Chapters
4&
12
Service Department Costing:
An Activity Approach
Overview
 Why allocate costs to departments?
 Three methods of allocation.
 Cost allocation issues.
Allocating Costs to Products
 Product mix decisions
 e.g. valves or flow controllers
 Pricing decisions
 Reimbursement requests
 e.g. government contracts
 Inventory valuation
 reporting, insurance
 Identification of inefficiencies or nonvalue added costs.
Allocating Costs to Operating Units
 Evaluate performance of operating
unit or unit manager.
 identify full cost of operations
 including use of shared resources
Information
Systems
 Provide information for decisionmaking.
 closing stores
 marketing strategy
Machining
Allocating Costs to Operating Units
 Motivate managers.
 discourage waste
 encourage new approaches for
increasing revenue or decreasing
costs
Information
Systems
 Identify inefficiencies.
 excessive corporate overhead
 inefficient information systems
department
Machining
Service Departments
Information Systems
?
Operating Departments
Assembly
?
Payroll
Stamping
Example: Service Department Cost Allocation
Support Department
Allocation Base
Information systems
Payroll
Processing hours
No. of employees
Info
Payroll
Stamping Assmbly
$9,500
$5,600
$38,500 $27,900
Processing hrs.
20
5
8
12
No. of employees
2
1
15
20
Budget overhead
Direct Allocation
 Support costs are allocated to operating
departments only.
 In determining allocation rates ignore the
usage of the support departments.
Direct Allocation
Support
Before alloc
Operating
Info
Systems
Payroll
Stamping
Assmbly
Total
$ 9,500
$ 5,600
$ 38,500
$ 27,900
$ 81,500
Allocation
Info Syst
(9,500)
Payroll
(5,600)
After alloc
Proc. hrs.
# employ
20
2
5
1
8
15
12
20
Step-Down Allocation
 Find the support department with the most
service to the other support departments.
$9,500 * 5/25 = $1,900
OR
$5,600 * 2/37 = $303
 Allocate to both operating and support
departments (based on usage of each.)
 One step at a time; never look back.
Step-Down Allocation
Support
Before alloc
Operating
Info
Systems
Payroll
Stamping
Assmbly
Total
$ 9,500
$ 5,600
$ 38,500
$ 27,900
$ 81,500
Allocation
Info Syst
(9,500)
Payroll
After alloc
Proc. hrs.
# employ
20
2
5
1
8
15
12
20
Reciprocal Allocation
 Find the total (reciprocated) cost of each service
department using a system of equations.
 Define variables for the total cost of each service
department:
I
P
=
=
total cost of info systems
total cost of payroll
 Set-up a system of equations:
I
P
=
=
9,500 + ( 2/37 ) * P
5,600 + ( 5/25 ) * I
Employees in every
department except
Payroll:
Info. Systems
Stamping
Assembly
Total
2
15
20
37
Processing hours in every
department except
Information Systems:
Payroll
Stamping
Assembly
Total
5
8
12
25
 Solve the system of equations:
I
P
=
=
9,500 + ( 2/37 ) * P
5,600 + ( 5/25 ) * I
 Allocate reciprocated costs to all operating
and service departments.
Reciprocal Allocation
Support
Before alloc
Operating
Info
Systems
Payroll
Stamping
Assmbly
Total
$ 9,500
$ 5,600
$ 38,500
$ 27,900
$ 81,500
Allocation
Info Syst
(9,910)
Payroll
(7,582)
After alloc
Proc. hrs.
# employ
20
2
5
1
8
15
12
20
Cost Allocation Issues
Cost Allocation Bases
 Cause and effect
Processing
hours
Info. Systems
Costs
 Benefits received
 payroll dept costs : number of employees
 corporate advertising: sales
 Fairness
 Ability to bear
Actual or Projected Usage?
Actual or Budgeted Costs?