Ch 6: Service Department Allocation

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Ch 6 Service Department Allocation
Service departments provide support for
production departments
Producing departments are responsible for the
creation of goods or services
Goods and Services
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A Hospital Example
Indirect Costs Salaries Supplies
Equipment Indirect Costs Equipment
Insurance Salaries
Admissions and records Housekeeping Pharmacy
Service Departments
Pediatrics Obstetrics Surgery
Producing Departments
Service to Patients
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Why do we need to allocate service department
costs?
Objectives
Objectives

• Price must cover all costs
• To compute product-line profitability
• For planning and control
• To motivate managers
• To value inventory

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Selecting Allocation Bases
Personnel Number ofemployees
Custodial Squarefootage
Receiving Unitshandled
Cafeteria Number ofemployees
Security Squarefootage
Power Kilowatthours
Accounting Staffhours
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Two Stages of Cost Allocation
First Stage Allocation Service department costs
are allocated to producing departments.
Service Department (Cafeteria)
Producing Department (Machining)
Service Department (Accounting)
The Product
Producing Department (Assembly)
Service Department (Personnel)
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Two Stages of Cost Allocation
Service Department (Cafeteria)
Producing Department (Machining)
Service Department (Accounting)
The Product
Producing Department (Assembly)
Service Department (Personnel)
Second Stage Allocation Producing department
overhead costs, plus allocated service department
costs, are applied to products usingdepartmental
predetermined overhead rates.
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Interdepartmental Services
Problem What do we do with the cost of
servicesprovided to other services
departments? Example Payroll and computer support
Solutions Direct Method Step method Reciprocal
method
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Direct Method
Service Department (Payroll)
Producing Department (Machining)
Interdepartmental services areignored and
all costs areallocated directlyto
operatingdepartments.
Service Department (Computer)
Producing Department (Assembly)
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Step (Sequential) Method
Service department costs are allocated to other
departments in a step-wise manner. Once a
servicedepartments costsare allocated, other
servicedepartment costsare not allocatedback
to it.
Service Department (Payroll)
Producing Department (Machining)
Service Department (Computer)
Producing Department (Assembly)
How do you decide which service department to
allocate first?
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Reciprocal Method
Service Department (Payroll)
Producing Department (Machining)
Interdepartmentalservices are givenfull
recognitionrather than partialrecognition as
withthe step method.
Service Department (Computers)
Producing Department (Assembly)
Which method is likely to be most accurate? How
do you decide which to use?
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Mechanics of Reciprocal Method

• 1. Set up equation for each service dept.
• Total cost Direct cost FROM another other
  dept
• 2. Solve the system of equations.
• 3. Allocate new cost to producing departments
  (at less than 100).
• 4. Check to see that all cost has been allocated.

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Behavioral Issues
But that would not be beneficial to the
company. What if we charged a flat annual fee for
the service?
Explain how cost allocation can create
dysfunctional behavior.
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Allocating Costs by Behavior
Allocatebudgeted costto producing
departmentsin proportion to thepeak-period
capacityrequired by the producing department.
Charge toproducingdepartments at abudgeted
rate timesthe actual usage of the activity base.
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In-Class Problem 6.1
Machining 400,000
Personnel 100,000
Job 781
Computer Support 200,000
Assembly 300,000
How much should we bid on job 781?