CHAPTER 15
Allocation of Support Department Costs,
Common Costs,and Revenues
15-2To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
Allocating Costs of a Supporting Department to Operating Departments
Supporting (Service) Department – provides the services that assist other internal departments in the company
Operating (Production) Department – directly adds value to a product or service
15-3To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
Methods to Allocate Support Department Costs Single-Rate Method – allocates costs in each
cost pool (service department) to cost objects (production departments) using the same rate per unit of a single allocation base No distinction is made between fixed and
variable costs in this method
15-4To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
Methods to Allocate Support Department Costs Dual-Rate Method – segregates costs within
each cost pool into two segments: a variable-cost pool and a fixed-cost pool.
Each pool uses a different cost-allocation base
15-5To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
Allocation Method Tradeoffs
Single-rate method is simple to implement, but treats fixed costs in a manner similar to variable costs
Dual-rate method treats fixed and variable costs more realistically, but is more complex to implement
15-6To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
Allocation Bases
Under either method, allocation of support costs can be based on one of the three following scenarios:
1. Budgeted overhead rate and budgeted hours2. Budgeted overhead rate and actual hours3. Actual overhead rate and actual hours
Choosing between actual and budgeted rates: budgeted is known at the beginning of the period, while actual will not be known with certainty until the end of the period
15-7To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
Methods of Allocating Support Costs to Production Departments
1. Direct
2. Step-Down
3. Reciprocal
15-8To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
Direct Method
Allocates support costs only to Operating Departments
No interaction between Support Departments prior to allocation
15-9To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
Direct Method
Manufacturing
Information Systems
Accounting
Packaging
Support Departments Production Departments
15-10To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
Step-Down Method
Allocates support costs to other support departments and to operating departments that partially recognizes the mutual services provided among all support departments
One-way interaction between Support Departments prior to allocation
15-11To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
Step-Down Method
Manufacturing
Information Systems
Accounting
Packaging
Support Departments Production Departments
15-12To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
Reciprocal Method
Allocates support department costs to operating departments by fully recognizing the mutual services provided among all support departments
Full two-way interaction between Support Departments prior to allocation
15-13To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
Reciprocal Method
Manufacturing
Information Systems
Accounting
Packaging
Support Departments Production Departments
15-14To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
Choosing Between Methods
Reciprocal is the most precise Direct and Step-Down are simple to compute
and understand Direct Method is widely used
15-15To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
Allocating Common Costs
Common Cost – the cost of operating a facility, activity, or like cost object that is shared by two or more users at a lower cost than the individual cost of the activity to each user
15-16To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
Methods of Allocating Common Costs Stand-Alone Cost-Allocation Method – uses
information pertaining to each user of a cost object as a separate entity to determine the cost-allocation weights
Individual costs are added together and allocation percentages are calculated from the whole, and applied to the common cost
15-17To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
Methods of Allocating Common Costs Incremental Cost-Allocation Method ranks the individual users
of a cost object in the order of users most responsible for a common cost and then uses this ranking to allocate the cost among the users The first ranked user is the Primary User and is allocated
costs up to the costs of the primary user as a stand-alone user (typically gets the highest allocation of the common costs)
The second ranked user is the First Incremental User and is allocated the additional cost that arises from two users rather than one
Subsequent users handled in the same manner as the second ranked user
15-18To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
Cost Allocations and Contracting
The US government reimburses most contractors in either of two main ways:
1. The contractor is paid a set price without analysis of actual contract cost data
2. The contractor is paid after an analysis of actual contract cost data. In some cases, the contract will state that the reimbursement amount is based on actual allowable costs plus a fixed fee (cost-plus contract)
15-19To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
Revenue Allocation and Bundled Products Revenue Allocation occurs when revenues are
related to a particular revenue object but cannot be traced to it in an economically feasible manner
Revenue Object – anything for which a separate measurement of revenue is desired
Bundled Product – a package of two or more products or services that are sold for single price, but individual components of the bundle also may be sold as separate items at their own “stand-alone” prices
15-20To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
Methods to Allocate Revenue to Bundled Products Stand-Alone (separate) Revenue Allocation
Method uses product-specific information on the products in the bundle as weights for allocating the bundled revenues to the individual products. Three types of weights may be used:
1. Selling Prices2. Unit Costs3. Physical Units
15-21To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
Methods to Allocate Revenue to Bundled Products Incremental Revenue-Allocation Method ranks
individual products in a bundle according to criteria determined by management and then uses this ranking to allocate bundled revenues to individual products (similar to earlier discussed Incremental Cost-Allocation Method) The first-ranked product is the primary product The second-ranked product is the first incremental
product The third-ranked product is the second incremental
product, etc.