Allocation of Support Department
Costs, Common Costs, and Revenues
Chapter 15
©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
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Learning Objective 1
Differentiate the single-rate
from the dual-rate
cost-allocation method.
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Single-Rate and
Dual-Rate Methods
The single-rate cost allocation method
pools together all costs in a cost pool.
The dual-rate cost allocation method
classifies costs in each cost pool into
two cost pools – a variable-cost cost
pool and a fixed-cost cost pool.
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Learning Objective 2
Understand how the uncertainty
user managers face is affected
by the choice between budgeted
and actual cost-allocation rates.
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Budgeted versus Actual Rates
Budgeted rates let the user department know in
advance the cost rates they will be charged.
During the budget period, the supplier department,
not the user departments, bears the risk of any
unfavorable cost variances.
Why?
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Budgeted versus Actual Rates
– because the user departments do not pay for
any costs that exceed the budgeted rates
When actual rates are used for cost allocation,
managers do not know the rates to be used
until the end of the budget period.
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Budgeted versus Actual
Usage Allocation Bases
Organizations commit to infrastructure costs on
the basis of a long-run planning horizon.
The use of budgeted usage to allocate these fixed
costs is consistent with the long-run horizon.
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Learning Objective 3
Allocate support department costs
using the direct, step-down,
and reciprocal methods.
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Allocating Support
Departments Costs
An operating department (a production
department in manufacturing companies)
adds value to a product or service.
A support department (service department)
provides the services that assist other operating
and support departments in the organization.
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Allocating Support
Departments Costs
Direct method:
Allocates support department costs to operating
departments only.
Step-down (sequential allocation) method:
Allocates support department costs to other support
departments and to operating departments.
Reciprocal allocation method:
Allocates costs by services provided among all
support departments.
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Allocating Support
Departments Costs
The Canton Division of Smith Corporation has two
operating departments and two support departments.
Assembly
and
Finishing
Maintenance
and
Human Resources
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Allocating Support
Departments Costs
Total square feet = 255,000
Total number of employees = 95
Maintenance is allocated using square feet.
Human Resources is allocated using
number of employees.
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Allocating Support
Departments Costs
Maintenance
Budgeted costs
before allocations:
$300,000
Square feet:
5,000
Number of employees:
8
Human
Resources
$2,160,000
30,000
15
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Allocating Support
Departments Costs
Assembly
Budgeted costs
before allocations:
$1,700,000
Square feet:
110,000
Number of employees:
48
Finishing
$900,000
110,000
24
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Direct Method
Support Departments
Maintenance
$300,000
0%
Operating Departments
110/220
$1,700,000
Assembly
24/72
$900,000
Finishing
0%
Human
Resources
$2,160,000
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Direct Method
Support Departments
Maintenance
$300,000
0%
Operating Departments
$150,000
$1,700,000
Assembly
$720,000
$900,000
Finishing
0%
Human
Resources
$2,160,000
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Direct Method
Original costs:
Maintenance Allocated:
Human Resources
Allocated:
Total
Assembly
$1,700,000
150,000
Finishing
$ 900,000
150,000
1,440,000
$3,290,000
720,000
$1,770,000
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Step-Down Method
Which support department should be allocated first?
Maintenance provides 12% of its services
to Human Resources.
Human Resources provides 10% of its
services to Maintenance.
Maintenance to Human Resources:
30,000 ÷ 250,000 (or 12%) × $300,000 = $36,000
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Step-Down Method
Maintenance to Assembly:
110,000 ÷ 250,000 (or 44%) × $300,000 = $132,000
Maintenance to Finishing:
110,000 ÷ 250,000 (or 44%) × $300,000 = $132,000
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Step-Down Method
Maintenance:
Human Resources:
Assembly:
Finishing:
Costs before
allocation
$ 300,000
$2,160,000
$1,700,000
$ 900,000
Allocated
costs
($300,000)
$ 36,000
$132,000
$132,000
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Step-Down Method
Human Resources costs to be allocated become
$2,160,000 + $36,000 = $2,196,000.
