managerial accounting by g. norren chap015

Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin

11th EditionChapter 15


Service Department Costing: An Activity

Approach

Chapter Fifteen


Reasons for Allocating Service Department Costs

To encourage operatingdepartments to wisely

use service departmentresources.

To encourage operatingdepartments to wisely

use service departmentresources.

To provide operatingdepartments with more

complete cost datafor making decisions.

To provide operatingdepartments with more

complete cost datafor making decisions.

To help measure theprofitability of operating

departments.

To help measure theprofitability of operating

departments.

To create incentivefor service departments

to operate efficiently.

To create incentivefor service departments

to operate efficiently.

To value inventory for external financial

reporting purposes.

To value inventory for external financial

reporting purposes.

To include all overheadin the cost base when

cost-plus pricing is used.

To include all overheadin the cost base when

cost-plus pricing is used.


$

Selecting Allocation Bases

OperatingDepartments

ServiceDepartments

The allocation bases used should“drive” the cost being allocated.

For example, when allocating costsof the employee cafeteria, the number

of meals served would be a goodchoice for the allocation base.

The allocation bases used should“drive” the cost being allocated.

For example, when allocating costsof the employee cafeteria, the number

of meals served would be a goodchoice for the allocation base.


Selecting Allocation Bases

OperatingDepartments

ServiceDepartments

$

A service department’s costs may beallocated using more than one base.

For example, a portion of the human resource departmentcosts might be allocated based on the number of employeesin each operating department and another portion might be

allocated based on hours spent in training employees ineach operating department.

A service department’s costs may beallocated using more than one base.

For example, a portion of the human resource departmentcosts might be allocated based on the number of employeesin each operating department and another portion might be

allocated based on hours spent in training employees ineach operating department.


Examples of Allocation Bases

Service Department Allocation BasesLaundry Pounds of laundryAirport Ground Services Number of flightsCafeteria Number of mealsMedical Facilities Cases handled; number of employees;

hours workedMaterials Handling Hours of service; volume handledInformation Technology Number of personal computers;

applications installedCustodial Services Square footage occupiedCost Accounting Labor hours; customers servedPower KWH used; capacity of machinesHuman Resources Number of employees; training hoursReceiving, Shipping, and Stores Units handled; number of requisitions;

space occupiedFactory Administration Total labor hoursMaintenance Machine hours

Exh.15-1


Interdepartmental Services

Problem

Allocating costs when service departmentsprovide services to each other

Problem

Allocating costs when service departmentsprovide services to each other

Solutions

Direct Method

Step Method

Reciprocal Method


Direct Method

Service Department(Cafeteria)

Service Department(Custodial)

Operating Department(Machining)

Operating Department(Assembly)

Interactionsbetween servicedepartments areignored and all

costs areallocated directly

to operatingdepartments.


Direct Method Example

Service Department Allocation Base

Cafeteria Number of employeesCustodial Square feet occupied





Allocation base: Number of employees

$360,000 ×20

20 + 30= $144,000




$360,000 ×30

20 + 30= $216,000



Allocation base: Square feet occupied

$90,000 ×25,000

25,000 + 50,000 = $30,000




50,000

25,000 + 50,000$90,000 × = $60,000




Step Method

Once a servicedepartment’s costs

are allocated, other service

department costsare not allocated

back to it.




Step Method

There are three key points to understand regarding the step method:

In both the direct and step methods, any amount of the allocation base attributable to the service department whose cost is being allocated is always ignored.

Any amount of the allocation base that is attributable to a service department whose cost has already been allocated is ignored.

Each service department assigns its own costs to operating departments plus the costs that have been allocated to it from other service departments.


Step Method Example



We will use the same data used in the direct method example.


Step Method Example

Allocate Cafeteria costs first sinceit provides more service than Custodial.

Allocate Cafeteria costs first sinceit provides more service than Custodial.


Step Method Example

$360,000 ×10

10 + 20 + 30= $60,000



Step Method Example

$360,000 ×20

10 + 20 + 30= $120,000



Step Method Example

$360,000 ×30

10 + 20 + 30= $180,000



Step Method Example

New total = $90,000 original Custodial cost plus $60,000 allocated from the Cafeteria.


Step Method Example

$150,000 ×25,000

25,000 + 50,000 = $50,000



Step Method Example

$150,000 ×50,000

25,000 + 50,000 = $100,000



Reciprocal Method

Interdepartmentalservices are given

full recognitionrather than partialrecognition as withthe step method.





