Week 5 - Support Department Cost Allocation

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Week 5 - Support Department Cost Allocation

• Chapter 7

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Learning Objectives

• Describe the difference between support
  departments and producing departments.
• Explain five reasons why support department costs
  may be assigned to producing departments.
• Calculate charging rates and distinguish between
  single and dual charging rates.
• Allocate support centre costs to producing
  departments using the direct, sequential, and
  reciprocal methods.
• Calculate departmental overhead rates.

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Support and Producing Departments

• I. Support Departments Units within an
  organization that provide essential support
  services for producing departments.
• Examples Laundry, power, maintenance,
  materials, grounds, and engineering.
• II. Producing Departments Units within an
  organization that are directly responsible for
  manufacturing or creating the products and
  services sold to customers.
• Examples Services auditing , tax, management
  advisory. Manufacturing machining and
  assembly.

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Steps in Allocating Support Costs

• Departmentalize the firm
• Classify each department
• Trace all costs
• Allocate support department costs
• Calculate predetermined rates
• Allocate overhead costs to products

The
Organization
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Cost Allocation The Achilles Heel for Accountants

• To obtain a mutually agreeable price
• To compute product-line profitability
• To predict the economic effects of planning and
  control
• To value inventory
• To motivate managers

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Examples of Cost Drivers forSupport Departments
Support Department Possible Driver
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
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Allocation by Cost Behaviour

• I. Variable Costs
• 1. Rate Determination. At the beginning of
  the year, the company determines what the
  variable cost per unit of service should be ( a
  budgeted rate, not an actual rate is used to
  assign variable costs).
• 2. Budgeted Usage. Each producing department
  determines its expected or budgeted usage of the
  service for the year.
• 3. Actual Usage Measurement. The actual units
  of service used by each producing department are
  measured.
• 4. Allocation. Variable support costs are
  allocated by multiplying the budgeted rate by the
  usage
• a. Product costing
• Allocation Budgeted Rate X Budgeted
  Usage
• b. Performance evaluation
• Allocation Budgeted Rate X Actual Usage

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Allocation by Cost BehaviourContd

• II. Fixed Costs
• 1. Determination of Budgeted Fixed Support Costs.
  The fixed support costs that should be incurred
  for a period need to be identified.
• 2. Computation of Allocation Ratio. Using
  Practical or normal capacity of each producing
  department, compute an allocation ratio as
  follows
• Allocation Ratio Producing Department
  Capacity/Total Capacity
• 3. Allocation. The fixed support costs are
  allocated in proportion to each producing
  departments original service needs
• Allocation Allocation Ratio X Budgeted Fixed
  Support Costs
• Note Fixed costs are allocated the same way for
  product costing and performance evaluation.

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Support Departments versus Producing
Departments A Hospital Example
Indirect Costs Salaries Supplies
Equipment Indirect Costs Equipment
Insurance Salaries
Admissions office Housekeeping Pharmacy
Support Departments
Pediatrics Obstetrics Surgery
Producing Departments
Service to Patients
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Selection of Cost-Allocation Bases Casual Factors

Admissions office Housekeeping Pharmacy
Support Departments
Pediatrics Obstetrics Surgery
Producing Departments

Allocate using cost drivers
Select Drivers Using Cause/effect Criterion
Service to Patients
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Allocation of Variable Costs (Dual Rates)

• Determine the Budgeted Rate.
• Determine Expected Usage of Service for the
  period.
• Determine the Actual Usage of Service by Each
  Unit.
• Allocation of Costs by Multiplying the Budgeted
  Rate by the Usage
• a. For Product Costing, Budgeted Rate x Budgeted
• Usage.
• b. For Performance Evaluation, Budgeted Rate x
  Actual Usage.

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Allocation of Fixed Costs (Dual Rates)

• Determine the Budgeted Fixed Costs.
• Compute the Allocation Ratio, Ratio Department
  Capacity/Total Capacity.
• Allocate fixed service costs in proportion to
  each producing departments original service
  needs, Allocation Allocation Ratio x Budgeted
  Fixed Service Costs.

