Service and Production Department Cost Allocation

Service and Production Department
Cost Allocation
Service
Department
(Cafeteria)
Direct
and
Indirect
Costs
Service
Department
(Accounting)
Service
Department
(Personnel)
Production
Department
(Machining)
Production
Department
(Assembly)
The
Product

Cost Allocation
First Phase: Trace direct costs
and allocate indirect costs to all departments
Service
Department
(Cafeteria)
Direct
and
Indirect
Costs
Service
Department
(Accounting)
Service
Department
(Personnel)
Production
Department
(Machining)
Production
Department
(Assembly)
The
Product

Cost Allocation
Service
Department
(Cafeteria)
Direct
and
Indirect
Costs
Service
Department
(Accounting)
Service
Department
(Personnel)
Second Phase: Allocate

service department costs
to production departments.
Production
Department
(Machining)
Production
Department
(Assembly)
The
Product

Cost Allocation
Service
Department
(Cafeteria)
Direct
and
Indirect
Costs
Service
Department
(Accounting)
Service
Department
(Personnel)
Production
Department
(Machining)
Production
Department
(Assembly)
The
Product
Third Phase: Allocate production department overhead

costs to products.
Methods of Allocating Service

Department Costs
Problem
Allocating costs when service departments
provide services to each other
Solutions
Direct method
Step method
Reciprocal method
Direct Method
Cost of services
between service
departments are
ignored and all
costs are
allocated directly
to user
departments.
Service
Department
(Cafeteria)
Production
Department
(Machining)
Service
Department
(Custodial)
Production
Department
(Assembly)
Direct Method Example
Departmental costs
before allocation
Number of employees
Square feet occupied
Service Departments
Production Departments
Cafeteria
Custodial
Machining
Assembly
$ 360,000
15
5,000
$ 90,000
10
2,000
$ 400,000
20
25,000
$ 700,000
30
50,000
Service Department
Allocation Base
Cafeteria
Custodial
Number of employees
Direct Method
Service Departments
Cafeteria
Custodial
Machining
Assembly
Departmental costs
before allocation
$ 360,000
$ 90,000
$ 400,000
$ 700,000
Cafeteria allocation
Custodial allocation
Total after allocation
Direct Method
Departmental costs
before allocation
Service Departments
Cafeteria
Custodial
Machining
Assembly
$ 360,000
$ 90,000
$ 400,000
$ 700,000
(360,000)
144,000
20
$360,000
= $144,000
20 + 30
Allocation base: Number of employees
Direct Method
Departmental costs
before allocation
Service Departments
Cafeteria
Custodial
Machining
Assembly
$ 360,000
$ 90,000
$ 400,000
$ 700,000
144,000
216,000
(360,000)
$360,000
30
= $216,000
20 + 30
Direct Method
Departmental costs
before allocation
Service Departments
Cafeteria
Custodial
Machining
Assembly
$ 360,000
$ 90,000
$ 400,000
$ 700,000
144,000
216,000
(360,000)
0
$
(90,000)
$
25,000
$90,000
25,000 + 50,000
30,000
$ 574,000
= $30,000
Allocation base: Square feet occupied
Direct Method
Departmental costs
before allocation
Service Departments
Cafeteria
Custodial
Machining
Assembly
$ 360,000
$ 90,000
$ 400,000
$ 700,000
144,000
216,000
30,000
60,000
$ 574,000
$ 976,000
(360,000)
0
$
(90,000)
$
50,000
$90,000
25,000 + 50,000
= $60,000
Step Method
Service department
costs are allocated
to other service
departments and
to production
departments, usually
starting with the
service department
that provides the
greatest amount of
service to other
departments.
Service
Department
(Cafeteria)
Production
Department
(Machining)
Service
Department
(Custodial)
Production
Department
(Assembly)
Step Method
Once a service
departments costs
are allocated,
other service
department costs
are not allocated
back to it.
Service
Department
(Cafeteria)
Production
Department
(Machining)
Service
Department
(Custodial)
Production
Department
(Assembly)
Step Method
Custodial will
have a new
total to allocate
to production
departments: its
own costs plus
those costs
allocated from
the cafeteria.
Service
Department
(Cafeteria)
Production
Department
(Machining)
Service
Department
(Custodial)
Production
Department
(Assembly)
Step Method Example

