1. Service Department Costing: An Activity Approach
Chapter 15
Service Department Costing: An Activity Approach

2. The Need for Cost Allocations
Operating Departments
Carry out the central purposes of an organization
Service Departments
Provide support to the operating departments

3. The Need for Cost Allocations
First, we identify the factor that drives costs in the service department.
This cost driver is used as the allocation base.
How are service department costs charged to operating departments?

4. The Need for Cost Allocations
Second, we measure the consumption of the allocation base in the operating departments.

5. The Need for Cost Allocations
Third, we allocate the service department cost based on the relative amount of the allocation base used in each operating department.

6. The Need for Cost Allocations
Allocated service department costs become a part of the overhead in each operating department.
What happens to service department costs after they are allocated to operating departments?

7. The Need for Cost Allocations
I get it. They become a part of the overhead that is applied to products with a predetermined overhead rate.
That’s right. Take a look at this flow chart.
I think it will summarize our discussion of the allocation process.

8. The Need for Cost Allocations
First Stage Allocations
Service department costs are allocated to operating departments.
Service Department
(Cafeteria)
Operating Department
(Machining)
Service Department
(Accounting)
The Products
Operating Department
(Assembly)
Service Department
(Personnel)

9. The Need for Cost Allocations
Second Stage Allocations
Operating department overhead costs and allocated service department costs are applied to products.
Service Department
(Cafeteria)
Operating Department
(Machining)
Service Department
(Accounting)
The Products
Operating Department
(Assembly)
Service Department
(Personnel)

10. Guidelines for Cost Allocation
Allocation bases
Interdepartmental services
Allocating costs by behavior
Allocation pitfalls to avoid
Allocation of actual or budgeted costs $
Service Departments
Operating Departments

11. Selecting Allocation Bases
Personnel:
Number of employees
Criteria
Custodial:
Square footage
Easiest
Receiving:
Units handled
Cafeteria:
Number of employees
Security:
Square footage
Accounting:
Staff hours
Power:
Kilowatt hours

12. Selecting Allocation Bases
Personnel:
Number of employees
Criteria
Custodial:
Square footage
Availability of space or equipment
Receiving:
Units handled
Cafeteria:
Number of employees
Security:
Square footage
Accounting:
Staff hours
Power:
Kilowatt hours

13. Selecting Allocation Bases
Personnel:
Number of employees
Criteria
Custodial:
Square footage
Receiving:
Units handled
Benefits received by the operating department
Cafeteria:
Number of employees
Security:
Square footage
Accounting:
Staff hours
Power:
Kilowatt hours

14. Selecting Allocation Bases
Personnel:
Number of employees
Criteria
Custodial:
Square footage
Receiving:
Units handled
Consumption of
resources
Cafeteria:
Number of employees
Security:
Square footage
Accounting:
Staff hours
Power:
Kilowatt hours

15. Interdepartmental Services
Problem
Allocating costs when service departments provide services to each other
Solutions
Direct Method
Step method
Reciprocal method

16. Direct Method Service Department (Cafeteria) Operating Department
(Machining)
Interactions between service
departments are ignored and all
costs are allocated directly to operating departments.
Service Department
(Custodial)
Operating Department
(Assembly)

17. Direct Method Example

18. Direct Method Example

19. Direct Method Example $360,000 × 20 20 + 30 = $144,000
$360,000 × 20
= $144,000
Allocation base: Number of employees

20. Direct Method Example $360,000 × 30 20 + 30 = $216,000
$360,000 × 30
= $216,000
Allocation base: Number of employees

21. Direct Method Example $90,000 × 25,000 25,000 + 50,000 = $30,000
$90,000 ×
25,000
25, ,000
= $30,000
Allocation base: Square feet occupied

22. Direct Method Example 50,000 25,000 + 50,000 $90,000 × = $60,000
$90,000 ×
= $60,000
Allocation base: Square feet occupied

23. Step Method Service Department (Cafeteria) Operating Department
(Machining)
Once a service department’s costs are allocated, other service department costs are not allocated back to it.
Service Department
(Custodial)
Operating Department
(Assembly)

24. Step Method Service Department (Cafeteria) Operating Department
(Machining)
Custodial will have a new total to allocate to operating departments; its own costs plus those costs allocated from the cafeteria.
Service Department
(Custodial)
Operating Department
(Assembly)

25. Step Method Example
We will use the same data used in the direct method example.

26. Step Method Example
Allocate Cafeteria costs first since it provides more service than Custodial.

27. Step Method Example $360,000 × 10 10 + 20 + 30 = $60,000
$360,000 × 10
= $60,000
Allocation base: Number of employees

28. Step Method Example $360,000 × 20 10 + 20 + 30 = $120,000
$360,000 × 20
= $120,000
Allocation base: Number of employees

29. Step Method Example $360,000 × 30 10 + 20 + 30 = $180,000
$360,000 × 30
= $180,000
Allocation base: Number of employees

30. Step Method Example
New total = $90,000 original custodial cost plus $60,000 allocated from the cafeteria.

31. Step Method Example $150,000 × 25,000 25,000 + 50,000 = $50,000
$150,000 ×
25,000
25, ,000
= $50,000
Allocation base: Square feet occupied

32. Step Method Example $150,000 × 50,000 25,000 + 50,000 = $100,000
$150,000 ×
50,000
25, ,000
= $100,000
Allocation base: Square feet occupied

33. Reciprocal Method Service Department (Cafeteria) Operating Department
(Machining)
Interdepartmental services are given full recognition rather than partial recognition as with the step method.
Service Department
(Custodial)
Operating Department
(Assembly)
Because of its mathematical complexity, the reciprocal method is rarely used.

