managing and allocating support- service costs - … 10, 2013 · managing and allocating...

Copyright © 2008 The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

10Managing and

Allocating Support-Service Costs


10-2

The Service-Cost Challenge

The goal of an organization is to achieve the objectives that prompted the creation of

the organization in the first place.

Commercial firms -goods and services

(while earning a competitive profit)

Nonprofit hospitals -superior health care (while covering their costs of operation)

City governments -

limits)

City governments -essential services

to their citizens (within budgetary

limits)


10-3

The Service-Cost Challenge

Achieving the goals of the organization requiresusing scarce resources and making complex

trade-offs among competing uses.

Needed:Reliable quantitative and

qualitative cost management information about relative costs and benefits of alternatives.

Needed:Reliable quantitative and

qualitative cost management information about relative costs and benefits of alternatives.


10-4

Factors to be considered

Internal or Outsourced Support Services?

Are service providers reliable?

Is the functionstrategic to us?

Who has the

knowledge base?

Who has the more adequate

knowledge base?

How do the costs compare?


10-5

Learning Objective 1


10-6

Cost Allocation CostObject

Indirectcosts

Cost allocation is the process of assigningindirect costs to cost objects.

Indirect costs arecommon costs

of shared facilitiesor services.

Cost objects can be:•Departments benefiting

from services•Time periods when

services were provided

Managing Internal Support-Service Costs


10-7

Do not charge internal customers

for support services and recover the

costs from general revenues.

Charge the cost of support services to using departments

and possibly recover the costs from these internal customers.


Alternatives

Internal customersmay overuse a

free good.DISADVANTAGES


10-8

Charge the cost of support services to using departments

and possibly recover the costs from these internal customers.


Alternatives

DISADVANTAGES Allocations are arbitrary Rates subject to dispute May discourage use

Do not charge internal customers

for support services and recover the

costs from general revenue.


10-9

But that would not bebeneficial to the company.What if we charged a flat

annual fee for the service?

My performance lookedgood until they

allocated those servicedepartment costs, soI’m not going to usethe service again.



10-10

That sounds better.If the fee is fixed,the more I use the

service the lower myaverage cost per

use will be.


Is that really

what we want?


10-11

First, we identify the activities that drive costs in each

service department.This cost driver is called

the allocation base.

How are servicedepartment costs

charged to productiondepartments?

Cost Allocation from Service Departments to Internal Customers


10-12

Second, we measure theconsumption of the

allocation base in theproduction departments.





10-13

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

allocation base used ineach production department.





10-14

The production department mightreimburse the service department,

but most likely the allocatedservice department costs

become a part of themanufacturing overhead in the production department.

What happens toservice departmentcosts after they are

allocated to productiondepartments?



10-15

I get it. They becomea part of the overhead

that is applied toproducts with apredeterminedoverhead rate.

That’s right. Take a look atthis flow chart.

I think it will summarizeour discussion of theallocation process.



10-16

First Stage AllocationsService department costs are

allocated to production departments.Service department(cafeteria)

Service department(accounting)

Service department(personnel)

Productiondepartment(machining)

Productiondepartment(assembly)

Theproduct



10-17

Service Department(Cafeteria)

Service Department(Accounting)

Service Department(Personnel)

ProductionDepartment(Machining)

ProductionDepartment(Assembly)

TheProduct

Second Stage AllocationsProducing department overhead costs and allocated

service department costs are applied to products.



10-18

Carry out the goals of an organizationby providing goods and

services directly to customers.

Provide support that facilitates the activities of production departments.

Productiondepartments

Support serviceSupport servicedepartments

Distinguishing Between Support Services & Production Departments


10-19

Required reporting:Tax regulationsExternal financial reporting

Influencing Behavior:Incentive to control theuse of support services

Cost-based contracts:Government FoundationPrivate industry

Reasons for Allocating Service Costs

To simulate an external market for internal services


10-20

1. Identify the costs to be allocatedto internal customers.


2. Choose the appropriate allocation base(s) and rate(s).

allocation 3. Select and use the cost-allocation method.

