COST MANAGEMENT Accounting & Control Hansen▪Mowen▪Guan COPYRIGHT © 2009 South-Western Publishing, a division of Cengage Learning. Cengage Learning and South-Western are trademarks used herein under license. 1 Chapter 7 Allocating Costs of Support Departments and Joint Products

2 Study Objectives 1.Describe the difference between support departments and producing departments. 2.Calculate charging rates, and distinguish between single and dual charging rates. 3.Allocate support center costs to producing departments using the direct method, the sequential method, and the reciprocal method. 4.Calculate departmental overhead rates. 5.Identify the characteristics of the joint production process, and allocate joint costs to products.

3 An Overview of Cost Allocation Allocation is dividing a pool of costs and assigning those costs to subunits The cost objects must be determined Cost objects are usually departments –Producing: creating products sold to customers –Support: provide essential services for producing departments

4 Departmentalization: Manufacturing Firm

5 Departmentalization: Service Firm

6 Allocating Support Department Costs to Producing Departments Departmentalize the firm Classify each department as support or producing Trace all overhead costs in the firm to the appropriate department Allocate support department costs to producing departments Calculate predetermined overhead rate for producing departments Allocate overhead to units produced Steps:

7 An Overview of Cost Allocation

8 Allocating One Department’s Costs to Another Department The costs of a support department are often allocated through the use of a charging rate. Major factors of rate selection: –Choice of single or dual rate –Use of budgeted or actual support department costs.

9 Allocating One Department’s Costs to Another Department Developing a fixed rate –Determine budgeted fixed costs –Compute allocation ratio –Allocate Developing the variable rate –Depends on the costs that change as the activity driver changes Dual rate: Fixed rate and a variable rate

10 Allocating One Department’s Costs to Another Department When allocating support department costs, should actual or budgeted costs be allocated? Answer: Budgeted – to prevent the transfer of efficiencies or inefficiencies from one department to another.

11 Allocating One Department’s Costs to Another Department

12 Allocating One Department’s Costs to Another Department

13 Choosing a Support Department Cost Allocation Method Direct method –Costs are allocated only to producing departments Sequential (step) method –Costs allocations are performed in a step- down fashion, using predetermined ranking procedures (e.g., degree of support) Reciprocal method –Recognizes interactions of support departments prior to allocation to producing departments

14 Choosing a Support Department Cost Allocation Method

15 Direct allocation Allocate Power Dept costs based on kilowatt- hours: Grinding Assembly Grinding Assembly Allocate Maintenance Dept costs based on maintenance-hours:

16 Direct allocation

17 Sequential allocation Rank support departments by their direct costs Allocate –First support department’s direct cost to all other support departments and producing departments –Next support department’s costs (direct + previously allocated) to subsequent support and producing –Etc. Once a support department’s costs are allocated it never receives a subsequent allocation

18 Sequential allocation Step 1: Allocate Power Dept costs based on kilowatt-hours: To Maintenance To Grinding To Assembly

19 Sequential allocation Step 2: Allocate Maintenance Dept costs (direct + allocated) based on maintenance-hours: To Grinding Costs to allocate: $160,000 direct + $50,000 allocated = $210,000 To Assembly

20 Sequential allocation

21 Reciprocal allocation

22 Reciprocal allocation Utilize a series of simultaneous linear equations

23 Reciprocal allocation Utilize a series of simultaneous linear equations

24 Reciprocal allocation Utilize a series of simultaneous linear equations

25 Reciprocal allocation

26 Choosing a Support Department Cost Allocation Method

27 Departmental Overhead Rates and Product Costing After allocating all support service costs to producing departments, an overhead rate is calculated for each department

28 Departmental Overhead Rates and Product Costing A product cost can now be determined: Direct materials +Direct labor +Assigned overhead Product cost

29 Accounting for Joint Production Processes Joint products are two or more products produced simultaneously by the same process up to a “split-off” point. –The split-off point is the point at which the joint products become separate and identifiable. Separable costs are easily traced to individual products and offer no particular problem.

30 Accounting for Joint Production Processes

31 Accounting for Joint Production Processes

32 Accounting for Joint Production Processes The distinction between joint and by- products rests solely on the relative importance of their sales value. A by-product is a secondary product recovered in the course of manufacturing a primary product. –Joint costs are not typically allocated –Sales revenue is classified as “other income” –Post-split-off processing costs are deducted from sales revenue

33 Joint Cost Allocation Methods Physical Units Method –Presumes that each unit of the final product costs as much to produce as any other Weighted Average Method –Applies weight factors to reflect differing materials, complexity, time, etc.

34 A sawmill processes logs into four grades of lumber and incurs total joint costs of $186,000: Joint Cost Allocation: Physical Units Method

35 A peach canning factory purchases $5,000 of peaches and grades and cans them by quality. Joint Cost Allocation: Weighted Average Method

36 Joint Cost Allocation Methods Sales-Value-at-Split-Off-Method –Allocates joint cost based on each product’s proportionate share of sales value at split-off Net Realizable Value Method –Allocates joint cost based on hypothetical market price (eventual market value minus processing costs beyond split-off) Constant Gross Margin Percentage Method –Allocates joint costs such that the gross margin is the same for each product

37 A sawmill processes logs into four grades of lumber and incurs total joint costs of $186,000: Joint Cost Allocation: Sales-Value-at-Split-Off Method

38 Joint Cost Allocation: Net Realizable Value Method A company manufactures two products, Alpha and Beta, from a joint process. One production run costs $5,750 and results in 1,000 gallons of Alpha and 3,000 gallons of Beta. The separable cost for Alpha is $1 per gallon and for Beta is $2 per gallon.

39 Joint Cost Allocation: Constant Gross Margin Method Determine gross margin percentage Joint cost allocation

COST MANAGEMENT Accounting & Control Hansen▪Mowen▪Guan COPYRIGHT © 2009 South-Western Publishing, a division of Cengage Learning. Cengage Learning and South-Western are trademarks used herein under license. 40 End Chapter 7