1. Managerial Accounting 2002e
Belverd E. Needles, Jr.
Susan Crosson
Multimedia Slides by:
Harry Hooper
Santa Fe Community College
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2. Chapter 14 Allocation of Internal Service Costs2

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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.
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4. 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.
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5. Internal Service Provider
OBJECTIVE 1
Discuss the allocation of service costs and its role in the management cycle. 5

6. 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.
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7. 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.
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8. 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
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9. Responsibility Centers and the Allocation of Service Costs
OBJECTIVE 2
Define the two kinds of responsibility
centers used in the allocation of service
costs.
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10. 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.
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11. Methods of Service Cost Allocation
OBJECTIVE 3
Use the direct method to assign service costs.
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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.
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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
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Direct Method
Service Centers A B C x y z
Revenue Centers
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15. The Step Method of Allocation
OBJECTIVE 4
Use the step method to assign service costs.
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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.
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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.
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18. Step Method A C B X Y Z Service Centers Revenue Centers Step 1 Step 2

19. 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.
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20. 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).
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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.
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22. Application of Overhead Rates
OBJECTIVE 6
Explain how service cost allocation relates to overhead rates.
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23. 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

24. 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.
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25. 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.
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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.
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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.