Allocating service departments costs:
• Service departments provide support and assist other internal
departments (both service and production).
• Examples of service departments:
- Information System Department
- Maintenance Department
• There are two methods to allocate service departments costs:
1- Single rate method
• no distinction between
varaible and fixed costs
2- Dual rate method
• Divide the costs of each
department into:
• - fixed costs
• - variable costs
Ex:
Assume a Company has two production department A and B, and
one service department Z provides the following information:
- Practical capacity of department Z 12,000 hours
- Fixed costs of operating dep. Z was $200,000
- Variable cost per hour of dep. Z was $15 (per hour used)
- Budgeted Direct labor usage of dep. Z was 8,000 hours
- Department A budgeted usage 6,000 hours of dep. Z services
- Department A used 5,000 hours of dep. Z services
- Department B budgeted usage 2,000 hours of dep. Z services
- Department B used 1,000 hours of dep. Z services
Requirement: allocate costs of the company service department to its
production department in two cases (based on the demand for
services – based on the supply of capacity)using:
- Single rate method
- Dual rate method
Solution:
Case 1 based on the demand for services (usage)
First: Cost allocation using Single rate method:
One combined allocation rate is used, calculated as follows:
1- Determine dep. Z total costs:
Dep. Z variable costs = $15 X 8,000 h= $120,000
Dep. Z fixed costs =
$200,000
Total costs of dep. Z = (Fixed+ variable)
$320,000
2- Determine dep. Z allocation rate:
Allocation rate = $320,000 / 8,000 h
= $40 per hour used
Calculate the cost allocated to each production
department:
1- Cost allocated to department A = $40 X 5000 h = $200,00
2- Cost allocated to department B = $40 X 1,000 h = $ 40,000
Total cost allocated
$240,000
Note:
Under Single rate method allocation rate is calculated
based on budgeted cost driver,
While production departments are charged with costs based
on their actual usage of cost driver (allocation base)
Second: Cost allocation using Dual rate method:
Calculate allocation rate for each cost pool:
Fixed costs allocation rate = $200,000/ 8,000 (budgeted hours)
= 25 $/hour
Variable costs allocation rate = Variable cost per hour of dep. Z =
$15
Calculate the cost allocated to each production
department:
1. Department A:
Variable Cost allocated to department A = $15 X 5000 h = $75,000
Fixed Cost allocated to department A = $25 X 6,000 h = $ 150,000
Total cost allocated to dep. A
$225,000
Department B:
Variable Cost allocated to department B = $15 X 1000 h = $15,000
Fixed Cost allocated to department B = $25 X 2,000 h = $ 50,000
Total cost allocated to dep. B
Total costs assigned to production departments
$65,000
$290,000
+
Note:
Under Dual rate method allocation rate must be chosen
for each cost pool,
✓ allocation rate is calculated based on budgeted cost
driver,
✓ While production departments are charged with
variable costs based on their actual usage of cost
driver (allocation base),
✓
charged with fixed costs based on their budgeted
usage of cost driver
Note:
Under both methods each production division was charged
with the same amount of variable cost.
Case 2 based on the capacity
Practical capacity = 12000 hours
Budgeted cost rate per hour
= Fixed costs/practical
capacity
= $200,000 / 12,000 hours
= $16.67
+
Budgeted variable cost per hour = $15
Budgeted total cost per hour
= $31.67
Using the same procedures for the single-rate and dual-rate methods
as in the previous section
First: Cost allocation using Single rate method:
Calculate the cost allocated to each production department:
3- Cost allocated to department A = $31.67 X 5000 (actual hours)
= $158,350
4- Cost allocated to department B = $31.67 X 1,000 (actual hours)
+
= $ 31,670
Total cost allocated to production departments
$190,020
5- Fixed Cost of unused (Idle) capacity
= (Practical capacity- Capacity used) X Fixed cost allocation
rate
= (12,000-5,000-1,000) hours X $16.67
= $100,020
Second: Cost allocation using Dual rate method:
Calculate the cost allocated to each production department:
2. Department A:
Variable Cost allocated to department A = $15 X 5000 (actual hours)
= $75,000
Fixed Cost allocated to department A = $16.67 X 6,000 (budgeted hours)
= $ 100,020
+
Total cost allocated to dep. A
$175,020
3. Department B:
Variable Cost allocated to department B = $15 X 1000 (actual hours)
= $15,000
Fixed Cost allocated to department B = $16.67 X 2,000 (budgeted hours)
= $ 33,340
Total cost allocated to dep. B
Total costs assigned to production departments
$48,340
$223,360
4. Fixed Cost of unused (Idle) capacity
= (Practical capacity- budgeted Capacity to be used) X Fixed cost allocation rate
= (12,000-6,000-2,000) hours X $16.67 = $66,680
Exercise (1):
The power plant serves all manufacturing departments of MidWest
Engineering, it has a budget for the coming year, expressed in the
following monthly terms:
Manufacturing
Practical Capacity
Average Expected
Department
Production Level
Monthly
(Kilowatt-Hours)
Usage (Kilowatt-Hours)
Rock
10,000
8,000
Peri
20,000
9,000
Hamd
12,000
7,000
+
Kan
8,000
6,000
Total
50,000
30,000
The expected monthly costs for operating the power plant during the
budget year are $15,000: $6,000 variable and $9,000 fixed.
Requirement:
What budgeted amounts will be allocated to each manufacturing
department if
(a) The rate is calculated based on practical capacity, assuming:
- single rate method is used.
- dual rate method is used.
(b) The rate is calculated based on expected monthly usage, assuming:
- single rate method is used.
- dual rate method is used.
Exercise (2):
Chocolate Inc. is a producer of premium chocolate based in Cairo. The
company has a separate division for each of its two products: dark
chocolate and milk chocolate. Chocolate purchases ingredients from
WI for its dark chocolate division and from LO for its milk chocolate
division. Both locations are the same distance from Cairo plant.
Chocolate Inc. operates trucks as a cost center that charges the
divisions for variable costs (drivers and fuel) and fixed costs (vehicle
depreciation, insurance, and registration fees) of operating the trucks.
The trucks had a practical capacity of 50 round-trips between the
plant and the two suppliers The co. recorded the following
information.
Budgeted Actual
Costs of truck
Number of round-trips for dark
$115,000 $96,750
30
30
20
15
chocolate division (Cairo plant—WI)
Number of round-trips for milk
chocolate division (Cairo plant—LO)
Chocolate Inc. decides to examine the effect of using the dual-rate
method for allocating truck costs to each round-trip. At the start of
2018, the budgeted costs were as follows:
Variable cost per round-trip
$1,350
Fixed costs
$47,500
The actual results for the 45 round-trips made in 2018 were as follows:
Variable cost
$58,500
Fixed costs
$38,250
Total
$96,750
Required:
1- allocate costs based on round-trips used by each division.
2- allocate costs based on round-trips budgeted for each division.