Cornerstones of cost management 3rd edition hansen mowen chapter 7

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 nu

ALLOCATING COSTS OF SUPPORT

DEPARTMENTS AND JOINT

PRODUCTS

CHAPTER 7

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

CHAPTER 7 OBJECTIVES

4 Calculate departmental overhead rates

5 Identify the characteristics of the joint

production process, and allocate joint

costs to products

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

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

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

EXHIBIT 7.1—EXAMPLES OF DEPARTMENTALIZATION

FOR A MANUFACTURING FIRM AND A SERVICE FIRM

EXHIBIT 7.1—EXAMPLES OF DEPARTMENTALIZATION

FOR A MANUFACTURING FIRM AND A SERVICE FIRM

(CONTINUED)

EXHIBIT 7.2—STEPS IN ALLOCATING SUPPORT

DEPARTMENT COSTS TO PRODUCING DEPARTMENTS

EXHIBIT 7.3—EXAMPLES OF POSSIBLE

ACTIVITY DRIVERS FOR SUPPORT

DEPARTMENTS

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

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

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

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

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

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

EXHIBIT 7.4—USE OF BUDGETED DATA FOR PRODUCT COSTING: COMPARISON OF SINGLE- AND

DUAL-RATE METHODS

EXHIBIT 7.5—USE OF ACTUAL DATA FOR PERFORMANCE

EVALUATION PURPOSES: COMPARISON OF SINGLE AND

DUAL RATE METHODS

EXHIBIT 7.6—DATA FOR SUPPORT AND

PRODUCING DEPARTMENTS

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

EXHIBIT 7.7—ALLOCATION OF SUPPORT DEPARTMENT COSTS TO PRODUCING DEPARTMENTS USING THE DIRECT METHOD

EXHIBIT 7.7—ALLOCATION OF SUPPORT DEPARTMENT COSTS TO PRODUCING DEPARTMENTS

USING THE DIRECT METHOD (CONTINUED)

EXHIBIT 7.7—ALLOCATION OF SUPPORT DEPARTMENT COSTS TO PRODUCING DEPARTMENTS

USING THE DIRECT METHOD (CONTINUED)

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

EXHIBIT 7.8—ALLOCATION OF SUPPORT DEPARTMENT COSTS TO PRODUCING DEPARTMENTS USING THE SEQUENTIAL METHODS

EXHIBIT 7.8—ALLOCATION OF SUPPORT DEPARTMENT COSTS TO PRODUCING DEPARTMENTS USING THE SEQUENTIAL METHODS (CONTINUED)

EXHIBIT 7.8—ALLOCATION OF SUPPORT DEPARTMENT COSTS TO PRODUCING DEPARTMENTS USING THE SEQUENTIAL METHODS (CONTINUED)

EXHIBIT 7.8—ALLOCATION OF SUPPORT DEPARTMENT COSTS TO PRODUCING DEPARTMENTS USING THE SEQUENTIAL METHODS (CONTINUED)

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

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

EXHIBIT 7.9—COMPARISON OF SUPPORT DEPARTMENT COST

ALLOCATIONS METHODS USING THE DIRECT, SEQUENTIAL,

AND RECIPROCAL METHODS

DEPARTMENTAL OVERHEAD RATES AND

PRODUCT COSTING

• After allocating all support service costs to

producing departments, an overhead rate

is calculated for each department

• The accuracy of product costs depends on

Allocated service costs + Producing department overhead costs

Measure of activity (direct labor hours, machine hours)

=

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

EXHIBIT 7.10—JOINT PRODUCTION

PROCESS

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

EXHIBIT 7.11—INDEPENDENT MULTIPLE-PRODUCT

PRODUCTION USING THE SAME MATERIAL

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

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

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

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

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

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’

END OF CHAPTER 7