COST MANAGEMENT

Accounting & Control

Hansen▪Mowen▪Guan

Chapter 7
Allocating Costs of
Support Departments
and Joint Products
COPYRIGHT © 2009 South-Western Publishing, a division of Cengage Learning. 1
Cengage Learning and South-Western are trademarks used herein under license.
 Study Objectives
1. Describe the difference between support departments
and producing departments.
2. Calculate charging rates, and distinguish between
single and dual charging rates.
3. Allocate support center costs to producing departments
using the direct method, the sequential method, and
the reciprocal method.
4. Calculate departmental overhead rates.

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 An Overview of Cost Allocation
• Allocation is dividing a pool of costs and
assigning those costs to subunits
• The cost objects must be determined
• Cost objects are usually departments
– Producing: creating products sold to
customers
– Support: provide essential services for
producing departments

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Departmentalization:
Manufacturing Firm

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Departmentalization:
Service Firm

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 Allocating Support Department
Costs to Producing Departments
Steps:
• Departmentalize the firm
• Classify each department as support or producing
• Trace all overhead costs in the firm to the appropriate
department
• Allocate support department costs to producing
departments
• Calculate predetermined overhead rate for producing
departments
• Allocate overhead to units produced

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An Overview of Cost Allocation

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Allocating One Department’s Costs
to Another Department
• The costs of a support department are
often allocated through the use of a
charging rate.
• Major factors of rate selection:
– Choice of single or dual rate
– Use of budgeted or actual support department
costs.

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Allocating One Department’s Costs
to Another Department
Single = Fixed costs + estimated variable costs
rate estimated usage

Dual rate: Fixed rate and a variable rate

• Developing a fixed rate
– Determine budgeted fixed costs
– Compute allocation ratio
– Allocate
• Developing the variable rate
– Depends on the costs that change as the activity
driver changes 9
Allocating One Department’s Costs
to Another Department
When allocating support department costs,
should actual or budgeted costs be
allocated?
Answer: Budgeted – to prevent the
transfer of efficiencies or inefficiencies
from one department to another.

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Allocating One Department’s Costs
to Another Department

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Allocating One Department’s Costs
to Another Department

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 Choosing a Support Department
Cost Allocation Method
• Direct method
– Costs are allocated only to producing
departments
• Sequential (step) method
– Costs allocations are performed in a step-
down fashion, using predetermined ranking
procedures (e.g., degree of support)
• Reciprocal method
– Recognizes interactions of support
departments prior to allocation to producing
departments 13
Choosing a Support Department
Cost Allocation Method

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 Direct allocation
Allocate Power Dept costs based on kilowatt-
hours:
600,000
Grinding  $250,000 = $187,500
 600,000 + 200,000
200,000
Assembly  $250,000 = $62,500
 600,000 + 200,000 
Allocate Maintenance Dept costs based on
maintenance-hours:
4,500
Grinding  $160,000 = $80,000
 4,500 + 4,500
4,500
Assembly  $160,000 = $80,000
 4,500 + 4,500 15
Direct allocation

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 Sequential allocation
• Rank support departments by their direct costs
• Allocate
– First support department’s direct cost to all other
support departments and producing departments
– Next support department’s costs (direct + previously
allocated) to subsequent support and producing
– Etc.
• Once a support department’s costs are allocated
it never receives a subsequent allocation

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 Sequential allocation
Step 1: Allocate Power Dept costs based on
kilowatt-hours:
200,000 Maint kWh
 $250,000 = $50,000
 200,000 + 600,000 + 200,000
Maint kWh Grinding kWh Assembly kWh  To Maintenance

600,000 Grinding kWh

 $250,000 = $150,000
 200,000 + 600,000 + 200,000
Maint kWh Grinding kWh Assembly kWh  To Grinding

200,000 Assembly kWh

 $250,000 = $50,000
 200,000 + 600,000 + 200,000
Maint kWh Grinding kWh Assembly kWh  To Assembly
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 Sequential allocation
Step 2: Allocate Maintenance Dept costs (direct
+ allocated) based on maintenance-hours:
Costs to allocate: $160,000 direct + $50,000 allocated = $210,000

4,500 Grinding
 $210,000 = $105,000
 4,500 + 4,500
Grinding Assembly  To Grinding

4,500 Assembly
 $210,000 = $105,000
 4,500 + 4,500
Grinding Assembly  To Assembly
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Sequential allocation

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Reciprocal allocation

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 Reciprocal allocation
Utilize a series of simultaneous linear equations

M = $160,000 + .2P
M = $160,000 + .2(250,000 + .1M)
M = $160,000 + 50,000 + .02M
.09M = $210,000
M = $214,286

P = $250,000 + .1P
P = $250,000 + .1(214,286)
P = $250,000 + 21,429
P = $271,429 22
 Reciprocal allocation
Utilize a series of simultaneous linear equations

M = $160,000 + .2P
M = $160,000 + .2(250,000 + .1M)
M = $160,000 + 50,000 + .02M
.98M = $210,000
M = $214,286

P = $250,000 + .1P
P = $250,000 + .1(214,286)
P = $250,000 + 21,429
P = $271,429 23
 Reciprocal allocation
Utilize a series of simultaneous linear equations

M = $160,000 + .2P
M = $160,000 + .2(250,000 + .1M)
M = $160,000 + 50,000 + .02M
.98M = $210,000
M = $214,286

P = $250,000 + .1P
P = $250,000 + .1(214,286)
P = $250,000 + 21,429
P = $271,429 24
Reciprocal allocation

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Choosing a Support Department
Cost Allocation Method

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 Departmental Overhead Rates
and Product Costing
After allocating all support service costs to
producing departments, an overhead rate is
calculated for each department

 Allocated   Producing 
 service    department 
 costs   overhead costs 
   
Measure of activity

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 Departmental Overhead Rates
and Product Costing
A product cost can now be determined:

Direct materials
+ Direct labor
+ Assigned overhead
Product cost

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