ipptchap017

Allocation of Support Activity Costs and Joint

Costs

Chapter 17

McGraw-Hill/Irwin Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Learning Objective 1

17-217-2

First, we identify the factor that drives costs in the

service department.

This cost driver is called the allocation base.

How are servicedepartment costs

charged to productiondepartments?

Service Department Cost Service Department Cost AllocationAllocation

17-3

ProductionDepartments

ServiceDepartments

Carry out the central purposes

of an organization.

Provide supportthat facilitates the

activities of production departments.


support

17-4

Well, we measure theconsumption of the

allocation base in theproduction departments.




17-5

Third, we allocate the servicedepartment cost based on the relative amount of the

allocation base consumed ineach production department.




17-6

Allocated service departmentcosts become a part of themanufacturing overhead in

each production department.

Service Department Cost Service Department Cost AllocationAllocationWhat happens to

service departmentcosts after they are

allocated to production

departments?

17-7

Allocated service departmentcosts become a part of themanufacturing overhead in

each production department.

I get it. They becomea part of the overhead

that is applied toproducts with apredeterminedoverhead rate.


17-8

So, the costs become a part of the finished

product via the application of the pre-

determined factoryoverhead rate.

Exactly. Take a look atthis flow chart.

I think it will summarizeour discussion of theallocation process.


17-9

Service Department(Cafeteria)

Service Department(Accounting)

Service Department(Personnel)

ProductionDepartment(Machining)

ProductionDepartment(Assembly)

The Product

Second Stage Allocations

Production department overhead costs, plus allocated service department costs, are applied to products using departmental predetermined overhead rates.

Service Department Cost AllocationService Department Cost AllocationFirst Stage Allocations

Service department costs are allocated to production departments.

17-10

Selecting Allocation BasesSelecting Allocation Bases

Personnel:Number ofemployees

Receiving:Units

handled

Security:Squarefootage

Power:Kilowatt

hours

Cafeteria:Number ofemployees

Custodial:Squarefootage

Accounting:Staffhours

TypicalAllocation

Bases

17-11

Selecting Allocation BasesSelecting Allocation Bases

Criteria forselection

Personnel:Number ofemployees

Receiving:Units

handled

Security:Squarefootage

Power:Kilowatt

hours

Cafeteria:Number ofemployees

Custodial:Squarefootage

Accounting:

Staffhours

Simplicity

Availabilityof space orequipment

Benefits receivedby the production

department

17-12

Interdepartmental ServicesInterdepartmental ServicesService

Department(Cafeteria)

Service Department(Custodial)



POWER DEPARTMENT

17-13

Interdepartmental ServicesInterdepartmental ServicesProblem

Allocating costs when service departmentsprovide services to each other

Solutions

Direct Method

Step-Down Method

17-14

Direct MethodDirect Method





Cost of servicesbetween servicedepartments areignored and all

costs areallocated directly

to productiondepartments.

For an example please see the textbook.17-15

Step-Down MethodStep-Down Method





Service departmentcosts are allocated

to other servicedepartments and

to productiondepartments, usually

starting with theservice department

that serves thelargest number of

other service departments.

17-16






Once a servicedepartment’s costs

are allocated, other service

departments’ costsare not allocated

back to it.

17-17






Custodial willhave a new

total to allocateto production

departments: itsown costs plus

those costsallocated fromthe cafeteria.

For an example please see the textbook.17-18


17-19

Result

When one departmentdecreases activity to

reduce allocations, alldepartments are penalized

because the chargeper use increases.

Remember, total fixedcosts do not change as

activity changes.

Fixed Versus Variable CostsFixed Versus Variable Costs

Problem

Allocating commonfixed costs using a

variable activityallocation base

17-20

Fixed Versus Variable CostsFixed Versus Variable Costs

Problem

Allocating commonfixed costs using a

variable activityallocation base

Solution

Use dual allocation method, allocatingfixed and variablecosts separately.

17-21

Charge toproduction

departments at abudgeted rate times

actual short-run usage of the allocation base.

Allocatebudgeted amounts

to operating departmentsin proportion to the

long-run averageusage of the

allocation base.

Budgeted costs should be allocated to avoid passing on inefficienciesfrom the service departments.

Dual Cost AllocationDual Cost Allocation

17-22

SimCo has a maintenance department and two productiondepartments: cutting and assembly. Variable maintenance

costs 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.

Long-runMaintenance Actual

Production Usage as a HoursDepartments % of Total UsedCutting 60% 80,000 Assembly 40% 40,000 Total 100% 120,000

Dual Cost AllocationDual Cost AllocationExampleExample

17-23

Cutting AssemblyDepartment Department

Variable cost allocation: $0.60 × 80,000 hours used 48,000$ $0.60 × 40,000 hours used 24,000$ Fixed cost allocation 60% of $200,000 120,000 40% of $200,000 80,000 Total allocated cost 168,000$ 104,000$

Variable costs are allocated based on hours used.Fixed costs are allocated based long-run average usage.

