Chapter Sixteen Allocation of Support Activity Costs and Joint Costs

FOCUS COMPANY

This chapter’s Focus Company is Riverside Clinic, an outpatient

medical facility in Hope, British Columbia. The clinic has two direct-patient-care departments: Orthopaedics and

Internal Medicine. In these two departments, patients are

treated by medical profession-als. Riverside Clinic also has three service departments, which are not directly involved in patient care. The clinic’s Patient Records, Human Resources, and Administration and Accounting departments are necessary for the clinic to function, but they operate in a support role

to the two direct-patient-care departments. In this chapter, we explore several methods for allocating the costs of the clinic’s service departments to the direct-patient-care departments.

IN CONTRAST

In contrast to the health-care services setting of Riverside Clinic, we explore a different type of allocation issue in the context of International Chocolate Company. This company uses a joint production process to turn cocoa beans into cocoa butter and cocoa powder. The cocoa powder can be processed further into instant cocoa mix. A joint production process results in two or more products, which are called joint products . We will discuss several different methods that International Chocolate Company might use to allocate the costs of its joint production process to its two joint products.

Chapter Sixteen

Allocation of Support Activity Costs and Joint Costs

After completing this chapter,

you should be able to:

1 Allocate service department

costs using the direct method

and the step-down method.

2 Allocate service department

costs using the reciprocal-

services method.

3 Use the dual approach to

service department cost

allocation.

4 Explain the difference between

two-stage cost allocation with

departmental overhead rates

and activity-based costing

(ABC).

5 Allocate joint costs among

joint products using each of

the following techniques:

physical-units method,

relative-sales-value method,

and net-realizable-value

method.

6 Describe the purposes for which

joint cost allocation is useful and

those for which it is not.

RIVERSIDE

CLINIC

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2 Chapter 16 Allocation of Support Activity Costs and Joint Costs

In earlier chapters, we studied cost allocation and explored its role in an organiza-tion’s overall managerial accounting system. We also examined several purposes of cost allocation. The goal of cost allocation is to ensure that all costs incurred by

the organization are ultimately assigned to its products or services. This is important for several purposes, including cost-based pricing and bidding, cost reimbursements from outside parties such as insurance companies, valuation of inventory, and deter-mination of cost of goods sold. In addition, the allocation of all costs to departments serves to make departmental managers aware of the costs incurred to produce ser-vices their departments use.

Service Department Cost Allocation

A service department is a unit in an organization that is not involved directly in pro-ducing the organization’s goods or services. However, a service department does pro-vide a service that enables the organization’s production process to take place. For example, the Maintenance Department in an automobile plant does not make auto-mobiles, but if it did not exist, the production process would stop when the manufac-turing machines broke down. Thus, the Maintenance Department is crucial to the production operation even though the repair personnel do not work directly on the plant’s products.

Service departments are important in nonmanufacturing organizations also. For example, a hospital’s Human Resources Department is responsible for staffing the hospital with physicians, nurses, lab technicians, and other employees. The Human Resources Department never serves the patients, yet without it the hospital would have no staff to provide medical care.

A service department such as the Maintenance Department or the Human Resources Department must exist in order for an organization to carry out its primary function. Therefore, the cost of running a service department is part of the cost in-curred by the organization in producing goods or services. In order to determine the cost of those goods or services, all service department costs must be allocated to the production departments in which the goods or services are produced. For this reason, the costs incurred in an automobile plant’s Maintenance Department are allocated to all of the production departments that have machinery. The costs incurred in a hospi-tal’s Human Resources Department are allocated to all of the departments that have personnel. Direct-patient-care departments, such as Surgery and Physical Therapy, are allocated their share of the Human Resources Department’s costs.

To see how service department cost allocation fits into the overall picture of product and service costing, it may be helpful to review Exhibit 3–13 in the text on page 96. The exhibit shows three types of allocation processes, as follows:

1. Cost distribution. Costs in various cost pools are distributed to all depart-ments, including both service and production departments.

2. Service department cost allocation. Service department costs are allocated to production departments.

3. Cost application. Costs are assigned to the goods or services produced by the organization.

It is the second type of allocation process listed above that we are focusing on now. The context for our discussion is Riverside Clinic, an outpatient medical facility in Hope, British Columbia.

The clinic is organized into three service departments and two direct-patient-care departments. Exhibit 16–1 displays a simple organization chart for Riverside Clinic. Since the clinic is not a manufacturing organization, we refer to direct-patient-care departments instead of production departments . These two departments, Orthopae-dics and Internal Medicine, directly provide the health care that is the clinic’s primary

Learning Objective 1

Allocate service department

costs using the direct method

and the step-down method.

RIVERSIDE

CLINIC


Chapter 16 Allocation of Support Activity Costs and Joint Costs 3

objective. Thus, the clinic’s direct-patient-care departments are like the production departments in a manufacturing firm.

Notice that the Human Resources Department and the Administration and Accounting Department provide services to each other. When this situation occurs, the two service departments exhibit reciprocal services .

Exhibit 16–2 provides some of the details for our illustration of service department cost allocation. Panel A shows the proportion of each service department’s output that is consumed by each of the departments using its services. Panel B shows the alloca-tion bases, which are used to determine the proportions shown in panel A. Further explanation of the information in Exhibit 16–2 follows.

