Allocation of
Support Department Costs,
Common Costs,
and Revenues
Edited for ACCT 7310 by Dr. Bailey
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Cost allocation is important topic
 Recent Survey of AICPA & IMA members ranks
overhead allocation as one of the most important
topics that we should cover.
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Purposes of Cost Allocation (from Ch. 14)
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Criteria for Cost-Allocation Decisions (from Ch. 14)
 Cause-and-effect—variables are identified that cause
resources to be consumed.
 Most credible to operating managers
 Integral part of ABC
 Benefits received—the beneficiaries of the outputs of
the cost object are charged with costs in proportion to
the benefits received.
 [continued…]
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Criteria for Cost-Allocation Decisions (from Ch. 14)
 Fairness (equity)—the basis for establishing a price
satisfactory to the government and its suppliers.
 Cost allocation here is viewed as a “reasonable” or “fair”
means of establishing selling price.
 Ability to bear—costs are allocated in proportion to
the cost object’s ability to bear them.
 Generally, larger or more profitable objects receive
proportionally more of the allocated costs.
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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
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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.
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Methods to Allocate
Support Department Costs
 Dual-rate method—segregates costs within each cost
pool into two segments: a variable-cost pool and a
fixed-cost pool.
 Each pool uses a different cost-allocation base.
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Allocation Method Trade-Offs
 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.
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Allocation Bases

Under either method, allocation of support costs
can be based on one of the three following
scenarios:
1.
2.
3.

Budgeted overhead rate and budgeted hours
Budgeted overhead rate and actual hours
Actual overhead rate and actual hours
Choosing between actual and budgeted rates:
budgeted is known at the beginning of the period,
whereas actual will not be known with certainty
until the end of the period
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Exh. 15-1: Effects of variation in actual usage on
fixed cost allocation (Discussion pp. 547-549)
Allocations using budgeted rates, actual hours
Allocating the total amt based on
proportion of actual usage causes
each division’s cost to depend on
the other division’s usage!
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Methods of Allocating Support Costs to
Production Departments
1.
2.
3.
Direct
Step-down
Reciprocal
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Direct, step, reciprocal?
Support Departments
Production Departments
Information Systems
Manufacturing
Packaging
Accounting
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Direct method ignores supportdepartment services to each other
Support Departments
Production Departments
Information Systems
Manufacturing
Packaging
Accounting
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Step considers some of the services
between depts
Support Departments
Production Departments
Information Systems
Manufacturing
Packaging
Accounting
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Reciprocal considers them all
Support Departments
Production Departments
Information Systems
Manufacturing
Packaging
Accounting
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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.
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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.
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Methods of Allocating
Common Costs
 Incremental cost-allocation method ranks the 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
the cost 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 are handled in the same manner as the second
ranked user.
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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.
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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:
Selling prices
2. Unit costs
3. Physical units
1.
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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,
and so on.
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Revenues and Bundled Products
A bundled product is a package of two or more
products (or services) sold for a single price.
Bundled product sales are also referred to
as “suite sales.”
The individual components of the bundle also
may be sold as separate items at their own
“stand-alone” prices.
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Revenues and Bundled Products
What businesses provide bundled products?
Banks
Checking
 Safety
deposit boxes
 Investment
advisory

Hotels
Lodging
 Food and
beverage
services
 Recreation

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Tours
Transportation
 Lodging
 Guides

Revenue Allocation Methods
English Languages Institute buys English
language software programs and
then sells them in Mexico and Central America.
English sells the following programs:
Grammar, Translation, and Composition
These programs are offered stand-alone
or in a bundle.
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Revenue Allocation Methods
Stand-alone Price
Grammar
$255
Translation $ 85
Composition $185
Purchasing these software
programs costs English
the following:
Grammar
$180
Translation
$ 45
Composition
$ 95
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Revenue Allocation Methods
Bundle (Suites)
Grammar + Translation
Grammar + Composition
Grammar + Translation + Composition
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Price
$290
$350
$410
Revenue Allocation Methods
The two main revenue allocation methods are:
1. The stand-alone
method
2. The incremental
method
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Stand-Alone Revenue
Allocation Method
There are four types of weights for the
stand-alone revenue allocation method.
1. Selling prices
3. Physical units
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2. Unit costs
Stand-Alone Revenue
Allocation Method
Consider the Grammar and Translation
suite, which sells for $290.
How much weight should English
Languages Institute assign to each item?
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Stand-Alone Revenue Allocation
Method
Selling prices:
The individual selling prices are $255 for
Grammar and $85 for Translation.
$255+85 = $340 total, so…
Grammar: $255 ÷ $340 = 0.75,
$290 bundle SP × 0.75 = $217.50
Translation:
$85 ÷ $340 = 0.25, $290 × 0.25 = $72.50
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Stand-Alone Revenue
Allocation Method
Unit costs:
This method uses the costs of the individual
products to determine the weights for the
revenue allocations.
Grammar:
$180 ÷ $225 = 0.80, $290 × 0.80 = $232
Translation:
$45 ÷ $225 = 0.20, $290 × 0.20 = $58
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Stand-Alone Revenue
Allocation Method
Physical units:
This method gives each product unit in the
suite the same weight when allocating
suite revenue to individual products.
With two products in the suite, each
product is allocated 50% of suite revenues.
1 ÷ (1 + 1) = 0.50
$290 × 0.50 = $145
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Stand-Alone Revenue
Allocation Method
Selling prices
Unit costs
Physical units
Revenue Allocation Weights
Grammar Translation
$217.50
$ 72.50
232.00
58.00
145.00
145.00
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Incremental Revenue
Allocation Method
The first-ranked product is termed the
primary product in the bundle.
The second-ranked product is termed
the first incremental product.
The third-ranked product is the second
incremental product, and so on.
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Incremental Revenue
Allocation Method
Assume that Grammar is designated
as the primary product.
If the suite selling price exceeds the standalone price of the primary product, the
primary product is allocated 100%
of its stand-alone revenue.
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Incremental Revenue
Allocation Method
Grammar and Translation suite selling price
= $290
Allocated to Grammar: $255
Remaining to be allocated: ($290 – $255) = $35
Allocated to Translation: $35
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The End
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