ALLOCATING COSTS OF SUPPORT
DEPARTMENTS AND JOINT
PRODUCTS
CHAPTER 7
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CHAPTER 7 OBJECTIVES
1. Describe the difference between support
departments and producing departments
2. Calculate charging rates, and distinguish
between single and dual charging rates
3. Allocate support center costs to producing
departments using the direct method, the
sequential method, and the reciprocal
method
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a passwordprotected website for classroom use.
CHAPTER 7 OBJECTIVES
4. Calculate departmental overhead rates
5. Identify the characteristics of the joint
production process, and allocate joint
costs to products
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a passwordprotected website for classroom use.
AN OVERVIEW OF COST ALLOCATION
• Common costs are mutually beneficial costs
• Occur when the same resource is used in the
output of two or more services or products
• May pertain to periods of time, individual
responsibilities, sales territories and classes of
customers
LO-1
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a passwordprotected website for classroom use.
AN OVERVIEW OF COST ALLOCATION
• A means of dividing a pool of costs and
assigning those costs to various subunits
• Does not affect the total cost
• Amount of cost assigned to the subunits can
be affected by the allocation procedure
chosen
LO-1
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a passwordprotected website for classroom use.
AN OVERVIEW OF COST ALLOCATION
Types of Departments
1. Producing departments: directly responsible for
creating the products or services sold to
customers
2. Support departments: provide essential services
for producing departments
• First step in cost allocation is to determine what the
cost objects are
• Usually the cost objects are departments
LO-1
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EXHIBIT 7.1—EXAMPLES OF DEPARTMENTALIZATION
FOR A MANUFACTURING FIRM AND A SERVICE FIRM
LO-1
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EXHIBIT 7.1—EXAMPLES OF DEPARTMENTALIZATION
FOR A MANUFACTURING FIRM AND A SERVICE FIRM
(CONTINUED)
LO-1
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EXHIBIT 7.2—STEPS IN ALLOCATING SUPPORT
DEPARTMENT COSTS TO PRODUCING DEPARTMENTS
LO-1
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EXHIBIT 7.3—EXAMPLES OF POSSIBLE ACTIVITY
DRIVERS FOR SUPPORT DEPARTMENTS
LO-1
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AN OVERVIEW OF COST ALLOCATION
Objectives of Allocation
• To obtain a mutually agreeable price
• To compute a product line profitability
• To predict the economic effects of planning
and control
• To value inventory
• To motivate managers
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© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a passwordprotected website for classroom use.
ALLOCATING ONE DEPARTMENT’S COSTS
TO OTHER DEPARTMENTS
• The costs of a support department are often
allocated to other departments through the
use of a charging rate
• Two major factors in determining charging
rate
• The choice of a single or dual charging rate
• The use of budgeted or actual support
department costs
LO-2
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a passwordprotected website for classroom use.
ALLOCATING ONE DEPARTMENT’S COSTS
TO OTHER DEPARTMENTS
A Single Charging Rate
• Similar in concept to a plant wide overhead rate
• All support department costs are accumulated in
the numerator and some measure of usage in the
denominator in the denominator
Single rate =
Fixed Costs + Estimated Variable Costs
Estimated Usage
LO-2
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a passwordprotected website for classroom use.
ALLOCATING ONE DEPARTMENT’S COSTS
TO OTHER DEPARTMENTS
Multiple Charging Rates
• Single charging rate masks the causal factors that
lead to a support department’s total costs
• Companies develop a dual rate with a fixed
component and a variable component
LO-2
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a passwordprotected website for classroom use.
ALLOCATING ONE DEPARTMENT’S COSTS
TO OTHER DEPARTMENTS
Multiple Charging Rates
•The allocation of fixed costs follows a three
step procedure
• Determination of budgeted fixed support service
costs
• Computation of the allocation ratio
Allocation ratio = Production department
capacity/Total capacity
Allocation = Allocation ratio × Budgeted fixed
support service costs
LO-2
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a passwordprotected website for classroom use.