“Support, or service, depart-

ment costs are becoming a

greater and greater percent-

age of our cost structure.”

(16a)

Chrysler

*The arrows in the organization chart depict the provision of service by the three service departments. For example, the Human Resources

Department serves the patient Records Department, but not vice versa.

Servicedepartments Patient

RecordsDepartment

HumanResourcesDepartment

Administrationand Accounting

Department

Direct-patient-caredepartments

OrthopaedicsDepartment

Internal MedicineDepartment

Exhibit 16–1 Organization Chart for

Riverside Clinic *

RIVERSIDE

CLINIC

A. Percentage of Service Output Consumed by Using Departments

Provider of Service

User of Service <Insert hiL26924_ta1701.eps>

Patient

Records

Human

Resources

Administration

and Accounting

Patient Records ................................... — 5% —

Service departments Human Resources ................................ — — 5%

Administration and Accounting .............. — 20% —

Direct-patient-care

departments

Orthopaedics ....................................... 30% 25% 35%

Internal Medicine ................................. 70% 50% 60%

{

B. Allocation Bases

Service Department Allocation Base

Patient Records ........................................................................................................................ Annual patient load

Human Resources ..................................................................................................................... Number of employees

Administration and Accounting ................................................................................................... Size of department

(measured in square

metres of space)

C. Service Department Costs

Service Department

Variable

Cost

Fixed

Cost

Total Cost to

Be Allocated

Patient Records ............................................................................... $24,000 $ 76,000 $100,000

Human Resources ............................................................................ 15,000 45,000 60,000

Administration and Accounting .......................................................... 47,500 142,500 190,000

Total ................................................................................................ $86,500 $263,500 $350,000

Exhibit 16–2 Provision of Services by

Service Departments in

20×1: Riverside Clinic

RIVERSIDE

CLINIC

{



Patient Records The service output of the Patient Records Department is consumed only by the Orthopaedics and Internal Medicine Departments. Annual patient load is the allocation base used to determine that 30 percent of the Patient Records Department’s services were consumed by Orthopaedics and 70 percent by Internal Medicine.

Human Resources The Human Resources Department serves each of the clinic’s other departments, including the other two service departments and the two direct-patient-care departments. The allocation base used to determine the proportions of the Human Resources Department’s output consumed by the four using departments is the number of employees in the using departments. For example, 5 percent of the clinic’s employees (excluding those in the Human Resources Department) work in the Patient Records Department.

Administration and Accounting This service department provides services only to the Human Resources Department, the Orthopaedics Department, and the Internal Medi-cine Department. A variety of services are provided, such as computer support, pa-tient billing, and general administration. Since greater amounts of these services are provided to the larger departments, departmental size is the allocation base used to determine the proportion of service output consumed by each department. Since the space devoted to each department is a convenient measure of departmental size, square metres is the measure used in Exhibit 16–2. For example, 5 percent of the clinic’s space (excluding that occupied by Administration and Accounting and Patient Records) is devoted to the Human Resources Department.

Panel C of Exhibit 16–2 shows the total budgeted cost of each service department that is to be allocated among the using departments.

There are two widely used methods of service department cost allocation, the direct method and the step-down method. These methods are discussed and illus-trated next, using the data for Riverside Clinic.

Direct Method

Under the direct method , each service department’s costs are allocated among only the direct-patient-care departments that consume part of the service department’s output. This method ignores the fact that some service departments provide services to other service departments. Thus, even though Riverside Clinic’s Human Resources Department provides services to two other service departments, none of its costs are allocated to those departments. Exhibit 16–3 presents Riverside Clinic’s service department cost allocations under the direct method.

Notice that the proportion of each service department’s costs to be allocated to each direct-patient-care department is determined by the relative proportion of the

Direct-Patient-Care Departments Using Services

Orthopaedics Internal Medicine

Provider of Service Cost to Be Allocated Proportion Amount Proportion Amount

Patient Records . .......................... $100,000 3/10 $ 30,000 7/10 $ 70,000

Human Resources ........................ 60,000 25/75 20,000 50/75 40,000

Administration and Accounting ...... 190,000 35/95 70,000 60/95 120,000

Total ............................................ $350,000 $120,000 $230,000

Grant total 5 $350,000

Exhibit 16–3 Direct Method of Service

Department Cost Allocation:

Riverside Clinic

RIVERSIDE

CLINIC

⎫⎪⎪⎪⎪⎪⎪⎪⎬⎪⎪⎪⎪⎪⎪⎪⎭



service department’s output consumed by each direct-patient-care department. For example, a glance at Exhibit 16–2 shows that the Human Resources Department pro-vides 25 percent of its services to Orthopaedics and 50 percent to Internal Medicine. Summing these two percentages yields 75 percent. Thus, 25/75 is the fraction of the Human Resources Department’s cost allocated to Orthopaedics and 50/75 is the frac-tion allocated to Internal Medicine.

