Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin Chapter Four Systems Design: Process Costing

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-2 Similarities Between Job-Order and Process Costing Both systems assign material, labor and overhead costs to products and they provide a mechanism for computing unit product cost. Both systems use the same manufacturing accounts, including Manufacturing Overhead, Raw Materials, Work in Process, and Finished Goods. The flow of costs through the manufacturing accounts is basically the same in both systems. Both systems assign material, labor and overhead costs to products and they provide a mechanism for computing unit product cost. Both systems use the same manufacturing accounts, including Manufacturing Overhead, Raw Materials, Work in Process, and Finished Goods. The flow of costs through the manufacturing accounts is basically the same in both systems.

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-3 Differences Between Job-Order and Process Costing Process costing is used when a single product is produced on a continuing basis or for a long period of time. Job-order costing is used when many different jobs are worked on each period. Process costing is used when a single product is produced on a continuing basis or for a long period of time. Job-order costing is used when many different jobs are worked on each period. Process costing systems accumulate costs by department. Job-order costing systems accumulated costs by individual jobs. Process costing systems accumulate costs by department. Job-order costing systems accumulated costs by individual jobs. Process costing systems compute unit costs by department. Job-order costing systems compute unit costs by job on the job cost sheet. Process costing systems compute unit costs by department. Job-order costing systems compute unit costs by job on the job cost sheet. Process costing is used when a single product is produced on a continuing basis or for a long period of time. Job-order costing is used when many different jobs are worked on each period. Process costing is used when a single product is produced on a continuing basis or for a long period of time. Job-order costing is used when many different jobs are worked on each period. Process costing systems accumulate costs by department. Job-order costing systems accumulated costs by individual jobs. Process costing systems accumulate costs by department. Job-order costing systems accumulated costs by individual jobs. Process costing systems compute unit costs by department. Job-order costing systems compute unit costs by job on the job cost sheet. Process costing systems compute unit costs by department. Job-order costing systems compute unit costs by job on the job cost sheet.

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-4 Process costing is used for products that are: a.Different and produced continuously. b.Similar and produced continuously. c.Individual units produced to customer specifications. d.Purchased from vendors. Process costing is used for products that are: a.Different and produced continuously. b.Similar and produced continuously. c.Individual units produced to customer specifications. d.Purchased from vendors. Quick Check

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-5 Process costing is used for products that are: a.Different and produced continuously. b.Similar and produced continuously. c.Individual units produced to customer specifications. d.Purchased from vendors. Process costing is used for products that are: a.Different and produced continuously. b.Similar and produced continuously. c.Individual units produced to customer specifications. d.Purchased from vendors. Quick Check

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-6 Processing Departments Any unit in an organization where materials, labor or overhead are added to the product. The activities performed in a processing department are performed uniformly on all units of production. Furthermore, the output of a processing department must be homogeneous.

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-7 Learning Objective 1 Record the flow of materials, labor, and overhead through a process cost system.

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-8 Comparing Job-Order and Process Costing Finished Goods Cost of Goods Sold Work in Proces s Direct Materials Direct Labor Manufacturing Overhead

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-9 Comparing Job-Order and Process Costing Finished Goods Cost of Goods Sold Direct Labor Manufacturing Overhead Jobs Costs are traced and applied to individual jobs in a job-order cost system. Direct Materials

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-10 Comparing Job-Order and Process Costing Finished Goods Cost of Goods Sold Direct Labor Manufacturing Overhead Processing Department Processing Department Costs are traced and applied to departments in a process cost system. Direct Materials

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-11 T-Account and Journal Entry Views of Cost Flows For purposes of this example, assume there are two processing departments – Departments A and B. We will use T-accounts and journal entries.

