Chapter 17
Allocation of
Support Activity
Costs and Joint
Costs
McGraw-Hill/Irwin
Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
Learning
Objective
1
McGraw-Hill/Irwin
Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
Service Department Cost
Allocation
How are service
department costs
charged to production
departments?
First, we identify the factor
that drives costs in the
service department.
This cost driver is called
the allocation base.
17-3
Service Department Cost
Allocation
Service
Departments
Provide support
that facilitates the
activities of production
departments.
support
Production
Departments
Carry out the
central purposes
of an organization.
17-4
Service Department Cost
Allocation
How are service
department costs
charged to production
departments?
Well, we measure the
consumption of the
allocation base in the
production departments.
17-5
Service Department Cost
Allocation
How are service
department costs
charged to production
departments?
Third, we allocate the service
department cost based on
the relative amount of the
allocation base consumed in
each production department.
17-6
Service Department Cost
Allocation
What happens to
service department
costs after they are
allocated to
production
departments?
Allocated service department
costs become a part of the
manufacturing overhead in
each production department.
17-7
Service Department Cost
Allocation
I get it. They become
a part of the overhead
that is applied to
products with a
predetermined
overhead rate.
Allocated service department
costs become a part of the
manufacturing overhead in
each production department.
17-8
Service Department Cost
Allocation
So, the costs become
a part of the finished
product via the
application of the predetermined factory
overhead rate.
Exactly. Take a look at
this flow chart.
I think it will summarize
our discussion of the
allocation process.
17-9
Service Department Cost Allocation
Service
Department
(Cafeteria)
Service
Department
(Accounting)
Service
Department
(Personnel)
First Stage Allocations
Service department costs are allocated
to production departments.
Production
Department
(Machining)
Production
Department
(Assembly)
The
Product
Second Stage Allocations
Production department overhead costs, plus allocated service department costs,
are applied to products using departmental predetermined overhead rates.17-10
17-10
Selecting Allocation Bases
Personnel:
Number of
employees
Typical
Allocation
Bases
Receiving:
Units
handled
Security:
Square
footage
Custodial:
Square
footage
Cafeteria:
Number of
employees
Accounting:
Staff
hours
Power:
Kilowatt
hours
17-11
Selecting Allocation Bases
Personnel:
Number of
employees
Receiving:
Units
handled
Security:
Square
footage
Criteria for
selection
Simplicity
Availability
of space or
equipment
Benefits received
by the production
department
Accounting:
Staff
hours
Custodial:
Square
footage
Cafeteria:
Number of
employees
Power:
Kilowatt
hours
17-12
Interdepartmental Services
Service
Department
(Cafeteria)
Production
Department
(Machining)
POWER DEPARTMENT
Service
Department
(Custodial)
Production
Department
(Assembly)
17-13
Interdepartmental Services
Problem
Allocating costs when service departments
provide services to each other
Solutions
Direct Method
Step Method
17-14
Direct Method
Cost of services
between service
departments are
ignored and all
costs are
allocated directly
to production
departments.
Service
Department
(Cafeteria)
Production
Department
(Machining)
Service
Department
(Custodial)
Production
Department
(Assembly)
For an example please see the textbook.
17-15
Step Method
Service department
costs are allocated
to other service
departments and
to production
departments, usually
starting with the
service department
that serves the
largest number of
other service
departments.
Service
Department
(Cafeteria)
Production
Department
(Machining)
Service
Department
(Custodial)
Production
Department
(Assembly)
17-16
Step Method
Once a service
department’s costs
are allocated,
other service
departments’ costs
are not allocated
back to it.
Service
Department
(Cafeteria)
Production
Department
(Machining)
Service
Department
(Custodial)
Production
Department
(Assembly)
17-17
Step Method
Custodial will
have a new
total to allocate
to production
departments: its
own costs plus
those costs
allocated from
the cafeteria.
Service
Department
(Cafeteria)
Production
Department
(Machining)
Service
Department
(Custodial)
Production
Department
(Assembly)
For an example please see the textbook.
17-18
Learning
Objective
2
McGraw-Hill/Irwin
Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
Fixed Versus Variable Costs
Problem
Allocating common
fixed costs using a
variable activity
allocation base
Result
When one department
decreases activity to
reduce allocations, all
departments are penalized
because the charge
per use increases.
Remember, total fixed
costs do not change as
activity changes.
17-20
Fixed Versus Variable Costs
Problem
Allocating common
fixed costs using a
variable activity
allocation base
Solution
Use dual allocation
method, allocating
fixed and variable
costs separately.
17-21
Dual Cost Allocation
Variable
Costs
Fixed
Costs
Charge to
production
departments at a
budgeted rate times
actual short-run usage of
the allocation base.
Allocate
budgeted amounts
to operating departments
in proportion to the
long-run average
usage of the
allocation base.
Budgeted costs should be allocated to avoid passing on inefficiencies
from the service departments.
17-22
17-22
Dual Cost Allocation
Example
SimCo has a maintenance department and two production
departments: cutting and assembly. Variable maintenance
costs are budgeted at $0.60 per machine hour. Fixed
maintenance costs are budgeted at $200,000 per year.
Data relating to the current year are:
Production
Departments
Cutting
Assembly
Total
Long-run
Maintenance
Usage as a
% of Total
60%
40%
100%
Actual
Hours
Used
80,000
40,000
120,000
Allocate maintenance costs to the two operating departments.
