Todays quote

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Todays quote

• Any idiot can face a crisis It is this
  day-to-day living that wears you out.
• --Anton Chekhov

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Allocation of Support Department Costs, Common
Costs, and Revenues

• Chapter 15

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Overview

• Allocation of support department costs
• Example of 3 ways
• Allocation of Common Costs
• Example of 2 ways
• Allocation of Revenues from Bundled
  products/services

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Operating vs. Support Departments
An operating department (a production department
in manufacturing companies) adds value to a
product or service.
A support department (service department) provides
the services that assist other operating and
support departments in the organization.
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Single-Rate andDual-Rate Methods
The single-rate cost allocation method pools
together all costs in a cost pool.
The dual-rate cost allocation method classifies
costs in each cost pool into two cost pools a
variable-cost cost pool and a fixed-cost cost
pool.
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Budgeted versus Actual Rates
Budgeted rates let the user department know
in advance the cost rates they will be charged.
During the budget period, the supplier
department, not the user departments, bears the
risk of any unfavorable cost variances.
Why?
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Budgeted versus ActualUsage Allocation Bases
Organizations commit to infrastructure costs
on the basis of a long-run planning horizon.
The use of budgeted usage to allocate these
fixed costs is consistent with the long-run
horizon.
Typically, you use actual usage to allocate
variable costs.
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Allocating SupportDepartments Costs3 methods
Direct method Allocates support department
costs to operating departments only.
Step-down (sequential allocation)
method Allocates support department costs to
other support departments and to operating
departments.
Reciprocal allocation method Allocates costs by
services provided among all support departments.
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Allocating SupportDepartments Costsin-class
example
John Deere Tractors, Inc. has two support
departments and two operating departments.
Implements and Engines
Maintenance and Legal
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Allocating SupportDepartments Costs (do in class)
Budgeted
Capacity
. To be supplied by Maintenance
Legal Implements Engines Maintenance
10 40 50 Legal 5 60
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Actual Usage
. Supplied
by Maintenance Legal Implements Engines Main
tenance 10 30 60 Legal
10 70 20   Actual costs were
Fixed Variable Maintenance 100,000
72,000 Legal 75,000
20,000   Fixed costs are allocated on the basis
of budgeted capacity. Variable costs are
allocated on the basis of actual usage. The
direct method is used to allocate service
department costs to operating departments. Also
do this problem assuming the step-down/dual and
then the reciprocal/dual methods. In other
problems, always remember to ignore self service.
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Direct Method--allocation
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Step-Down Method--allocation
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Reciprocal Method--equations

• For each cost (fixed and variable if dual rate or
  just total cost if single rate) you have to solve
  a set of equations for the unknown artificial
  cost of each support department.
• Example in class
• (also called simultaneous, cross-allocation,
  matrix-allocation, or double-distribution method)

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Reciprocal equations

• For fixed costs
• Mf 100,000 0.05Lf and Lf 75,000 0.1Mf
• (each depts. fixed cost plus proportion it uses
  of the other support departments support)
• For variable costs
• Mv 72,000 0.1 Lv and Lv 20,000 0.1Mv

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Reciprocal Method--allocation
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Allocating Common Costs
Two methods for allocating common costs are
1. Stand-alone cost allocation method
2. Incremental cost allocation method
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Stand-Alone Example
A consultant in Tampa is planning to go
to Chicago and meet with an international client.
The round-trip Tampa/Chicago/Tampa airfare costs
540.
The consultant is also planning to attend a
business meeting with a North Carolina client in
Durham.
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Stand-Alone Example
The round-trip Tampa/Durham/Tampa airfare costs
360.
The consultant decides to combine the two trips
into a Tampa/Durham/Chicago/Tampa itinerary that
will cost 760.
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Stand-Alone Example
How much should the consultant charge to the
North Carolina client?
360 (360 540) .40
.40 760 304
How much to the international client?
760 304 456
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Incremental Cost Example
Assume that the business meeting in Chicago is
viewed as the primary party.
What would be the cost allocation?
International client (primary) 540 Durham
client (incremental) 760 540 220
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Revenues and Bundled Products
A bundled product is a package of two or
more products (or services) sold for a single
price.
Bundled product sales are also referred to as
suite sales.
The individual components of the bundle also may
be sold as separate items at their
own stand-alone prices.
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Revenues and Bundled Products
What businesses provide bundled products?
Banks
Hotels
Tours

• Checking
• Safety
• deposit boxes
• Investment
• advisory

• Lodging
• Food and
• beverage
• services
• Recreation

• Transportation
• Lodging
• Guides

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Allocation of Revenues
Allocation of the revenues of a bundled package
to the individual products in that package is
similar to allocation of common costs.
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End of Chapter 15