Management Accounting for Business

1. Management Accounting for Business Dr. Mohamed A. Hamada Lecturer of Accounting Information Systems Chapter 4 Allocation of Support Activity Costs

2. LEARNING OBJECTIVES • Describe the difference between support departments and producing departments. • Calculate single & multiple charging rates for a support department. • Allocate support-department costs to producing departments using the direct, sequential, & reciprocal methods. • Compute departmental overhead rates

3. General Framework for Cost Allocation Producing departments are where employees Work on the organization’s products or services. Service departments exist only to support other departments or customers.

4. ALLOCATION: Definition A means of dividing a pool of costs & assigning it to various subunits.

5. COST allocation effects While cost allocation does not affect total product cost, it will affect pricing&profitability of individual products depending on method used.

6. Objectives of Cost 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.

7. CAUSAL FACTORS: Definition Activities within a producing department that provoke the incurrence of support service costs.

8. How are costs allocated from departments to products? First, support department costs are assigned to producing departments. Then overhead rates are developed to cost products.

9. What kinds of charging rates are used? Companies use either a single charging rate or multiple charging rates.

10. Allocating One Department’s Costs to Another Department Dual rate: Fixed rate and a variable rate

11. PHOTOCOPYING DEPT.:Barry & Hamilton

12. FORMULAS: Single Charging Rate Charging rate = Total estimated costs / Estimated usage $ 32,400 / 270,000 = $0.12 per page Allocating charges: Allocated charges= Actual Pages x Charging rate

13. CHARGE ALLOCATION: Single Charging Rate

14. What are the uses of budgeted costs? Budgeted costs are used 1) to help determine overhead rate and 2) for service department performance evaluation.

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

16. 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)

17. 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.

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

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

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

21. 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)

22. 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)

23. An Overview of Cost Allocation • Allocation is dividing a pool of costs and assigning those costs to subunits • The cost objects must be determined • Cost objects are usually departments • Producing: creating products sold to customers • Support: provide essential services for producing departments

24. ALLOCATION METHODS: Multiple Service Departments • Direct allocation method • Allocate support department costs only to producing departments • Sequential allocation method • Allocate support department costs in step-down approach

25. Allocating Support Department Costs to Producing Departments Steps: • Determine the all Departments of the firm • Classify each department as support or producing • Trace all overhead costs in the firm to the appropriate department • Allocate support department costs to producing departments • Calculate predetermined overhead rate for producing departments • Allocate overhead to units produced

26. Examples of Departments for a Manufacturing Firm

27. Examples of Departments for a services Firm

28. An Overview of Cost Allocation

29. Choosing a Support Department Cost Allocation Method • Directmethod • Costs are allocated only to producing departments • Sequential (step) method • Costs allocations are performed in a step-down fashion, using predetermined ranking procedures (e.g., degree of support)

30. Choosing a Support Department Cost Allocation Method

31. Direct allocation Allocate Power Dept costs based on kilowatt-hours: Grinding Assembly Allocate Maintenance Dept costs based on maintenance-hours: Grinding Assembly

32. Direct allocation

33. Sequential allocation • Rank support departments by their direct costs • Allocate • First support department’s direct cost to all other support departments and producing departments • Next support department’s costs (direct + previously allocated) to subsequent support and producing • Etc. • Once a support department’s costs are allocated it never receives a subsequent allocation

35. Sequential allocation Step 1: Allocate Power Dept costs based on kilowatt-hours: To Maintenance To Grinding To Assembly

36. To Grinding To Assembly Sequential allocation Step 2: Allocate Maintenance Dept costs (direct + allocated) based on maintenance-hours: Costs to allocate: $160,000 direct + $50,000 allocated = $210,000

37. Sequential allocation

38. Departmental Overhead Ratesand Product Costing After allocating all support service costs to producing departments, an overhead rate is calculated for each department

39. Departmental Overhead Ratesand Product Costing A product cost can now be determined: Direct materials + Direct labor + Assigned overhead Product cost

40. COSTING PROCESS Has following steps • Identify supporting and producing departments • Allocate supporting department costs to producing departments • Allocate overhead to producing departments at predetermined rates

41. Very thanks