ch14 cost allocations additional

Copyright © 2007 Pearson Education Canada Inc.

Cost Allocation

Chapter 14

14-1


Purposes of Cost Allocation

Provide information for economic decisions

Motivate managers and other employees Justify costs or compute reimbursement

amounts Measure income and assets for reporting

to tax authorities

14-2


Six-Function Value Chain

Research &

DevelopmentDistributionMarketingProductionDesign

Customer Service

TIME

Traditional Life Cycle approach may not yield the costs necessary to meet the four-purpose criteria for cost allocation

Costs necessary for decision making may pull costs from some or all of these six functions

14-3


Criteria for Cost-Allocation Decisions Cause and Effect

Variables are identified that cause resources to be consumed

Most credible to operating managers Integral part of ABC

Benefits Received The beneficiaries of the outputs of the cost

object are charged with costs in proportion to the benefits received

14-4


Criteria for Cost-Allocation Decisions

Fairness (Equity) The basis cited for establishing a price satisfactory

to the government, customers and suppliers Cost allocation here is viewed as a “reasonable” or “fair”

means of establishing a selling price

Ability to Bear Costs are allocated in proportion to the cost

object’s ability to bear them Generally, larger or more profitable objects receive

proportionally more of the allocated costs

14-5


Supporting Departments and Operating Departments

Supporting (Service) Department Provides the services that assist

other internal departments in the organization

Operating (Production) Department Directly adds value to a product or

service

14-6


Methods to Allocate Support Department Costs

Single-Rate Method Dual-Rate Method

14-7


Single-Rate Method

Pools all costs into one cost pool and allocates them to cost objects using the same rate per unit of the single allocation base No distinction is made between fixed and

variable costs in this method

Total Costs (all pools added together)

Total Allocation base

14-8


Dual-Rate Method Classifies costs within each cost pool into two

typical segments: a variable cost pool a fixed cost pool.

Each pool uses a different cost-allocation base

Total Fixed Costs__Total Allocation base

Total Variable Costs Total Allocation base

14-9


Allocation Method Tradeoffs

Single-rate method Simple to implement, but treats fixed costs

in a manner similar to variable costs Dual-rate method

Treats fixed and variable costs more realistically, but is more complex to implement

14-10


Allocation Bases Under either method, allocation of support

costs can be based on one of the three following scenarios:

1. Budgeted overhead rate and budgeted hours2. Budgeted overhead rate and actual hours3. Actual overhead rate and actual hours

Choosing between actual and budgeted rates: Budgeted is known at the beginning of the period Actual will not be known with certainty until the

end of the period

14-11


FirstService department costs are allocated to user departmentsService

Department(Computer)

Service Department(Accounting)

Service Department

(Maintenance)

UserDepartment(Assembly)

UserDepartment(Machining)

Product

Stages of Cost AllocationSecondUser department costs, plusallocated service departmentcosts, are applied to products

14-12


Methods of Allocating Support Costs to Production Departments

1. Direct

2. Step-Down

3. Reciprocal

14-13


Direct Method

Allocates support costs to only the Operating Departments

No interaction between Support Departments prior to allocation

14-14


Direct Method

Manufacturing

Information Systems

Accounting

Packaging

Support Departments Production Departments

14-15


Direct Method Example

Service Department Allocation Base

Maintenance Budgeted labour hoursInformation system Budgeted computer hours

Maintenance Info Systems Machining Assembly

Departmental costs

before allocation 600,000$ 116,000$ 400,000$ 200,000$

Budgeted labour hours 1,600 2,400 4,000

Percentage 3/8 5/8

Budgeted computer hours 200 1,600 200

Percentage 8/9 1/9

14-16


Plant Maintenance

$600,000

Information Systems$116,000

MachineryDepartment$400,000

Plus allocated$328,111

AssemblyDepartment$200,000

Plus allocated $387,889

Products

Direct Approach to Cost Allocation

$225,000

$375.000

$103,111

$12,889

$728,111 will be allocated in total to products


14-17


Direct MethodService Departments Production Departments

Maintenance Info systems Machining Assembly

Departmental costs


Maintenence allocation ? ? ? ?