4. Determine if the cost allocations achieve the desired results - if not, begin the process again.


10-21



10-22

COST POOLSCOST POOLSBudgeted or actualspending amountsfor distinct sets of

resources

Multiple cost pools facilitate managing the different types of support services and should allow more accurate cost allocations to internal customers.

Identify the Costs to be Allocated to Internal Customers

Custodial

Personnel

Cafeteria

Security

Allocate only service department resourcesused, not resources supplied.


10-23



10-24

A cost driver is thefactor that causes or “drives”

an activity’s costs.

Machinerelatedcosts

Laborrelatedcosts

Occupancyrelatedcosts

Servicerelatedcosts

Choosing a Cost-Allocation Base


10-25

A cost driver is thefactor that causes or “drives”

an activity’s costs.

Selection criteria

Causalrelation

Benefitsreceived

Reasonableness



10-26

Examples

Criteria forselection

Where possible use Activity-Based Costing analysis toselect cost driver allocationbases.



10-27

Common Cost Typical Allocation BaseCategory Example for Common Cost

Supervision Number of employeesLabor Payroll dollars

related Labor hoursPersonnel services Number of employees

Equipment insurance Equipment valueTaxes on equipment Equipment value

Machine Equipment depreciation Machine hoursrelated Equipment cost

Equipment maintenance Number of machinesMachine hours



10-28

Common cost Typical allocation baseCategory Example for common cost

Building rental Space occupiedBuilding insurance Space occupied

Occupancy Heat & A/C Space or volume occupiedrelated Concession rental Space occupied

Desirability of locationBuilding Maintenance Space occupied

Materials Handling Quantity or value of materialsService Laundry Weight of laundry processedrelated Billing and accounting Number of documents

Indirect materials Value of direct materialsCafeteria Number of meals



10-29



10-30

Methods of Allocating Service Department Costs

ProblemAllocating costs when service departments

provide services to each other

SolutionsDirect methodStep method

Reciprocal method


10-31

Direct Method

Service department(cafeteria)

Service department(custodial)



Cost of servicesbetween servicedepartments areignored and all

costs areallocated directly

to productiondepartments.


10-32

Direct Method Example

Service department Allocation base

Cafeteria Number of employeesCustodial Square feet occupied

Service Departments Production Departments

Cafeteria Custodial Machining AssemblyDepartmental costs before allocation 360,000$ 90,000$ 400,000$ 700,000$ Number of employees 15 10 20 30 Square feet occupied 5,000 2,000 25,000 50,000


10-33



Cafeteria Custodial Machining AssemblyDepartmental costs before allocation 360,000$ 90,000$ 400,000$ 700,000$

Cafeteria allocation ? ? ? ?

Custodial allocation ? ? ? ?

Total after allocation ? ? ? ?


10-34




Cafeteria allocation (360,000) 0 144,000 ?



$360,000 ×20

20 + 30= $144,000

Allocation base: Number of employees


10-35




Cafeteria allocation (360,000) 0 144,000 216,000



$360,000 ×30

20 + 30= $216,000



10-36




Custodial allocation 0 (90,000) 30,000 ?

Total after allocation $ 0 $ 0 574,000$ ?


$90,000 ×25,000

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

Allocation base: Square feet occupied


10-37




Custodial allocation 0 (90,000) 30,000 60,000

Total after allocation $ 0 $ 0 574,000$ 976,000$


50,00025,000 + 50,000

= $60,000$90,000 ×



10-38

Step Method

Service departmentcosts are allocated

to other servicedepartments and

to productiondepartments, usually

starting with theservice departmentthat provides the

greatest amount ofservice to otherdepartments.






10-39

Step Method





Once a servicedepartment’s costs

are allocated, other service

department costsare not allocated

back to it.


