Chapter 10 Service Department and Joint Cost Allocation

10-2 Learning Objectives 4.Allocate service department costs using the reciprocal method. 2.Allocate service department costs using the direct method. 3.Allocate service department costs using the step method. 5.Explain why joint costs are allocated. 1.Explain why service costs are allocated. 6.Allocate joint costs using the net realizable value method. 7.Allocate joint costs using the physical quantities method. 8.Explain how cost data are used in the sell-or-process-further decision. 9.Account for by-products. 10. (Appendix) Use spreadsheets to solve reciprocal cost allocation problems.

10-3 Department that uses the functions of service departments. Department that provides service to other subunits in the organization. Cost center whose costs are charged to other departments in the organization. Service Department Cost Allocation Service DepartmentUser Department Intermediate Cost Center Cost center, such as a production or marketing department, whose costs are not allocated to another cost center. Final Cost Center L.O. 1 Explain why service costs are allocated.

10-4 Service Department Cost Allocation Continued Product costing Cross-department monitoring

10-5 Carlyle Coal Company (CCC) Service Department Cost Allocation Continued Service Department: Information Systems (S1) Service and User Departments of Service Department: Administration (S2) User Department: Hilltop Mine (P1) User Department: Pacific Mine (P2)

10-6 Service Department Cost Allocation Continued Carlyle Coal Company Information Systems (S1) Total S1 Costs $800,000 Allocation Base: Computer Hours

10-7 Service Department Cost Allocation Continued Carlyle Coal Company Administration (S2) Total S2 Costs $5,000,000 Allocation Base: Employees

10-8 Direct Method L.O. 2 Allocate service department costs using the direct method. Charges costs of service departments to user departments without making allocations between or among service departments. Direct Method S1S2 P1P2

10-9 Cost Allocation: Direct Method Service Department Cost Allocation

10-10 Service Department Cost Allocation Cost Allocation: Direct Method Continued

10-11 Step Method L.O. 3 Allocate service department costs using the step method. Allocates some service department costs to other service departments. Once an allocation is made from a service department no further allocations are made back to that service department. Generally allocate in order of proportion of services provided to other service departments. S1S2 P1P2

10-12 Cost Allocation: Step Method Service Department Cost Allocation

10-13 Cost Allocation: Step Method Continued Service Department Cost Allocation k $5,800,000 of service department costs were ultimately allocated to production departments.

10-14 Reciprocal Method L.O. 4 Allocate service department costs using the reciprocal method. Recognizes all services provided by any service department, including services provided to other service departments. Reciprocal method accounts for cost flows among service departments providing services to each other. Requires a simultaneous equation solution. S1S2 P1P2

10-15 The Simultaneous Equation 1.Write the costs of each service department in equation form. Total Service Department Direct cost of the service department Cost allocated from other service departments 2.Solve equations simultaneously using matrix algebra. =+

10-16 Cost Allocation: Reciprocal Method S2=$5,000,000+$400, S2 = $6,000, S1 = $800, S22. S2 = $5,000, S1 S2=$5,000, $800, S2.90 S2=$5,400,000

10-17 Cost Allocation: Reciprocal Method Continued S1=$800, $6,000,000 S1= $2,000,000

10-18 Reciprocal Method: An Exampled Continued Service Department Cost Allocation

10-19 Reciprocal Method: An Exampled Continued Service Department Cost Allocation i $5,800,000 of service department costs were ultimately allocated to production departments.

10-20 Comparison of Direct, Step and Reciprocal Method

10-21 Joint Cost Joint Product Split-Off Point Cost of a manufacturing process with two or more outputs. Outputs from a common input and common production process. Stage of processing that separates two or more products. Joint Cost

10-22 Joint Cost Continued Joint Cost Flows Mining Costs: $270,000 Split-off Point Hi-Grade Coal: 15,000 units Sales Value $300,000 Lo-Grade Coal: 30,000 units Sales Value $450,000

10-23 Allocation of Joint Costs L.O. 5 Explain why joint costs are allocated. Evaluating executive performance Valuing products Net realizable value method Physical quantities method

10-24 Allocation of Joint Costs L.O. 6 Allocate joint costs using the net realizable value method. Net realizable value (NRV) Sales value of each product at the split-off point. Net realizable value method Allocates joint costs based on their net realizable value. Estimated net realizable value Sales price of a final product minus additional processing costs necessary to prepare a product for sale.

10-25 NRV Method: An Example Carlyle Coal Company Joint Cost Allocation NRV Method; no additional processing costs

10-26 NRV Method: An Example Continued Carlyle Coal Company Gross Margin Computations

10-27 Estimating NRV: An Example When no sales value exists for outputs at the split-off point, the Estimated NRV should be determined. Further Processing of Coal: Cost Flows Mining Costs: $270,000 Split-off Point Hi-Grade Coal: 15,000 units Sales Value $300,000 Mid-Grade Coal: 30,000 units Sales Value $550,000 $50,000 Processing costs

10-28 Estimating NRV: An Example Continued Carlyle Coal Company Gross Margin Computations Using NRV

10-29 Physical Quantities Method L.O. 7 Allocate joint costs using the physical quantities method. Joint cost allocation based on measurement of the volume, weight, or other physical measure of the joint products at the split-off point. Significant processing occurs between the split-off point and the first point of marketability. Product prices are not set by the market. Output product prices are volatile.

10-30 Physical Quantities Method: An Example Carlyle Coal Company Joint Cost Allocation Physical Quantities Method

10-31 Sell or Process Further L.O. 8 Explain how cost data are used in the sell-or-process-further decision. Suppose CCC can sell lo-grade coal for $450,000 at the split-off point or process it further to make mid-grade coal. Mid-grade coal would sell for $550,000 and additional processing costs would be $50,000. Additional revenue $100,000 Additional costs $50,000

10-32 Sell or Process Further Continued Carlyle Coal Company Sell or Process Further Differential Analysis $50,000 net gain from processing further

10-33By-products L.O. 9 Account for by-products. Outputs of joint production processes that are relatively minor in quantity or value. The net realizable value from sale of the by-product is deducted from the cost of the main product(s). The proceeds from sale of the by-product are treated as other revenue. Method 1Method 2

10-34 Method One: An Example Carlyle Coal Company By-Product

10-35 Method Two: An Example Carlyle Coal Company By-Product

10-36 Chapter 10