Because of its mathematical complexity,

the reciprocal method is rarely used.


Revenue Producing Service Departments

If a service departmentgenerates revenue, such as a

cafeteria that charges for the service itprovides, the revenue generated should

be offset against the costs incurred.Only the remaining net amount

of costs should be allocated to other departments.


Quick Check Datafor Direct and Step Methods

Allocation bases:Business school administration costs (ADMIN): Number of employees

Business Administration computer services (BACS): Number of personal computers

The direct method of allocation is used.


Quick Check

How much cost will be allocated from Administration to Accounting? a. $ 36,000b. $144,000c. $180,000d. $ 27,000





Quick Check

$180,000 ×20

20 + 80= $36,000


Quick Check

How much total cost will be allocated from ADMIN and BACS combined to the Accounting Department?a. $ 52,500b. $135,000c. $270,000d. $ 49,500



Quick Check



$90,000 ×18

18 + 102= $13,500


Quick Check Data

Allocation bases:Business school administration costs (ADMIN): Number of employees

Business administration computer services (BACS): Number of personal computers

The step method of allocation is used.


Quick Check

How much total cost will be allocated from ADMIN and BACS combined to the Accounting Department?a. $35,250b. $49,072c. $18,000d. $26,333





Quick Check


Allocating Costs by Behavior

When possible,variable and fixed

service department costsshould be allocated

separately.


Variable servicedepartment costs should be

allocated to consuming departmentsaccording to the activity

causing incurrence of the cost.



Allocate fixed service department costs to consuming departments in predeterminedlump-sum amounts that are based on theconsuming departments’ peak or long-run

average needs. Fixed cost allocations:

Allocate fixed service department costs to consuming departments in predeterminedlump-sum amounts that are based on theconsuming departments’ peak or long-run

average needs. Fixed cost allocations:

Are based on amounts ofcapacity each consuming

department requires.

Should not vary fromperiod to period.




Budgeted variableand fixed service departmentcosts should be allocated to

operating departments.



If variable cost allocations are made at thebeginning of the year, the budgeted variable

rate should be multiplied by the budgetedactivity level of each consuming department.

If variable cost allocations are made at thebeginning of the year, the budgeted variable

rate should be multiplied by the budgetedactivity level of each consuming department.

Allocations madeat the beginning of theyear provide data for

pricing and otherdecisions.



If variable cost allocations are made at theend of the year, the budgeted variablerate should be multiplied by the actual

activity level of each consuming department.

If variable cost allocations are made at theend of the year, the budgeted variablerate should be multiplied by the actual

activity level of each consuming department.

Allocations made atthe end of the year provide

data for performanceevaluation.


SimCo has a maintenance department and two operatingdepartments: 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.

SimCo: An Example


Hours planned

SimCo: Beginning of the Year


Percent of peak-period capacity.

SimCo: Beginning of the Year

Hours planned


Hours used

SimCo: End of the Year


Percent of peak-period capacity.

SimCo: End of the Year

Hours used


Fixed cost allocations are the same at the end and at the beginning because they are

based on capacity instead of usage.

Fixed cost allocations are the same at the end and at the beginning because they are

based on capacity instead of usage.

SimCo: Comparison of Results


SimCo: Comparison of Results

Only budgeted variable and fixed servicedepartment costs were allocated to the

two operating departments.

The cost of service department inefficiencies,contained in the actual costs, should not

be passed along to operating departments.


Quick Check:Allocating Costs by Behavior

Foster City has an ambulance service that is used by the two public hospitals in the city. Variable

ambulance costs are budgeted at $4.20 per mile. Fixed ambulance costs are budgeted at $120,000

per year. Data relating to the current year are:

Percent ofPeak-Period Capacity Miles Miles

Hospitals Required Planned UsedMercy 45% 15,000 16,000 Northside 55% 17,000 17,500 Total 100% 32,000 33,500


Quick Check

How much ambulance service cost will be allocated to Mercy Hospital at the beginning of the year?a. $117,000b. $254,400c. $114,480d. $119,250





Quick Check


Quick Check

How much ambulance service cost will be allocated to Mercy Hospital at the end of the year?a. $114,000b. $118,800c. $110,400d. $121,200





Quick Check


Effect of Allocations onOperating Departments

Once service department costallocations are completed, they areincluded in operating departments’:

Once service department costallocations are completed, they areincluded in operating departments’:

Performanceevaluations

Performanceevaluations

Profitabilitydetermination

Profitabilitydetermination

Overhead rate computations

Overhead rate computations


First Stage AllocationsService department costs are

allocated to operating departments.Service Department(Cafeteria)

Service Department(Accounting)

Service Department(Personnel)



The Products




Service Department(Accounting)

Service Department(Personnel)



The Products

Second Stage Allocations

Operating department overhead costs and allocated service department costs are

applied to products.



