support department cost allocation

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Support Support Department Department

Cost Cost AllocationAllocation

Prepared by Douglas Cloud

Pepperdine University

Prepared by Douglas Cloud

Pepperdine University

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1. Describe the difference between support departments and producing departments.

2. Explain five reasons why support cost may be assigned to producing departments.

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

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

ObjectivesObjectivesObjectivesObjectives

After studying this After studying this chapter, you should chapter, you should

be able to:be able to:

After studying this After studying this chapter, you should chapter, you should

be able to:be able to:

ContinuedContinuedContinuedContinued

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5. Calculate departmental overhead rates.

ObjectivesObjectivesObjectivesObjectives

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Types of DepartmentsTypes of DepartmentsTypes of DepartmentsTypes of Departments

Producing departments are

directly responsible for creating the products or

services sold to customers.

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Types of DepartmentsTypes of DepartmentsTypes of DepartmentsTypes of Departments

Supporting departments provide

essential support services for producing

departments.

Maintenance, grounds, Maintenance, grounds, engineering, personnel, engineering, personnel,

storagestorage

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Examples of Departmentalization for a Examples of Departmentalization for a Manufacturing FirmManufacturing Firm

Production Departments Support DepartmentsProduction Departments Support DepartmentsAssembly: Materials Storeroom:

Supervisors’ salaries Clerk’s salarySmall tools Depreciation on forkliftIndirect materials Cafeteria:Depreciation on machinery Food

Finishing: Cooks’ salariesSandpaper Depreciation on storesDepreciation on sanders Maintenance:

Janitors’ salariesCleaning suppliesMachine oil and lubricants

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1. Departmentalize the firm.

2. Classify each department as a support department or a producing department.

3. Trace all overhead costs in the firm to a support department or producing department.

4. Allocate support department costs to the producing departments.

Steps in Allocating Support Department Steps in Allocating Support Department Costs to Producing DepartmentsCosts to Producing Departments

Steps in Allocating Support Department Steps in Allocating Support Department Costs to Producing DepartmentsCosts to Producing Departments

ContinuedContinuedContinuedContinued

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5. Calculate predetermined overhead rates for producing departments.

6. Allocate overhead costs to the units of individual products through predetermined overhead rates.

Steps in Allocating Support Department Steps in Allocating Support Department Costs to Producing DepartmentsCosts to Producing Departments

Steps in Allocating Support Department Steps in Allocating Support Department Costs to Producing DepartmentsCosts to Producing Departments

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Examples of Cost Drivers forExamples of Cost Drivers forSupport DepartmentsSupport Departments

Examples of Cost Drivers forExamples of Cost Drivers forSupport DepartmentsSupport Departments

Accounting Number of transactions

Cafeteria Number of employees

Engineering Number of change orders

Maintenance Machine hours; maintenance hours

Payroll Number of employees

Personnel Number of employees, firings, layoffs, new hires

Support Department Possible DriverSupport Department Possible Driver

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Objectives of Allocation*Objectives of Allocation*Objectives of Allocation*Objectives of 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

*As identified by the IMA

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Fixed costs………………$26,190Variable costs….. $0.023 per page

Hamish Hamish and and

BartonBarton

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Estimated usage in pages by the three producing departments is as follows:

Audit Department

94,500 Tax Department

67,500 MAS Department

108,000 Total

270,000

Variable cost: 270,000 x $0.023 $ 6,210

Fixed cost 26,190

Total cost for 270,000 pages $32,400

Average cost ($32,400 ÷ 270,000) $0.12 per page

A Single Charge Rate

Hamish Hamish and and

BartonBarton

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A Single Charge Rate

Total Photocopying Department ChargeTotal Photocopying Department Charge

Number of Pages

Charge per Page

Total Charge

x =

Audit Department 92,000 $0.12 $11,040

Tax Department 65,000 0.12 7,800

MAS Department 115,000 0.12 13,800

Total 272,000 $32,640

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The allocation of fixed costs follow a three-step procedure:1) Determination of budgeted fixed support

service costs

2) Computation of the allocation ratio

Allocation ratio =Producing department capacity

Total capacity

ContinuedContinuedContinuedContinued

Dual Charging RateDual Charging RateDual Charging RateDual Charging Rate

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3) Allocation

Allocation = Allocation ratio x Budgeted fixed support service costs

Dual Charging RateDual Charging RateDual Charging RateDual Charging Rate

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PercentBudgeted

Fixed Cost

Allocated Fixed Cost

Audit 94,500 35% $26,190 $ 9,167

Tax 67,500 25 26,190 6,548

MAS 108,000 40 26,190 10,476

Total 270,000 $26,191

Original Number of Copies

Dual Charging RateDual Charging RateDual Charging RateDual Charging Rate

100%

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Developing a Variable RateDeveloping a Variable Rate

