Today’s quote

1. Today’s quote • Any idiot can face a crisis: It is this day-to-day living that wears you out. --Anton Chekhov

2. Allocation of: Support Department Costs, Common Costs, and Revenues Chapter 15

3. Overview • Allocation of support department costs • Example of 3 ways • Allocation of Common Costs • Example of 2 ways • Allocation of Revenues from Bundled products/services

4. Operating vs. Support Departments An operating department (a production department in manufacturing companies) adds value to a product or service. A support department (service department) provides the services that assist other operating and support departments in the organization.

5. Single-Rate andDual-Rate Methods The single-rate cost allocation method pools together all costs in a cost pool. The dual-rate cost allocation method classifies costs in each cost pool into two cost pools: a variable-cost cost pool and a fixed-cost cost pool.

6. Budgeted versus Actual Rates Budgeted rates let the user department know in advance the cost rates they will be charged. During the budget period, the supplier department, not the user departments, bears the risk of any unfavorable cost variances. Why?

7. Budgeted versus ActualUsage Allocation Bases Organizations commit to infrastructure costs on the basis of a long-run planning horizon. The use of budgeted usage to allocate these fixed costs is consistent with the long-run horizon. Typically, you use actual usage to allocate variable costs.

8. Allocating SupportDepartments Costs—3 methods Direct method: Allocates support department costs to operating departments only. Step-down (sequential allocation) method: Allocates support department costs to other support departments and to operating departments. Reciprocal allocation method: Allocates costs by services provided among all support departments.

9. Allocating SupportDepartments Costs—in-class example John Deere Tractors, Inc. has two support departments and two operating departments. Maintenance and Legal Implements and Engines

10. Allocating SupportDepartments Costs (do in class) Budgeted Capacity . To be supplied by:MaintenanceLegalImplementsEngines Maintenance 10% 40% 50% Legal 5% 60% 35% Actual Usage . Supplied by:MaintenanceLegalImplementsEngines Maintenance 10% 30% 60% Legal 10% 70% 20% Actual costs were: FixedVariable Maintenance $100,000 $ 72,000 Legal $ 75,000 $ 20,000 Fixed costs are allocated on the basis of budgeted capacity. Variable costs are allocated on the basis of actual usage. The direct method is used to allocate service department costs to operating departments. Also do this problem assuming the step-down/dual and then the reciprocal/dual methods. * In other problems, always remember to ignore self service.

11. Direct Method--allocation

12. Step-Down Method--allocation

13. Reciprocal Method--equations • For each cost (fixed and variable if dual rate or just total cost if single rate) you have to solve a set of equations for the unknown “artificial cost” of each support department. • Example in class (also called: simultaneous, cross-allocation, matrix-allocation, or double-distribution method)

14. Reciprocal equations • For fixed costs: Mf = 100,000 + 0.05Lf and Lf = 75,000 + 0.1Mf (each depts. fixed cost plus proportion it uses of the other support departments support) • For variable costs: Mv = 72,000 + 0.1 Lv and Lv = 20,000 + 0.1Mv

15. Reciprocal Method--allocation

16. Allocating Common Costs Two methods for allocating common costs are: 1. Stand-alone cost allocation method 2. Incremental cost allocation method

17. Stand-Alone Example A consultant in Tampa is planning to go to Chicago and meet with an international client. The round-trip Tampa/Chicago/Tampa airfare costs $540. The consultant is also planning to attend a business meeting with a North Carolina client in Durham.

18. Stand-Alone Example The round-trip Tampa/Durham/Tampa airfare costs $360. The consultant decides to combine the two trips into a Tampa/Durham/Chicago/Tampa itinerary that will cost $760.

19. Stand-Alone Example How much should the consultant charge to the North Carolina client? $360 ÷ ($360 + $540) = .40 .40 × $760 = $304 How much to the international client? $760 – $304 = $456

20. Incremental Cost Example Assume that the business meeting in Chicago is viewed as the primary party. What would be the cost allocation? International client (primary) $540 Durham client (incremental) $760 – $540 = $220

21. Revenues and Bundled Products A bundled product is a package of two or more products (or services) sold for a single price. Bundled product sales are also referred to as “suite sales.” The individual components of the bundle also may be sold as separate items at their own “stand-alone” prices.

22. Revenues and Bundled Products What businesses provide bundled products? Banks Hotels Tours • Checking • Safety deposit boxes • Investment advisory • Lodging • Food and beverage services • Recreation • Transportation • Lodging • Guides

23. Allocation of Revenues Allocation of the revenues of a bundled package to the individual products in that package is similar to allocation of common costs.

24. End of Chapter 15