1. Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Allocation of Support Activity Costs and Joint Costs 18 Chapter Eighteen

2. First, we identify the factor that drives costs in the service department. This cost driver is called the allocation base. How are service department costs charged to production departments? Service Department Cost Allocation

3. Production Departments Service Departments Carry out the central purposes of an organization. Provide support that facilitates the activities of production departments. Service Department Cost Allocation support

4. Well, we measure the consumption of the allocation base in the production departments. Service Department Cost Allocation How are service department costs charged to production departments?

5. Third, we allocate the service department cost based on the relative amount of the allocation base consumed in each production department. Service Department Cost Allocation How are service department costs charged to production departments?

6. Allocated service department costs become a part of the manufacturing overhead in each production department. Service Department Cost Allocation What happens to service department costs after they are allocated to production departments?

7. Allocated service department costs become a part of the manufacturing overhead in each production department. I get it. They become a part of the overhead that is applied to products with a predetermined overhead rate. Service Department Cost Allocation

8. So, the costs become a part of the finished product via the application of the pre- determined factory overhead rate. Exactly. Take a look at this flow chart. I think it will summarize our discussion of the allocation process. Service Department Cost Allocation

9. Service Department (Cafeteria) Service Department (Accounting) Service Department (Personnel) Production Department (Machining) Production Department (Assembly) The Product Service Department Cost Allocation First Stage Allocations Service department costs are allocated to production departments.

10. Service Department (Cafeteria) Service Department (Accounting) Service Department (Personnel) Production Department (Machining) Production Department (Assembly) The Product Second Stage Allocations Production department overhead costs, plus allocated service department costs, are applied to products using departmental predetermined overhead rates. Service Department Cost Allocation

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

12. Selecting Allocation Bases Criteria for selection Personnel: Number of employees Receiving: Units handled Security: Square footage Power: Kilowatt hours Cafeteria: Number of employees Custodial: Square footage Accounting: Staff hours Simplicity

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

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

15. Interdepartmental Services Service Department (Cafeteria) Service Department (Custodial) Production Department (Machining) Production Department (Assembly) POWER DEPARTMENT

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

17. Direct Method Service Department (Cafeteria) Service Department (Custodial) Production Department (Machining) Production Department (Assembly) Cost of services between service departments are ignored and all costs are allocated directly to production departments.

18. Direct Method Example

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

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

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

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

23. Step Method Service Department (Cafeteria) Service Department (Custodial) Production Department (Machining) Production Department (Assembly) Service department costs are allocated to other service departments and to production departments, usually starting with the service department that serves the largest number of other service departments.

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

25. Step Method Service Department (Cafeteria) Service Department (Custodial) Production Department (Machining) Production Department (Assembly) Custodial will have a new total to allocate to production departments: its own costs plus those costs allocated from the cafeteria.

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

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

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

29. Step Method Example $360,000 × 30 10 + 20 + 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 Allocation base: Square feet occupied

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

33. Comparison of Methods

34. Fixed Versus Variable Costs Are fixed and variable costs allocated differently?

35. Result When one department decreases activity to reduce allocations, all departments are penalized because the charge per use increases. Remember, total fixed costs do not change as activity changes. Fixed Versus Variable Costs Problem Allocating common fixed costs using a variable activity allocation base

36. Fixed Versus Variable Costs Problem Allocating common fixed costs using a variable activity allocation base Solution Use dual allocation method, allocating fixed and variable costs separately.

37. Charge to production departments at a budgeted rate times actual short-run usage of the allocation base. Allocate budgeted amounts to operating departments in proportion to the long-run average usage of the allocation base. Variable Costs Fixed Costs Budgeted costs should be allocated to avoid passing on inefficiencies from the service departments. Dual Cost Allocation

38. SimCo has a maintenance department and two production 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. Dual Cost Allocation Example

39. Variable costs are allocated based on hours used. Dual Cost Allocation Example

40. Variable costs are allocated based on hours used. Fixed costs are allocated based long-run average usage. Dual Cost Allocation Example

41. A Behavioral Problem Problem Department managers may underestimate long-run average usage to reduce fixed cost allocations. Solution Reward managers for making accurate estimates of long-run average service department needs.

42. The New Manufacturing Environment More accurate cost tracing systems reduce the need for allocation of indirect costs.

43. The Rise of Activity-Based Costing Service Department (Cafeteria) Service Department (Accounting) Service Department (Personnel) The Product First stage allocations are to activities, not departments. Activity One Activity Two

44. Joint Product Costs Product Joint Product Cost Allocation

45. Concept: –In some industries, a number of products are produced from a single raw material input. Key terms: –Joint products – products resulting from a process with a common input. –Split-off point – the stage of processing where joint products are separated. –Joint product cost – costs of processing joint products prior to the split-off point. Joint Product Cost Allocation

46. Consider the following example of an oil refinery. We will assume only two products, gasoline and oil. Joint Product Cost Allocation

47. Separate Processing Costs Final Sale Separate Processing Final Sale Separate Processing Separate Processing Costs Joint Input Joint Production Process Split-Off Point Joint Product Costs Oil Gasoline Joint Product Cost Allocation

48. Allocating Joint Costs Joint Product Costs Physical-Units Method Relative- Sales-Value Method Net-Realizable- Value Method

49. Allocating Joint Costs Allocation based on the relative values of the products at the split-off point. Allocation based on a physical measure of the joint products at the split-off point. Allocation based on final sales values less separable processing costs. Relative-Sales- Value Method Physical-Units Method Net-Realizable- Value Method

50. Let’s look at an example illustrating the joint cost allocation methods. Allocating Joint Costs

51. 240,000 gallons 360,000 gallons Joint Production Process Split-Off Point Oil Gasoline Joint material cost = $275,000 Joint conversion cost = $225,000 Physical-Units Method

52. $225,000 joint conversion cost plus $275,000 joint material cost

53. $200,000 sales value at split-off point $600,000 sales value at split-off point Joint Production Process Split-Off Point Oil Gasoline Joint material cost = $275,000 Joint conversion cost = $225,000 Relative-Sales-Value Method

54. $225,000 joint conversion cost plus $275,000 joint material cost Relative-Sales-Value Method

55. Net-Realizable-Value Method If products require further processing beyond the split-off point before they are marketable, it may be necessary to estimate the net realizable value (NRV) at the split-off point. Estimated NRV Final Sales Value Added Processing Costs –=

56. Net-Realizable-Value Method Joint Production Process Oil Gasoline Separate Processing Separate Processing Joint material cost = $275,000 Joint conversion cost = $225,000 Sales Value $500,000 Sales Value $1,200,000 Split-Off Point, Sales Value Unknown Separate Processing Costs $500,000 Separate Processing Costs $200,000

57. Net-Realizable-Value Method

58. By-Products Joint Input Joint Production Process Split-Off Point Joint Costs By-products Major Product Relatively low value or quantity when compared to major products Major Product

59. Two commonly used methods of accounting for by-products are... Ê By-product NRV is deducted from cost of joint process before allocation. Ë By-product NRV is deducted from cost of main product. 1 2 By-Products