Step-Down Method

As stated above, the direct method ignores the provision of services by one service department to another service department. This shortcoming is overcome partially by the step-down method of service department cost allocation. Under this method, the managerial accountant first chooses a sequence in which to allocate the service de-partments’ costs. A common way to select the first service department in the sequence is to choose the one that serves the largest number of other service departments. The service departments are ordered in this manner, with the last service department be-ing the one that serves the smallest number of other service departments. 1 Then the managerial accountant allocates each service department’s costs among the direct-patient-care departments and all of the other service departments that follow it in the sequence. Note that the ultimate cost allocations assigned to the direct-patient-care departments will differ depending on the sequence chosen.

The step-down method is best explained by way of an illustration. Riverside Clinic’s Human Resources Department serves two other service departments: Patient Records, and Administration and Accounting. The Administration and Accounting Department serves only one other service department: Human Resources. Finally, the Patient Records Department serves no other service departments. Thus, Riverside Clinic’s service department sequence is as follows:

(1)Human

Resources

(2)Administration

and Accounting

(3)Patient

Records

In accordance with this sequence, each service department’s costs are allocated to the other departments as follows:

Cost Allocated from This Service Department To These Departments

Human Resources ............................................................................................................ Administration and Accounting

Patient Records

Orthopaedics

Internal Medicine

Administration and Accounting .......................................................................................... Orthopaedics

Internal Medicine

Patient Records ............................................................................................................... Orthopaedics

Internal Medicine

Notice that even though Administration and Accounting serves Human Resources, there is no cost allocation in that direction. This results from the placement of Human Resources before Administration and Accounting in the allocation sequence. More-over, no costs are allocated from Patient Records to either of the other service depart-ments, because Patient Records does not serve those departments.

Exhibit 16–4 presents the results of applying the step-down method at Riverside Clinic. First, the Human Resources Department’s $60,000 in cost is allocated among the four departments using its services. Second, the cost of the Administration and

“Allocating service depart-

ment costs to the academic

units serves a variety of

purposes. For one thing, it

makes the [academic] units

aware that their activities

result in those costs being

incurred behind the

scenes.” (16b)

Cornell University



Accounting Department is allocated. The total cost to be allocated is the department’s original $190,000 plus the $12,000 allocated from the Human Resources Department. The new total of $202,000 is allocated to the Orthopaedics and Internal Medicine Departments according to the relative proportions in which these two departments use the services of the Administration and Accounting Department. Finally, the Patient Records Department’s cost is allocated.

Reciprocal-Services Method

The direct method and the step-down method both ignore the fact that the Administra-tion and Accounting Department serves the Human Resources Department. Neither of these methods allocates any of the costs incurred in Administration and Accounting back to Human Resources.

Review the relationships between the service departments depicted in Exhibit 16–1. Notice that the Administration and Accounting Department and the Human Resources Department serve each other . This mutual provision of service is called reciprocal service . A more accurate method of service department cost allocation, called the reciprocal-services method , fully accounts for the mutual provision of services. The relationships between Riverside Clinic’s three service departments are portrayed in the following diagram.


Allocate service department

costs using the reciprocal-

services method.

Patient Records(Department R)

Human Resources(Department H)

Administration and Accounting(Department A)

The first step in the technique is to specify a set of equations that express the re-lationships between the departments. The following equations, which express these relationships for Riverside Clinic, are based on the data in Exhibit 16–2:

R H� �100 000 05, . (1)H A� �60 000 05, . (2)A .20H� �190 000, (3)

where R denotes the total cost of the Patient Records Department

H denotes the total cost of the Human Resources Department

A denotes the total cost of the Administration and Accounting Department

RIVERSIDE

CLINIC

Exhibit 16–4 Step-Down Method of Service

Department Cost Allocation:

Riverside Clinic

RIVERSIDE

CLINIC

Service Department Direct-Patient-Care Department

Human

Resources

Administration

and Accounting Patient Records Orthopaedics

Internal

Medicine

Costs prior to allocation ................................. $60,000 $190,000 $100,000

Allocation of Human Resources

Department costs ....................................... $60,000 12,000 (20/100)† 3,000 (5/100) $ 15,000 (25/100) $ 30,000 (50/100)

Allocation of Administration and

Accounting Department costs ................................................... $202,000 74,421* (35/95) 127,579* (60/95)

Allocation of Patient Records

Department costs .......................................................................................................... $103,000 30,900 (30/100) 72,100 (70/100)

Total cost allocated to

each department ............................................................................................................................................. $120,321 $229,679

Total cost allocated

to direct-patient-care departments ...................................................................................................................................... $350,000

*Rounded.

†Fractions in parentheses are relative proportions of service department’s output consumed by departments to which costs are allocated.



Equation (1) says that the total cost of operating the Patient Records Depart-ment ( R ) is $100,000 plus 5 percent of the total cost of operating the Human Resources Department ( H ). The $100,000 comes from Exhibit 16–2 (panel C) and is the total cost traceable to the Patient Records Department. We add to this amount 5 percent of the total cost of operating the Human Resources Department. Why? Because Exhibit 16–2 (panel A) tells us that the Patient Records Department used 5 percent of the Human Resources Department’s services. Similar explanations underlie equations (2) and (3).

The second step in the reciprocal-services method is to solve the simultaneous equations. 2 Let’s begin by substituting the expression for A from equation (3) into equation (2), and solving for H as follows:

H H� � �

� �

60 000 05 190 000 20

60 000 9 500 01

, . ( , . )

, , . HH

H

H

. ,

, ( )

99 69 500

70 202

�

� rounded

�

Then we substitute the value for H we just obtained into equation (3), and solve for A as follows:

A H� �

� �

�

190 000 20

190 000 20 70 202

204 04

, .