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-12 Raw Materials Process Cost Flows (in T-account form) Work in Process Department B Work in Process Department A Direct Materials

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-13 Process Cost Flows (in journal entry form)

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-14 Process Cost Flows (in T-account form) Work in Process Department B Work in Process Department A Wages Payable Direct Materials Direct Labor

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-15 Process Costing (in journal entry form)

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-16 Process Cost Flows (in T-account form) Work in Process Department B Work in Process Department A Manufacturing Overhead Overhead Applied to Work in Process Applied Overhead Direct Labor Direct Materials Direct Labor Direct Materials Actual Overhead

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-17 Process Costing (In journal entry form)

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-18 Process Cost Flows (in T-account form) Work in Process Department B Work in Process Department A Direct Materials Direct Labor Applied Overhead Direct Materials Direct Labor Applied Overhead Transferred to Dept. B Transferred from Dept. A

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-19 Process Costing (in journal entry form)

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-20 Finished Goods Process Cost Flows (in T-account form) Work in Process Department B Cost of Goods Manufactured Direct Materials Direct Labor Applied Overhead Transferred from Dept. A Cost of Goods Manufactured

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-21 Process Costing (in journal entry form)

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-22 Finished Goods Cost of Goods Sold Process Cost Flows (in journal entry form) Work in Process Department B Cost of Goods Manufactured Direct Materials Direct Labor Applied Overhead Transferred from Dept. A Cost of Goods Sold Cost of Goods Manufactured

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-23 Process Costing (in journal entry form)

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-24 Equivalent Units of Production Equivalent units are the product of the number of partially completed units and the percentage completion of those units. We need to calculate equivalent units because a department usually has some partially completed units in its beginning and ending inventory.

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-25 Equivalent Units – The Basic Idea Two half completed products are equivalent to one completed product. So, 10,000 units 70% complete are equivalent to 7,000 complete units. + = 1

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-26 For the current period, Jones started 15,000 units and completed 10,000 units, leaving 5,000 units in process 30 percent complete. How many equivalent units of production did Jones have for the period? a. 10,000 b. 11,500 c. 13,500 d. 15,000 For the current period, Jones started 15,000 units and completed 10,000 units, leaving 5,000 units in process 30 percent complete. How many equivalent units of production did Jones have for the period? a. 10,000 b. 11,500 c. 13,500 d. 15,000 Quick Check

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-27 For the current period, Jones started 15,000 units and completed 10,000 units, leaving 5,000 units in process 30 percent complete. How many equivalent units of production did Jones have for the period? a. 10,000 b. 11,500 c. 13,500 d. 15,000 For the current period, Jones started 15,000 units and completed 10,000 units, leaving 5,000 units in process 30 percent complete. How many equivalent units of production did Jones have for the period? a. 10,000 b. 11,500 c. 13,500 d. 15,000 10,000 units + (5,000 units × 0.30) = 11,500 equivalent units Quick Check

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-28 Calculating Equivalent Units Equivalent units can be calculated two ways:  The First-In, First-Out Method – FIFO is covered in the appendix to this chapter.  The Weighted-Average Method – This method will be covered in the main portion of the chapter. Equivalent units can be calculated two ways:  The First-In, First-Out Method – FIFO is covered in the appendix to this chapter.  The Weighted-Average Method – This method will be covered in the main portion of the chapter.

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-29 Learning Objective 2 Compute the equivalent units of production using the weighted-average method.

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-30 Equivalent Units of Production Weighted-Average Method The weighted-average method... Makes no distinction between work done in prior or current periods. Blends together units and costs from prior and current periods. Determines equivalent units of production for a department by adding together the number of units transferred out plus the equivalent units in ending work in process inventory.

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-31 Treatment of Direct Labor Direct labor costs may be small in comparison to other product costs in process cost systems. Direct labor costs may be small in comparison to other product costs in process cost systems. Direct Materials Type of Product Cost Dollar Amount Direct Labor Conversion

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-32 Treatment of Direct Labor Type of Product Cost Dollar Amount Conversion Direct labor and manufacturing overhead may be combined into one product cost called conversion. Direct Materials Direct labor costs may be small in comparison to other product costs in process cost systems. Direct labor costs may be small in comparison to other product costs in process cost systems.

