Allocation of Support Department Costs, Common Costs, and Revenues Chapter 15 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 15 - 1 Learning Objective 1 Differentiate the single-rate from the dual-rate cost-allocation method. ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 15 - 2 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. ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 15 - 3 Learning Objective 2 Understand how the uncertainty user managers face is affected by the choice between budgeted and actual cost-allocation rates. ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 15 - 4 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? ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 15 - 5 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. ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 15 - 6 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. ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 15 - 7 Learning Objective 3 Allocate support department costs using the direct, step-down, and reciprocal methods. ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 15 - 8 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. ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 15 - 9 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. ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 15 - 10 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 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 15 - 11 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. ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 15 - 12 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 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 15 - 13 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 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 15 - 14 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 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 15 - 15 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 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 15 - 16 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 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 15 - 17 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 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 15 - 18 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 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 15 - 19 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 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 15 - 20 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 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 15 - 21 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 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 15 - 22 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 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 15 - 23 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 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 15 - 24 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 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 15 - 25 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 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 15 - 26 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. ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 15 - 27 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? ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 15 - 28 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 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 15 - 29 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 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 15 - 30 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 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 15 - 31 Comparison of Rates Direct method: Step-down method: Reciprocal method: Assembly Finishing 471% $75.32 472% $75.06 467% $76.45 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 15 - 32 Learning Objective 4 Allocate common costs using either the stand-alone or incremental method. ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 15 - 33 Allocating Common Costs Two methods for allocating common cost are: 1. Stand-alone cost allocation method 2. Incremental cost allocation method ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 15 - 34 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. ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 15 - 35 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. ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 15 - 36 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 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 15 - 37 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 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 15 - 38 Learning Objective 5 Explain the importance of explicit agreement between contracting parties when reimbursement is based on costs incurred. ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 15 - 39 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). ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 15 - 40 End of Chapter 15 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 15 - 41