17-23
Dual Cost Allocation
Example
Cutting
Department
Variable cost allocation:
$0.60 × 80,000 hours used
$0.60 × 40,000 hours used
Fixed cost allocation
60% of $200,000
40% of $200,000
Total allocated cost
$
Assembly
Department
48,000
$
24,000
$
80,000
104,000
120,000
$
168,000
Variable costs are allocated based on hours used.
Fixed costs are allocated based long-run average usage.
17-24
A Behavioral Problem
Problem
Solution
Department managers
may underestimate
long-run average usage
to reduce fixed cost
allocations.
Reward managers for
making accurate estimates
of long-run average
service department needs.
17-25
Learning
Objective
3
McGraw-Hill/Irwin
Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
The New Manufacturing
Environment
More accurate cost tracing systems
reduce the need for allocation
of indirect costs.
17-27
The Rise of Activity-Based
Costing
Service
Department
(Cafeteria)
Service
Department
(Accounting)
Service
Department
(Personnel)
First stage allocations are to
activities, not departments.
Activity
One
The
Product
Activity
Two
17-28
Learning
Objective
4
McGraw-Hill/Irwin
Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
Joint Product Cost Allocation
Product
Joint Product
Costs
Product
Product
17-30
Joint Product Cost Allocation
• Concept:
– In some industries, a number of products are
produced from a single raw material input.
• Key terms:
– Joint products – products resulting from a
process with a common input.
– Split-off point – the stage of processing where
joint products are separated.
– Joint product cost – costs of processing joint
products prior to the split-off point.
17-31
Joint Product Cost Allocation
Consider the following
example of an oil
refinery.
We will assume only
two products,
gasoline and oil.
17-32
Joint Product Cost Allocation
Joint
Product
Costs
Joint
Input
Oil
Joint
Production
Process
Final
Sale
Separate
Processing Costs
Gasoline
Split-Off
Point
Separate
Processing
Separate
Processing
Final
Sale
Separate
Processing Costs
17-33
Learning
Objective
5
McGraw-Hill/Irwin
Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
Allocating Joint Costs
Physical-Units
Method
Joint Product
Costs
RelativeSales-Value
Method
Net-RealizableValue Method
17-35
Allocating Joint Costs
Physical-Units
Method
Allocation based on a
physical measure of the
joint products at the
split-off point.
Relative-SalesValue Method
Allocation based on
the relative values
of the products at
the split-off point.
Net-RealizableValue Method
Allocation based on
final sales values less
separable processing
costs.
17-36
Allocating Joint Costs
Let’s look at an
example illustrating
the joint cost
allocation methods.
17-37
Physical-Units Method
Joint conversion
cost = $225,000
Joint material
cost = $275,000
Oil
240,000 gallons
Gasoline
360,000 gallons
Joint
Production
Process
Split-Off
Point
17-38
Physical-Units Method
Product
Oil
Output quantities in gallons
Proportionate share:
240,000 ÷ 600,000
360,000 ÷ 600,000
Allocated joint costs:
$500,000 × 40%
$500,000 × 60%
240,000
Gasoline
360,000
Total
600,000
40%
60%
$ 200,000
$ 300,000
$225,000 joint conversion cost plus
$275,000 joint material cost
17-39
Relative-Sales-Value Method
Joint conversion
cost = $225,000
Joint material
cost = $275,000
Oil
$200,000
sales value at
split-off point
Gasoline
$600,000
sales value at
split-off point
Joint
Production
Process
Split-Off
Point
17-40
Relative-Sales-Value Method
Product
Oil
Sales value at split-off point
Proportionate share:
$200,000 ÷ $800,000
$600,000 ÷ $800,000
Allocated joint costs:
$500,000 × 25%
$500,000 × 75%
Gasoline
Total
$ 200,000 $ 600,000 $ 800,000
25%
75%
$ 125,000
$ 375,000
$225,000 joint conversion cost plus
$275,000 joint material cost
17-41
Net-Realizable-Value Method
If products require further processing
beyond the split-off point before they
are marketable, it may be necessary
to estimate the net realizable value
(NRV) at the split-off point.
Estimated
NRV
=
Final
Sales
Value
–
Added
Processing
Costs
17-42
Net-Realizable-Value Method
Joint
conversion
cost = $225,000
Joint material
cost = $275,000
Oil
Joint
Production
Process
Separate
Processing Costs
$200,000
Gasoline
Split-Off
Point, Sales
Value Unknown
Sales
Value
$500,000
Separate
Processing
Separate
Processing
Sales
Value
$1,200,000
Separate
Processing Costs
$500,000
17-43
Net-Realizable-Value Method
Product
Oil
Sales value
Less additional processing costs
Estimated NRV at split-off point
Proportionate share:
$300,000 ÷ $1,000,000
$700,000 ÷ $1,000,000
Allocated joint costs:
$500,000 × 30%
$500,000 × 70%
Gasoline
Total
$ 500,000 $ 1,200,000 $ 1,700,000
200,000
500,000
700,000
$ 300,000 $ 700,000 $ 1,000,000
30%
70%
$ 150,000
$ 350,000
17-44
By-Products
Joint
Costs
Joint
Input
Joint
Production
Process
Major
Product
Major
Product
By-products
Relatively low
value or quantity
when compared to
major products
Split-Off
Point
17-45
By-Products
Two commonly used
methods of accounting for
by-products are . . .
1. By-product NRV is
deducted from cost of joint
process before allocation.
2. By-product NRV is
deducted from cost of main
product.
17-46
Learning
Objective
6
McGraw-Hill/Irwin
Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
Reciprocal Services Method
•Fully accounts for reciprocal services
•More accurate
•Can be combined with dual allocation
17-48
End of Chapter 17
17
17-49