We will use the same data used in the direct method example.
Departmental costs
before allocation
Number of employees
Service Departments
Cafeteria
Custodial
Machining
Assembly
$ 360,000
15
5,000
$ 90,000
10
2,000
$ 400,000
20
25,000
$ 700,000
30
50,000
Service Department
Allocation Base
Cafeteria
Custodial
Number of employees
Step Method
Service Departments
Cafeteria
Custodial
Machining
Assembly
Departmental costs
before allocation
$ 360,000
$ 90,000
$ 400,000
$ 700,000
Step Method
Departmental costs
before allocation
Service Departments
Cafeteria
Custodial
Machining
Assembly
$ 360,000
$ 90,000
$ 400,000
$ 700,000
(360,000)
60,000
10
$360,000
10 + 20 + 30
= $60,000
Step Method
Departmental costs
before allocation
Service Departments
Cafeteria
Custodial
Machining
Assembly
$ 360,000
$ 90,000
$ 400,000
$ 700,000
60,000
120,000
(360,000)
20
$360,000
10 + 20 + 30
= $120,000
Step Method
Departmental costs
before allocation
Service Departments
Cafeteria
Custodial
Machining
Assembly
$ 360,000
$ 90,000
$ 400,000
$ 700,000
60,000
120,000
180,000
(360,000)
30
$360,000
10 + 20 + 30
= $180,000
Step Method
Departmental costs
before allocation
Service Departments
Cafeteria
Custodial
Machining
Assembly
$ 360,000
$ 90,000
$ 400,000
$ 700,000
60,000
120,000
180,000
(360,000)
(150,000)
$
New total = $90,000 original custodial cost

plus $60,000 allocated from the cafeteria.
Step Method
Departmental costs
before allocation
Service Departments
Cafeteria
Custodial
Machining
Assembly
$ 360,000
$ 90,000
$ 400,000
$ 700,000
60,000
120,000
180,000
(150,000)
50,000
$ 570,000
(360,000)
$150,000
0
$
25,000
25,000 + 50,000
= $50,000
Step Method
Departmental costs
before allocation
Service Departments
Cafeteria
Custodial
Machining
Assembly
$ 360,000
$ 90,000
$ 400,000
$ 700,000
60,000
120,000
180,000
(150,000)
50,000
100,000
$ 570,000
$ 980,000
(360,000)
0
$
50,000
$150,000
25,000 + 50,000
= $100,000
Reciprocal Method
Interdepartmental
services are given
full recognition
rather than partial
recognition as with
the step method.
Service
Department
(Cafeteria)
Production
Department
(Machining)
Service
Department
(Custodial)
Production
Department
(Assembly)
Reciprocal Method Example

We will use the same data used in the previous examples.
Departmental costs
before allocation
Number of employees
Service Departments
Cafeteria
Custodial
Machining
Assembly
$ 360,000
15
5,000
$ 90,000
10
2,000
$ 400,000
20
25,000
$ 700,000
30
50,000
Service Department
Allocation Base
Cafeteria
Custodial
Number of employees
Reciprocal Method
The Custodial Department receives:
10
10 + 20 + 30
1
of Cafeteria costs.
6
The Cafeteria Department receives:

5,000
5,000 + 25,000 + 50,000
1
of Custodial costs.
16
The total cost of each service department is equal to:

Direct costs of that department
+ Costs allocated to that department
Reciprocal Method
In equation form:
Cu = $90,000 +
and
Ca = $360,000 +
Cu
1 Ca
6
1
16
Cu = Total costs of Custodial Department

