Allocation of Support Activity Costs and Joint Costs

1. 18 ChapterEighteen Allocation of Support Activity Costs and Joint Costs

2. First, we identify the factor that drives costs in theservice department. This cost driver is called the allocation base. How are servicedepartment costscharged to productiondepartments? Service Department Cost Allocation

3. ProductionDepartments ServiceDepartments Carry out the central purposesof an organization. Provide supportthat facilitates theactivities of production departments. Service Department Cost Allocation support

4. How are servicedepartment costscharged to productiondepartments? Service Department Cost Allocation Well, we measure theconsumption of theallocation base in theproduction departments.

5. How are servicedepartment costscharged to productiondepartments? Service Department Cost Allocation Third, we allocate the servicedepartment cost based on the relative amount of theallocation base consumed ineach production department.

6. Allocated service departmentcosts become a part of themanufacturing overhead in each production department. Service Department Cost Allocation What happens toservice departmentcosts after they areallocated to production departments?

7. Service Department Cost Allocation I get it. They becomea part of the overheadthat is applied toproducts with apredeterminedoverhead rate. Allocated service departmentcosts become a part of themanufacturing overhead in each production department.

8. Service Department Cost Allocation So, the costs become a part of the finished product via the application of the pre- determined factory overhead rate. Exactly. Take a look atthis flow chart. I think it will summarizeour discussion of theallocation process.

9. Service Department Cost Allocation First Stage Allocations Service department costs are allocated to production departments. Service Department (Cafeteria) ProductionDepartment (Machining) Service Department (Accounting) The Product ProductionDepartment (Assembly) Service Department (Personnel)

10. Service Department Cost Allocation Service Department (Cafeteria) ProductionDepartment (Machining) Service Department (Accounting) The Product ProductionDepartment (Assembly) Service Department (Personnel) Second Stage Allocations Production department overhead costs, plus allocated service department costs, are applied to products usingdepartmental predetermined overhead rates.

11. TypicalAllocationBases Personnel: Number ofemployees Custodial: Squarefootage Receiving: Unitshandled Cafeteria: Number ofemployees Security: Squarefootage Accounting: Staffhours Power: Kilowatthours Selecting Allocation Bases

12. Criteria forselection Selecting Allocation Bases Personnel: Number ofemployees Custodial: Squarefootage Cafeteria: Number ofemployees Receiving: Unitshandled Simplicity Security: Squarefootage Accounting: Staffhours Power: Kilowatthours

13. Criteria forselection Selecting Allocation Bases Personnel: Number ofemployees Custodial: Squarefootage Availabilityof space orequipment Receiving: Unitshandled Cafeteria: Number ofemployees Security: Squarefootage Accounting: Staffhours Power: Kilowatthours

14. Criteria forselection Selecting Allocation Bases Personnel: Number ofemployees Custodial: Squarefootage Benefits receivedby the productiondepartment Receiving: Unitshandled Cafeteria: Number ofemployees Security: Squarefootage Accounting: Staffhours Power: Kilowatthours

15. Interdepartmental Services Service Department (Cafeteria) ProductionDepartment (Machining) POWER DEPARTMENT ProductionDepartment (Assembly) Service Department (Custodial)

16. Interdepartmental Services Problem Allocating costs when service departmentsprovide services to each other Solutions Direct Method Step Method

17. Direct Method Service Department (Cafeteria) ProductionDepartment (Machining) Cost of servicesbetween service departments areignored and all costs areallocated directlyto productiondepartments. Service Department (Custodial) ProductionDepartment (Assembly)

18. Direct Method Example

19. 20 20 + 30 $360,000 × = $144,000 Direct Method Example Allocation base: Number of employees

20. 30 20 + 30 $360,000 × = $216,000 Direct Method Example Allocation base: Number of employees

21. 25,000 25,000 + 50,000 $90,000 × = $30,000 Direct Method Example Allocation base: Square feet occupied

22. 50,000 25,000 + 50,000 $90,000 × = $60,000 Direct Method Example Allocation base: Square feet occupied

23. Step Method Service departmentcosts are allocatedto other service departments andto productiondepartments, usuallystarting with theservice departmentthat serves thelargest number of other service departments. Service Department (Cafeteria) ProductionDepartment (Machining) Service Department (Custodial) ProductionDepartment (Assembly)