Human Resources to Assembly:
48 ÷ 72 × $2,196,000 = $1,464,000
Human Resources to Finishing:
24 ÷ 72 × $2,196,000 = $732,000
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Step-Down Method
Human
Resources:
Assembly:
Finishing:
Costs before Allocated
allocation
costs
Allocated
costs
$2,160,000
$1,700,000
$ 900,000
($2,196,000)
$ 1,464,000
$ 732,000
$ 36,000
$132,000
$132,000
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Step-Down Method
Total cost after allocation:
Assembly Department:
$1,700,000 + $132,000 + $1,464,000 = $3,296,000
Finishing Department:
$900,000 + $132,000 + $732,000 = $1,764,000
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Reciprocal
M
HR
A
F
Maintenance
–
12%
44%
44%
Human Resources 10%
–
60%
30%
Maintenance cost = $300,000 + .10P
Human Resource cost = $2,160,000 + .12M
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Reciprocal
Maintenance cost (M)
= $300,000 + .10($2,160,000 + .12M)
M = $300,000 + $216,000 + .012M
.988M = $516,000  M = $522,267
HR = $2,160,000 + .12($522,267)
HR = $2,160,000 + $62,672 = $2,222,672
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Reciprocal
M
Before
allocation:
Allocation:
Allocation:
Total
HR
A
$300,000 $2,160,000 $1,700,000
(522,267)
62,672
229,797
222,267 ($2,222,672) 1,333,603
$3,263,400
F
$ 900,000
229,797
666,802
$1,796,599
Total cost Assembly Department: $3,263,400
Total cost Finishing Department: $1,796,599
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Overview of Methods
Overhead rate for the Assembly Department is
determined using direct labor cost as a denominator.
Overhead rate for the Finishing Department is
determined using machine-hours as the denominator.
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Comparison of Methods
Assembly
Finishing
Direct labor cost:
$698,880
$349,440
Machine-hours:
24,000
23,500
What are the various overhead rates using the
three methods?
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Overhead Rates Direct Method
Assembly:
$3,290,000 ÷ $698,880 direct labor costs
= 471% of direct labor costs
Finishing:
$1,770,000 ÷ 23,500 = $75.32 per machine-hour
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Overhead Rates
Step-Down Method
Assembly:
$3,296,000 ÷ $698,880 direct labor costs
= 472% of direct labor cost
Finishing:
$1,764,000 ÷ 23,500 = $75.06 per machine-hour
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Overhead Rates Reciprocal
Assembly:
$3,263,400 ÷ $698,880 direct labor costs
= 467% of direct labor cost
Finishing:
$1,796,599 ÷ 23,500 = $76.45 per machine-hour
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Comparison of Rates
Direct method:
Step-down method:
Reciprocal method:
Assembly Finishing
471%
$75.32
472%
$75.06
467%
$76.45
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Learning Objective 4
Allocate common costs
using either the stand-alone
or incremental method.
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Allocating Common Costs
Two methods for allocating common cost are:
1. Stand-alone cost
allocation method
2. Incremental cost
allocation method
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Stand-Alone Example
A consultant in Tampa is planning to go to
Chicago and meet with an international client.
The round-trip Tampa/Chicago/Tampa
airfare costs $540.
The consultant is also planning to attend
a business meeting with a North Carolina
client in Durham.
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Stand-Alone Example
The round-trip Tampa/Durham/Tampa
airfare costs $360.
The consultant decides to combine the two
trips into a Tampa/Durham/Chicago/Tampa
itinerary that will cost $760.
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Stand-Alone Example
How much should the consultant charge
to the North Carolina client?
$360 ÷ ($360 + $540) = .40
.40 × $760 = $304
How much to the international client?
$760 – $304 = $456
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Incremental Cost Example
Assume that the business meeting in Chicago
is viewed as the primary party.
What would be the cost allocation?
International client (primary)
$540
Durham client (incremental) $760 – $540 = $220
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Learning Objective 5
Explain the importance of
explicit agreement between
contracting parties when
reimbursement is based
on costs incurred.
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Cost Allocation and Contracts
Many commercial contracts include clauses that
require the use of cost accounting information.
Contract disputes arise with some regularity,
often with respect to cost allocation.
Cost assignment rules should be as explicit as
possible (and in writing).