34. Comparison of Methods

35. Quick Check Data The direct method of allocation is used.
Allocation bases:
Business school administration costs (ADMIN): Number of employees
Business administration computer services (BACS): Number of personal computers

36. Quick Check 
How much cost will be allocated from Administration to Accounting?
a. $ 36,000
b. $144,000
c. $180,000
d. $ 27,000

37. Quick Check 
How much cost will be allocated from Administration to Accounting?
a. $ 36,000
b. $144,000
c. $180,000
d. $ 27,000
$180,000 × 20
= $36,000

38. Quick Check 
How much total cost will be allocated from ADMIN and BACS combined to the Accounting Department?
a. $ 52,500
b. $135,000
c. $270,000
d. $ 49,500

39. Quick Check 
How much total cost will be allocated from ADMIN and BACS combined to the Accounting Department?
a. $ 52,500
b. $135,000
c. $270,000
d. $ 49,500
$90,000 × 18
= $13,500

40. Quick Check Data The step method of allocation is used.
Allocation bases:
Business school administration costs (ADMIN): Number of employees
Business administration computer services (BACS): Number of personal computers

41. Quick Check 
How much total cost will be allocated from ADMIN and BACS combined to the Accounting Department?
a. $35,250
b. $49,072
c. $18,000
d. $26,333

42. Quick Check 
How much total cost will be allocated from ADMIN and BACS combined to the Accounting Department?
a. $35,250
b. $49,072
c. $18,000
d. $26,333

43. What if we charged a flat annual fee for the service?
Allocating Fixed Costs
My performance looked good until they allocated those service department costs, so I’m not going to use the service again.
But that would not be beneficial to the company; most of those costs are fixed.
What if we charged a flat annual fee for the service?

44. Allocating Fixed Costs
That sounds better.
If the fee is fixed, the more I use the service the lower my average cost per use will be.

45. Allocating Costs by Behavior
Variable Costs
Charge to operating departments at a budgeted rate times the usage of the
allocation base.
Fixed Costs
Allocate budgeted amounts to operating departments in proportion to the peak-period capacity required by the operating department.

46. Allocating Costs by Behavior
Variable Costs
Fixed Costs
Charge to operating departments at a budgeted rate times the usage of the
allocation base.
Allocate budgeted amounts to operating departments in proportion to the peak-period capacity required by the operating department.
Budgeted costs should be allocated to avoid passing on inefficiencies from the service departments.

47. Allocating Costs by Behavior
Allocations are made at the beginning of the period to provide data for predetermined overhead rates and flexible budgets.
Allocations are made at the end of the period to provide data for comparing actual performance to planned performance.

48. Allocating Costs by Behavior Example
SimCo has a maintenance department and two operating 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:
Allocate maintenance costs to the two operating departments.

49. Allocating Costs by Behavior Example: Beginning of the Period
Hours planned

50. Percent of peak-period capacity.
Allocating Costs by Behavior Example: Beginning of the Period
Percent of peak-period capacity.

51. Allocating Costs by Behavior Example: End of the Period
Hours used

52. Percent of peak-period capacity.
Allocating Costs by Behavior Example: End of the Period
Percent of peak-period capacity.

53. Allocating Costs by Behavior Example
Fixed cost allocations are the same at the end and at the beginning because they are based on capacity instead of usage.

54. Quick Check Data
Foster City has an ambulance service that is used by the two public hospitals in the city. Variable ambulance costs are budgeted at $4.20 per mile. Fixed ambulance costs are budgeted at $120,000 per year. Data relating to the current year are:

55. Quick Check 
How much ambulance service cost will be allocated to Mercy Hospital at the beginning of the year?
a. $117,000
b. $254,400
c. $114,480
d. $119,250

56. Quick Check 
How much ambulance service cost will be allocated to Mercy Hospital at the beginning of the year?
a. $117,000
b. $254,400
c. $114,480
d. $119,250

57. Quick Check 
How much ambulance service cost will be allocated to Mercy Hospital at the end of the year?
a. $114,000
b. $118,800
c. $110,400
d. $121,200

58. Quick Check 
How much ambulance service cost will be allocated to Mercy Hospital at the end of the year?
a. $114,000
b. $118,800
c. $110,400
d. $121,200

59. Allocation Pitfalls to Avoid
Using sales dollars as an allocation base
Result
Departments that increase revenues are penalized by receiving more allocated costs.

60. Allocation Pitfalls to Avoid
Allocating fixed costs using a variable activity allocation base
Result
Total fixed costs do not change, but departments that increase activities to support increased revenues are penalized by receiving more allocated costs.

61. End of Chapter 15