, (. )( , )

, 00 rounded( )

Now we can solve for R by substituting the value for H into equation (1) as follows:

R H� �

� �

�

100 000 05

100 000 05 70 202

103 51

, .

, (. )( , )

, 00 rounded( )

Thus, we have determined that H = 70,202, A = 204,040, and R = 103,510. Their sums add up to more than $350,000 because of cross-allocations.

The final step in the reciprocal-services method is to allocate the total cost of operating each service department ( R , H , and A ) to the various departments that use its services. For example, we will allocate the total cost of operating the Human Resources Department ( H ) among all four of Riverside Clinic’s other departments, because they all use services from Human Resources. This allocation is made in proportion to the use of Human Resources’ services by the other departments, as given in Exhibit 16–2 (panel A).

The allocations are shown in Exhibit 16–5. Focus on the second row of numbers, which refers to the Human Resources Department. The $70,202 shown in parentheses in the Human Resources column is that department’s total cost, as computed using the simultaneous equations. This $70,202 total cost is allocated as follows:

• 20 percent (or $14,040) to Administration and Accounting, because that de-partment uses 20 percent of the Human Resources Department’s services

• 5 percent (or $3,510) to Patient Records, because that department uses 5 percent of the Human Resources Department’s services

• 25 percent (or $17,551) to Orthopaedics, because that department uses 25 percent of the Human Resources Department’s services

• 50 percent (or $35,101) to Internal Medicine, because that department uses 50 percent of the Human Resources Department’s services.

A similar explanation underlies the Administration and Accounting row and the Pa-tient Records row in Exhibit 16–5.



The total costs allocated to Riverside Clinic’s two direct-patient-care departments are as follows: $120,018 to Orthopaedics and $229,982 to Internal Medicine. Notice that these two amounts add up to $350,000, which is the total of the original traceable costs for the three service departments. Thus, all service department costs have been fully allocated.

The reciprocal-services method is more accurate than the direct and step-down methods, because it fully accounts for reciprocal services. To make the reciprocal-services method even more accurate, it can be combined with the dual-allocation ap-proach, discussed below.

Fixed versus Variable Costs

In our allocation of Riverside Clinic’s service department costs, we did not distin-guish between fixed and variable costs. Under some circumstances, this simple ap-proach can result in an unfair cost allocation among the using departments. To illustrate, we will use the data about Riverside Clinic’s fixed and variable costs given in panel C of Exhibit 16–2. Consider the cost data for the Patient Records Depart-ment, which serves only the Orthopaedics and Internal Medicine departments. Under the direct method of service department cost allocation, the Patient Records Depart-ment’s costs were allocated as follows:

Patient Records Orthopaedics

Cost Allocation for 20x1: Direct Method

($100,000)(3/10) = $30,000

Internal Medicine

($100,000)(7/10) = $70,000

Variable cost

Fixed cost

Total cost

$ 24,000

76,000

$100,000

. . . . . . . . . . . .

. . . . . . . . . . . .

. . . . . . . . . . . ..

..

The allocation base used in this cost allocation is the annual patient load in the Orthopaedics and Internal Medicine departments. Let’s assume the following patient loads in 20x1, the year for which the cost allocation has been done.


Human

Resources

Administration

and Accounting

Patient

Records Orthopaedics

Internal

Medicine

Traceable costs ................................... $60,000 $190,000 $100,000


Department costs ........................... (70,202) 14,040*(.20) 3,510*(.05) $ 17,551*(.25) $ 35,101 (.50)


Accounting Department costs .......... 10,202 (.05)† (204,040) –0– (0) 71,414 (.35) 122,424 (.60)


Department costs ........................... –0– (0) –0– (0) (103,510) 31,053 (.30) 72,457 (.70)

Total cost allocated to each

direct-patient-care department ......................................................................................................................... $120,018 $229,982

Total costs allocated ....................................................................................................................................................................... $350,000

*Rounded.

†Percentages in parentheses are relative proportions of a service department’s output consumed by departments to which costs are allocated (from Exhibit 16–2, panel A).

Exhibit 16–5 Reciprocal-Services Method

of Service Department Cost

Allocation: Riverside Clinic

RIVERSIDE

CLINIC



Department Patient Load Proportion of Total

Orthopaedics ..................................................... 30,000 .......................................... (30,000/100,000) 5 3/10

Internal Medicine ............................................... 70,000 .......................................... (70,000/100,000) 5 7/10

Total .................................................................. 100,000

Now suppose the projections for 20x2 are as follows:

Department Projected Patient Load Projected Proportion of Total

Orthopaedics ..................................................... 30,000 .......................................... (30,000/80,000) 5 3/8

Internal Medicine ............................................... 50,000 .......................................... (50,000/80,000) 5 5/8

Total .................................................................. 80,000

Department Budgeted Variable Cost Budgeted Fixed Cost Budgeted Total Cost

Patient Records ................... $19,200 .................................... $76,000 .................................... $95,200

The projections for 20x2 include a stable patient load in the Orthopaedics Department but a decline in the patient load of the Internal Medicine Department. Since the projected total patient load is lower for 20x2, the projected variable cost in the Patient Records Department is lower also.