Pitfall 1

Allocating fixed costs using a variable

allocation base

Allocation Pitfalls to Avoid

Result

Fixed costsallocated to onedepartment are

heavily influenced bywhat happens in

other departments.


Kolby Products: An Example

Kolby Products has two sales territories,the Eastern Territory and the Western Territory. Both sales territories are serviced by one auto

service center whose costs are all fixed. Contraryto good practice, Kolby allocates the fixed servicecenter costs to the sales territories on the basis

of actual miles driven (a variable base).

Kolby Products has two sales territories,the Eastern Territory and the Western Territory. Both sales territories are serviced by one auto

service center whose costs are all fixed. Contraryto good practice, Kolby allocates the fixed servicecenter costs to the sales territories on the basis

of actual miles driven (a variable base).


Kolby Products: An Example

Year 1 Year 2Auto service center costs (all fixed) 120,000$ 120,000$

Miles driven Western sales territory 1,500,000 1,500,000 Eastern sales territory 1,500,000 900,000

Total miles driven 3,000,000 2,400,000

Allocation rate per mile 0.04$ 0.05$

$120,000 ÷ 3,000,000 miles

$120,000 ÷ 2,400,000 miles


Kolby Products:First–year Allocations

Western sales territory1,500,000 miles @ $0.04 per mile 60,000$

Eastern sales territory1,500,000 miles @ $0.04 per mile 60,000

Total cost allocated 120,000$


Eastern sales territory1,500,000 miles @ $0.04 per mile 60,000


The two sales territories share the servicecenter’s costs equally because the miles

driven in each territory are equal.


Kolby Products:Second–year Allocation


Eastern sales territory900,000 miles @ $0.05 per mile 45,000



Eastern sales territory900,000 miles @ $0.05 per mile 45,000


Western territory has the same number of miles aslast year, but $15,000 more cost allocated

because Eastern’s miles declined in year 2.


Pitfall 2

Using salesdollars as an

allocation base

Allocation Pitfalls to Avoid

Result

Sales of one departmentinfluence the service

department costsallocated to other

departments.


Clothier Inc. – An Example

Clothier Inc., a men’s clothing store has oneservice department and three sales departments,

Suits, Shoes, and Accessories. Service departmentcosts total $60,000 for both years in the example.Contrary to good practice, Clothier allocates the

service department costs based on sales.

Clothier Inc., a men’s clothing store has oneservice department and three sales departments,

Suits, Shoes, and Accessories. Service departmentcosts total $60,000 for both years in the example.Contrary to good practice, Clothier allocates the

service department costs based on sales.


Clothier Inc. – First-year Allocation

Suits Shoes Accessories TotalSales by department 260,000$ 40,000$ 100,000$ 400,000$ Percentage of total sales 65% 10% 25% 100%Allocation of service department costs 39,000$ 6,000$ 15,000$ 60,000$

Departments

$260,000 ÷ $400,000 65% of $60,000

In the next year, the manager of the Suit Departmentincreased sales by $100,000. Sales in the other departmentsare unchanged. Let’s allocate the $60,000 service department

cost for the second year given the sales increase.

In the next year, the manager of the Suit Departmentincreased sales by $100,000. Sales in the other departmentsare unchanged. Let’s allocate the $60,000 service department

cost for the second year given the sales increase.


Clothier Inc. – Second-year Allocation

Suits Shoes Accessories TotalSales by department 360,000$ 40,000$ 100,000$ 500,000$ Percentage of total sales 72% 8% 20% 100%Allocation of service department costs 43,200$ 4,800$ 12,000$ 60,000$

Departments

$360,000 ÷ $500,000 72% of $60,000

If you were the suit department manager, wouldyou be happy with the increased service department

costs allocated to your department?

If you were the suit department manager, wouldyou be happy with the increased service department

costs allocated to your department?


End of Chapter 15

managerial accounting by g. norren chap015

Education

direct method of allocation

service departments

service department costs

step method example

cost base

allocation base attributable

service department costing

service department resources