service department costing: an activity approach chapter 15

Service Department Costing: An Activity

Approach

Chapter 15

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The Need for Cost Allocations

OperatingDepartments

Carry out the central purposes

of an organization

ServiceDepartments

Provide supportto the

operatingdepartments

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First, we identify the factor that drives costs in the

service department.

This cost driver is usedas the allocation base.

The Need for Cost Allocations

How are servicedepartment costs

charged to operatingdepartments?

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The Need for Cost Allocations

Second, we measure theconsumption of the

allocation base in theoperating departments.

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The Need for Cost Allocations

Third, we allocatethe service

department costbased on the

relative amount of the allocation base

used in eachoperating department.

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What happens toservice department

costs after theyare allocated to

operatingdepartments?

The Need for Cost Allocations

Allocated service departmentcosts become a part ofthe overhead in each

operating department.

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The Need for Cost Allocations

I get it. They becomea part of the overhead

that is applied toproducts with apredeterminedoverhead rate.

That’s right. Take a lookat this flow chart.

I think it will summarizeour discussion of theallocation process.

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The Need for Cost Allocations

First Stage AllocationsService department costs are

allocated to operating departments.Service Department(Cafeteria)

Service Department(Accounting)

Service Department(Personnel)

Operating Department(Machining)

Operating Department(Assembly)

The Products

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The Need for Cost Allocations

Service Department(Cafeteria)

Service Department(Accounting)

Service Department(Personnel)

Operating Department(Machining)

Operating Department(Assembly)

The Products

Second Stage Allocations

Operating department overhead costs and allocated service department costs are

applied to products.

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Guidelines for Cost Allocation

OperatingDepartments

ServiceDepartments

1. Allocation bases

2. Interdepartmental services

3. Allocating costs by behavior

4. Allocation pitfalls to avoid

5. Allocation of actual or budgeted costs

$

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Selecting Allocation Bases

Personnel:Number ofemployees

Receiving:Units

handled

Security:Squarefootage

Power:Kilowatt

hours

Cafeteria:Number ofemployees

Custodial:Squarefootage

Accounting:Staffhours

Criteria

Easiest

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Selecting Allocation Bases

Availabilityof space orequipment

Personnel:Number ofemployees

Receiving:Units

handled

Security:Squarefootage

Power:Kilowatt

hours

Cafeteria:Number ofemployees

Custodial:Squarefootage

Accounting:Staffhours

Criteria

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Selecting Allocation Bases

Benefits receivedby the operating

department

Personnel:Number ofemployees

Receiving:Units

handled

Security:Squarefootage

Power:Kilowatt

hours

Cafeteria:Number ofemployees

Custodial:Squarefootage

Accounting:Staffhours

Criteria

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Selecting Allocation Bases

Consumption ofresources

Personnel:Number ofemployees

Receiving:Units

handled

Security:Squarefootage

Power:Kilowatt

hours

Cafeteria:Number ofemployees

Custodial:Squarefootage

Accounting:Staffhours

Criteria

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Interdepartmental Services

Problem

Allocating costs when service departmentsprovide services to each other

Problem

Allocating costs when service departmentsprovide services to each other

Solutions

Direct Method

Step method

Reciprocal method

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Direct Method

Service Department(Cafeteria)

Service Department(Custodial)

Operating Department(Machining)

Operating Department(Assembly)

Interactionsbetween servicedepartments areignored and all

costs areallocated directly

to operatingdepartments.

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Direct Method Example

Service Department Allocation Base

Cafeteria Number of employeesCustodial Square feet occupied

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Direct Method Example

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Direct Method Example

Allocation base: Number of employees

$360,000 ×20

20 + 30= $144,000

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Direct Method Example

Allocation base: Number of employees

$360,000 ×30

20 + 30= $216,000

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Direct Method Example

$90,000 ×25,000

25,000 + 50,000 = $30,000

Allocation base: Square feet occupied

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Direct Method Example

Allocation base: Square feet occupied

50,000

25,000 + 50,000$90,000 × = $60,000

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Operating Department(Machining)

Operating Department(Assembly)

Step Method

Once a servicedepartment’s costs

are allocated, other service

department costsare not allocated

back to it.

Service Department(Cafeteria)

Service Department(Custodial)

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Step Method

Service Department(Cafeteria)

Service Department(Custodial)

Operating Department(Machining)

Operating Department(Assembly)

Custodial willhave a new

total to allocateto operating

departments; itsown costs plus

those costsallocated fromthe cafeteria.

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Step Method Example

Service Department Allocation Base

Cafeteria Number of employeesCustodial Square feet occupied

We will use the same data used in the direct method example.

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Step Method Example

Allocate Cafeteria costs first sinceit provides more service than Custodial.

Allocate Cafeteria costs first sinceit provides more service than Custodial.

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Step Method Example

$360,000 ×10

10 + 20 + 30= $60,000

Allocation base: Number of employees

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Step Method Example

$360,000 ×20

10 + 20 + 30= $120,000

Allocation base: Number of employees

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Step Method Example

$360,000 ×30

10 + 20 + 30= $180,000

Allocation base: Number of employees

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Step Method Example

New total = $90,000 original custodial cost plus $60,000 allocated from the cafeteria.

