Cost Allocation - From the Simple to the Sublime: Handout due by 11/6/14

After reading the attached article "Cost Allocation - From the Simple to the Sublime", please complete the questions listed below. Any questions, please let me know.

1. Allocate the service department costs (administrative, housekeeping and maintenance costs) to the revenue producing departments (patient rooms and diagnosis & treatment) using the Direct Allocation Method.

Costs Av # employees

% of employees

Square Ft of area

% of Square Ft of area

# of Requisitions

% of Requisitions

Administration 2,000,000 50 20 40,000 16 80 8Housekeeping 900,000 30 12 10,000 4 120 12Maintenance 400,000 10 4 20,000 8 0 0Patient Rooms 5,000,000 120 48 120,000 48 500 50Diagnosis & Treatment

9,000,000 40 16 60,000 24 300 30

17,300,000 250 100 250,000 100 1000 100

Costs Administration Housekeeping Maintenance TotalAdministration 2,000,000 -2,000,000 0Housekeeping 900,000 -900,000 0Maintenance 400,000 -400,000 0Patient Rooms 5,000,000 1,500,000 600,000 250,000 7,350,000Diagnosis & Treatment

9,000,000 500,000 300,000 150,000 9,950,000

17,300,000 17,300,000

2. Allocate the service department costs (administrative, housekeeping and maintenance costs) to the revenue producing departments (patient rooms and diagnosis & treatment) using the Step Allocation Method.

Costs Av # employees

% of employees

Square Ft of area

% of Square Ft of area

# of Requisitions

% of Requisitions

Administration 2,000,000 50 20 40,000 16 80 8Housekeeping 900,000 30 12 10,000 4 120 12Maintenance 400,000 10 4 20,000 8 0 0Patient Rooms 5,000,000 120 48 120,000 48 500 50Diagnosis & Treatment 9,000,000 40 16 60,000 24 300 30

17,300,000 250 100 250,000 100 1000 100

Costs Administration Housekeeping Maintenance TotalAdministration 2,000,000 -2,000,000 0Housekeeping 900,000 300,000 -1,200,000 1,200,000

Maintenance 400,000 100,000 120,000 -620,000 -620,000Patient Rooms 5,000,000 1,200,000 720,000 387,500 7,307,500Diagnosis & Treatment 9,000,000 400,000 360,000 232,500

17,300,000 17,300,000

3. Why do we allocate service department costs to production departments?

A service department such as the Maintenance Department or the Personnel Department must exist in order for an organization to carry out its primary function. Therefore, the cost of running a service department is part of the cost incurred by the organization in producing goods or services. In order to determine the cost of those goods or services, all service department costs must be allocated to the production departments in which the goods or services are produced.

4. What are the advantages and disadvantages of using the direct method of cost allocation over the step method of cost allocation?

The direct cost allocation method is much simpler and faster than the step cost allocation method, because it requires less information to complete. Because the costs associated with each support department are allocated directly to the appropriate departments without regard for reciprocal services and self-consumption. Although the direct method is simple, it is less accurate than the other methods because it ignores interdepartmental services. This method cannot be used to allocate costs to other service departments. . The direct method ignores the cost drivers that are related to the service departments and concentrates only on the cost drivers attributes to the production departments. It can be used only to allocate costs to production departments

The step cost allocation method is more accurate and in depth than the direct cost allocation method, because it requires more information to complete, it includes at least partial consideration of reciprocal services. You can get a much better look at the costs if you use the step cost allocation method. The advantages of using the step cost allocation method are to produce more accurate estimations on final costs and to evaluate the costs being assigned to other service departments. The step cost method provides for allocation of a service department’s costs to other service departments, as well as, to operating departments. The step-cost method is sequential.

5. Which method do you feel would be the most accurate method for allocating service department costs to their appropriate product departments?

I feel that the step cost allocation is more accurate because it takes into consideration more of the details, and once the costs of a service department have been allocated, no costs are allocated back to that service department. The intermediate allocations from service department to service department improve the accuracy of those final allocations.