allocating costs of support departments & joint products

COST MANAGEMENT

COPYRIGHT © 2009 South-Western Publishing, a division of Cengage Learning.Cengage Learning and South-Western are trademarks used herein under license.

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Accounting & ControlHansen▪Mowen▪Guan

Chapter 7Allocating Costs of

Support Departments and Joint Products

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Study Objectives1. Describe the difference between support departments

and producing departments.

2. Calculate charging rates, and distinguish between single and dual charging rates.

3. Allocate support center costs to producing departments using the direct method, the sequential method, and the reciprocal method.

4. Calculate departmental overhead rates.

5. Identify the characteristics of the joint production process, and allocate joint costs to products.

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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

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Departmentalization:Manufacturing Firm

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Departmentalization:Service Firm

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Allocating Support Department Costs to Producing Departments

• Departmentalize 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

Steps:

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An Overview of Cost Allocation

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Allocating One Department’s Costs to Another Department

• The costs of a support department are often allocated through the use of a charging rate.

• Major factors of rate selection:– Choice of single or dual rate– Use of budgeted or actual support department

costs.

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• Developing a fixed rate– Determine budgeted fixed costs– Compute allocation ratio– Allocate

• Developing the variable rate– Depends on the costs that change as the activity

driver changes

Fixed costs + estimated variable costsSingle =rate estimated usage

Dual rate: Fixed rate and a variable rate

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When allocating support department costs, should actual or budgeted costs be allocated?

Answer: Budgeted – to prevent the transfer of efficiencies or inefficiencies from one department to another.

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Choosing a Support Department Cost Allocation Method

• Direct method– 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)

• Reciprocal method– Recognizes interactions of support

departments prior to allocation to producing departments

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Direct allocation

600,000 $250,000 = $187,500

600,000 + 200,000

200,000 $250,000 = $62,500

600,000 + 200,000

4,500 $160,000 = $80,000

4,500 + 4,500

4,500 $160,000 = $80,000

4,500 + 4,500

Allocate Power Dept costs based on kilowatt-hours:

Grinding

Assembly

Grinding

Assembly

Allocate Maintenance Dept costs based on maintenance-hours:

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Direct allocation

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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

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200,000 Maint kWh $250,000 = $50,000

200,000 600,000 200,000+ +Maint kWh Grinding kWh Assembly kWh

Step 1: Allocate Power Dept costs based on kilowatt-hours:

To Maintenance

600,000 Grinding kWh $250,000 = $150,000


200,000 Assembly kWh $250,000 = $50,000


To Grinding

To Assembly

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Sequential allocationStep 2: Allocate Maintenance Dept costs (direct + allocated) based on maintenance-hours:

4,500 Grinding $210,000 = $105,000

4,500 4,500+Grinding Assembly

To Grinding

Costs to allocate: $160,000 direct + $50,000 allocated = $210,000

To Assembly 4,500 Assembly $210,000 = $105,000

4,500 4,500+Grinding Assembly

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Reciprocal allocation

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M = $160,000 + .2PM = $160,000 + .2(250,000 + .1M)M = $160,000 + 50,000 + .02M

.09M = $210,000M = $214,286

Utilize a series of simultaneous linear equations

P = $250,000 + .1PP = $250,000 + .1(214,286)P = $250,000 + 21,429P = $271,429

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M = $160,000 + .2PM = $160,000 + .2(250,000 + .1M)M = $160,000 + 50,000 + .02M

.98M = $210,000M = $214,286


P = $250,000 + .1PP = $250,000 + .1(214,286)P = $250,000 + 21,429P = $271,429

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M = $160,000 + .2PM = $160,000 + .2(250,000 + .1M)M = $160,000 + 50,000 + .02M

.98M = $210,000M = $214,286


P = $250,000 + .1PP = $250,000 + .1(214,286)P = $250,000 + 21,429P = $271,429

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Departmental Overhead Ratesand Product Costing

After allocating all support service costs to producing departments, an overhead rate is calculated for each department

Allocated Producingservice departmentcosts overhead costs

Measure of activity

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Departmental Overhead Ratesand Product Costing

A product cost can now be determined:

Direct materials+ Direct labor+ Assigned overhead

Product cost

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Accounting for JointProduction Processes

• Joint products are two or more products produced simultaneously by the same process up to a “split-off” point.– The split-off point is the point at which the

joint products become separate and identifiable.