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Allocation of Variable and Fixed Costs An Example


Dept. A Dept. B
Total Budgeted Machine Hours 40,000
60,000 Actual Machine Used
45,000 58,000 Budgeted Fixed
Costs -------
------- 350,000 Budgeted Variable Costs
------- -------
180,000 Variable Cost Rate
1.80 1.80 Fixed Costs
Allocation Ratio 40
60
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Allocation of Variable and Fixed Costs An
Example (Continued)

Dept. A
Dept. B Variable Cost Allocated (product
costing) 72,000
108,000 Variable Cost Allocated (performance
eval.) 81,000 104,400 Fixed
Cost Allocated
140,000 210,000
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Allocation Budgeted or Actual Costs

Admissions office Radiology Pharmacy
Support Departments
Do Not Transfer Inefficiencies
Pediatrics Obstetrics Surgery
Producing Departments

Allocate Budgeted Costs
Service to Patients
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Choosing A Support Department Cost Allocation
MethodThree Methods for Allocating Support
Department Costs
Direct, Sequential, and Reciprocal

• The Direct Method
• The Sequential Method
• The Reciprocal Method

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Support Department Allocation An Example
Support
Producing
Departments
Departments
A B
1 2
3
Direct Costs 200,000 125,000
80,000 50,000 130,000 Square Feet
4,000 6,000 40,000
44,000 10,000 Purchase Orders
600 400 1,300
3,000 4,000 Machine Hours
20,000
5,000 15,000 Labour Hours
3,000
2,000 5,000
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Support Department Allocation (Direct Method)
Support
Producing
Departments
Departments
A B
1 2
3
Direct Costs 200,000 125,000
80,000 50,000 130,000 Department A
(200,000) 100,000
25,000 75,000 Department B
(125,000) 37,500 25,000
62,500 Total
217,500 100,000
267,500
Allocated on basis of machine hours at 5.00 per
machine hour Allocated on basis of labour hours
at 12.50 per labour hour
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Sequential Method
Support Department Allocation (Sequential
Method)
Support
Producing
Departments
Departments
A B
1 2
3
Direct Costs 200,000 125,000
80,000 50,000 130,000 ADepartment
A (200,000) 12,000 80,000
88,000 20,000 BDepartment B
(137,000) 24,401 56,310
56,289 Total
184,401 194,310
206,289
ACost allocated to other departments on basis of
square feet at 2.00 per square foot. Please
note the sequence of allocation (Dept.. A is
allocated first). BCost allocated to other
departments on basis of purchase orders at 18.77
per purchase order.
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Strategic Attributes and Computerization

• Management accounting will be linked to strategy
• Computerization of information will be discussed
  as it applies to management accounting

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Topics from Seven Chapters

• Introduction
• Basic cost concepts
• Activity cost behaviour
• Job-order costing
• Process costing
• Support department cost allocation

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Steps

• Must know strategy to determine management
  accounting requirements
• Must know strategy to to determine information
  technology requirements

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SAP Finance

• Financial accounting
• Controlling
• Asset management
• Treasury
• Investment management
• Project system

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SAP Logistics

• Materials management
• Sales and distribution
• Production and planning
• Plant maintenance
• Quality management
• Service management

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SAP Human Resources

• Personnel management
• Personnel development
• Payroll accounting
• Time management

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SAP Industrial Packages

• Aerospace
• Automotive
• Chemicals
• Consumer products
• Engineering/construction
• Healthcare, public sector
• High-tech/electronics
• Oil and gas
• Pharmaceuticals
• Retail
• Telecommunications

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Enterprise Resource Planning

• Large number of programs
• Data warehouses
• First seven chapters dealt with by SAPs
  controlling module

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Numerical Questions from the Back of Chapter 7

• W7-5
• E7-3
• E7-5
• E7-9

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Question E7-3

• Please go to your text to read the question.

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Question E7-5

• Please go to your text to read the question.

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Question E7-9

• Please go to your text to read the question.

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The End