Copyright 1998 Dekker, Ltd. 1

Copyright 1998 Dekker, Ltd. 2

3 Two Stage Allocations Understand why the difference between production and service departments is important Understand allocation of service department costs to production departments Identify and use the two stages of cost allocations should know how conventional two-stage allocation methods often distort production costs use activity-based costing systems to estimate product costs assign selling and distribution costs to products Understand why the difference between production and service departments is important Understand allocation of service department costs to production departments Identify and use the two stages of cost allocations should know how conventional two-stage allocation methods often distort production costs use activity-based costing systems to estimate product costs assign selling and distribution costs to products

Copyright 1998 Dekker, Ltd. 4 Production Departments Those departments directly responsible for some of the work of converting raw materials into finished products Those departments directly responsible for some of the work of converting raw materials into finished products Examples of Production Departments Casting Stamping Machining Assembly Packing Examples of Production Departments Casting Stamping Machining Assembly Packing

Copyright 1998 Dekker, Ltd. 5 Service Departments Those departments performing activities that support production, but are not responsible for any of the conversion stages Examples of Service Departments Machine maintenance Machine setup Production scheduling Examples of Service Departments Machine maintenance Machine setup Production scheduling

Copyright 1998 Dekker, Ltd. 6 The Conventional, Two- Stage Allocation Method Stage 1: Indirect costs are identified with production and service departments. These costs are then allocated to production departments. Stage 1: Indirect costs are identified with production and service departments. These costs are then allocated to production departments.

Copyright 1998 Dekker, Ltd. 7 Stage 2: The costs that have been accumulated in production departments are assigned to individual products or jobs based on predetermined cost driver rates Stage 2: The costs that have been accumulated in production departments are assigned to individual products or jobs based on predetermined cost driver rates The Conventional, Two- Stage Allocation Method

Copyright 1998 Dekker, Ltd. 8 Stage 1: Step 1 Service Departments Production Departments $300$400$500 $50$200$100 Total Indirect Costs $1,  1996 Prentice Hall Business Publishing Management Accounting, 2nd ed., Atkinson, Banker, Kaplan, and Young

Copyright 1998 Dekker, Ltd. 9 Stage 1: Step 2 Service Departments Production Departments $425$550$575 $50 $200 $  1996 Prentice Hall Business Publishing Management Accounting, 2nd ed., Atkinson, Banker, Kaplan, and Young Allocation of Service Department Costs to Production Departments

Copyright 1998 Dekker, Ltd. 10 Stage 2: Allocation of Production Department Costs to Jobs and Products Production Departments-> $425$550$575 Job 1 $365 Job 2 $400 Job 3 $525 Job 4 $  1996 Prentice Hall Business Publishing Management Accounting, 2nd ed., Atkinson, Banker, Kaplan, and Young

Copyright 1998 Dekker, Ltd. 11 Distortions of Two- Stage Allocations Two-Stage Allocation results in distortion of allocated costs because it breaks the link between the cause for overhead costs and the basis for assignment of the costs

Copyright 1998 Dekker, Ltd. 12 Distortions of Two- Stage Allocations Traditional costs systems have not taken into account batch-related and product- sustaining costs when it comes to overhead allocation

Copyright 1998 Dekker, Ltd. 13 Applying the Concepts Exercise #1 Identify a cost driver for each of the following activities: Machine maintenance Machine setup Utilities Quality control Material ordering Production scheduling Factory depreciation Production supervision Exercise #1 Identify a cost driver for each of the following activities: Machine maintenance Machine setup Utilities Quality control Material ordering Production scheduling Factory depreciation Production supervision

Copyright 1998 Dekker, Ltd. 14 Applying the Concepts Exercise #1 Identify a cost driver for each of the following activities: Machine maintenance# of machine hours Machine setup# of setup hours Utilities# of kilowatt hours Quality control# of inspections Material ordering# of orders Production scheduling# of production runs Factory depreciation# of square feet Production supervisionDirect labor hours Exercise #1 Identify a cost driver for each of the following activities: Machine maintenance# of machine hours Machine setup# of setup hours Utilities# of kilowatt hours Quality control# of inspections Material ordering# of orders Production scheduling# of production runs Factory depreciation# of square feet Production supervisionDirect labor hours

Copyright 1998 Dekker, Ltd. 15 Applying the Concepts Exercise #2 Turn to page 282 and work Exercise Exercise #2 Turn to page 282 and work Exercise 6-22.

16 Activity-Based Costing Systems Costing systems based on cost drivers that link activities performed to products and allocate support activity costs directly to products using these cost drivers Costing systems based on cost drivers that link activities performed to products and allocate support activity costs directly to products using these cost drivers

Copyright 1998 Dekker, Ltd. 17 Overcome cost distortions resulting from two-stage systems Use the actual cost driver for each activity to assign costs directly to products Have changed the way many decision- makers think about management accounting Overcome cost distortions resulting from two-stage systems Use the actual cost driver for each activity to assign costs directly to products Have changed the way many decision- makers think about management accounting Activity-Based Costing Systems

Copyright 1998 Dekker, Ltd. 18 ABC Allocation Procedures Trace all overhead costs to activity cost pools Supervision: Casting $26,000 Depreciation: Assembly $9,000 Machine Setup $300,000 Supervision: Packing $23,  1996 Prentice Hall Business Publishing Management Accounting, 2nd ed., Atkinson, Banker, Kaplan, and Young

Copyright 1998 Dekker, Ltd. 19 ABC Allocation Procedures Determine Cost Drivers Supervision: Casting Casting setup hours Depreciation: Assembly Assembly machine-hours Machine Setup Total setup hours Supervision: Packing Packing direct labor hours 6-24  1996 Prentice Hall Business Publishing Management Accounting, 2nd ed., Atkinson, Banker, Kaplan, and Young

Copyright 1998 Dekker, Ltd. 20 ABC Allocation Procedures Determine Normal Level of Cost Driver Supervision: Casting 500 hours Depreciation: Assembly 9,000 hours Machine Setup 300 hours Supervision: Packing 6,000 hours 6-25  1996 Prentice Hall Business Publishing Management Accounting, 2nd ed., Atkinson, Banker, Kaplan, and Young

Copyright 1998 Dekker, Ltd. 21 ABC Allocation Procedures Determine Cost Driver Rates Supervision: Packing $23,600 6,000 hours Supervision: Casting $26, hours = $52/hour Depreciation: Assembly $9,000 9,000 hours = $1/hour Machine Setup $300, hours = $1,000/hour= $3.93/hour 6-26  1996 Prentice Hall Business Publishing Management Accounting, 2nd ed., Atkinson, Banker, Kaplan, and Young

Copyright 1998 Dekker, Ltd. 22 Allocate Costs to Jobs/Products on Basis of Level of Activity Supervision: Casting $26, hours = $52/hour Depreciation: Assembly $9,000 9,000 hours = $1/hour Machine Setup $300, hours = $1,000/hour Supervision: Packing $23,600 6,000 hours = $3.93/hour 6-27  1996 Prentice Hall Business Publishing Management Accounting, 2nd ed., Atkinson, Banker, Kaplan, and Young ABC Allocation Procedures

Copyright 1998 Dekker, Ltd. 23 Applying the Concepts Exercise #2 Turn to page 283 and work Problem Exercise #2 Turn to page 283 and work Problem 6-24.

Copyright 1998 Dekker, Ltd. 24