CHAPTER 15
Allocation of
Support Department Costs,
Common Costs,
and Revenues
Allocating Costs of a Supporting
Department to Operating Departments
 Supporting (Service) Department – provides
the services that assist other internal
departments in the company
 Operating (Production) Department – directly
adds value to a product or service
To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
15-2
Methods to Allocate
Support Department Costs
 Single-Rate Method – allocates costs in each
cost pool (service department) to cost objects
(production departments) using the same rate
per unit of a single allocation base

No distinction is made between fixed and
variable costs in this method
To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
15-3
Methods to Allocate
Support Department Costs
 Dual-Rate Method – segregates costs within
each cost pool into two segments: a variablecost pool and a fixed-cost pool.
 Each pool uses a different cost-allocation
base
To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
15-4
Allocation Method Tradeoffs
 Single-rate method is simple to implement,
but treats fixed costs in a manner similar to
variable costs
 Dual-rate method treats fixed and variable
costs more realistically, but is more complex
to implement
To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
15-5
Allocation Bases

Under either method, allocation of support costs
can be based on one of the three following
scenarios:
1.
2.
3.

Budgeted overhead rate and budgeted hours
Budgeted overhead rate and actual hours
Actual overhead rate and actual hours
Choosing between actual and budgeted rates:
budgeted is known at the beginning of the period,
while actual will not be known with certainty until
the end of the period
To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
15-6
Methods of Allocating Support Costs
to Production Departments
Direct
2. Step-Down
3. Reciprocal
1.
To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
15-7
Direct Method
 Allocates support costs only to Operating
Departments
 No interaction between Support Departments
prior to allocation
To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
15-8
Direct Method
Support Departments
Production Departments
Information Systems
Manufacturing
Packaging
Accounting
To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
15-9
Step-Down Method
 Allocates support costs to other support
departments and to operating departments
that partially recognizes the mutual services
provided among all support departments
 One-way interaction between Support
Departments prior to allocation
To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
15-10
Step-Down Method
Support Departments
Production Departments
Information Systems
Manufacturing
Packaging
Accounting
To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
15-11
Reciprocal Method
 Allocates support department costs to
operating departments by fully recognizing
the mutual services provided among all
support departments
 Full two-way interaction between Support
Departments prior to allocation
To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
15-12
Reciprocal Method
Support Departments
Production Departments
Information Systems
Manufacturing
Packaging
Accounting
To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
15-13
Choosing Between Methods
 Reciprocal is the most precise
 Direct and Step-Down are simple to compute
and understand
 Direct Method is widely used
To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
15-14
Allocating Common Costs
 Common Cost – the cost of operating a
facility, activity, or like cost object that is
shared by two or more users at a lower cost
than the individual cost of the activity to each
user
To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
15-15
Methods of Allocating
Common Costs
 Stand-Alone Cost-Allocation Method – uses
information pertaining to each user of a cost
object as a separate entity to determine the
cost-allocation weights
 Individual costs are added together and
allocation percentages are calculated from
the whole, and applied to the common cost
To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
15-16
Methods of Allocating
Common Costs
 Incremental Cost-Allocation Method ranks the individual users of
a cost object in the order of users most responsible for a
common cost and then uses this ranking to allocate the cost
among the users
 The first ranked user is the Primary User and is allocated
costs up to the costs of the primary user as a stand-alone
user (typically gets the highest allocation of the common
costs)
 The second ranked user is the First Incremental User and is
allocated the additional cost that arises from two users rather
than one
 Subsequent users handled in the same manner as the
second ranked user
To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
15-17
Cost Allocations and Contracting

The US government reimburses most
contractors in either of two main ways:
1.
2.
The contractor is paid a set price without
analysis of actual contract cost data
The contractor is paid after an analysis of
actual contract cost data. In some cases,
the contract will state that the reimbursement
amount is based on actual allowable costs
plus a fixed fee (cost-plus contract)
To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
15-18
Revenue Allocation and
Bundled Products
 Revenue Allocation occurs when revenues are
related to a particular revenue object but cannot be
traced to it in an economically feasible manner
 Revenue Object – anything for which a separate
measurement of revenue is desired
 Bundled Product – a package of two or more
products or services that are sold for single price, but
individual components of the bundle also may be sold
as separate items at their own “stand-alone” prices
To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
15-19
Methods to Allocate Revenue to
Bundled Products

Stand-Alone (separate) Revenue Allocation
Method uses product-specific information on
the products in the bundle as weights for
allocating the bundled revenues to the
individual products. Three types of weights
may be used:
1.
2.
3.
Selling Prices
Unit Costs
Physical Units
To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
15-20
Methods to Allocate Revenue to
Bundled Products
 Incremental Revenue-Allocation Method ranks
individual products in a bundle according to criteria
determined by management and then uses this
ranking to allocate bundled revenues to individual
products (similar to earlier discussed Incremental
Cost-Allocation Method)



The first-ranked product is the primary product
The second-ranked product is the first incremental
product
The third-ranked product is the second incremental
product, etc.
To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
15-21