IES 342 Industrial Cost Analysis & Control | Dr. Karndee Prichanont, SIIT 1 Cost Allocation: Service Departments & Joint Product Costs Chapter 12 Objectives: Identify the strategic role of cost allocation Use the three steps of departmental cost allocation Use the three joint product costing methods Use the four by-product costing method

IES 342 Industrial Cost Analysis & Control | Dr. Karndee Prichanont, SIIT 2 Strategic Roles of Cost Allocation 1.Determine accurate departmental and product costs as a basis for evaluating the cost efficiency of departments and the profitability of different products. 2.Motivate managers to exert a high level of effort to achieve the goals of top management. 3.Provide the right incentive for managers to make decisions that are consistent with the goals of top management. 4.Fairly determine the rewards earned by the managers for their effort and skill and for the effectiveness of their decision making.

IES 342 Industrial Cost Analysis & Control | Dr. Karndee Prichanont, SIIT 3 Types of Overhead Cost Allocation - Review DIRECT Overhead allocated directly to products DIRECT Overhead allocated directly to products DEPARTMENTAL Overhead allocated to departments, and then from departments to products DEPARTMENTAL Overhead allocated to departments, and then from departments to products ABC Overhead allocated to production activities, and then from production activities to products ABC Overhead allocated to production activities, and then from production activities to products

IES 342 Industrial Cost Analysis & Control | Dr. Karndee Prichanont, SIIT 4 Cost Allocation to Service and Production Departments Production Departments Service Departments

IES 342 Industrial Cost Analysis & Control | Dr. Karndee Prichanont, SIIT 5 3 Phases in Departmental Cost Allocation Service Department (Cafeteria) Service Department (Cafeteria) Service Department (Accounting) Service Department (Accounting) Service Department (Personnel) Service Department (Personnel) Production Department (Machining) Production Department (Machining) Production Department (Assembly) Production Department (Assembly) The Product Direct and Indirect Costs

IES 342 Industrial Cost Analysis & Control | Dr. Karndee Prichanont, SIIT 6 Service Department (Cafeteria) Service Department (Cafeteria) Service Department (Accounting) Service Department (Accounting) Service Department (Personnel) Service Department (Personnel) Production Department (Machining) Production Department (Machining) Production Department (Assembly) Production Department (Assembly) The Product Direct and Indirect Costs 3 Phases in Departmental Cost Allocation

IES 342 Industrial Cost Analysis & Control | Dr. Karndee Prichanont, SIIT 7 Service Department (Cafeteria) Service Department (Cafeteria) Service Department (Accounting) Service Department (Accounting) Service Department (Personnel) Service Department (Personnel) Production Department (Machining) Production Department (Machining) Production Department (Assembly) Production Department (Assembly) The Product Direct and Indirect Costs 3 Phases in Departmental Cost Allocation

IES 342 Industrial Cost Analysis & Control | Dr. Karndee Prichanont, SIIT 8 Service Department (Cafeteria) Service Department (Cafeteria) Service Department (Accounting) Service Department (Accounting) Service Department (Personnel) Service Department (Personnel) Production Department (Machining) Production Department (Machining) Production Department (Assembly) Production Department (Assembly) The Product Direct and Indirect Costs 3 Phases in Departmental Cost Allocation

IES 342 Industrial Cost Analysis & Control | Dr. Karndee Prichanont, SIIT 9 Methods of Allocating Service Department Costs Objective: Allocating costs when service departments provide services to each other 1.____________ 2.____________ 3.____________

IES 342 Industrial Cost Analysis & Control | Dr. Karndee Prichanont, SIIT Direct Method Service Department 1 Service Department 1 Service Department 2 Service Department 2 Production Department (Machining) Production Department (Machining) Production Department (Assembly) Production Department (Assembly)