Dual Cost AllocationDual Cost AllocationExampleExample

17-24

A Behavioral ProblemA Behavioral Problem

Problem

Department managers may underestimate

long-run average usage to reduce fixed cost

allocations.

Solution

Reward managers formaking accurate estimates

of long-run averageservice department needs.

17-25


17-26

The New Manufacturing The New Manufacturing EnvironmentEnvironment

More accurate cost tracing systemsreduce the need for allocation

of indirect costs.

More accurate cost tracing systemsreduce the need for allocation

of indirect costs.

17-27

The Rise of Activity-Based The Rise of Activity-Based CostingCosting


Service Department(Accounting)

Service Department(Personnel)

The Product

First stage allocations are toactivities, not departments.

ActivityOne

ActivityTwo

17-28


17-29

Joint Product Costs

Product

Product

Product

Joint Product Cost AllocationJoint Product Cost Allocation

17-30


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.

17-31

Consider the following example of an oil

refinery.We will assume only

two products,gasoline and oil.


17-32

SeparateProcessing Costs

FinalSale

SeparateProcessing

FinalSale

SeparateProcessing


JointInput

JointProduction

Process

Split-OffPoint

JointProductCosts Oil

Gasoline


17-33


17-34

Allocating Joint CostsAllocating Joint Costs

Joint Product Costs

Physical-UnitsMethod

Relative-Sales-Value

Method

Net-Realizable-Value Method

17-35


Allocation based onthe relative valuesof the products at

the split-off point.

Allocation based on a physical measure of the

joint products at the split-off point.

Allocation based onfinal sales values lessseparable processing

costs.

Relative-Sales-Value Method

Physical-UnitsMethod

Net-Realizable-Value Method

17-36

Let’s look at anexample illustrating

the joint costallocation methods.


17-37

240,000 gallons

360,000 gallons

JointProduction

Process

Split-OffPoint

Oil

Gasoline

Joint material

cost = $275,000

Joint conversioncost = $225,000

Physical-Units MethodPhysical-Units Method

17-38

Product

Oil Gasoline Total

Output quantities in gallons 240,000 360,000 600,000 Proportionate share: 240,000 ÷ 600,000 40% 360,000 ÷ 600,000 60%

Allocated joint costs: $500,000 × 40% 200,000$ $500,000 × 60% 300,000$

Physical-Units MethodPhysical-Units Method

$225,000 joint conversion cost plus$275,000 joint material cost

17-39

$200,000sales value atsplit-off point

$600,000sales value atsplit-off point

JointProduction

Process

Split-OffPoint

Oil

Gasoline

Joint material

cost = $275,000

Joint conversioncost = $225,000

Relative-Sales-Value MethodRelative-Sales-Value Method

17-40

Product

Oil Gasoline Total

Sales value at split-off point 200,000$ 600,000$ 800,000$Proportionate share: $200,000 ÷ $800,000 25% $600,000 ÷ $800,000 75%


$225,000 joint conversion cost plus$275,000 joint material cost

Relative-Sales-Value MethodRelative-Sales-Value Method

17-41

Net-Realizable-Value MethodNet-Realizable-Value Method If products require further processing

beyond the split-off point before they are marketable, it may be necessary to estimate the net realizable value (NRV)

at the split-off point.

EstimatedNRV

FinalSalesValue

AddedProcessing

Costs–=

17-42

Net-Realizable-Value MethodNet-Realizable-Value Method

JointProduction

Process

Oil

Gasoline SeparateProcessing

SeparateProcessing

Joint material

cost = $275,000

Joint conversioncost = $225,000 Sales

Value$500,000

SalesValue

$1,200,000Split-OffPoint, Sales

Value Unknown SeparateProcessing Costs

$500,000


$200,000

17-43

Product

Oil Gasoline Total

Sales value 500,000$ 1,200,000$ 1,700,000$Less additional processing costs 200,000 500,000 700,000 Estimated NRV at split-off point 300,000$ 700,000$ 1,000,000$

Proportionate share: $300,000 ÷ $1,000,000 30% $700,000 ÷ $1,000,000 70%


Net-Realizable-Value MethodNet-Realizable-Value Method

17-44

By-ProductsBy-Products

JointInput

JointProduction

Process

Split-OffPoint

JointCosts

By-products

MajorProduct

Relatively lowvalue or quantity

when compared tomajor products

MajorProduct

17-45

By-ProductsBy-Products

Two commonly used methods of accounting for by-products are . . .1. By-product NRV is

deducted from cost of joint process before allocation.

2. By-product NRV isdeducted from cost of main product.

1 2

17-46


17-47

Reciprocal-Services MethodReciprocal-Services Method

• Fully accounts for reciprocal services

• More accurate

• Can be combined with dual allocation

17-48

End of Chapter 17End of Chapter 17

17

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17-49

ipptchap017

Documents

service departments

production departments

allocation basespersonnel

allocation bases17

allocation process

manufacturing overhead

number of employeescustodial

number of employeesreceiving