Info systems allocation ? ? ? ?

Total after allocation ? ? ? ?

14-18


Direct Method

Service Departments Production Departments


Departmental costs


Maintenence allocation (600,000) 225,000 ?



$600,000 ×2,400

2,400 + 4,000 = $225,000

Allocation base: budgeted labour hours 14-19


Direct Method Service Departments Production Departments


Departmental costs


Maintenence allocation (600,000) 225,000 375,000



$600,000 ×4,000

2,400 + 4,000= $375,000

Allocation base: Budgeted labour hours

14-20




Departmental costs


Maintenence allocation (600,000) 225,000 375,000

Info systems allocation (116,000) 103,111 ?

Total after allocation 728,111$ ?

Direct Method

$116,000 × 1,600

1,600 + 200 = $103,111

Allocation base: Budgeted computer hours14-21




Departmental costs


Maintenance allocation 3/8,5/8 (600,000) - 225,000 375,000

Info systems allocation 8/9,1/9 (116,000) 103,111 12,889

Total after allocation $0 $0 728,111$ 587,889$

Direct Method

200

1,600 + 200 = $12,889$116,000 ×

Allocation base: Budgeted computer hours 14-22


Step-Down Method

Allocate support costs to other support departments and operating departments in a pre-determined (ranked) order which partially recognizes the mutual services provided among all support departments

One-way interaction between Support Departments prior to allocation

14-23


Step-Down Method

Manufacturing

Information Systems

Accounting

Packaging


14-24


Step-Down Method Example




Departmental costs



Percentage 2/10 3/10 5/10


Percentage 8/9 1/9

Same data used in the direct allocation method example

14-25


Plant Maintenance

$600,000


Plus $120,000





Products

Step-Down Approach to Cost Allocation

$180,000

$300.000

$209,778

$26,222



$120,000

14-26


Step-Down Allocation Method Example



Departmental costs





14-27





Departmental costs


Maintenence allocation (600,000) 120,000 ?



$600,000 ×1,600

1,600 +2,400 + 4,000 = $120,000

Allocation base: budgeted labour hours 14-28




Cafeteria Custodial Machining Assembly

Departmental costs


Maintenence allocation (600,000) 120,000 180,000 ?



Allocation base: budgeted labour hours

$600,000 × 2,400 1,600 +2,400 + 4,000 = $180,000

14-29





Departmental costs


Maintenence allocation (600,000) 120,000 180,000 300,000



$600,000 ×4,000

1,600+2,400 + 4,000= $300,000

Allocation base: Budgeted labour hours

14-30




Departmental costs


Maintenence allocation (600,000) 120,000 180,000 300,000

Info systems allocation (236,000) 209,778 ?

Total after allocation 789,778$ ?


$236,000 × 1,600

1,600 + 200 = $209,778

Allocation base: Budgeted computer hours14-31




Departmental costs


Maintenance allocation 2/10,3/10,5/10 (600,000) 120,000 180,000 300,000

Info systems allocation 8/9,1/9 (236,000) 209,778 26,222



200

1,600 + 200 = $26,222$236,000 ×

Allocation base: Budgeted computer hours 14-32


Reciprocal Method

Allocates support department costs to operating departments by fully recognizing the mutual services provided among all support departments

Full two-way interaction between Support Departments prior to allocation

Utilization of simultaneous equations to obtain reciprocal costs

14-33


Reciprocal Method

Manufacturing

Information Systems

Accounting

Packaging


14-34


Reciprocal Method Example




Departmental costs



Percentage 20% 30% 50%


Percentage 10% 80% 10%

Same data used in the direct allocation method example

14-35


Plant Maintenance

$600,000 Plus $24,082


Plus $124,816





Products

Reciprocal Approach to Cost Allocation

$187,225

$312,041

$192,652

$24,082



$24,082$124,816

14-36


Reciprocal Method

The total cost of each service department is equal to:

