Support Department Cost Allocation

Learning Objectives
1. Describe the difference between support departments and producing departments.
2. Calculate single and multiple charging rates for a support department.
3. Assign support department costs to producing departments using the direct, sequential,
and reciprocal methods.
4. Calculate departmental overhead rates.

1. AN OVERVIEW OF COST ALLOCATION

In prior chapters, we discussed factory overhead allocation. However, we took the
existence of factory overhead cost in a producing department as a given. This chapter
asks us to step back and trace these factory overhead costs from incurrence through
assignment to units produced.
Use the opening scenario to introduce the concept of the two categories of departments:
support departments and producing departments. Each type of department should be
defined, and it should be indicated that this chapter is primarily concerned with
describing ways of allocating support-department costs to producing departments.

A. Types of Departments
If departments are the cost objects, departments are classified as either producing
departments or support departments.

Definition:
Examples:

responsible for creating the

products
or services sold to customers
assembly department, finishing
department

provide support services for

producing departments
maintenance, personnel, security

Although support departments do not work directly on the products of an organization,

the costs of providing these support services are part of the total product cost.
Three steps in allocating costs are:
1. trace all overhead costs to a support or producing department
2. allocate support-department costs to the producing departments, and

3. allocate overhead costs to units of individual products using a predetermined overhead

rate. The predetermined overhead rate is calculated as follows:

Note that a producing departments overhead consists of two parts:

overhead directly associated with the producing department

overhead allocated to the producing department from the support
departments

In addition, Hansen and Mowen state that some basic guidelines should be followed
when allocating support-department costs. These guidelines are essentially compatible
with the five objectives.
1. As nearly as possible, cost drivers (causal factors) should be used as the basis for cost
allocation.
2. Budgeted or expected costs, not actual costs, should be allocated.
3. Costs should be allocated by behavior; fixed costs and variable costs should be
allocated separately.

B. Types of Drivers

Causal factors are cost drivers within a producing department that cause
or drive the consumption of support service costs.
In general, causal factors should be used as the basis for allocating service
costs.
For example, if power costs were to be allocated, kilowatt hours would be
the cost driver or causal factor that could be used as the allocation base.

C. Objectives of Assigning Support Department Costs

The major objectives associated with the allocation of support-department

costs to producing departments and ultimately to specific products are:
to obtain a mutually agreeable price
to compute product-line profitability
to predict economic effects of planning and control
to value inventory
to motivate managers

2. ASSIGNING DEPARTMENT COSTS TO PRODUCING DEPARTMENTS

A charging rate is used to allocate the costs of a support department to user

departments.

A. A Single Charging Rate

If a single charging rate is used, fixed costs and variable costs are
combined and then divided by estimated activity.

The amount charged to producing departments is calculated as follows:

Single charging rate Producing department usage

Two reasons for allocating support-department costs are:

1. for product costing (to determine the cost of units produced), and
2. for performance evaluation.

For product costing, the allocation is made at the beginning of the year
based on budgeted usage so that a predetermined overhead rate can be
computed to cost products during the year.
For performance evaluation purposes, the allocation is made at the end of
the period based on actual usage.

Usage:

Budgeted usage

Actual usage

Service department
allocation:

Budgeted rate Budgeted usage

Budgeted rate Actual usage

Cornerstone 14-1: How to Calculate and Use a Single Charging Rate

See Mowen and Hansen text for in-class, demo problems.

B. Multiple Charging Rates

Instead of using a single charging rate, a company may break support

department resources and causal factors into multiple charging rates.
For example, two rates may be used to assign support department costs:
o one rate for variable costs (based on actual usage), and
o one rate for fixed costs (based on planned peak usage).

Variable costs of support departments vary with usage so it makes sense to

charge the variable rate for each unit of service consumed by the
producing departments.
Fixed costs are incurred to provide the capacity necessary to deliver the
service units required by the producing departments. Thus, it is reasonable
to assign the fixed costs to producing departments in proportion to their
planned peak usage.

Cornerstone 14-2: How to Calculate and Assign Service Costs Using

Multiple Charging Rates

See Mowen and Hansen text for in-class, demo problems.

C. Assigning Budget versus Actual Service Costs

Budgeted, not actual, costs should be allocated so that support

departments efficiencies or inefficiencies are not passed on to the
producing departments.
A general principle of performance evaluation is that managers should not
be held responsible for costs or activities over which they have no control.

3. CHOOSING A SUPPORT DEPARTMENT COST ALLOCATION

METHOD
There are three methods commonly used to allocate support costs: (1) the direct method;
(2) the sequential (or step) method; and (3) the reciprocal method. Many instructors
choose to defer coverage of the reciprocal method to cost accounting. It is important for
students to realize that no matter which method of support department cost allocation is
used, total factory overhead costs remain unchanged. That is, the different allocation
methods simply split up the costs differently among the producing departments.
Three methods used to allocate support-department costs to producing departments are:
1. direct method
2. sequential method, and
3. reciprocal method.

A. Direct Method of Allocation

The direct method allocates support-department costs directly to the producing

departments based on relative use.
This method ignores reciprocal services (services provided by one support
department to another support department). For example, this method would
ignore service provided by the data processing department to other support
departments, such as personnel or maintenance.

Cornerstone 14-3: How to Assign Support Department Costs Using the

Direct Method

See Mowen and Hansen text for in-class, demo problems.

B. Sequential Method of Allocation

The sequential (or step) method allocates support-department costs to

the producing depart ments an d to some support departments. Thus, the
sequential method partially recognizes reciprocal services.
The sequential method is applied in the following manner:

1. Select a support department and allocate its costs to the producing departments and
support departments to which it provides services. (The support department with the
greatest total costs is allocated first.)
2. Select another support department and allocate its cost to the producing departments
and the remaining support departments.
3. Proceed in this manner until all of the support-department costs have been allocated to
the producing departments.

Notice that once the costs of a support department are allocated, no further
allocations are made to that support department.

Cornerstone 14-4: How to Assign Support

See Mowen and Hansen text for in-class, demo problems.

Department Costs Using the Sequential Method

See Mowen and Hansen text for in-class, demo problems.

C. Reciprocal Method of Allocation

The reciprocal method fully recognizes the reciprocal services provided

by support departments to other support departments.
The reciprocal method requires the use of simultaneous equations.
The total cost of a support department is calculated:
Total cost of support department = Direct costs + Allocated costs of
other support departments

The reciprocal method fully recognizes the reciprocal services provided

by support departments to other support departments.

4. DEPARTMENTAL OVERHEAD RATES AND PRODUCT COSTING

When all costs are allocated from the support departments to the production departments,
overhead rates can be calculated for each production department. These calculations are
similar to overhead calculations discussed in earlier chapters.
Support-department costs are allocated to the producing departments, and then the
support-department costs are included in the producing departments overhead
application rates.
The flow of costs could be diagramed as follows:
Support Department Costs

Producing Department
Overhead Costs

Units of Product

$400,000
$200,000

$200,000
$600,000

The $600,000 of producing department overhead would be allocated to units of product

using a cost driver such as direct labor hours or machine hours.

Cornerstone 14-5: How to Calculate and Use Departmental Overhead

Rates

See Mowen and Hansen text for in-class, demo problems.

SUMMARY
To summarize, the four steps involved in support-department allocation are as follows:
1. Prepare departmental budgets for producing and support departments.
2. Select an allocation base for use in allocating the support-department costs.
3. Allocate the budgeted support-department costs to the producing departments using
either the direct, sequential, or reciprocal method.
4. Calculate a predetermined overhead application rate for each producing department to
apply total overhead costs to units of product produced