What will be the effect of these changes on the 20x2 allocation of the Patient Records Department’s costs? Using the direct method, we obtain the following allocation:

Patient Records Orthopaedics

Cost Allocation for 20x2: Direct Method

($95,200)(3/8) = $35,700

Internal Medicine

($95,200)(5/8) = $59,500

Variable cost

Fixed cost

Total cost

$ 19,200

76,000

$ 95,200

. . . . . . . . . . . .

. . . . . . . . . . . .

. . . . . . . . . . . ..

..

Compare the costs allocated to the two direct-patient-care departments in 20x1 and 20x2. Notice that the cost allocated to the Orthopaedics Department increased by $5,700 (from $30,000 to $35,700), even though Orthopaedics’ pa-tient load is projected to remain constant. What has happened here? The projected decline in the Internal Medicine Department’s volume resulted in lower budgeted variable costs for the Patient Records Department, but the budgeted fixed costs did not change. At the same time, the lower projected patient load in Internal Medicine resulted in a higher proportion of the total projected patient load for Orthopaedics (from 3/10 in 20x1 up to 3/8 in 20x2). As the following analysis shows, this results in an increased allocation of fixed costs to the Orthopaedics Department in 20x2.

20x1 20x2

Fixed cost in Patient Records Department ..................................................................... $76,000 $76,000

Orthopaedics Department’s proportion of total patient load ............................................ 33/10 33/8

Orthopaedics Department’s allocation of fixed cost ........................................................ $22,800 $28,500

Difference 5 $5,700



This difference of $5,700 is equal to the increase in the Orthopaedics Department’s total cost allocation from the Patient Records Department in 20x2.

To summarize, the projected decline in Internal Medicine’s 20x2 patient load will result in an increased cost allocation from the Patient Records Department to the Orthopaedics Department in 20x2. The cause of this increased allocation is our failure to distinguish between fixed and variable costs in the allocation process.

Dual Cost Allocation

The problem illustrated in the preceding section can be resolved by allocating fixed and variable costs separately. This approach is called dual cost allocation . Under dual cost allocation, variable costs are allocated on the basis of short-run usage of the service department’s output; fixed costs are allocated on the basis of long-run average usage of the service department’s output. The rationale for this approach is that fixed costs are capacity-producing costs. When service departments are estab-lished, their size and scale usually are determined by the projected long-run needs of the using departments.

To illustrate dual cost allocation for Riverside Clinic, we need estimates of the long-run average usage of each service department’s output by each using depart-ment. These estimates are given in Exhibit 16–6.

To combine the dual-allocation approach with either the direct method or the step-down method, we simply apply the allocation method twice, as follows:

Costs to Be Allocated Basis for Allocation Allocation Method

Variable costs in 20x1

(Exhibit 16–2, panel C)

Short-run usage in 20x1

(Exhibit 16–2, panel A)

Direct

method

Step-down

method

or

Fixed costs in 20x1

(Exhibit 16–2, panel C)

Long-run average usage

(Exhibit 16–6)

Direct

method

Step-down

method

After both of these allocation procedures have been completed, the resulting variable and fixed-cost allocations for each direct-patient-care department are summed. Exhibit 16–7 presents the allocation computations when the dual approach is combined with the direct method. Compare the final direct allocations with those in Exhibit 16–3, where the dual approach was not used. Notice that the final alloca-tions are different. Exhibit 16–8 presents the computations for the step-down method. Compare the final step-down allocations with those in Exhibit 16–4, where the dual approach was not used. Again, the final allocations are different.

A Behavioural Problem Dual cost allocation prevents a change in the short-run activity of one using department from affecting the cost allocated to another using department. However, the approach sometimes presents a problem of its own. In order to implement


Use the dual approach to

service department cost

allocation.

Exhibit 16–6 Provision of Services by

Service Departments:

Long-Run Average Usage,

Riverside Clinic

Provider of Service

User of Service

Patient

Records

Human

Resources

Administration

and Accounting

Patient Records ..................................... — 10% —

Service departments Human Resources .................................. — — 10%

Administration and Accounting ................ — 10% —

Direct-patient-care

departments

Orthopaedics ......................................... 40% 20% 45%

Internal Medicine ................................... 60% 60% 45%

{{

RIVERSIDE

CLINIC



Exhibit 16–7 Dual Allocation Combined

with Direct Method:

Riverside Clinic

Direct-Patient-Care Department Using Services

Orthopaedics Internal Medicine

Provider of Service Cost to Be Allocated Proportion Amount Proportion Amount

I. Variable Costs

Patient Records ................................ $ 24,000 3/10 $ 7,200 7/10 $ 16,800

Human Resources ............................. 15,000 25/75 5,000 50/75 10,000

Administration and Accounting ........... 47,500 35/95 17,500 60/95 30,000

Total variable cost ............................. $ 86,500 $ 29,700 $ 56,800

II. Fixed Costs

Patient Records ................................ $ 76,000 4/10 $ 30,400 6/10 $ 45,600

