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
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
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
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
Allocation Bases
•
Under either method, allocation of support
costs can be based on one of the three
following scenarios:
1. Budgeted overhead rate and budgeted hours
2. Budgeted overhead rate and actual hours
3. 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
Homework
• Work 7-16, 17, 18
Methods of Allocating Support Costs to
Production Departments
1. Direct
2. Step-Down
3. Reciprocal
Direct Method
• Allocates support costs only to Operating
Departments
• No interaction between Support Departments
prior to allocation
Direct Method
Support Departments
Production Departments
Information Systems
Manufacturing
Packaging
Accounting
Homework
• Work 7-21 (part 1)
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
Step-Down Method
Support Departments
Production Departments
Information Systems
Manufacturing
Packaging
Accounting
Homework
• Work 7-21 (part 2)
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
Reciprocal Method
Support Departments
Production Departments
Information Systems
Manufacturing
Packaging
Accounting
Choosing Between Methods
• Reciprocal is the most precise
• Direct and Step-Down are simple to compute
and understand
• Direct Method is widely used
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
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
Methods of Allocating
Common Costs
• Incremental Cost-Allocation Method ranks 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
Methods of Allocating
Common Costs
• Shapley Value Method
 Allocates to each item the average of the costs allocated as
the primary and as the incremental item.
 Calculate the incremental values at with each as primary, then
divide (by 2 if only two items) to get an average.
Homework
• Work 7-23 and 24
Cost Allocations and Contracting
•
The US government reimburses most
contractors in either of two main ways:
1. The contractor is paid a set price without analysis
of actual contract cost data
2. 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)
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
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. Selling Prices
2. Unit Costs
3. Physical Units
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.
Homework
• Work 7-25