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Learning Objective 6
Understand how bundling
of products gives rise to
revenue-allocation issues.
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Revenues and Bundled Products
A bundled product is a package of two or more
products (or services) sold for a single price.
Bundled product sales are also referred to
as “suite sales.”
The individual components of the bundle also
may be sold as separate items at their own
“stand-alone” prices.
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Revenues and Bundled Products
What businesses provide bundled products?
Banks
Checking
 Safety
deposit boxes
 Investment
advisory

Hotels
Lodging
 Food and
beverage
services
 Recreation

Tours
Transportation
 Lodging
 Guides

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Learning Objective 7
Allocate the revenues of
a bundled package to
the individual products
in that package.
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Revenue Allocation Methods
English Languages Institute buys English
language software programs locally and
then sells them in Mexico and Central America.
English sells the following programs:
Grammar, Translation, and Composition
These programs are offered stand-alone
or in a bundle.
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Revenue Allocation Methods
Stand-alone
Grammar
Translation
Composition
Price
$255
$ 85
$185
Purchasing these software
programs costs English
the following:
Grammar
$180
Translation
$ 45
Composition
$ 95
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Revenue Allocation Methods
Bundle (Suites)
Grammar + Translation
Grammar + Composition
Grammar + Translation + Composition
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Price
$290
$350
$410
15 - 47
Revenue Allocation Methods
The two main revenue allocation methods are:
1. The stand-alone
method
2. The incremental
method
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Stand-Alone Revenue
Allocation Method
There are four types of weights for the
stand-alone revenue allocation method.
1. Selling prices
2. Unit costs
3. Physical units
4. Stand-alone
product revenues
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Stand-Alone Revenue
Allocation Method
Consider the Grammar and Translation
suite, which sells for $290 per day.
How much weight should English
Languages Institute assign to each item?
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Stand-Alone Revenue
Allocation Method
Selling prices:
The individual selling prices are $255 for
Grammar and $85 for Translation.
Grammar:
$255 ÷ $340 = 0.75, $290 × 0.75 = $217.50
Translation:
$85 ÷ $340 = 0.25, $290 × 0.25 = $72.50
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Stand-Alone Revenue
Allocation Method
Unit costs:
This method uses the costs of the individual
products to determine the weights for the
revenue allocations.
Grammar:
$180 ÷ $225 = 0.80, $290 × 0.80 = $232
Translation:
$45 ÷ $225 = 0.20, $290 × 0.20 = $58
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Stand-Alone Revenue
Allocation Method
Physical units:
This method gives each product unit in the
suite the same weight when allocating
suite revenue to individual products.
With two products in the suite, each
product is allocated 50% of suite revenues.
1 ÷ (1 + 1) = 0.50
$290 × 0.50 = $145
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Stand-Alone Revenue
Allocation Method
Stand-alone product revenues:
This method captures the quantity of each
product sold as well as their selling prices.
Assume that the stand-alone revenues in 2003
are Grammar $734,400, Translation $81,600,
and Composition $133,200.
What are the weights for the Grammar
and Translation suite?
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Stand-Alone Revenue
Allocation Method
Grammar:
$734,400 ÷ $816,000 = 0.90, $290 × 0.90 = $261
Translation:
$81,600 ÷ $816,000 = 0.10, $290 × 0.10 = $29
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Stand-Alone Revenue
Allocation Method
Revenue Allocation Weights
Grammar Translation
Selling prices
$217.50 $ 72.50
Unit costs
232.00
58.00
Physical units
145.00 145.00
Stand-alone product revenues 261.00
29.00
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Incremental Revenue
Allocation Method
The first-ranked product is termed the
primary product in the bundle.
The second-ranked product is termed
the first incremental product.
The third-ranked product is the second
incremental product, and so on.
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Incremental Revenue
Allocation Method
Assume that Grammar is designated
as the primary product.
If the suite selling price exceeds the standalone price of the primary product, the
primary product is allocated 100%
of its stand-alone revenue.
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Incremental Revenue
Allocation Method
Grammar and Translation suite selling price
= $290 per day
Allocated to Grammar: $255
Remaining to be allocated: ($290 – $255) = $35
Allocated to Translation: $35
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End of Chapter 15
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