Ca = Total costs of Cafeteria Department
Reciprocal Method
In equation form:
Cu = $90,000 +
and
Ca = $360,000 +
1 Ca
6
1 Cu
16
Two equations and two unknowns are solved by substitution:

Ca = $360,000 + 1 ($90,000 + 1 Ca)
16
6
Ca = $369,474 (rounded)
and
Cu = $90,000 + 1 ($369,474) = $151,579
6
Reciprocal Method
Service Departments
Cafeteria
Custodial
Machining
Assembly
Departmental costs
before allocation
$ 360,000
$ 90,000
$ 400,000
$ 700,000
Reciprocal Method
Departmental costs
before allocation
Service Departments
Cafeteria
Custodial
Machining
Assembly
$ 360,000
$ 90,000
$ 400,000
$ 700,000
(369,474)
61,579
10
$369,474
10 + 20 + 30
= $61,579
Reciprocal Method
Departmental costs
before allocation
Service Departments
Cafeteria
Custodial
Machining
Assembly
$ 360,000
$ 90,000
$ 400,000
$ 700,000
61,579
123,158
(369,474)
20
$369,474
10 + 20 + 30
= $123,158
Reciprocal Method
Departmental costs
before allocation
Service Departments
Cafeteria
Custodial
Machining
Assembly
$ 360,000
$ 90,000
$ 400,000
$ 700,000
61,579
123,158
184,737
(369,474)
30
$369,474
10 + 20 + 30
= $184,737
Reciprocal Method
Departmental costs
before allocation
Service Departments
Cafeteria
Custodial
Machining
Assembly
$ 360,000
$ 90,000
$ 400,000
$ 700,000
61,579
123,158
184,737
(369,474)
$151,579
9,474
$
(151,579)
$
5,000
= $9,474 (rounded)
5,000 + 25,000 + 50,000
Reciprocal Method
Departmental costs
before allocation
Service Departments
Cafeteria
Custodial
Machining
Assembly
$ 360,000
$ 90,000
$ 400,000
$ 700,000
61,579
123,158
184,737
(151,579)
47,368
$ 570,526
(369,474)
$151,579
9,474
$
25,000
= $47,368 (rounded)
5,000 + 25,000 + 50,000
Reciprocal Method
Departmental costs
before allocation
Service Departments
Cafeteria
Custodial
Machining
Assembly
$ 360,000
$ 90,000
$ 400,000
$ 700,000
61,579
123,158
184,737
(151,579)
47,368
94,737
$ 570,526
$ 979,474
(369,474)
$151,579
9,474
$
50,000
= $94,737 (rounded)
5,000 + 25,000 + 50,000
Comparison of Methods
Totals after allocation
Method
Direct
Machining
Department
Assembly
Department
574,000
976,000
Step
570,000
980,000
Reciprocal
570,526
979,474
Comparison of Methods
The reciprocal method is superior because:
It considers all services provided to other
service departments.
The total cost of operating a service department
is computed.
The reciprocal method
requires the use of matrix
algebra with three or more
service departments.
Joint Costs
Joint Product Costing

Joint
Costs
Joint
Input
Oil
Common
Production
Process
Final
Sale
Separate
Processing Costs
Gasoline
Split-Off
Point
Additional
Processing
Additional
Processing
Separate
Processing Costs
Final
Sale
Joint Cost Allocation Methods

Physical
measure
Sales value
at split-off
Joint costs are

allocated based
on a relative
measure (weight,
volume, etc.)
of products at the
split-off point.
Joint costs are

allocated based
on relative
values of
products at the
split-off point.
Net Realizable
Value
Joint costs are

allocated based
on relative values
of products at the
final market point
subtracting any
additional processing
costs beyond
the split-off point.
Physical Measure Method

Joint
Costs
Joint
Input
Oil
240,000 gallons
Common
Production
Process
Gasoline
Split-Off
Point
360,000 gallons

