 Why allocate costs to departments?  Three methods of allocation.  Cost allocation issues. Overview 4 & 12 Service Department Costing: An Activity Approach Chapters

 Product mix decisions  e.g. valves or flow controllers  Pricing decisions  Reimbursement requests  e.g. government contracts  Inventory valuation  reporting, insurance  Identification of inefficiencies or non- value added costs. Allocating Costs to Products

 Evaluate performance of operating unit or unit manager.  identify full cost of operations  including use of shared resources  Provide information for decision- making.  closing stores  marketing strategy Information Systems Machining Allocating Costs to Operating Units

 Motivate managers.  discourage waste  encourage new approaches for increasing revenue or decreasing costs  Identify inefficiencies.  excessive corporate overhead  inefficient information systems department Information Systems Machining

Service DepartmentsOperating Departments ? ? Information Systems Payroll Stamping Assembly

InfoPayrollStampingAssmbly Budget overhead$9,500$5,600$38,500$27,900 Processing hrs No. of employees Support DepartmentAllocation Base Information systemsProcessing hours PayrollNo. of employees Example: Service Department Cost Allocation

 Support costs are allocated to operating departments only.  In determining allocation rates ignore the usage of the support departments. Direct Allocation

Total StampingAssmbly Operating Info Systems Payroll Support $ 9,500 (9,500) $ 81,500$ 38,500$ 5,600 (5,600) $ 27,900Before alloc Allocation Info Syst Payroll After alloc Proc. hrs # employ211520

Step-Down Allocation  Find the support department with the most service to the other support departments.  Allocate to both operating and support departments (based on usage of each.)  One step at a time; never look back. OR $9,500 * 5/25 = $1,900 $5,600 * 2/37 = $303

Step-Down Allocation Total StampingAssmbly Operating Info Systems Payroll Support $ 9,500 (9,500) $ 81,500$ 38,500$ 5,600$ 27,900Before alloc Allocation Info Syst Payroll After alloc Proc. hrs # employ211520

Reciprocal Allocation  Find the total (reciprocated) cost of each service department using a system of equations.  Define variables for the total cost of each service department: I=total cost of info systems P=total cost of payroll

I=9,500 + ( 2/37 ) * P P=5,600 + ( 5/25 ) * I  Set-up a system of equations: Employees in every department except Payroll: Info. Systems2 Stamping15 Assembly 20 Total37 Processing hours in every department except Information Systems: Payroll5 Stamping8 Assembly 12 Total25

 Solve the system of equations:  Allocate reciprocated costs to all operating and service departments. I=9,500 + ( 2/37 ) * P P=5,600 + ( 5/25 ) * I

Reciprocal Allocation Total StampingAssmbly Operating Info Systems Payroll Support $ 9,500 (9,910) $ 81,500$ 38,500$ 5,600 (7,582) $ 27,900Before alloc Allocation Info Syst Payroll After alloc Proc. hrs # employ211520

Cost Allocation Issues  Cause and effect  Benefits received  payroll dept costs : number of employees  corporate advertising: sales  Fairness  Ability to bear Processing hours Info. Systems Costs Cost Allocation Bases

Actual or Projected Usage? Actual or Budgeted Costs?