• Separable costs are easily traced to individual products and offer no particular problem.

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• The distinction between joint and by-products rests solely on the relative importance of their sales value.

• A by-product is a secondary product recovered in the course of manufacturing a primary product.– Joint costs are not typically allocated– Sales revenue is classified as “other income”– Post-split-off processing costs are deducted

from sales revenue

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Joint Cost Allocation Methods

• Physical Units Method– Presumes that each unit of the final product

costs as much to produce as any other• Weighted Average Method

– Applies weight factors to reflect differing materials, complexity, time, etc.

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A sawmill processes logs into four grades of lumber and incurs total joint costs of $186,000:

Joint Cost Allocation:Physical Units Method

Grades Board FeetPercentof Units

Joint CostAllocation

First and second 450,000 15.00% 27,900$ No. 1 common 1,200,000 40.00% 74,400 No. 2 common 600,000 20.00% 37,200 No. 3 common 750,000 25.00% 46,500

3,000,000 186,000$

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A peach canning factory purchases $5,000 of peaches and grades and cans them by quality.

Joint Cost Allocation:Weighted Average Method

GradesNumberof Cases

WeightFactor

Weighted Numberof Cases Percent

Joint Cost

AllocationFancy 100 1.30 130 21.67% 1,083$ Choice 120 1.10 132 22.00% 1,100 Standard 303 1.00 303 50.50% 2,525 Pie 70 0.50 35 5.83% 292

600 5,000$

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Joint Cost Allocation Methods

• Sales-Value-at-Split-Off-Method– Allocates joint cost based on each product’s

proportionate share of sales value at split-off• Net Realizable Value Method

– Allocates joint cost based on hypothetical market price (eventual market value minus processing costs beyond split-off)

• Constant Gross Margin Percentage Method– Allocates joint costs such that the gross margin is the

same for each product

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A sawmill processes logs into four grades of lumber and incurs total joint costs of $186,000:

Joint Cost Allocation:Sales-Value-at-Split-Off Method

Grades Board Feet

Price at Split-Off

(per 1,000board ft.)

Sales Value at Split-Off Percent

Joint CostAllocation

First and second 450,000 300$ 135,000 26.99% 50,201$ No. 1 common 1,200,000 200 240,000 47.99% 89,261 No. 2 common 600,000 121 72,600 14.52% 27,007 No. 3 common 750,000 70 52,500 10.50% 19,530

3,000,000 500,100 185,999$ does not sum to $186,000 due to rounding

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Joint Cost Allocation:Net Realizable Value Method

A company manufactures two products, Alpha and Beta, from a joint process. One production run costs $5,750 and results in 1,000 gallons of Alpha and 3,000 gallons of Beta. The separable cost for Alpha is $1 per gallon and for Beta is $2 per gallon.

Market Price

Further Processing

CostHypothetical Market Price

Number of Units

Hypothetical Market Value Percent

Allocated Joint Cost

Alpha $5 $1 $4 1,000 4,000$ 40.0% 2,300$ Beta 4 2 2 3,000 6,000 60.0% 3,450

10,000$ 5,750$

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Joint Cost Allocation:Constant Gross Margin Method

Revenue:Alpha ($5 × 1,000) 5,000$ Beta ($4 × 3,000) 12,000 17,000$ 100%

CostsAlpha ($1 × 1,000) 1,000$ Beta ($2 × 3,000) 6,000 Joint costs 5,750 12,750 75%

Gross Margin 4,250$ 25%

Determine gross margin percentage

Alpha BetaEventual market value 5,000$ 12,000$ Less: Gross margin at 25% (1,250) (3,000)

Cost of goods sold 3,750$ 9,000$ Less: seperable costs (1,000) (6,000)

Allocated joint costs 2,750$ 3,000$

Joint cost allocation

COST MANAGEMENT

COPYRIGHT © 2009 South-Western Publishing, a division of Cengage Learning.Cengage Learning and South-Western are trademarks used herein under license.

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Accounting & ControlHansen▪Mowen▪Guan

End Chapter 7

allocating costs of support departments & joint products

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