Managing and Allocating Support-Service Costs

Chapter 10

Productive vs. service functions

Productive functionsGenerate revenueProvide services/products to external

customers

Service functionsCost centersProvide services to internal customers

Productive functionsOther service functions

Support/service departments

Organizational units providing support to other segments of the organizationAccountingHuman resourcesInformation technologyMaintenancePurchasingEtc.

Allocation of service costsWhy?

All costs must be coveredService costs must be pushed down to productive

functions

nternal chargingPromotes more efficient use of internal services

Compliance with contracts

Required reportingRegulated industries, non-profits, etc.

Allocation of service costs

Identify costs to be allocated

Cost pools for distinct types of services or resources

Resources used, not resources supplied

Unused resources represent excess capacity

Should not be charged to service users

Allocation of service costs

Choose an appropriate allocation base for each type of service or resourceRent, insurance, maintenance Square footageHeating/cooling Volume of spaceAccounting, data processing # of transactionsHuman resources, payroll # of employeesInformation technology # of computersPurchasing # of purchase

ordersMotor pool # of vehicles

Allocation methods

Direct method

Service costs allocated directly to productive functions

No inter-service function allocation

Ignores the services each service function provides to the other service functions

Direct method

Service #1Productive

#1

Service #2Productive

#2

Service #3Productive

#3

Department cost

EmployeesPurchase

ordersSquare footage

Human resources 240,000$ 10 40 2,000

Purchasing 142,000$ 8 25 1,500

Maintenance 620,000$ 12 150 1,000

Surgery 3,285,000$ 50 90 3,600

Emergency 2,756,000$ 30 120 6,600

Radiology 930,000$ 20 90 1,800

Example

Direct methodSurgery Emergency Radiology

Human resources 240,000$ 120,000$ 72,000$ 48,000$

(50/100) (30/100) (20/100)

Purchasing 142,000$ 42,600$ 56,800$ 42,600$

(90/300) (120/300) (90/300)

Maintenance 620,000$ 186,000$ 341,000$ 93,000$

(3,600/12,000) (6,600/12,000) (1,800/12,000)

Service cost 1,002,000$ 348,600$ 469,800$ 183,600$

Department cost 6,971,000$ 3,285,000$ 2,756,000$ 930,000$

Total cost 7,973,000$ 3,633,600$ 3,225,800$ 1,113,600$

Allocation methods

Step method

Most wide-spread service cost allocated to other service and productive functions

Next most wide-spread service cost is allocated to remaining service and productive functions

Recognizes some of the inter-service function services

Service #1Productive

#1

Service #2Productive

#2

Service #3Productive

#3

Step method

Step methodHuman

resources Purchasing Maintenance Surgery Emergency RadiologyService cost 240,000$ 142,000$ 620,000$

Human resources (240,000)$ 16,000$ 24,000 100,000$ 60,000$ 40,000$ (8/120) (12/120) (50/120) (30/120) (20/120)

158,000$

Purchasing (158,000)$ 52,667 31,600$ 42,133$ 31,600$ (150/450) (90/450) (120/450) (90/450)

696,667$

Maintenance (696,667)$ 209,000$ 383,167$ 104,500$ (3,600/12,000) (6,600/12,000) (1,800/12,000)

Service cost 340,600$ 485,300$ 176,100$

Department cost 3,285,000$ 2,756,000$ 930,000$

Total cost -$ -$ -$ 3,625,600$ 3,241,300$ 1,106,100$

One other method

Reciprocal methodConsiders all inter-service department

services

Most accurate

Allocation requires complex calculationsBeyond the scope of this course