7 -1 Support Department Cost Allocation CHAPTER

Describe the difference between support departments and producing departments. 2.Calculate single and multiple changing rates for a support department. 3.Allocate support-department costs to producing departments using the direct, sequential, and reciprocal methods. 4.Calculate departmental overhead rates. ObjectivesObjectives After studying this chapter, you should be able to:

7 -3 Types of Departments Producing departments are directly responsible for creating the products or services sold to customers.

7 -4 Types of Departments Supporting departments provide essential support services for producing departments. Maintenance, grounds, engineering, personnel, storage

Departmentalize the firm. 2.Classify each department as a support department or a producing department. 3.Trace all overhead costs in the firm to a support department or producing department. 4.Allocate supports department costs to the producing departments. Steps in Allocating Support Department Costs to Producing Departments ContinuedContinued

Calculate predetermined overhead rates for the producing departments. 6.Allocate overhead costs to the units of individual products through the predetermined overhead rates. Steps in Allocating Support Department Costs to Producing Departments

7 -7 Examples of Cost Drivers for Support Departments AccountingNumber of transactions Cafeteria Number of employees Engineering Number of change orders MaintenanceMachine hours; maintenance hours PayrollNumber of employees Personnel Number of employees, firings, layoffs, new hires Support Department Possible Driver Support Department Possible Driver

To obtain a mutually agreeable price. 2.To compute product-line profitability. 3.To predict the economic effects of planning and control. 4.To value inventory. 5.To motivate managers. Objectives of Allocation

7 -9 Note Objective 5: Allocations can be used to motivate managers.

7 -10 AND Fixed costs………………$26,190 Variable costs…..$0.023 per page

7 -11 Estimated usage (in pages) by the three producing departments is as follows: Audit Department94,500 Tax Department67,500 MAS Department108,000 Total270,000 Variable cost: 270,000 x $0.023 $ 6,210 Fixed cost 26,190 Total cost for 270,000 pages$32,400 Average cost ($32,400 ÷ 270,000)$0.12 per page A Single Charge Rate

7 -12 A Single Charge Rate Total Photocopying Department Charge Number of Pages Charge per Page Total Charges x= Audit Department92,000$0.12$11,040 Tax Department65, ,800 MAS Department115, ,800 Total272,000$32,640

7 -13 Multiple Charging Rates Peak Number of Pages Proportion of Peak Usage Total Fixed Costs Amount Allocated to Each Department Audit7, $26,190$ 5,238 Tax22, ,19014,928 MAS 9, ,190 6,024 Total39,375$26,190

7 -14 Multiple Charging Rates Number of Pages x $0.023 Fixed Cost Allocation Total Charges Audit department$2,116$ 5,238$ 7,354 Tax department1,49514,92816,423 MAS department 2,645 6,024 8,669 Total$6,256$26,190$32,446 + =

7 -15 Budgeted Versus Actual Usage When we allocate support- department costs to the producing departments, should we allocate actual or budgeted costs?

7 -16 Budgeted Versus Actual Usage Budgeted costs.

7 -17 Budgeted Versus Actual Usage A general principle of performance evaluation is that managers should not be held responsible for costs or activities over which they have no control.

7 -18 Use of Budgeted Data for Product Costing Number of Copies Total Rate Allocated Charges Audit Department94,500$0.12$11,340 Tax Department67, ,100 MAS Department108, ,960 Total270,000$32,400 x=

7 -19 Use of Actual Data for Performance Evaluation Purposes Number of Copies Total Rate Allocated Charges Audit department92,000$0.12$11,040 Tax department65, ,800 MAS department115, ,800 Total272,000$32,640 x=

7 -20 Choosing A Service Department Cost Allocation Method The three methods for allocating service department costs to producing departments are:  The Direct Method  The Sequential Method  The Reciprocal Method

7 -21 Support Departments Producing Departments Direct costs*$250,000$160,000$100,000$ 60,000 Normal activity: Kilowatt-hours ,000600,000200,000 Maintenance hours1, ,5004,500 * For a producing department, direct costs refer only to overhead costs that are directly traceable to the department. Data for Illustrating Allocation Methods Power Maintenance Grinding Assembly

7 -22 Direct Method of Allocation PowerMaintenance GrindingAssembly

7 -23 Direct Method of Allocation PowerMaintenance Grinding Assembly

7 -24 STEP 1—CALCULATE ALLOCATION RATIOS Grinding Assembly Grinding Assembly Power = 600,000 (600, ,000) ,000 (600, ,000) 0.25 Maintenance = 4,500 (4, ,500) ,500 (4, ,500) 0.50 Direct Method

