Cornerstones of Managerial Accounting 2e Chapter Fourteen Support Department Cost Allocation Mowen/Hansen Copyright © 2008 Thomson South-Western, a part of the Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license.

Producing Departments Directly responsible for creating the products or services sold to customers Examples: Grinding Assembly Use services of the support departments

Support Departments Provide essential support services for producing departments Examples: Maintenance Grounds Engineering Housekeeping Personnel Storage

Steps for Determining Product Costs by Using Predetermined Determined Overhead Rates Departmentalize the firm. Classify each department or a producing department. Trace all overhead costs in the firm to a support department or producing department. Assign support department costs to the producing departments using drivers that measure the consumption of support department services. Calculate predetermined overhead rates for producing departments. Assign overhead costs to the units of individual products using the predetermined overhead rates.

Drivers Activities that cause costs to be incurred Used to assign support department costs to producing departments Causal factors within a producing department that measure consumption of support service costs Using drivers results in: More accurate product costs Managers having better control over the consumption of support services

Objectives of Assigning Support Department Costs To obtain a mutually agreeable price If costs are not accurate, bids could be: Too high, causing a loss of potential business Too low, producing losses To compute product line profitability Need to be sure all products are profitable Managers are able to evaluate the mix of services offered

Objectives of Assigning Support Department Costs To predict the economic effects of planning and control To value inventory GAAP requires direct manufacturing costs and all indirect manufacturing costs be assigned to products To motivate managers Managers will use a service until the marginal benefit of the service equals its marginal cost

Single Charging Rate Used to assign support department costs to producing departments Calculated as Total expected service department cost divided by expected usage of all producing departments Note: support departments are not assigned costs from other support departments Rate is applied in one of two ways: Budgeted rate × Budgeted usage Budgeted rate × Actual usage

Budgeted Rate × Budgeted Usage Computed at beginning of the year Added to budgets of each producing department Serves two purposes: Enables a predetermined overhead rate to be computed for product costing Sets a benchmark for comparing actual performance with planned performance

Budgeted Rate × Actual Usage Computed at end of the year Provides the actual cost assigned to the producing departments Needed for comparing with planned performance

Multiple Charging Rates Support departments costs include: Variable Assigned on a per unit of service basis Fixed Considered capacity costs Initially based on peak usage of the producing departments Assigned based on proportion of planned peak usage

Allocation Methods Most companies have multiple support departments Support departments provide services to both producing departments and other support departments Three allocation methods: Direct method Sequential method Reciprocal method

Direct Method Ignores the interactions between support departments Allocates costs to producing departments only Simplest and most straightforward method Either single or dual-rate allocation: Single rate Total service costs assigned based on expected or normal usage Dual rate Variable service costs assigned based on expected or normal usage Fixed costs are assigned in proportion to the expected peak usage of the service

Sequential Method Recognizes the interactions between support departments Does not fully account for the interaction Allocation performed in a step-down fashion following a predetermined ranking procedure Costs of the support department providing the most service is allocated first All costs of support departments are allocated: Direct costs Costs allocated to it from other support departments

Reciprocal Method Recognizes all interactions between support departments Each support department’s costs are allocated to the: Producing departments Other support departments Complicated method that is not widely used Accomplished through a system of simultaneous linear equations

Departmental Overhead Rates Computed after all support department costs are allocated Costs to be allocated should include: Allocated support department costs Overhead costs that are directly traceable to the producing department Divide by a measure of activity Direct labor hours Machine hours