ALLOCATING ONE DEPARTMENT’S COSTS
TO OTHER DEPARTMENTS
Budgeted versus Actual Usage
• By allocating budgeted costs instead of actual costs of
a support department to producing departments, no
inefficiencies or efficiencies are transferred from one
department to another
• For product costing, the allocation is done at the
beginning of the year on the basis of budgeted usage so
that a predetermined overhead rate can be computed
• As the causal factors can differ for fixed and variable
costs, these types of costs should be allocated
separately
LO-2
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a passwordprotected website for classroom use.
EXHIBIT 7.4—USE OF BUDGETED DATA FOR PRODUCT
COSTING: COMPARISON OF SINGLE- AND
DUAL-RATE METHODS
LO-2
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EXHIBIT 7.5—USE OF ACTUAL DATA FOR PERFORMANCE
EVALUATION PURPOSES: COMPARISON OF SINGLE AND
DUAL RATE METHODS
LO-2
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EXHIBIT 7.6—DATA FOR SUPPORT AND
PRODUCING DEPARTMENTS
LO-3
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CHOOSING A SUPPORT DEPARTMENT COST
ALLOCATION METHOD
Direct Method of Allocation
• All costs of the support departments are allocated
directly to producing departments in proportion to
each producing department’s usage of the service
• Does not allocate any support department cost to
another support department, even if other support
departments use the services of a support
department
LO-3
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a passwordprotected website for classroom use.
EXHIBIT 7.7—ALLOCATION OF SUPPORT
DEPARTMENT COSTS TO PRODUCING
DEPARTMENTS USING THE DIRECT METHOD
LO-3
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EXHIBIT 7.7—ALLOCATION OF SUPPORT
DEPARTMENT COSTS TO PRODUCING DEPARTMENTS
USING THE DIRECT METHOD (CONTINUED)
LO-3
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a passwordprotected website for classroom use.
EXHIBIT 7.7—ALLOCATION OF SUPPORT
DEPARTMENT COSTS TO PRODUCING DEPARTMENTS
USING THE DIRECT METHOD (CONTINUED)
LO-3
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a passwordprotected website for classroom use.
CHOOSING A SUPPORT DEPARTMENT COST
ALLOCATION METHOD
Sequential Method of Allocation
• Recognizes that interactions among the support
departments do occur
• Takes only partial account of this interaction
• Performed in a step down fashion, following a
predetermined ranking procedure
LO-3
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EXHIBIT 7.8—ALLOCATION OF SUPPORT
DEPARTMENT COSTS TO PRODUCING
DEPARTMENTS USING THE SEQUENTIAL METHODS
LO-3
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EXHIBIT 7.8—ALLOCATION OF SUPPORT
DEPARTMENT COSTS TO PRODUCING DEPARTMENTS
USING THE SEQUENTIAL METHODS (CONTINUED)
LO-3
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EXHIBIT 7.8—ALLOCATION OF SUPPORT
DEPARTMENT COSTS TO PRODUCING DEPARTMENTS
USING THE SEQUENTIAL METHODS (CONTINUED)
LO-3
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a passwordprotected website for classroom use.
EXHIBIT 7.8—ALLOCATION OF SUPPORT
DEPARTMENT COSTS TO PRODUCING DEPARTMENTS
USING THE SEQUENTIAL METHODS (CONTINUED)
LO-3
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a passwordprotected website for classroom use.
CHOOSING A SUPPORT DEPARTMENT COST
ALLOCATION METHOD
Sequential Method of Allocation
• Recognizes all interactions of support departments
• The usage of one support department by another is
used to determine the total cost of each support
department
• The total cost reflects interactions among the support
departments
• Then, the new total of support department costs is
allocated to the producing departments
LO-3
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a passwordprotected website for classroom use.
