Copyright © 2013 Nelson Education Ltd. PowerPoint Presentations for Cornerstones of Cost Accounting First Canadian Edition Adapted by George Gekas Ryerson University

ALLOCATING COSTS OF SUPPORT DEPARTMENTS AND JOINT PRODUCTS Copyright © 2013 Nelson Education Ltd.

7-3 An Overview of Cost Allocation Allocation A means of dividing a pool of costs and assigning those costs to various subunits Total cost is neither reduced or increased by allocation But … the amounts assigned to the subunits CAN be affected by the allocation procedure chosen First step: Determine what the cost objects are 1 Copyright © 2013 Nelson Education Ltd.

7-4 Usually the cost objects are departments Two types: Producing departments: Directly responsible for creating the products or services sold to customers Support departments: Provide essential services for producing departments 1 An Overview of Cost Allocation Copyright © 2013 Nelson Education Ltd.

7-5 1 An Overview of Cost Allocation Copyright © 2013 Nelson Education Ltd.

7-6 1 An Overview of Cost Allocation Copyright © 2013 Nelson Education Ltd.

7-7 An Overview of Cost Allocation 1 Copyright © 2013 Nelson Education Ltd.

Objectives of Allocation 1. To obtain a mutually agreeable price 2. To compute a product line profitability 3. To predict the economic effects of planning and control 4. To value inventory 5. To motivate managers 7-8 An Overview of Cost Allocation 1 Copyright © 2013 Nelson Education Ltd.

7-9 Single and Dual Allocation Rates Support department costs are often allocated to other departments through the use of a charging or allocation rate Major factors to consider: Single or dual charging rate Use of budgeted or actual support department costs 2 Copyright © 2013 Nelson Education Ltd.

7-10 Using a single rate is similar in concept to a plantwide overhead rate All support department costs are accumulated in the numerator and some measure of usage in the denominator Single rate = Fixed costs + Estimated variable costs Estimated usage Single and Dual Allocation Rates 2 Copyright © 2013 Nelson Education Ltd. See Cornerstone 7-1

7-11 Sometimes when using a single charging rate, it will mask the causal factors that lead to a support department’s total costs Some companies will develop a dual rate with a fixed component and a variable component The allocation of fixed costs follows a three step procedure: 1. Determination of budgeted fixed support service costs 2. Computation of the allocation ratio 3. Allocation Single and Dual Allocation Rates 2 Copyright © 2013 Nelson Education Ltd.

7-12 Question: 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 Single and Dual Allocation Rates 2 Copyright © 2013 Nelson Education Ltd.

7-13 Direct, Sequential, and Reciprocal Cost Allocation Methods Methods for Allocating Support Costs: Direct Method Simplest and most straightforward method All costs of the support departments are allocated directly to producing departments in proportion to each producing department’s usage of the service Does not allocate any support department costs to another support department, even if other support departments use the services of a support department 3 Copyright © 2013 Nelson Education Ltd. See Cornerstone 7-3

7-14 Allocation of Support Department Costs to Producing Departments Using the Direct Method Direct, Sequential, and Reciprocal Cost Allocation Methods 3 Copyright © 2013 Nelson Education Ltd.

7-15 Methods for Allocating Support Costs: Sequential Method Recognizes that interactions among the support departments do occur… but only partial interactions are considered Performed in a step-down fashion Direct, Sequential, and Reciprocal Cost Allocation Methods 3 Copyright © 2013 Nelson Education Ltd. See Cornerstone 7-4

7-16 Allocation of Support Department Costs to Producing Departments Using the Sequential Method Direct, Sequential, and Reciprocal Cost Allocation Methods 3 Copyright © 2013 Nelson Education Ltd.

7-17 Methods for Allocating Support Costs: Reciprocal Method Recognizes all interactions of support departments The usage of one support department by another is used to determine the total cost of each support department—after the equations are solved, the total costs of each support department are known. Total cost = Direct costs + Allocated costs Direct, Sequential, and Reciprocal Cost Allocation Methods 3 Copyright © 2013 Nelson Education Ltd.

7-18 Departmental Overhead Rates After allocating all support service costs to producing departments, an overhead rate is calculated for each department. Allocated service costs + Producing department overhead costs Measure of activity (direct labour hours, machine hours) 4 Copyright © 2013 Nelson Education Ltd. See Cornerstone 7-6

7-19 Departmental Overhead Rates The accuracy of product costs depends on the accuracy of the assignment of overhead costs A product cost is now determined by: Materials + Labour + Overhead Product Cost 4 Copyright © 2013 Nelson Education Ltd.

7-20 Accounting for Joint Production Processes Joint Products Two or more products produced simultaneously by the same process up to a “split-off” point Split-off Point The point at which the joint products become separate and identifiable Separable Costs Easily traced to individual products and offer no particular problem 5 Copyright © 2013 Nelson Education Ltd.

7-21 Accounting for Joint Production Processes 5 Copyright © 2013 Nelson Education Ltd.

7-22 Accounting for Joint Production Processes 5 Distinction between joint and by-products rests solely on the relative importance of their sales value By-product is a secondary product recovered in the course of manufacturing a primary product Copyright © 2013 Nelson Education Ltd.

7-23 Accounting for Joint Production Processes 5 Benefits Received Approaches Physical Units Method Weighted Average Method Allocation Based on Relative Market Value Sales-Value-at-Split-Off Method Net Realizable Value Method Copyright © 2013 Nelson Education Ltd.

7-24 Accounting for Joint Production Processes 5 Physical Units Method Joint costs distributed on the basis of a physical measure—like kilograms, tons, litres, board metres, atomic weight, or heat units Weighted Average Method Uses weighted factors (like amount of material used, time consumed) to distribute joint costs Copyright © 2013 Nelson Education Ltd. See Cornerstones 7-7 and 7-8

7-25 Accounting for Joint Production Processes 5 Sales-Value-at-Split-Off Method Allocates joint cost based on each product’s proportionate share of market value or sales value at the split-off point The higher the market value, the greater the share of joint cost charged against the product Net Realizable Value Method Used if no ready market price for the individual products at split-off point Useful when one or more products cannot be sold at the split-off point but must be processed further Copyright © 2013 Nelson Education Ltd. See Cornerstones 7-9 and 7-10

7-26 Accounting for Joint Production Processes 5 Constant Gross Margin Percentage Method Assigns all profit to the hypothetical market value Further processing costs are assumed to have no profit value even though they are critical to selling the products Copyright © 2013 Nelson Education Ltd. See Cornerstone 7-11

7-27 Accounting for Joint Production Processes 5 By-Products Products obtained from joint production processes that have relatively little sales value Two methods of accounting for by-product sales: Credit by-product revenue to “Other Income” or “Revenue from Sale of By-Product” Reduction of joint costs allocated to the main products by the amount of the by product revenue Copyright © 2013 Nelson Education Ltd.

7-28 End of Chapter 7