IES 342 Industrial Cost Analysis & Control | Dr. Karndee Prichanont, SIIT Step Method Service Department 1 Service Department 2 Production Department (Machining) Production Department (Machining) Production Department (Assembly) Production Department (Assembly)

IES 342 Industrial Cost Analysis & Control | Dr. Karndee Prichanont, SIIT Step Method Service Department 1 Service Department 1 Service Department 2 Service Department 2 Production Department (Machining) Production Department (Machining) Production Department (Assembly) Production Department (Assembly) Once a service department ’ s costs are allocated, other service department costs are not allocated back to it. Service Dept. 2 will have a new total to allocate to production departments: its own costs plus those costs allocated from Service Dept. 1.

IES 342 Industrial Cost Analysis & Control | Dr. Karndee Prichanont, SIIT Reciprocal Method Service Department (Cafeteria) Service Department (Cafeteria) Service Department (Custodial) Service Department (Custodial) Production Department (Machining) Production Department (Machining) Production Department (Assembly) Production Department (Assembly)

IES 342 Industrial Cost Analysis & Control | Dr. Karndee Prichanont, SIIT 14 Comparison of Methods The reciprocal method is superior because: –It considers all services provided to other service departments. –The total cost of operating a service department is computed. The reciprocal method requires the use of matrix algebra with three or more service departments.

IES 342 Industrial Cost Analysis & Control | Dr. Karndee Prichanont, SIIT 15 Separate Fixed and Variable Costs: Dual Allocation Charge to user departments at a budgeted rate times the actual usage of the allocation base. Allocate budgeted amounts to user departments in proportion to the capacity demanded by the user department.

IES 342 Industrial Cost Analysis & Control | Dr. Karndee Prichanont, SIIT 16 Dual Allocation Example 5-year lease Computer Department School of Business Actual computer hours = 200 School of Engineering Actual computer hours = 400 Assume that: 8 Budgeted Fixed Cost: $100,000 per month 8 Budgeted Variable Cost: $200 per computer hour 8 Primary activity performed: Computer Processing 8 Long-run average monthly usage: 210 hours for Business School 490 hours for Engineering School

IES 342 Industrial Cost Analysis & Control | Dr. Karndee Prichanont, SIIT 17 Joint Product Costing Joint Costs Product

IES 342 Industrial Cost Analysis & Control | Dr. Karndee Prichanont, SIIT 18 Joint Product Costing Concept: –In some industries, a number of products are produced from a single raw material input. Key terms: –_______________ – products resulting from a process with a common input. –_______________– the stage of processing where joint products are separated. –_______________– costs of processing joint products prior to the split-off point.

IES 342 Industrial Cost Analysis & Control | Dr. Karndee Prichanont, SIIT 19 Example of Joint Product Joint Input Common Production Process Final Sale Final Sale __________ Oil Gasoline Additional Processing Additional Processing __________

IES 342 Industrial Cost Analysis & Control | Dr. Karndee Prichanont, SIIT 20 Joint Cost Allocation Methods Joint costs are allocated based on relative values of products at the final market point subtracting any additional processing costs beyond the split-off point. Joint costs are allocated based on a relative measure (weight, volume, etc.) of products at the split-off point. Joint costs are allocated based on relative values of products at the split-off point. Additional Examples / Final Exam (03)

IES 342 Industrial Cost Analysis & Control | Dr. Karndee Prichanont, SIIT 21 By-Product Costing Method 1.Asset Recognition Methods: –Net Realizable Value Method –Other Income at Production Point Method 2.Revenue Methods: –Other Income at Selling Point Method –Manufacturing Cost Reduction at Selling Point Method

IES 342 Industrial Cost Analysis & Control | Dr. Karndee Prichanont, SIIT 22 Revisit Northern Company Example Additional info At the split-off point, 5 gallons of by-product XYZ emerges By-product XYZ must be further processed at the cost of $5/gallon By-product XYZ can be sold at the market price of $10/gal Only 4 gallons are sold during this accounting period