Variable Rate

Variable Amount

Fixed Amount

Audit 92,000 $0.023 $2,116 $ 9,167 $11,283

Tax 65,000 0.023 1,495 6,548 8,043

MAS 115,000 0.023 2,645 10,476 13,121

Total 272,000 $6,256 $26,191 $32,447

Actual Number of Copies x = +

Total Charge=

Dual Charging RateDual Charging RateDual Charging RateDual Charging Rate

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Hamish Hamish and and

BartonBarton

The adjusted cost allocation ratios and allocated fixed cost based on the newly budgeted usage

Number of Copies Percent

Allocated Fixed Cost

Audit 94,500 41.1 % $10,764

Tax 67,500 29.3 7,674

MAS 68,000 29,6 7,752

Total 230,000 100.0 % $26,190

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Choosing A Support Department Cost Allocation

MethodThe three methods for allocating support department costs to producing departments are:

The Direct MethodThe Sequential MethodThe Reciprocal Method

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Direct Method of AllocationDirect Method of Allocation

Power Maintenance

Grinding Assembly

Support Departments

Producing Departments

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Direct Method of AllocationDirect Method of Allocation

Power Maintenance

Grinding Assembly

Support Departments

Producing Departments

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Support Departments Producing Departments

Direct Costs* $250,000 $160,000 $100,000$ 60,000

Normal Activity:

Kilowatt hours ----- 200,000 600,000200,000

Maintenance hours 1,000 ----- 4,5004,500

*For a producing department, direct costs refer only to overhead costs that are directly traceable to the department.

Data for Illustrating Allocation MethodsData for Illustrating Allocation MethodsData for Illustrating Allocation MethodsData for Illustrating Allocation Methods

Power Maint. Grinding Assembly

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STEP 1—CALCULATE ALLOCATION RATIOSSTEP 1—CALCULATE ALLOCATION RATIOS Grinding AssemblyGrinding Assembly

Power =600,000

(600,000 + 200,000)0.75

200,000

(600,000 + 200,000)0.25

Maintenance =4,500

(4,500 + 4,500)0.50

4,500

(4,500 + 4,500)0.50

Direct MethodDirect Method

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STEP 2—ALLOCATE SUPPORT DEPARTMENT STEP 2—ALLOCATE SUPPORT DEPARTMENT COSTS USING THE ALLOCATION RATIOSCOSTS USING THE ALLOCATION RATIOS

Power Maintenance Grinding AssemblyPower Maintenance Grinding Assembly

Support Departments Producing DepartmentsSupport Departments Producing Departments

Direct costs $250,000 $160,000 $100,000 $ 60,000

Power -250,000 --- 187,500 62,500

Maintenance --- -160,000 80,000 80,000

$ 0 $ 0 $367,500 $202,500

a

b

a 0.75 x $250,000 = $187,500; 0.25 x $250,000 = $62,500

0.50 x $160,000 = $80,000 b

Direct MethodDirect Method

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Sequential Method of AllocationSequential Method of Allocation

STEP 1: Rank service departments

Maintenance

11

Grinding

22

Assembly

33

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Sequential Method of AllocationSequential Method of Allocation

Power

Maintenance AssemblyGrinding

STEP 2

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Sequential Method of AllocationSequential Method of Allocation

Maintenance

AssemblyGrinding

STEP 2

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STEP 1—CALCULATE ALLOCATION RATIOSSTEP 1—CALCULATE ALLOCATION RATIOS Maint. Grinding AssemblyMaint. Grinding Assembly

Power =200,000

(200,000 + 600,000 + 200,000)

0.20

600,000

(200,000 + 600,000 + 200,000)

0.60

Sequential MethodSequential Method

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STEP 1—CALCULATE ALLOCATION RATIOSSTEP 1—CALCULATE ALLOCATION RATIOS Maint. Grinding AssemblyMaint. Grinding Assembly