CHOOSING A SUPPORT DEPARTMENT COST
ALLOCATION METHOD
Total Cost of Support Departments
Total cost = Direct costs + Allocated costs
• Each equation, which is a cost equation for a
support department, is the sum of the department’s
direct costs plus the proportion of service received
from other support departments
LO-3
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EXHIBIT 7.9—COMPARISON OF SUPPORT DEPARTMENT COST
ALLOCATIONS METHODS USING THE DIRECT, SEQUENTIAL,
AND RECIPROCAL METHODS
LO-3
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DEPARTMENTAL OVERHEAD RATES AND
PRODUCT COSTING
• After allocating all support service costs to
producing departments, an overhead rate is
calculated for each department
=
Allocated service costs + Producing department overhead costs
Measure of activity (direct labor hours, machine hours)
• The accuracy of product costs depends on
the accuracy of the assignment of
overhead costs
LO-4
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ACCOUNTING FOR JOINT PRODUCTION
PROCESSES
• Joint Products are two or more products
produced simultaneously by the same
process up to a ‘split-off’ point
• The split-off point is the point at which the
joint products become separate and
identifiable
• Joint or main products have relatively
significant sales value
LO-5
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EXHIBIT 7.10—JOINT PRODUCTION PROCESS
LO-5
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ACCOUNTING FOR JOINT PRODUCTION
PROCESSES
Cost Separability and the Need for Allocation
• Separable costs are easily traced to
individual products and offer no particular
problem
• If not separable, they are allocated to various
products for various reasons
• Cost allocations are arbitrary
LO-5
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EXHIBIT 7.11—INDEPENDENT MULTIPLE-PRODUCT
PRODUCTION USING THE SAME MATERIAL
LO-5
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ACCOUNTING FOR JOINT PRODUCTION
PROCESSES
Accounting for Joint Product Costs
• Joint costs must be allocated to the individual
products for purposes of financial reporting
• Several methods have been developed to allocate
joint costs
•
•
•
•
•
Physical units method
Weighted average method
Sales-value-at-split-off method
Net realizable value method
Constant gross margin method
LO-5
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a passwordprotected website for classroom use.
ACCOUNTING FOR JOINT PRODUCTION
PROCESSES
Physical Units Method
• Joint costs distributed on the basis of a physical
measure—pounds, tons, gallons, board feet, atomic
weight, or heat units
Weighted Average Method
• Uses weight factors (like amount of material used,
time consumed, and size of unit) to distribute joint
costs
LO-5
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ACCOUNTING FOR JOINT PRODUCTION
PROCESSES
Sales-Value-at-Split-Off Method
• Allocates joint cost based on each product’s
proportionate share of market value or sales value
at the split-off point
• The higher the market value, the greater the share
of joint cost charged against the product
LO-5
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a passwordprotected website for classroom use.
ACCOUNTING FOR JOINT PRODUCTION
PROCESSES
Net Realizable Value Method
• Used if there is no ready market price for the individual
products at the split-off point
• First, a hypothetical sales value is obtained for each joint
product by subtracting all separable (or further)
processing costs from the eventual market value.
• Then, use the net realizable value method to prorate the
joint costs based on each product’s share of
hypothetical sales value.
• Useful when one or more products cannot be sold at the
split-off point but must be processed further
LO-5
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ACCOUNTING FOR JOINT PRODUCTION
PROCESSES
Constant Gross Margin Percentage Method
• Recognizes that costs incurred after the split-off
point are part of the cost total on which profit is
expected to be earned
• Allocates joint cost such that the gross margin
percentage is the same for each product
LO-5
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ACCOUNTING FOR JOINT PRODUCTION
PROCESSES
Accounting for By-Products
• A secondary product recovered in the course of
manufacturing a primary product
• Obtained from joint production processes that have
relatively little sales value
• Two methods of accounting for by-product sales
• Credit by-product revenue to ‘Other Income’ or ‘Sale
of By-Product’
• Reduction of the joint costs allocated to the main
products by the amount of the by product revenue
LO-5
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END OF CHAPTER 7
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