Joint conversion
cost = $225,000
Joint material
cost = $275,000
Oil
240,000 gallons
Common
Production
Process
Gasoline
Split-Off
Point
360,000 gallons

Product
Oil
Output quantities in gallons
Proportionate share:
240,000
Gasoline
360,000
?
?
Allocated joint costs:
?
?
Total
600,000

Product
Oil
240,000 600,000
360,000 600,000
240,000
Gasoline
360,000
40%
60%

?
?
Total
600,000

Product
Oil
240,000 600,000
360,000 600,000
$500,000 40%
$500,000 60%
240,000
Gasoline
360,000
40%
60%
$ 200,000
$ 300,000
Total
600,000
Sales Value at Split-Off Method

Joint
Costs
Joint
Input
Oil
Common
Production
Process
Gasoline
Split-Off
Point

Joint conversion
cost = $225,000
Joint material
cost = $275,000
Oil
$200,000
sales value at
split-off point
Gasoline
$600,000
sales value at
split-off point
Common
Production
Process
Split-Off
Point

Product
Oil
Sales value at split-off point
Gasoline
Total
$ 200,000 $ 600,000 $ 800,000

?
?

?
?

Product
Oil
$200,000 $800,000
$600,000 $800,000
Gasoline
Total
$ 200,000 $ 600,000 $ 800,000

25%
75%

?
?

Product
Oil
$200,000 $800,000
$600,000 $800,000
$500,000 25%
$500,000 75%
Gasoline
Total
$ 200,000 $ 600,000 $ 800,000

25%
75%
$ 125,000
$ 375,000
$275,000 joint conversion cost plus

$225,000 joint material cost
Net Realizable Value Method

If products require further processing
beyond the split-off point before they
are marketable, it may be necessary to
estimate the net realizable value at the
split-off point.
Estimated
NRV
Final
Sales
Value
Added
Processing
Costs

Joint
Costs
Joint
Input
Oil
Common
Production
Process
Final
Sale
Additional
Processing Costs
Gasoline
Split-Off
Point
Additional
Processing
Additional
Processing
Additional
Processing Costs
Final
Sale

Joint conversion
cost = $225,000
Joint material
cost = $275,000
Oil
Common
Production
Process
Sales
Value
$500,000
Additional
Processing Costs
$200,000
Gasoline
Split-Off
Point, Sales
Value Unknown
Additional
Processing
Additional
Processing
Additional
Processing Costs
$500,000
Sales
Value
$1,200,000

Product
Oil
Sales value
Less additional processing costs
Estimated NRV at split-off point
Gasoline
Total
$ 500,000 $ 1,200,000 $ 1,700,000

?
?
?
?
?
?
?
?

?
?

Product
Oil
Sales value
Gasoline
Total
$ 500,000 $ 1,200,000 $ 1,700,000

200,000
500,000
700,000
$ 300,000 $ 700,000 $ 1,000,000
?
?

?
?

Product
Oil
Sales value
$300,000 $1,000,000
$700,000 $1,000,000
Gasoline
Total
$ 500,000 $ 1,200,000 $ 1,700,000

200,000
500,000
700,000
$ 300,000 $ 700,000 $ 1,000,000
30%
70%

?
?

Product
Oil
Sales value
$300,000 $1,000,000
$700,000 $1,000,000
$500,000 30%
$500,000 70%
Gasoline
Total
$ 500,000 $ 1,200,000 $ 1,700,000

200,000
500,000
700,000
$ 300,000 $ 700,000 $ 1,000,000
30%
70%
$ 150,000
$ 350,000
By-Product Costing
1. Asset Recognition Methods:
a. Net Realizable Value Method
b. Other Income at Production Point Method
2. Revenue Methods:
a. Other Income at Selling Point Method
b. Manufacturing Cost Reduction at Selling
Point Method

Service and Production Department Cost Allocation

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Service and Production Department