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Step Method Example

$150,000 ×25,000

25,000 + 50,000 = $50,000

Allocation base: Square feet occupied

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Step Method Example

$150,000 ×50,000

25,000 + 50,000 = $100,000

Allocation base: Square feet occupied

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Reciprocal Method

Interdepartmentalservices are given

full recognitionrather than partialrecognition as withthe 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.

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Comparison of Methods

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Quick Check Data

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.

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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

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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 ×20

20 + 80= $36,000

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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

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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 ×18

18 + 102= $13,500

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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.

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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

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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

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But that would not be beneficial to the

company; most of those costs are fixed.

What if we charged a flat annual fee for the service?

Allocating Fixed Costs

My performance lookedgood until they

allocated those service department costs, so I’m not going to use

the service again.

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Allocating Fixed Costs

That sounds better.

If the fee is fixed,the more I use the

service the lower myaverage cost per

use will be.

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Allocating Costs by Behavior

VariableCosts

Charge tooperating

departments at abudgeted rate times

the usage of theallocation base.

FixedCosts

Allocatebudgeted amounts

to operating departmentsin proportion to the

peak-period capacityrequired by the

operating department.

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VariableCosts

Charge tooperating

departments at abudgeted rate times

the usage of theallocation base.

FixedCosts

Allocatebudgeted amounts

to operating departmentsin proportion to the

peak-period capacityrequired by the

operating department.

Allocating Costs by Behavior

Budgeted costs should be allocatedto avoid passing on inefficiencies

from the service departments.

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Allocations are made at the beginning of theperiod to provide data for predetermined

overhead rates and flexible budgets.

Allocations are made at the end of the period to provide data for comparing actual

performance to planned performance.

Allocations are made at the beginning of theperiod to provide data for predetermined

overhead rates and flexible budgets.

Allocations are made at the end of the period to provide data for comparing actual

performance to planned performance.

Allocating Costs by Behavior

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Allocating Costs by BehaviorExampleSimCo has a maintenance department and two operating

departments: cutting and assembly. Variable maintenancecosts are budgeted at $0.60 per machine hour. Fixed

maintenance costs are budgeted at $200,000 per year.Data relating to the current year are:

Allocate maintenance costs to the two operating departments.

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Allocating Costs by BehaviorExample: Beginning of the Period

Cutting AssemblyDepartment Department

Variable cost allocation: $0.60 × 75,000 hours 45,000$ $0.60 × 50,000 hours 30,000$ Fixed cost allocation

Total allocated cost

Hours planned

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Allocating Costs by BehaviorExample: Beginning of the Period

Cutting AssemblyDepartment Department

Variable cost allocation: $0.60 × 75,000 hours 45,000$ $0.60 × 50,000 hours 30,000$ Fixed cost allocation 60% of $200,000 120,000 40% of $200,000 80,000 Total allocated cost 165,000$ 110,000$

Percent of peak-period capacity.

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Hours used

Allocating Costs by BehaviorExample: End of the Period

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Percent of peak-period capacity.

Allocating Costs by BehaviorExample: End of the Period

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Fixed cost allocations are the same at the end and at the beginning because they are

based on capacity instead of usage.

Fixed cost allocations are the same at the end and at the beginning because they are

based on capacity instead of usage.

Allocating Costs by BehaviorExample

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Quick Check Data

Foster City has an ambulance service that is used by the two public hospitals in the city. Variable

ambulance costs are budgeted at $4.20 per mile. Fixed ambulance costs are budgeted at $120,000

per year. Data relating to the current year are:

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Quick Check

How much ambulance service cost will be allocated to Mercy Hospital at the beginning of the year?

a. $117,000

b. $254,400

c. $114,480

d. $119,250

How much ambulance service cost will be allocated to Mercy Hospital at the beginning of the year?

a. $117,000

b. $254,400

c. $114,480

d. $119,250

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How much ambulance service cost will be allocated to Mercy Hospital at the beginning of the year?

a. $117,000

b. $254,400

c. $114,480

d. $119,250

How much ambulance service cost will be allocated to Mercy Hospital at the beginning of the year?

a. $117,000

b. $254,400

c. $114,480

d. $119,250

Quick Check

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Quick Check

How much ambulance service cost will be allocated to Mercy Hospital at the end of the year?

a. $114,000

b. $118,800

c. $110,400

d. $121,200

How much ambulance service cost will be allocated to Mercy Hospital at the end of the year?

a. $114,000

b. $118,800

c. $110,400

d. $121,200

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How much ambulance service cost will be allocated to Mercy Hospital at the end of the year?

a. $114,000

b. $118,800

c. $110,400

d. $121,200

How much ambulance service cost will be allocated to Mercy Hospital at the end of the year?

a. $114,000

b. $118,800

c. $110,400

d. $121,200

Quick Check

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Pitfall 1

Using salesdollars as an

allocation base

Allocation Pitfalls to Avoid

Result

Departments thatincrease revenues arepenalized by receivingmore allocated costs.

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Pitfall 2

Allocating fixed costs using a variable

activity allocationbase

Allocation Pitfalls to Avoid

Result

Total fixed costs do notchange, but departmentsthat increase activities to

support increasedrevenues are penalized

by receiving moreallocated costs.

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End of Chapter 15