7 -25 STEP 2—ALLOCATE SUPPORTS DEPARTMENT COSTS USING THE ALLOCATION RATIOS Power Maintenance Grading Assembly Power Maintenance Grading Assembly Support Departments Producing Departments Support Departments Producing Departments Direct costs$250,000 $160,000$100,000$ 60,000 Power-250, ,50062,500 Maintenance ,000 80,000 80,000 $ 0$ 0$367,500$202,500 a b a 0.75 x $250,000 = $187,500; 0.25 x $250,000 = $62, x $160,000 = $80,000 b Direct Method

7 -26 Sequential Method of Allocation STEP 1: Rank service departments Power 1 Maintenance 2

7 -27 Sequential Method of Allocation Power MaintenanceAssemblyGrinding STEP 2

7 -28 Sequential Method of Allocation Maintenance Assembly Grinding STEP 2

7 -29 STEP 1—CALCULATE ALLOCATION RATIOS Maint. Grinding Assembly Maint. Grinding Assembly Power = 200,000 (200, , ,000) ,000 (200, , ,000) 0.60 Sequential Method

7 -30 STEP 1—CALCULATE ALLOCATION RATIOS Maint. Grinding Assembly Maint. Grinding Assembly 4,500 (4, ,500) 0.50 Mainte- nance 4,500 (4, ,500) 0.50 = Sequential Method

7 -31 STEP 2—ALLOCATE SUPPORT DEPARTMENT COSTS USING THE ALLOCATION RATIOS Power Maintenance Grading Assembly Power Maintenance Grading Assembly Support Departments Producing Departments Support Departments Producing Departments Direct costs$250,000 $160,000$100,000$ 60,000 Power-250,00050,000150,00050,000 Maintenance , , ,000 $ 0$ 0$355,000$215,000 a b a 0.20 x $250,000 = $50,000; 0.60 x $250,000 = $150,000; 0.20 x $250,000 = $50, x $210,000 = $105,000 b Sequential Method

7 -32 The reciprocal method of allocation recognizes all interactions among support departments.

7 -33 Power Maintenance Grading Assembly Power Maintenance Grading Assembly Support Departments Producing Departments Support Departments Producing Departments Normal activity: Kilowatt-hours---200,000600,000200,000 Maintenance hours1, ,5004,500 Reciprocal Method Power Maintenance Grading Assembly Power Maintenance Grading Assembly Proportion of Output Used by Departments Proportion of Output Used by Departments Allocated ratios: Power Maintenance Direct costs:

7 -34 M = Direct costs + Share of Power’s costs M = $160,000 + $50, M 0.98M = $210,000 M = $214,286

7 -35 P = Direct cost + Share of Maintenance’s cost = $250, ($214,286)P =$250,000 + $21,429 P =$271,429 P

7 -36 ALLOCATE SUPPORT DEPARTMENT COSTS USING THE ALLOCATION RATIOS AND THE SUPPORT-DEPARTMENT COSTS FROM RECIPROCAL METHODS EQUATIONS Power Maintenance Grading Assembly Power Maintenance Grading Assembly Support Departments Producing Departments Support Departments Producing Departments Direct costs$250,000 $160,000$100,000$ 60,000 Power-271,42954,286162,85754,286 Maintenance 271, ,286 96,429 96,429 Total$ 0$ 0$359,286$210,715 from Slide 7-34 from Slide 7-35

7 -37 Direct Method Grinding Assembly Grinding Assembly Comparison of Support Department Cost Allocations Using the Direct, Sequential, and Reciprocal Methods Direct costs$100,000$ 60,000 Allocated from power187,50062,500 Allocated from maintenance 80,000 80,000 Total cost$367,500$202,500 Click on button to compare with sequential method Click on button to compare with reciprocal method Return to show Return to show

7 -38 Sequential Method Sequential Method Grinding Assembly Grinding Assembly Comparison of Support Department Cost Allocations Using the Direct, Sequential, and Reciprocal Methods Direct costs$100,000$ 60,000 Allocated from power150,00050,000 Allocated from maintenance 105, ,000 Total cost$355,000$215,000 Click on button to compare with direct method Click on button to compare with reciprocal method Return to show Return to show

7 -39 Reciprocal Method Grinding Assembly Grinding Assembly Comparison of Support Department Cost Allocations Using the Direct, Sequential, and Reciprocal Methods Direct costs$100,000$ 60,000 Allocated from power162,85754,286 Allocated from maintenance 96,429 96,429 Total cost$359,286$210,715 Click on button to compare with direct method Click on button to compare with sequential method Return to show Return to show

7 -40 Departmental Overhead Rates The overhead rate for the grinding department is computed as follows (assuming the normal level of activity is 71,000 MH): OH rate = $355,000  71,000 = $5 per MH The overhead rate for the assembly department is computed as follows (assuming the normal level of activity is 107,500 DLH): OH rate = $215,000  107,500 = $2 per DLH

7 -41 Product Unit Cost A product requires two machine hours of grinding per unit and one hour of assembly. Overhead cost assigned: 2 x $5$10 1 x $2 2 Total assigned$12

7 -42 The End Chapter Seven

7 -43