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Why allocate costs to departments? Three methods of allocation. Cost allocation issues.

4 & 12. Chapters. Service Department Costing: An Activity Approach. Overview. Why allocate costs to departments? Three methods of allocation. Cost allocation issues. Allocating Costs to Products. Product mix decisions e.g. valves or flow controllers Pricing decisions

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Why allocate costs to departments? Three methods of allocation. Cost allocation issues.

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  1. 4 & 12 Chapters Service Department Costing: An Activity Approach Overview • Why allocate costs to departments? • Three methods of allocation. • Cost allocation issues.

  2. Allocating Costs to Products • Product mix decisions • e.g. valves or flow controllers • Pricing decisions • Reimbursement requests • e.g. government contracts • Inventory valuation • reporting, insurance • Identification of inefficiencies or non-value added costs.

  3. Allocating Costs to Operating Units • Evaluate performance of operating unit or unit manager. • identify full cost of operations • including use of shared resources • Provide information for decision-making. • closing stores • marketing strategy Information Systems Machining

  4. Allocating Costs to Operating Units • Motivate managers. • discourage waste • encourage new approaches for increasing revenue or decreasing costs • Identify inefficiencies. • excessive corporate overhead • inefficient information systems department Information Systems Machining

  5. Information Systems Assembly ? ? Payroll Stamping Service Departments Operating Departments

  6. Example: Service Department Cost Allocation Support DepartmentAllocation Base Information systems Processing hours Payroll No. of employees InfoPayrollStampingAssmbly Budget overhead $9,500 $5,600 $38,500 $27,900 Processing hrs. 20 5 8 12 No. of employees 2 1 15 20

  7. Direct Allocation • Support costs are allocated to operating departments only. • In determining allocation rates ignore the usage of the support departments.

  8. Direct Allocation Support Operating Info Systems Payroll Stamping Assmbly Total Before alloc Allocation Info Syst Payroll After alloc $ 9,500 $ 5,600 $ 38,500 $ 27,900 $ 81,500 (9,500) (5,600) Proc. hrs. 20 5 8 12 # employ 2 1 15 20

  9. Step-Down Allocation • Find the support department with the most service to the other support departments. $9,500 * 5/25 = $1,900 $5,600 * 2/37 = $303 OR • Allocate to both operating and support departments (based on usage of each.) • One step at a time; never look back.

  10. Step-Down Allocation Support Operating Info Systems Payroll Stamping Assmbly Total Before alloc Allocation Info Syst Payroll After alloc $ 9,500 $ 5,600 $ 38,500 $ 27,900 $ 81,500 (9,500) Proc. hrs. 20 5 8 12 # employ 2 1 15 20

  11. Reciprocal Allocation • Find the total (reciprocated) cost of each service department using a system of equations. • Define variables for the total cost of each service department: I = total cost of info systems P = total cost of payroll

  12. Processing hours in every department except Information Systems: Employees in every department except Payroll: Payroll 5 Stamping 8 Assembly 12 Total 25 Info. Systems 2 Stamping 15 Assembly 20 Total 37 • Set-up a system of equations: I = 9,500 + ( 2/37 ) * P P = 5,600 + ( 5/25 ) * I

  13. Solve the system of equations: I = 9,500 + ( 2/37 ) * P P = 5,600 + ( 5/25 ) * I • Allocate reciprocated costs to all operating and service departments.

  14. Reciprocal Allocation Support Operating Info Systems Payroll Stamping Assmbly Total Before alloc Allocation Info Syst Payroll After alloc $ 9,500 $ 5,600 $ 38,500 $ 27,900 $ 81,500 (9,910) (7,582) Proc. hrs. 20 5 8 12 # employ 2 1 15 20

  15. Cost Allocation Issues Cost Allocation Bases • Cause and effect Processing hours Info. Systems Costs • Benefits received • payroll dept costs : number of employees • corporate advertising: sales • Fairness • Ability to bear

  16. Actual or Projected Usage? Actual or Budgeted Costs?

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