4,500

(4,500 + 4,500)0.50

Mainte- nance

4,500

(4,500 + 4,500)0.50=

Sequential MethodSequential Method

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STEP 2—ALLOCATE SUPPORT DEPARTMENT STEP 2—ALLOCATE SUPPORT DEPARTMENT COSTS USING THE ALLOCATION RATIOSCOSTS USING THE ALLOCATION RATIOS

Power Maintenance Grinding AssemblyPower Maintenance Grinding Assembly

Support Departments Producing DepartmentsSupport Departments Producing Departments

Direct costs $250,000 $160,000 $100,000 $ 60,000

Power -250,000 50,000 150,000 50,000

Maintenance --- -210,000 105,000 105,000

$ 0 $ 0 $355,000 $215,000

a

b

a 0.20 x $250,000 = $50,000; 0.60 x $250,000 = $150,000;0.20 x $250,000 = $50,000

0.50 x $210,000 = $105,000 b

Sequential MethodSequential Method

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The reciprocal method of allocation recognizes all interactions among support departments.

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Power Maintenance Grinding AssemblyPower Maintenance Grinding Assembly

Support Departments Producing DepartmentsSupport Departments Producing Departments

Direct costs:Fixed $200,000 $100,000 $ 80,000 $50,000Variable 50,000 60,000 20,000 10,000 Total $250,000 $160,000 $100,000 $60,000

Reciprocal Method

Power Maintenance Grinding AssemblyPower Maintenance Grinding Assembly

Proportion of Output Used by DepartmentsProportion of Output Used by Departments

Allocation ratios:

Power --- 0.20 0.60 0.20

Maintenance 0.10 --- 0.45 0.45

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M = Direct costs + Share of Power’s costs

M = $160,000 + $50,000 + 0.02M

0.98M = $210,000

M = $214,286

M = $160,000 + 0.2P (Power’s cost equation)

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P = Direct cost + Share of Maintenance’s cost

= $250,000 + 0.1($214,286) P

= $250,000 + $21,429P

= $271,429P

P = $250,000 + 0.1M (Maintenance cost equation)

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Reciprocal Method

Allocated toAllocated toGrinding AssemblyGrinding AssemblyTotal CostTotal Cost

Power $271,429 $162,857 $ 54,286

Maintenance 214,286 96,429 96,429

Total $259,286 $150,715.60 x $271,429 .20 x $271,429

.45 x $214,286 .45 x $214,286

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Direct MethodDirect Method

Grinding AssemblyGrinding Assembly

Comparison of Support Department Cost Allocations Using the Direct, Sequential, and

Reciprocal Methods

Comparison of Support Department Cost Allocations Using the Direct, Sequential, and

Reciprocal Methods

Direct costs $100,000 $ 60,000

Allocated from Power 187,500 62,500

Allocated from Maintenance 80,000 80,000

Total cost $367,500 $202,500

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Sequential MethodSequential Method

Grinding AssemblyGrinding Assembly

Comparison of Support Department Cost Allocations Using the Direct, Sequential, and

Reciprocal Methods

Comparison of Support Department Cost Allocations Using the Direct, Sequential, and

Reciprocal Methods

Direct costs $100,000 $ 60,000

Allocated from Power 150,000 50,000

Allocated from Maintenance 105,000 105,000

Total cost $355,000 $215,000

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Reciprocal MethodReciprocal Method

Grinding AssemblyGrinding Assembly

Comparison of Support Department Cost Allocations Using the Direct, Sequential, and

Reciprocal Methods

Comparison of Support Department Cost Allocations Using the Direct, Sequential, and

Reciprocal Methods

Direct costs $100,000 $ 60,000

Allocated from Power 162,857 54,285

Allocated from Maintenance 96,429 96,429

Total cost $359,286 $210,714

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Departmental Overhead Rates

The overhead rate for the Grinding Department is computed as follows (assuming the normal level of activity is 71,000 MH):

OH rate = $355,000 71,000 = $5 per MH

The overhead rate for the assembly department is computed as follows (assuming the normal level of activity is 107,500 DLH):

OH rate = $215,000 107,500 = $2 per DLH

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ChapteChapterr

End ofEnd of

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