to allocate based on actual usage  Actual rates ensure that all support department costs are allocated  Fixed costs  Budgeted rates allow managers better planning insight  Amount to be allocated is known in advance  Budgeted rates provide support department managers incentives to control costs fixed

Methods of Allocating Costs of Multiple Support Departments 7 Direct MethodStep-Down Method Reciprocal Method Allocates support department costs to Production departments only Some support departments and to production departments All support and production departments Fails to recognize that support departments provide services to all other support departments Partially recognizes the mutual services provided among all support departments Fully recognizes the mutual services provided among all support departments

The Big Picture 8 Ultimately, some costs that are initially thought of as period costs become product costs when merged with the production costs of the respective cost objects.  Managers of support departments are held responsible for controllable costs in their department  Total costs remain the same as before allocation  After allocation, a production department will contain two overhead components:  Overhead directly associated with the production department  Overhead allocated to the production department from support departments

9 The End