Human Resources ............................. 45,000 20/80 11,250 60/80 33,750

Administration and Accounting ........... 142,500 45/90 71,250 45/90 71,250

Total fixed cost .................................. $263,500 $112,900 $150,600

Total cost (variable 1 fixed) ............... $350,000 $142,600 $207,400

Grand total 5 $350,000


Human

Resources

Administration

and Accounting

Patient

Records Orthopaedics

Internal

Medicine

I. Variable Costs

Variable cost prior to allocation ............... $15,000 $ 47,500 $24,000


Department costs .............................. $15,000 3,000 (20/100)† 750 (5/100) $ 3,750 (25/100) $ 7,500 (50/100)

Allocation of Administration

and Accounting Department costs ...... $ 50,500 18,605* (35/95) 31,895* (60/95)


Department costs .............................. $24,750 7,425 (30/100) 17,325 (70/100)

Total variable cost allocated

to each department ........................... $ 29,780 $ 56,720

II. Fixed Costs

Fixed cost prior to allocation ................... $45,000 $142,500 $76,000


Department costs .............................. $45,000 4,500 (10/100) 4,500 (10/100) $ 9,000 (20/100) $ 27,000 (60/100)


Accounting Department costs ............. $147,000 73,500 (45/90) 73,500 (45/90)


Department costs .............................. $ 80,500 32,200 (40/100) 48,300 (60/100)

Total fixed cost allocated

to each department ........................... $ 114,700 $ 148,800

Total cost allocated to each

department (variable 1 fixed) ............. $ 144,480 $ 205,520

Grand total 5 $350,000

*Rounded.

†Fractions in parentheses are relative proportions of service department’s output consumed by departments to which costs are allocated. Variable costs allocated on basis of short-run

proportions. Fixed costs allocated on basis of long-run average proportions.

Exhibit 16–8Dual Allocation Combined

with Step-Down Method:

Riverside Clinic

RIVERSIDE

CLINIC

RIVERSIDE

CLINIC

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the technique, we need accurate projections of the long-run average usage of each ser-vice department’s output by each using department. This is the information in Exhibit 16–6. Typically, these estimates come from the managers of the departments that con-sume the services. The problem is that the higher a manager’s estimate of the depart-ment’s long-run average usage is, the greater the department’s allocation of fixed service department costs will be. This creates an incentive for using- department man-agers to understate their expected long-run service needs. Ultimately, such understate-ments can result in building service facilities that are too small.

How can we prevent this behavioural problem? First, we can rely on the profes-sionalism and integrity of the managers who provide the estimates. Second, we can reward managers through promotions and pay raises for making accurate estimates of their departments’ service needs.

Allocate Budgeted Costs

When service department costs are allocated to production departments, such as the direct-patient-care departments of Riverside Clinic, budgeted service department costs should be used. If actual costs are allocated instead, any operating inefficiencies in the service departments are passed along to the using departments. This reduces the incentive for service department managers to control the costs in their depart-ments. The proper approach is as follows:

1. Compare budgeted and actual service department costs and compute any variances.

2. Use these variances to help control costs in the service departments. 3. Close out the service department cost variances against the period’s income. 4. Allocate the service departments’ budgeted costs to the departments that

directly produce goods or services.

Today’s Advanced Manufacturing Environment

In traditional manufacturing environments, service department costs are allocated to production departments to ensure that all manufacturing costs are assigned to products. For example, the costs incurred in a machine-maintenance department typically are al-located to the other service departments and the production departments that use main-tenance services. Service department cost allocation continues to be used in the new manufacturing environment, characterized by the JIT philosophy and CIM systems. However, the extent of such allocations is diminished in advanced manufacturing sys-tems, because more costs are directly traceable to product lines. In a flexible manufac-turing system (FMS), almost all operations are performed in the FMS cell. Even machine maintenance is done largely by the FMS cell operators rather than a separate mainte-nance department. Inspection is often performed by FMS cell operators, eliminating the need for a separate inspection department. In short, as more and more costs become di-rectly traceable to products, the need for allocation of indirect costs declines.

The Rise of Activity-Based Costing

Service department cost allocation is one type of allocation procedure used in two stage allocation with departmental overhead rates. Under this approach, costs first are distrib-uted to departments ; then they are allocated from service departments to production departments . Finally, they are assigned from production departments to products or services. Departments play a key role as intermediate cost objects under this approach.

In an activity-based costing (ABC) system, on the other hand, the key role is played by activities , not departments. First, the costs of various activities are assigned to activity cost pools; then these costs are assigned to products or services.

Explain the difference between

two-stage cost allocation with

departmental overhead rates

and activity-based costing

(ABC).




The breakdown of costs by activity in an ABC system is much finer than a breakdown by departments. For example, under the service department cost allo-cation approach, the Purchasing Department might be one of the service depart-ments identified. However, under ABC, the various activities engaged in by purchasing personnel would be separately identified. Activities such as part speci-fication, vendor identification, vendor selection, price negotiation, ordering, expe-diting, receiving, inspection, and invoice paying might be identified separately under ABC. Then the costs of each of these activities would be assigned to prod-ucts or services on the basis of the appropriate cost drivers. The ABC approach generally will provide a much more accurate cost for each of the organization’s products or services.

Joint Product Cost Allocation

A joint production process results in two or more products, which are termed joint products . The cost of the input and the joint production process is called a joint prod-uct cost . The point in the production process where the individual products become separately identifiable is called the split-off point .


