Chapter 15final

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Allocation of Support Department Costs,

Common Costs,and Revenues


Allocating Costs of a Supporting Department to Operating DepartmentsSupporting (Service) Department – provides

the services that assist other internal departments in the company

Operating (Production) Department – directly adds value to a product or service


Methods to Allocate Support Department CostsSingle-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 baseNo distinction is made between fixed and

variable costs in this method


Methods to Allocate Support Department CostsDual-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


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


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


Comparative Allocation Bases Illustrated


Methods of Allocating Support Costs to Production Departments

1. Direct2. Step-Down3. Reciprocal


Direct Method

Allocates support costs only to Operating Departments

No Interaction between Support Departments prior to allocation


Direct Method

Manufacturing

Information Systems

Accounting

Packaging

Support Departments Production Departments


Data Used in Cost Allocation Illustrations


Direct Allocation Method Illustrated


Direct Allocation Method Illustrated, cont.


Step-Down MethodAllocates 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


Step-Down Method

Manufacturing

Information Systems

Accounting

Packaging



Step-Down Allocation Method Illustrated


Step-Down Allocation Method Illustrated, cont.


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


Reciprocal Method

Manufacturing

Information Systems

Accounting

Packaging



Reciprocal Allocation Method (Repeated Iterations) Illustrated


Reciprocal Allocation Method (Linear Equations) Illustrated


Choosing Between Methods

Reciprocal is the most preciseDirect and Step-Down are simple to compute

and understandDirect Method is widely used


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


Methods of Allocating Common CostsStand-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


Methods of Allocating Common CostsIncremental 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 usersThe first ranked user is the Primary User and is allocated

costs up the cost 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


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)


Revenue Allocation and Bundled ProductsRevenue 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


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


Methods to Allocate Revenue to Bundled ProductsIncremental 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 productThe second-ranked product is the first incremental

productThe third-ranked product is the second incremental

product, etc


Technology

Chapter 15final