Managerial Accounting: An Introduction To Concepts, Methods, And Uses Chapter 15 Allocating Costs to Responsibility Centers Maher, Stickney and Weil

Learning Objectives (Slide 1 of 2) Explain what comprises common (or indirect) costs. Explain why companies allocate common costs to departments and products. Describe how to allocate service department costs to production departments. Explain why activity-based costing is used to allocate service department costs.

Learning Objectives (Slide 2 of 2) Identify methods of allocating marketing and administrative costs to departments. Explain how to allocate joint-process costs. Explain why joint-process costs are allocated.

Common Costs Common or indirect costs result from the joint use of a facility or service by several products, departments, or processes Common costs are allocated to develop division, department or product cost information

Service Departments Service departments offer services internally to other departments Costs of providing these services must be allocated to other departments This allocation is done for several reasons Provides incentives to control use of support services External reporting requirements for tax and financial reporting purposes require such an allocation

Cost allocation The goal of cost allocation is to assign or allocate all overhead costs to product departments Cost allocation is a three step process: Assign direct costs to departments Allocate indirect costs to departments Allocate service department costs to production departments

Allocating Service Department Costs Allocating service department costs to production departments can be accomplished by several methods For example, the step method allocates costs in steps as follows: Begin with the service dept that receives the smallest amount of services from other service depts. Allocate its costs to other service and production departments Distribute the total costs of the service dept receiving the next smallest amount of service from other depts. and so on until all service dept costs have been allocated to production depts.

Activity-Based Costing A more accurate approach to allocate service dept costs might use ABC principles This approach involves: Measuring each service dept’s resource spending by unit, batch, product, customer, and facility Identify and measure activities demanded by other depts. that require support service Identify appropriate cost drivers and calculate cost-driver rates Allocate service dept costs based on other depts’ usage of cost-driver bases

Marketing and Administrative Expenses Management will often allocate marketing and administrative costs to departments Bases for allocating such costs might include the following: Cost Basis Storage Costs Floor Space Handling Costs Tonnage Handled Delivery Expenses Number of Miles Operated

Allocating Joint-Process Costs (Slide 1 of 4) A joint process produces several different products from one input Costs to operate joint processes are called joint-process costs Products resulting from a joint process are called joint products Joint-process costs must be allocated to joint products to provide managers with product cost information for decision making and performance evaluation

Allocating Joint-Process Costs (Slide 2 of 4) Two major methods of allocating joint-process costs are: Net realizable value method Physical quantities method

Allocating Joint-Process Costs (Slide 3 of 4) The net realizable value method allocates joint-process costs based on the net realizable value (NRV) of each product at the splitoff point NRV is the estimated sales price at splitoff point May be necessary to estimate NRV if product requires further processing

Allocating Joint-Process Costs (Slide 4 of 4) The physical quantities method allocates joint-process costs based on a physical measure of volume, weight, or any other physical measure This method is often used when Product prices are highly volatile Significant processing occurs between splitoff point and first point of marketability

Why Allocate Joint-Process Costs? Measuring performance Determining regulatory rate changes Estimating casualty losses Resolving contractual interests and obligations For financial and tax reporting to value inventories and cost of goods sold

Dr. Donald R. Trippeer, CPA Colorado State University-Pueblo If you have any comments or suggestions concerning this PowerPoint Presentation for Managerial Accounting, An Introduction To Concepts, Methods, And Uses, please contact: Dr. Donald R. Trippeer, CPA donald.trippeer@colostate-pueblo.edu Colorado State University-Pueblo