7-1 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Support Department Cost Allocation 7 PowerPresentation® prepared by David J. McConomy, Queen’s University

7-2 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Learning Objectives l Describe the difference between support departments and producing departments. l Calculate single and multiple charging rates for a support department.

7-3 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Learning Objectives l Allocate support-department costs to producing departments using the direct, sequential, and reciprocal methods. l Calculate departmental overhead rates.

7-4 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Support and Producing Departments Support departments are units within an organization that provide essential support services for producing departments. Examples:maintenance, grounds, engineering, housekeeping, personnel, and stores Producing departments are units within an organization that are directly responsible for creating the products or services sold to customers. Examples:Services: auditing, tax, management advisory Manufacturing: grinding and assembly

7-5 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Definitions l Mutually beneficial costs, which occur when the same resource is used in the output of two or more services or products, are common costs. Example:security guard wages at a factory l Causal factors are variables or activities within a producing department that bring about support service costs.

7-6 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Steps in Allocating Support Department Costs to Producing Departments 1.Departmentalize the company. 2.Classify each department as a support or producing department. 3.Trace all overhead costs in the company to a support or producing department.

7-7 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Steps in Allocating Support Department Costs to Producing Departments 4.Allocate support-department costs to the producing departments. 5.Calculate predetermined overhead rates for producing departments. 6.Allocate overhead costs to the units of individual products through the predetermined overhead rates.

7-8 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Objectives Objectives of Allocation l To obtain a mutually agreeable price. l To compute product-line profitability. l To predict the economic effects of planning and control. l To value inventory. l To motivate managers.

7-9 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Examples of Cost Drivers for Support Departments Accounting Number of transactions Cafeteria Number of employees Engineering Number of change orders Maintenance Machine hours Payroll Number of employees Personnel Number of new hires Support DepartmentPossible Driver

7-10 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Support Departments and Producing Departments Support departments provide support for production departments Producing departments are responsible for the creation of goods or services Goods and Services

7-11 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. A Single Charging Rate Example l A firm developed an in-house photocopying department to serve its three producing departments (audit, tax, and management advisory systems or MAS). l The costs of the photocopying department include fixed costs of $26,190 per year and variable costs of $0.023 per page copied. l Estimated usage in pages by the three producing departments is as follows: Audit department94,500 Tax department67,500 MAS department108,000 Total270,000 ======

7-12 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. A Single Charging Rate (continued) Total costs = $26,190 + (270,000 x $0.023) = $32,400 Overhead rate = $32,400  270,000 = $0.12 per page Suppose the actual usage per department is: Audit department92,000 Tax department65,000 MAS115,000

7-13 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. A Single Charging Rate (continued) The total photocopying department charges would be as shown: Total # of PagesOH rateCharges Audit92,000$0.12$11,040 Tax65,000$0.127,800 MAS115,000$0.1213,800 Total272,000$32,640======

7-14 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Multiple Charging Rates The total photocopying department charges would be as shown: Total Peak PagesShareFixedAllocated Audit 7,87520% $26,190 $ 5,238 Tax 22,50057%26,190$14,928 MAS 9,00023%26,190$ 6,024 Total 39,375100%$26,190 ============

7-15 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Multiple Charging Rates The total photocopying department charges would be as shown: Fixed Variable CostAllocationAllocated Audit $2,116 $ 5,238 $ 7,354 Tax 1,49514,928$16,423 MAS 2,6456,024$ 8,669 Total $6,256$26,190$32,446

7-16 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Budgeted Versus Actual Usage When we allocate support-department costs to the producing departments, should we allocate actual or budgeted costs? Budgeted costs

7-17 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Budgeted Versus Actual Usage (continued) There are two basic reasons for allocating support-department costs. 1.To assign costs to units produced 2.For performance evaluations

7-18 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Choosing A Service Department Cost Allocation Method The three methods for allocating service department costs to producing departments are: The Direct Method The Sequential Method The Reciprocal Method

7-19 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Service Department Allocation An Example Support Departments Producing Departments PowerMaint.GrindingAssembly Direct Costs*$250,000$160,000$100,000$ 60,000 Normal Activity: Kilowatt-hours ,000600,000200,000 Maintenance hours1, ,5004,500 *For a producing department, direct costs refer only to overhead costs that are directly traceable to the department.

7-20 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Service Department Allocation Direct Method Support Departments Producing Departments PowerMaint.GrindingAssembly Direct Costs$250,000$160,000$100,000$ 60,000 Power(250,000) ,50062,500 Maintenance (160,000) 80,000 80,000 Total$ 0$ 0$367,500$202,500 ============================

7-21 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Service Department Allocation Sequential Method Support Departments Producing Departments PowerMaint.GrindingAssembly Direct Costs$250,000$160,000$100,000$ 60,000 Power(250,000)50,000150,00050,000 Maintenance ---(210,000) 105, ,000 Total$ 0$ 0$355,000$215,000 ===========================

7-22 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Reciprocal Method The reciprocal method of allocation recognizes all interactions among support departments.

7-23 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Reciprocal Method (continued) Support Departments Producing Departments PowerMaint.GrindingAssembly Direct Costs: Fixed$200,000$100,000$ 80,000$50,000 Variable 50,000 60,000 20,000 10,000 Total$250,000$160,000$100,000$60,000 =========================== Proportion of Output Used by PowerMaint.GrindingAssembly Allocation Ratios: Power Maintenance

7-24 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Reciprocal Method (continued) The cost equation for each support department can be expressed as follows: P= Direct costs + Share of Maintenance’s cost P=$250, (M) M= Direct costs + Share of Power’s costs M= $160, P

7-25 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Reciprocal Method (continued) Substituting the Power equation into the Maintenance equation, we get: M =$160, ($250, M) M =$160,000 + $50, M 0.98M =$210,000 M =$214,286

7-26 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Reciprocal Method (continued) Substituting the value for M into the Power equation we get: P =$250, ($214,286) P =$250,000 + $21,429 P =$271,429

7-27 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Reciprocal Method (continued) Support Departments Producing Departments PowerMaint.GrindingAssembly Direct Costs$250,000$160,000$100,000$ 60,000 Power(271,429)54,286162,85754,286 Maintenance 21,429(214,286) 96,429 96,429 Total$ 0$ 0$359,286$210,715 ============================

7-28 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Departmental Overhead Rates The overhead rate for the grinding department is computed as follows (assuming the normal level of activity is 71,000 MH): OH rate = $355,000  71,000 = $5.00 per MH The overhead rate for the assembly department is computed as follows (assuming the normal level of activity is 107,500 DLH): OH rate = $215,000  107,500 = $2.00 per DLH