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-33 Weighted-Average Example Double Diamond Skis reported the following activity in Shaping and Milling Department for the month of May:

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-34 The first step in calculating the equivalent units is to identify the units completed and transferred out of the Department in May (4,800 units) Weighted-Average Example

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-35 The second step is to identify the equivalent units of production in ending work in process with respect to materials for the month (160 units) and add this to the 4,800 units from step one. Weighted-Average Example

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-36 Weighted-Average Example The third step is to identify the equivalent units of production in ending work in process with respect to conversion for the month (100 units) and add this to the 4,800 units from step one.

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-37 Equivalent units of production always equals: Units completed and transferred + Equivalent units remaining in work in process Equivalent units of production always equals: Units completed and transferred + Equivalent units remaining in work in process Weighted-Average Example

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-38 Beginning Work in Process 200 Units 55% Complete Ending Work in Process 400 Units 40% Complete 5,000 Units Started 4,800 Units Started and Completed Weighted-Average Example Materials 4,800 Units Completed 160 Equivalent Units 400 × 40% 4,960 Equivalent units of production

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin ,000 Units Started 4,800 Units Completed 4,800 Units Started and Completed 100 Equivalent Units 400 × 25% 4,900 Equivalent units of production Beginning Work in Process 200 Units 30% Complete Ending Work in Process 400 Units 25% Complete Weighted-Average Example Conversion

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-40 Learning Objective 3 Compute the cost per equivalent unit using the weighted-average method.

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-41 Beginning work in process: 200 units Materials: 55% complete $9,600 Conversion: 30% complete5,575 Production started during May5,000 units Production completed during May4,800 units Costs added to production in May Materials cost $ 368,600 Conversion cost 350,900 Ending work in process 400 units Materials: 40% complete Conversion: 25% complete Beginning work in process: 200 units Materials: 55% complete $9,600 Conversion: 30% complete5,575 Production started during May5,000 units Production completed during May4,800 units Costs added to production in May Materials cost $ 368,600 Conversion cost 350,900 Ending work in process 400 units Materials: 40% complete Conversion: 25% complete Compute and Apply Costs

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-42 Compute and Apply Costs The formula for computing the cost per equivalent unit is : Cost per equivalent unit = Cost of beginning work in process inventory Cost added during the period Equivalent units of production +

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-43 Here is a schedule with the cost and equivalent unit information. Compute and Apply Costs

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-44 Compute and Apply Costs $356,475 ÷ 4,900 units = $72.75 $378,200 ÷ 4,960 units = $76.25 Here is a schedule with the cost and equivalent unit information.

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-45 Learning Objective 4 Assign costs to units using the weighted-average method.

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-46 Applying Costs

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-47 Applying Costs

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-48 Applying Costs

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-49 Computing the Cost of Units Transferred Out

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-50 Computing the Cost of Units Transferred Out

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-51 Computing the Cost of Units Transferred Out

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-52 Reconciling Costs

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-53 Reconciling Costs

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-54 Operation Costing Operation cost is a hybrid of job-order and process costing because it possesses attributes of both approaches Operation costing is commonly used when batches of many different products pass through the same processing department.

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin Appendix 4A FIFO Method

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-56 FIFO vs. Weighted-Average Method The FIFO method (generally considered more accurate that the weighted-average method) differs from the weighted-average method in two ways: 1.The computation of equivalent units. 2.The way in which the costs of beginning inventory are treated in the cost reconciliation report. 1.The computation of equivalent units. 2.The way in which the costs of beginning inventory are treated in the cost reconciliation report.

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-57 Learning Objective 5 Compute the equivalent units of production using the FIFO method.

