Managerial Accounting 2002e Belverd E. Needles, Jr. Susan Crosson - - - - - - - - - - - Multimedia Slides by: Harry Hooper Santa Fe Community College Copyright © by Houghton Miffin Company. All rights reserved.
Chapter 14 Allocation of Internal Service Costs 2
Copyright © by Houghton Miffin Company. All rights reserved. LEARNING OBJECTIVES Discuss the allocation of service costs and its role in the management cycle. Define the two kinds of responsibility centers used in the allocation of service costs. Use the direct method to assign service costs. Copyright © by Houghton Miffin Company. All rights reserved.
LEARNING OBJECTIVES (continued…) Use the step method to assign service costs. Describe other methods of service cost allocation, including the two-step method, the simultaneous equation method, the ability to pay method and the physical measures method. Explain how service cost allocation relates to overhead rates. Copyright © by Houghton Miffin Company. All rights reserved.
Internal Service Provider OBJECTIVE 1 Discuss the allocation of service costs and its role in the management cycle. 5
Internal Service Providers All organizations have departments that provide support for the main activities of the business. For long-term profitability, internal service providers’ costs must be included in the full cost of products and services. Copyright © by Houghton Miffin Company. All rights reserved.
Allocation of Common Service Costs Common costs may not have a direct relationship to the products or services produced by the business. Cost Allocation is used to shift costs from the internal service providers to the responsibility centers that generate revenue. When all costs have been allocated, full cost can be determined. Prices and overall profitability can be calculated. Copyright © by Houghton Miffin Company. All rights reserved.
Service Cost Allocation and the Management Cycle Planning – determine cost allocation methods and allocation bases Executing – assign service center costs to revenue centers Reviewing – evaluate profitability and review and revise allocation bases as needed Reporting – prepare and use cost allocation reports Copyright © by Houghton Miffin Company. All rights reserved.
Responsibility Centers and the Allocation of Service Costs OBJECTIVE 2 Define the two kinds of responsibility centers used in the allocation of service costs. Copyright © by Houghton Miffin Company. All rights reserved.
Responsibility Centers Revenue Centers – directly responsible for producing products or services sold to external buyers. Revenue centers also incur their own directly traceable costs. Service Centers – provide benefits to other responsibility centers (including other service centers). A cost driver is an activity that causes another center’s use of a service center. Copyright © by Houghton Miffin Company. All rights reserved.
Methods of Service Cost Allocation OBJECTIVE 3 Use the direct method to assign service costs. Copyright © by Houghton Miffin Company. All rights reserved.
Copyright © by Houghton Miffin Company. All rights reserved. Direct Method Step 1: Calculate allocation fractions. Step 2: Determine the dollar amount to assign to each revenue center. Step 3: Total the costs for each revenue center. Copyright © by Houghton Miffin Company. All rights reserved.
Copyright © by Houghton Miffin Company. All rights reserved. Direct Method Features: assigns service center costs to revenue centers only (not to other service centers) ignores reciprocal services easy and straightforward may not reflect revenue centers’ actual use of services Copyright © by Houghton Miffin Company. All rights reserved.
Copyright © by Houghton Miffin Company. All rights reserved. Direct Method Service Centers A B C x y z Revenue Centers Copyright © by Houghton Miffin Company. All rights reserved.
The Step Method of Allocation OBJECTIVE 4 Use the step method to assign service costs. Copyright © by Houghton Miffin Company. All rights reserved.
Copyright © by Houghton Miffin Company. All rights reserved. Step Method Step 1: Calculate the allocation fractions. Step 2: Determine the dollar amount to assign to each open service center and each revenue center. Step 3: Total the costs for each revenue center. Copyright © by Houghton Miffin Company. All rights reserved.
Copyright © by Houghton Miffin Company. All rights reserved. Step Method Features: assigns service center costs to both service and revenue centers based upon descending order of usage. requires a sequence of allocation steps. (Costs cannot be assigned back to a previous service center). recognizes that service centers also provide services to each other. may not accurately recognize full reciprocal usage of services. Copyright © by Houghton Miffin Company. All rights reserved.
Step Method A C B X Y Z Service Centers Revenue Centers Step 1 Step 2
Other Activity-Based Methods of Service Cost Allocation OBJECTIVE 5 Describe other methods of service cost allocation, including the ability to pay method, the simultaneous equation method, and the physical measures method. Copyright © by Houghton Miffin Company. All rights reserved.
Other Service Cost Allocation Methods Internal Billing – service departments may actually invoice other departments for their services. Two-step method – to fully recognize reciprocal services, first allocate costs between service departments only, with no sequencing. Then use the direct method to allocate costs. Simultaneous Equation Method – also fully recognizes reciprocal services using linear programming techniques (often complex). Copyright © by Houghton Miffin Company. All rights reserved.
Copyright © by Houghton Miffin Company. All rights reserved. Ability to Pay Method – charges most service costs to revenue centers with most revenue, not usage of the services. May not provide desirable motivation to successful center managers. Physical Measures Method – assigns service costs in proportion to the number of users, rather than the amount of usage. May result in unnecessary or excessive usage. Copyright © by Houghton Miffin Company. All rights reserved.
Application of Overhead Rates OBJECTIVE 6 Explain how service cost allocation relates to overhead rates. Copyright © by Houghton Miffin Company. All rights reserved.
Departmental Overhead Rates A single rate is used in each department. It combines assigned service center costs with directly traceable department overhead costs, based on the quantity of an activity-based cost driver. Overhead rate = Revenue Center Overhead + Assigned Service Costs Cost Driver Applied Overhead = Actual Quantity of Cost Driver x Overhead Rate
Activity-Based Costing Rates Multiple overhead rates can be developed for a single revenue center, based on multiple activities. Full cost of product or service can be determined to more accurately reflect actual usage of services and overhead and actual cost. Copyright © by Houghton Miffin Company. All rights reserved.
The True Cost of a Product or Service Long-term profitability depends on managing the full cost of products and services, not just direct costs. Allocating internal service costs requires judgment and many approaches are arbitrary. Most methods of cost allocation include improved decision-making information and better cost data. Copyright © by Houghton Miffin Company. All rights reserved.
Copyright © by Houghton Miffin Company. All rights reserved. OK, Let’s Review Discuss the allocation of service costs and its role in the management cycle. Define the two kinds of responsibility centers used in the allocation of service costs. Use the direct method to assign service costs. Copyright © by Houghton Miffin Company. All rights reserved.
Copyright © by Houghton Miffin Company. All rights reserved. And Finally… Use the step method to assign service costs. Describe other methods of service cost allocation, including the two-step method, the simultaneous equation method, the ability to pay method, and the physical measures method. Explain how service cost allocation relates to overhead rates. Copyright © by Houghton Miffin Company. All rights reserved.