Allocate joint costs among joint

products using each of the

following techniques:

physical-units method,

relative-sales-value method, and

net-realizable-value method.

To illustrate, International Chocolate Company produces cocoa powder and cocoa butter by processing cocoa beans in the joint production process depicted in Exhibit 16–9.

Milk processing provides an example of joint product cost allocation in the agriculture industry. The cost of producing raw milk must be allocated among such joint prod-ucts as heavy cream, light cream, whole milk, 2 percent milk, and skim milk.

Cocoa beanscosting $500per 1-tonne batch

Total joint cost:$1,100 per 1-tonne batch

Split-off point

Joint productionprocess costing$600 per tonne

Cocoa buttersales value:$750 for1,500 kilograms

Cocoa powdersales value:$500 for500 kilograms

Separableprocesscosting$800

Instant cocoa mixsales value:$2,000 for500 kilograms

CocoaBeans

Separableprocesscosting$1,560

Sun screensales value:$3,000 for1,500 kilograms

Exhibit 16–9 Joint Processing of Cocoa Beans: International Chocolate Company



As the diagram shows, cocoa beans are processed in 1-ton batches. The beans cost $500 and the joint process costs $600, for a total joint cost of $1,100. The process results in 1,500 kilograms of cocoa butter and 500 kilograms of cocoa powder. Each of these two joint products can be sold at the split-off point or processed further. Co-coa butter can be separately processed into a sun screen, and cocoa powder can be separately processed into instant cocoa mix.

Allocating Joint Costs

For product-costing purposes, a joint product cost usually is allocated to the joint products that result from the joint production process. Such allocation is necessary for inventory valuation and income determination, among other reasons. As we discussed in Chapter 13, however, joint cost allocation is not useful for making substantive eco-nomic decisions about the joint process or the joint products. For example, Chapter 13 shows that joint cost allocation is not useful in deciding whether to process a joint product further. (See pages 536–537.) There are three commonly used methods for allocating joint product costs. Each of these is explained next.

Physical-Units Method The physical-units method allocates joint product costs on the basis of some physical characteristic of the joint products at the split-off point. Panel A of Exhibit 16–10 illustrates this allocation method for International Choco-late Company using the weight of the joint products as the allocation basis.

Relative-Sales-Value Method The relative-sales-value method is based on the relative sales value of each joint product at the split-off point . In the International Chocolate


Describe the purposes for

which joint cost allocation is

useful and those for which

it is not.

Exhibit 16–10 Methods for Allocating Joint

Product Costs

*Sales value of

final product2

Incremental cost

of processing5

Net realizable

value †Calculation of relative proportions:

$3,000 2 $1,560 5 $1,440 $1,440 1 $1,200 5 $2,640

2,000 2 800 5 1,200 1,440 4 2,640 5 6/11

1,200 4 2,640 5 5/11

A. Physical-Units Method

Joint Cost Joint Products Weight at Split-off Point

Relative

Proportion

Allocation of

Joint Cost

$1,100

Cocoa butter .............................................. 1,500 kilograms ................. 3/4 ........... $ 825

Cocoa powder ........................................... 500 kilograms ................. 1/4 ........... 275

Total joint cost allocated ........................................................................................................ $1,100

B. Relative-Sales-Value Method

Joint Cost Joint Products

Sales Value at

Split-off Point

Relative

Proportion

Allocation of

Joint Cost

$1,100

Cocoa butter ................................................. $750 ......................... 3/5 ................ $ 660

Cocoa powder .............................................. 500 ......................... 2/5 ................ 440

Total joint cost allocated ....................................................................................................... $1,100

C. Net-Realizable-Value Method

Joint

Cost Joint Products

Sales Value

of Final

Product

Separable

Cost of

Processing

Net

Realizable

Value

Relative

Proportion

Allocation

of Joint

Cost

Sun screen ................. $3,000 .......... $1,560 .......... $1,440* .......... 6/11† . ...... $ 600

$1,100 Instant cocoa mix ....... 2,000 .......... 800 .......... 1,200* .......... 5/11† ....... 500

Total joint cost allocated ....................................................................................................... $1,100

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Company illustration, these joint products are cocoa butter and cocoa powder. This method is illustrated in Exhibit 16–10 (panel B).

Net-Realizable-Value Method Under the net-realizable-value method , the relative value of the final products is used to allocate the joint cost. International Chocolate Company’s final products are sun screen and instant cocoa mix. The net realizable value of each final product is its sales value less any separable costs incurred after the split-off point. The joint cost is allocated according to the relative magnitudes of the final products’ net realizable values. Panel C of Exhibit 16–10 illustrates this al-location method.

Notice how different the cost allocations are under the three methods, particu-larly the physical-units method. Since the physical-units approach is not based on the economic characteristics of the joint products, it is the least preferred of the three methods.

By-Products A joint product with very little value relative to the other joint products is termed a by-product . For example, whey is a by-product in the production of cheese. A common practice in accounting is to subtract a by-product’s net realizable value from the cost of the joint process. Then the remaining joint cost is allocated among the major joint products.

An alternative procedure is to inventory the by-product at its sales value at split off. Then the by-product’s sales value is deducted from the production cost of the main products.