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-58 Equivalent Units – FIFO Method Let’s revisit the Double Diamond Skis example. Assume the following activity is reported in Shaping and Milling Department for May:

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-59 Equivalent Units – FIFO Method Step 1 Step 1: Determine equivalent units needed to complete beginning inventory.

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-60 Equivalent Units – FIFO Method Step 2 Step 2: Determine units started and completed during the period.

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-61 Equivalent Units – FIFO Method Step 3 Step 3: Add the equivalent units in ending working in process inventory.

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-62 Beginning Work in Process 200 Units 55% Complete Ending Work in Process 400 Units 40% Complete 5,000 Units Started 4,600 Units Started and Completed FIFO Example MaterialsMaterials 4,600 Units Completed 160 Equivalent Units 400 × 40% 4,850 Equivalent units of production 90 Equivalent Units 200 × 45%

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-63 Beginning Work in Process 200 Units 30% Complete Ending Work in Process 400 Units 25% Complete 5,000 Units Started 4,600 Units Started and Completed FIFO Example Conversion 4,600 Units Completed 100 Equivalent Units 400 × 25% 4,840 Equivalent units of production 140 Equivalent Units 200 × 70%

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-64 Equivalent Units: Weighted Average vs. FIFO As shown below, the equivalent units in beginning inventory are subtracted from the equivalent units of production per the weighted- average method to obtain the equivalent units of production under the FIFO method.

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-65 Learning Objective 6 Compute the cost per equivalent unit using the FIFO method.

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-66 Cost per Equivalent Unit - FIFO Let’s revisit the Double Diamond Skis Shaping and Milling Department for the Month of May to prepare our production report. Beginning work in process: 200 units Materials: 55% complete $9,600 Conversion: 30% complete5,575 $15, 175 Production started during May5,000 units Production completed during May4,800 units Costs added to production in May Materials cost $ 368,600 Conversion cost 350,900 Ending work in process: 400 units Materials: 40% complete Conversion: 25% complete Beginning work in process: 200 units Materials: 55% complete $9,600 Conversion: 30% complete5,575 $15, 175 Production started during May5,000 units Production completed during May4,800 units Costs added to production in May Materials cost $ 368,600 Conversion cost 350,900 Ending work in process: 400 units Materials: 40% complete Conversion: 25% complete

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-67 Cost per Equivalent Unit - FIFO The formula for computing the cost per equivalent unit under FIFO method is : Cost per equivalent unit = Cost added during the period Equivalent units of production

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-68 Cost per Equivalent Unit - FIFO

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-69 Learning Objective 7 Assign costs to units using the FIFO method.

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-70 Applying Costs - FIFO Step 1 Step 1: Record the equivalent units of production in ending work in process inventory.

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-71 Applying Costs - FIFO Step 2 Step 2: Record the cost per equivalent unit.

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-72 Applying Costs - FIFO Step 3 Step 3: Compute the cost of ending work in process inventory.

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-73 Cost of Units Transferred Out Step 1 Step 1: Record the cost in beginning work in process inventory.

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-74 Cost of Units Transferred Out Step 2 Step 2: Compute the cost to complete the units in beginning work in process inventory.

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-75 Cost of Units Transferred Out Step 3 Step 3: Compute the cost of units started and completed this period.

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-76 Cost of Units Transferred Out Step 4 Step 4: Compute the total cost of units transferred out.

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-77 Reconciling Costs

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-78 Reconciling Costs

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-79 A Comparison of Costing Methods In a lean production environment, FIFO and weighted-average methods yield similar unit costs. When considering cost control, FIFO is superior to weighted-average because it does not mix costs of the current period with costs of the prior period.

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin Appendix 4B Service Department Allocations

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-81 Operating Departments An operating department carries out the central purpose of the organization The Accounting Department at your University. An Assembly Department at General Motors.

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-82 Service Departments A service department does not directly engage in operating activities. The Accounting Department at Macys The Human Resources Department at Walgreens.

