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AGUS SISWANDI

01153056

MANAGEMENT ACCOUNTING

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Chapter Seven

Support DepartmentCost Allocation

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Learning Objectives

Describe the difference between support departments and producing departments.

Calculate single charging rates for a support department.

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Learning Objectives (continued)

Allocate support-department costs to producing departments using the direct, sequential, and reciprocal methods.

Calculate departmental overhead rates.

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Support and Producing Departments

Support departments are units within an organization that provide essential support services for producing departments.

Examples: maintenance, grounds, engineering, housekeeping, personnel, and stores

Producing departments are units within an organization that are directly responsible for creating the products or services sold to customers.

Examples: Services: auditing, tax, management advisory Manufacturing: grinding and assembly

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Definitions

Mutually beneficial costs, which occur when the same resource is used in the output of two or more services or products, are common costs.

Example: security guard wages at a factory

Causal factors are variables or activities within a producing department that provoke the incurrence of service costs.

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Steps in Allocating Support Department Costs to Producing Departments

1. Departmentalize the firm.

2. Classify each department as a support or a producing department.

3. Trace all overhead costs in the firm to a support or producing department.

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Steps in Allocating Support Department Costs to Producing Departments

4. Allocate support-department costs to the producing departments.

5. Calculate predetermined overhead rates for producing departments.

6. Allocate overhead costs to the units of individual products through the predetermined overhead rates.

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Objectives

Objectives of Allocation

To obtain a mutually agreeable price.

To compute product-line profitability.

To predict the economic effects of planning and control.

To value inventory.

To motivate managers.

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Examples of Cost Drivers forSupport Departments

Accounting Number of transactions

Cafeteria Number of employees

Engineering Number of change orders

Maintenance Machine hours

Payroll Number of employees

Personnel Number of new hires

Support Department Possible Driver

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A Single Charging Rate Example A firm developed an in-house photocopying department to

serve its three producing departments (audit, tax, and management advisory systems or MAS).

The costs of the photocopying department include fixed costs of $26,190 per year and variable costs of $0.023 per page copied.

Estimated usage in pages by the three producing departments is as follows:

Audit department 94,500

Tax department 67,500

MAS department 108,000

Total 270,000

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A Single Charging Rate (continued)

Total costs = $26,190 + (270,000 x $0.023) = $32,400

Overhead rate = $32,400 270,000 = $0.12 per page

Suppose the actual usage per department is:

Audit department 92,000Tax department 65,000MAS 115,000

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A Single Charging Rate (continued)

The total photocopying department charges would be as shown:

Total# of Pages OH rate Charges

Audit 92,000 $0.12 $11,040

Tax 65,000 $0.12 7,800

MAS 115,000 $0.12 13,800

Total 272,000 $32,640

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Budgeted Versus Actual Usage

When we allocate support-department costs to the producing departments, should we allocate actual or budgeted costs?

Budgeted costs

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Budgeted Versus Actual Usage (continued)

There are two basic reasons for allocating support-department costs.

1. To calculate unit costs

2. For performance evaluations

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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

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Service Department AllocationAn Example

Support Departments Producing Departments

Power Maint. Grinding Assembly

Direct Costs* $250,000 $160,000 $100,000 $ 60,000

Normal Activity:

Kilowatt-hours ----- 200,000 600,000 200,000

Maintenance hours 1,000 ----- 4,500 4,500

*For a producing department, direct costs refer only to overhead costs that are directly traceable to the department.

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Service Department AllocationDirect Method

Support Departments Producing Departments

Power Maint. Grinding Assembly

Direct Costs $250,000 $160,000 $100,000 $ 60,000

Power (250,000 ) -------- 187,500 62,500

Maintenance -------- (160,000 ) 80,000 80,000

Total $ 0 $ 0 $367,500 $202,500

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Service Department AllocationSequential Method

Support Departments Producing Departments

Power Maint. Grinding Assembly

Direct Costs $250,000 $160,000 $100,000 $ 60,000

Power (250,000 ) 50,000 150,000 50,000

Maintenance --- (210,000 ) 105,000 105,000

Total $ 0 $ 0 $355,000 $215,000

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Reciprocal Method

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

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Reciprocal Method (continued)

Support Departments Producing Departments

Power Maint. Grinding Assembly

Direct Costs:

Fixed $200,000 $100,000 $ 80,000 $50,000

Variable 50,000 60,000 20,000 10,000

Total $250,000 $160,000 $100,000 $60,000

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Proportion of Output Used by

Power Maint. Grinding Assembly

Allocation Ratios:

Power --- 0.20 0.60 0.20

Maintenance 0.10 --- 0.45 0.45

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Reciprocal Method (continued)

The cost equation for each support department can be expressed as follows:

P = Direct costs + Share of Maintenance’s cost

P = $250,000 + 0.1(M)

M = Direct costs + Share of Power’s costs

M = $160,000 + 0.2P

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Reciprocal Method (continued)

Substituting the Power equation into the Maintenance equation, we get:

M = $160,000 + 0.2 ($250,000 + 0.1M)

M = $160,000 + $50,000 + 0.02M

0.98M = $210,000

M = $214,286

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Reciprocal Method (continued)

Substituting the value for M into the Power equation we get:

P = $250,000 + 0.1 ($214,286)

P = $250,000 + $21,429

P = $271,429

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Reciprocal Method (continued)

Support Departments Producing Departments

Power Maint. Grinding Assembly

Direct Costs $250,000 $160,000 $100,000 $ 60,000

Power (271,429) 54,286 162,857 54,286

Maintenance 21,429 (214,286) 96,429 96,429

Total $ 0 $ 0 $359,286 $210,715

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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 = $359,286 71,000 = $5.06 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 = $210,715 107,500 = $1.96 per DLH

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End of Chapter 7