24. Step Method Service Department (Cafeteria) ProductionDepartment (Machining) Once a servicedepartment’s costsare allocated, other servicedepartments’ costsare not allocatedback to it. Service Department (Custodial) ProductionDepartment (Assembly)

25. Step Method Service Department (Cafeteria) ProductionDepartment (Machining) Custodial willhave a newtotal to allocateto productiondepartments: itsown costs plusthose costsallocated fromthe cafeteria. Service Department (Custodial) ProductionDepartment (Assembly)

26. Step Method Example We will use the same data used in the direct method example.

27. 10 10 + 20 + 30 $360,000 × = $60,000 Step Method Example Allocation base: Number of employees

28. 20 10 + 20 + 30 $360,000 × = $120,000 Step Method Example Allocation base: Number of employees

29. 30 10 + 20 + 30 $360,000 × = $180,000 Step Method Example Allocation base: Number of employees

30. Step Method Example New total = $90,000 original custodial cost plus $60,000 allocated from the cafeteria.

31. 25,000 25,000 + 50,000 $150,000 × = $50,000 Step Method Example Allocation base: Square feet occupied

32. 50,000 25,000 + 50,000 $150,000 × = $100,000 Step Method Example Allocation base: Square feet occupied

33. Comparison of Methods

34. Fixed Versus Variable Costs Are fixedand variablecosts allocateddifferently?

35. Result When one departmentdecreases activity toreduce allocations, alldepartments are penalizedbecause the chargeper use increases. Remember, total fixedcosts do not change asactivity changes. Fixed Versus Variable Costs Problem Allocating commonfixed costs using avariable activityallocation base

36. Solution Use dual allocation method, allocatingfixed and variablecosts separately. Fixed Versus Variable Costs Problem Allocating commonfixed costs using avariable activityallocation base

37. VariableCosts FixedCosts Dual Cost Allocation Allocatebudgeted amountsto operating departmentsin proportion to thelong-run averageusage of theallocation base. Charge toproductiondepartments at abudgeted rate timesactual short-run usage of the allocation base. Budgeted costs should be allocatedto avoid passing on inefficienciesfrom the service departments.

38. Dual Cost AllocationExample SimCo has a maintenance department and two productiondepartments: cutting and assembly. Variable maintenancecosts are budgeted at $0.60 per machine hour. Fixedmaintenance costs are budgeted at $200,000 per year.Data relating to the current year are: Allocate maintenance costs to the two operating departments.

39. Dual Cost AllocationExample Variable costs are allocated based on hours used.

40. Dual Cost AllocationExample Variable costs are allocated based on hours used. Fixed costs are allocated based long-run average usage.

41. Problem Department managers may underestimatelong-run average usage to reduce fixed cost allocations. Solution Reward managers formaking accurate estimatesof long-run averageservice department needs. A Behavioral Problem

42. The New Manufacturing Environment More accurate cost tracing systemsreduce the need for allocationof indirect costs.

43. The Rise of Activity-Based Costing First stage allocations are toactivities, not departments. Service Department (Cafeteria) ActivityOne Service Department (Accounting) The Product ActivityTwo Service Department (Personnel)

44. Joint Product Cost Allocation Product Joint Product Costs Product Product

45. Joint Product Cost Allocation • Concept: • In some industries, a number of products are produced from a single raw material input. • Key terms: • Joint products – products resulting from a process with a common input. • Split-off point – the stage of processing where joint products are separated. • Joint product cost – costs of processing joint products prior to the split-off point.

46. Consider the following example of an oil refinery. We will assume only two products,gasoline and oil. Joint Product Cost Allocation

47. JointProduct Costs Separate Processing Final Sale Oil Joint Production Process SeparateProcessing Costs Joint Input Separate Processing Final Sale Gasoline Split-Off Point SeparateProcessing Costs Joint Product Cost Allocation

48. Physical-UnitsMethod Relative-Sales-Value Method Joint Product Costs Net-Realizable-Value Method Allocating Joint Costs

49. Allocation based on a physical measure of the joint products at the split-off point. Physical-UnitsMethod Allocation based onthe relative valuesof the products at the split-off point. Relative-Sales-Value Method Allocation based onfinal sales values lessseparable processingcosts. Net-Realizable-Value Method Allocating Joint Costs

50. Let’s look at anexample illustratingthe joint costallocation methods. Allocating Joint Costs