Direct costs of that department

+ Costs allocated to that department

The Information systems Department receives: 1,600

1,600 + 2,400 + 4,000= of maintenance costs

210

The Maintenance Department receives:200

200 + 1,600 + 200 = of Information systems costs1

10

14-37


Reciprocal Method

PM = Total costs of Maintenance Department

IS = Total costs of Information systems Cafeteria Department

Express in linear equation form the relationships

PM = $ 600,000 + 0.1 IS

IS = $ 116,000 + 0.2 PM

14-38


Reciprocal Method

PM = $ 600,000 + 0.1 ISIS = $ 116,000 + 0.2 PM

Solve simultaneous equations by substitution

PM = $ 600,000 + 0.1 IS

PM = $ 600,000 + [0.1($ 116,000 + 0.2 PM)]

0.98PM = $ 611,600

PM = $ 624,082

IS = $ 116,000 + 0.2 ( $ 624,082)

IS = $ 240,816

14-39


Reciprocal Method



Departmental costs





14-40




Departmental costs


Maintenance allocation 20%,30%,50% (624,082) 124,816 187,225 312,041

Info systems allocation 10%,80%,10% 24,082 (240,816) 192,652 24,082


Reciprocal Method

Allocations based on % usage of service department resources as calculated in the data slide 14-35 and as noted above in the table

14-41


Comparison of Methods

Totals after allocation

Machining Assembly

Method Department Department

Direct 728,111$ 587,889$

Step down 789,778 526,222

Reciprocal 779,877 536,123

14-42


Choosing Between Methods

Reciprocal is the most precise Direct and Step-Down are simple to apply

and understand Direct Method is widely used and the

simplest Often not a significant difference between

methods to justify additional cost to implement costlier analysis

14-43


Common Costs

The cost of operating a facility, activity, or like cost object that is shared by two or more users

14-44


Methods of Allocating Common Costs

Stand-Alone Cost Allocation Method

Incremental Cost Allocation Method

14-45


Stand-Alone Cost Allocation Method

Uses information pertaining to each user of a cost object as a separate entity to determine the cost-allocation weights Individual costs are added together and

Allocated on the basis of each user’s percentage of the total of the individual stand-alone costs

14-46


Incremental Cost-Allocation Method Ranks the individual users of a cost object in the order

of users most responsible for a common cost and then uses this ranking to allocate the cost among the users

The first ranked user is the Primary User and is allocated costs up to the costs of the primary user as a stand-alone user (typically gets the highest allocation of the common costs)

The second ranked user is the First Incremental User and is allocated the additional cost that arises from two users rather than one

Subsequent users handled in the same manner as the second ranked user

14-47


Cost Allocations and Contracting The government reimburses most contractors

in either of two main ways:1. The contractor is paid a set price without analysis

of actual contract cost data

2. The contractor is paid after an analysis of actual contract cost data. In some cases, the contract will state that the reimbursement amount is based on actual allowable costs plus a fixed fee (cost-plus contract)

14-48


Common Cost Example Data Winnipeg-Halifax round trip airfare $1,200 Winnipeg-Montreal round trip airfare $800 Winnipeg-Montreal-Halifax airfare $1,500

Common cost $1,500 to be allocated between two potential employers

Halifax Montreal

14-49


Stand-Alone Cost Allocation

$1,200

$1,200 + $800

X $1,500 = 0.60 x $1,500 = $900

Halifax Employer

Montreal Employer

$800$1,200 + $800

X $1,500 = 0.40 x $1,500 = $600

Information about the stand alone return airfares are used to determine the allocation weights

14-50


Incremental-Cost Allocation

One user viewed as primary and others as secondary

Party Costs Allocated Costs remaining to be

Allocated to Other Parties

Halifax (primary) $1,200 $300($1,500 - $1,200)

Montreal (incremental) 300 0

14-51

ch14 cost allocations additional

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