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-83 Interdepartmental Services Service Department Operating Department Costs of the service department become overhead costs to the operating department

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-84 Allocation Approaches Direct Method   Step-Down Method   Reciprocal Method  

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-85 Reciprocal Services Service Department 1 Service Department 2 When service departments provide services to each other we call them reciprocal services.

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-86 Learning Objective 8 Allocate service department costs to operating departments using the direct method.

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-87 Direct Method Service Department (Cafeteria) Service Department (Custodial) Operating Department (Machining) Operating Department (Assembly) Interactions between service departments are ignored and all costs are allocated directly to operating departments. Interactions between service departments are ignored and all costs are allocated directly to operating departments.

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-88 Direct Method

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-89 Direct Method How much of the Cafeteria and Custodial costs should be allocated to each operating department using the direct method of cost allocation?

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-90 Direct Method Allocation base: Number of employees $360,000 × = $144,000

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-91 Direct Method Allocation base: Number of employees $360,000 × = $216,000

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-92 Direct Method Allocation base: Square feet occupied $90,000 × 25,000 25, ,000 = $30,000

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-93 Direct Method Allocation base: Square feet occupied 50,000 25, ,000 $90,000 × = $60,000

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-94 Learning Objective 9 To allocate service department costs to operating departments using the step-down method.

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-95 Operating Department (Machining) Operating Department (Assembly) Step Method Once a service department’s costs are allocated, other service department costs are not allocated back to it. Service Department (Cafeteria) Service Department (Custodial)

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-96 Step Method There are three key points to understand regarding the step method:  In both the direct and step methods, any amount of the allocation base attributable to the service department whose cost is being allocated is always ignored.  Any amount of the allocation base that is attributable to a service department whose cost has already been allocated is ignored.  Each service department assigns its own costs to operating departments plus the costs that have been allocated to it from other service departments.

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-97 Step Method We will use the same data used in the direct method example.

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-98 Step Method Allocate Cafeteria costs first since it provides more service than Custodial.

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 4-99 Step Method $360,000 × = $60,000 Allocation base: Number of employees

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin Step Method $360,000 × = $120,000 Allocation base: Number of employees

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin Step Method $360,000 × = $180,000 Allocation base: Number of employees

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin Step Method New total = $90,000 original Custodial cost plus $60,000 allocated from the Cafeteria.

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin Step Method $150,000 × 25,000 25, ,000 = $50,000 Allocation base: Square feet occupied

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin Step Method $150,000 × 50,000 25, ,000 = $100,000 Allocation base: Square feet occupied

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin Reciprocal Method Interdepartmental services are given full recognition rather than partial recognition as with the step method. Service Department (Cafeteria) Service Department (Custodial) Operating Department (Machining) Operating Department (Assembly) Because of its mathematical complexity, the reciprocal method is rarely used.

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin Quick Check Data for Direct and Step Methods Allocation bases: Business school administration costs (ADMIN): Number of employees Business Administration computer services (BACS): Number of personal computers The direct method of allocation is used.

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin Quick Check How much cost will be allocated from Administration to Accounting? a. $ 36,000 b. $144,000 c. $180,000 d. $ 27,000 How much cost will be allocated from Administration to Accounting? a. $ 36,000 b. $144,000 c. $180,000 d. $ 27,000

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin How much cost will be allocated from Administration to Accounting? a. $ 36,000 b. $144,000 c. $180,000 d. $ 27,000 How much cost will be allocated from Administration to Accounting? a. $ 36,000 b. $144,000 c. $180,000 d. $ 27,000 Quick Check $180,000 × = $36,000

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 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 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

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 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 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 × = $13,500

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin Quick Check Data Allocation bases: Business school administration costs (ADMIN): Number of employees Business administration computer services (BACS): Number of personal computers The step method of allocation is used.

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 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 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

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 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 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 Quick Check

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin End of Chapter 4