10-40

Step Method

Custodial willhave a new

total to allocateto production

departments: itsown costs plus

those costsallocated fromthe cafeteria.






10-41

Step Method Example

Service Department Allocation Base

Cafeteria Number of employeesCustodial Square feet occupied

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


Cafeteria Custodial Machining AssemblyDepartmental costs before allocation 360,000$ 90,000$ 400,000$ 700,000$ Number of employees 15 10 20 30 Square feet occupied 5,000 2,000 25,000 50,000


10-42

Step Method Example



Cafeteria allocation ? ? ? ?




10-43

Step Method Example



Cafeteria allocation (360,000) 60,000 ? ?



$360,000 ×10

10 + 20 + 30= $60,000



10-44

Step Method Example



Cafeteria allocation (360,000) 60,000 120,000 ?



$360,000 ×20

10 + 20 + 30= $120,000



10-45

Step Method Example



Cafeteria allocation (360,000) 60,000 120,000 180,000



$360,000 ×30

10 + 20 + 30= $180,000



10-46

Step Method Example




Custodial allocation ? (150,000) ? ?

Total after allocation ? $ 0 ? ?

New total = $90,000 original custodial costplus $60,000 allocated from the cafeteria.


10-47

Step Method Example




Custodial allocation 0 (150,000) 50,000 ?

Total after allocation $ 0 $ 0 570,000$ ?

25,00025,000 + 50,000

= $50,000$150,000 ×



10-48

Step Method Example




Custodial allocation 0 (150,000) 50,000 100,000

Total after allocation $ 0 $ 0 570,000$ 980,000$

= $100,000$150,000 ×


50,00025,000 + 50,000


10-49

Comparison of Methods

Totals after allocationMachining Assembly

Method Department DepartmentDirect 574,000$ 976,000$ Step 570,000 980,000


10-50



10-51

Cost Allocation Accuracy

The Direct method does not consider interactions among service departments.

The Reciprocal method is more thorough in considering interactions among service

departments. (Appendix A)

ABC cost-driver bases should reflect cause-and-effect relationship between resource

spending and use.

Moreaccurate but

also morecomplexand more

costly.

The Step method considers some interactionsamong service departments.

Comparison of Methods


10-52

COST ALLOCATION EFFECTS

If support-service departments provide significant services to eachother, the amounts of costs allocated to production

departments probably differ significantly under each method.

Significantdifferences can affect:

Contracts

Decisionmaking

Performanceevaluations

Determine if the Cost Allocations Achieve Desired Results


10-53

Problem

Users overuse services because per use

allocation is too low.

Users underuse services because per use

allocation is too high.

Solution

Adjust allocation rates upor down to get the desired

behavior by users.


Cost allocations may have unexpected side effects. Common problems and

possible solutions are:


10-54

Problem

Performance evaluations based on allocated service department costs frustrate managers as they have no control over the incurrence

of costs in the service department.

Solution

Remove allocations from performance evaluations.

Allocate budgeted instead of actual service

department costs.


Cost allocations may have unexpected side effects. Common problems and

possible solutions are:


10-55

COST ALLOCATION COSTS AND BENEFITS

Complex cost-allocationsystems are difficultand costly to design.

Complex cost-allocationsystems are difficult

and costly to maintain.

Cost-allocation systems may require revision in a continual process of improvement, which is costly but

can be justified if decisions and organizational performance also continue to improve.



10-56

Companies having both commercial and government business may attempt to shift overhead to the cost-plus government business. Each dollar of additional cost results in additional

revenue on the government work.

To avoid disputes, both parties should agree in the contract precisely how common costs will be allocated.

Ethical Role of Cost Allocations


10-57



10-58

Reciprocal Method

Appropriate for use when service departments provide services to each other

Allows simultaneous allocations of cost between those service departments

Uses matrix algebra to solve a set of simultaneous equations

cafeteria

custodial


10-59

End of Chapter 10

managing and allocating support- service costs - … 10, 2013 · managing and allocating...

Documents