“Joint costing problems

crop up more often than you

might think. They’re among

the thornier [cost manage-

ment] issues our clients

have to deal with.” (16c)

A. T. Kearney

JOINT COST ALLOCATION IN THE PETROLEUM INDUSTRY

One of the most complicated problems in joint cost allocation routinely occurs in the petroleum industry. When an oil company, such as Petro-Canada , drills a successful oil well, the well almost always produces natural gas in addition to crude oil. Moreover, the crude oil produced by a typical oil well is of various grades. Lighter crude oils suitable for production of such products as gasoline are generally near the top of an oil reservoir, while the heavier crudes are near the bottom. The heavier crude oils are used to make such products as fuel oil for heating homes and businesses and for the generation of electricity.

All of these products obtained from a successful oil well are joint products: the vari-ous grades of crude oil and the natural gas. Most of these products will require further processing before they will be saleable products such as gasoline, diesel fuel, or home heating oil. Thus, substantial separable costs will be incurred in processing the joint prod-ucts in addition to the joint costs incurred in the oil field operations. Millions of dollars of joint costs are incurred in the development of an offshore oil field. The costs of locating the oil field, building the drilling platforms, and the drilling itself are all joint costs. Then there are the costs of crewing the oil rigs and the ongoing costs of bringing oil and natural gas to the surface.

Oil companies such as Petro-Canada typically use the net realizable value of the products manufactured as the basis for allocating the joint production costs. The full costs of the company’s various products then become the basis for pricing and product-mix decisions.

The next time you pump gas for your automobile, think about the salaries of the helicopter pilots who bring food and other supplies to the many offshore oil platforms. Those costs make up part of the joint cost allocated to the gasoline you obtain from the pump.

Petro-Canada

M

A

P

anagement

ccounting

ractice



Chapter Summary

Service departments are not involved directly in producing an organization’s final output of goods or services, but they do provide essential services in an organization. Thus, in order to determine the full cost of the organization’s final services or goods, service department costs are allocated to the depart-ments directly involved in producing the organization’s final output. Three methods are used commonly in practice: the direct method, the step-down method, and the reciprocal method. Any one of these meth-ods may be combined with the dual-allocation approach, in which variable and fixed costs are allocated separately.

A joint production process results in two or more joint products, which become separately identifi-able at the splitoff point. The joint costs of production are allocated in order to determine the complete cost of manufacturing the joint products. Three methods are used for this purpose: the physical-units method, the relative-sales-value method, and the net-realizable-value method. Joint cost allocation is useful for product-costing purposes, but the allocated costs should not affect substantive economic decisions.

Review Problem on Service Departmental Cost Allocation

Renaissance School of Music and Art provides classes for school-age children. The students are enrolled in two departments: Music Education and Art Education. The school also has two service departments: Administration and Human Resources (A & HR) and Maintenance (M). The budgeted costs in the two service departments are as follows:

Administration and Human Resources ............................................................................................................ $342,000

Maintenance ................................................................................................................................................ 171,000

The usage of the service department’s output for the year is as follows:

Provider of Service

User of Service

Administration &

Human Resources Maintenance

Administration & Human Resources ................................................................... — 5%

Maintenance .................................................................................................... 10% —

Music Education ............................................................................................... 40% 40%

Art Education .................................................................................................... 50% 55%

Required: Allocate the two services departments’ costs to the Music Education and Art Education departments using each of the following allocation methods.

1. Direct method

2. Step-down method (Since each service department serves one other service department, allocate the cost of A & HR first.)

Solution to Review Problem

1. Cost allocation using direct method:

Departments Using Services

Music Education Art Education

Provider of Service

Cost to Be

Allocated Proportion Amount Proportion Amount

A & HR .............................. $342,000 (4/9) $152,000 (5/9) $190,000

M* .................................... 171,000 (8/19) 72,000 (11/19) 99,000

Total .................................. $513,000 $224,000 $289,000

* (8/19) 5 [40/(40 1 55)]; (11/19) 5 [55/(40 1 55)].



2. Cost allocation using step-down method:

Service Departments Departments Using Services

A&HR M Music Education Art Education

Costs prior to allocation .............................. $342,000 $171,000

Allocation of A & HR

costs ....................................................... $342,000 34,200 (10%) $136,800 (40%) $171,000 (50%)

Allocation of M

costs* ..................................................... $205,200 86,400 (8/19) 118,800 (11/19)

Total costs allocated to

each department ..................................... $223,200 $289,800

Total cost allocated to

academic departments ............................. $513,000

* (8/19) 5 [40/(40 1 55)]; (11/19) 5 [55/(40 1 55)].

Key Terms

For each term’s definition, refer to the indicated page or turn to the glossary at the end of the text.

by-product, 15

direct method, 4

dual cost allocation, 10

joint production process, 13

joint products, 13

net realizable value, 15

net-realizable-value method, 15

physical-units method, 14

reciprocal service, 6

reciprocal-services method, 6

relative-sales-value method, 14

service department, 2

split-off point, 13

step-down method, 5

Review Questions

16–1. Distinguish between a service department and a pro-duction department. Give an example of the counter-part of a manufacturer’s “production” department in a bank.

16–2. Define the term reciprocal services .

16–3. Explain briefly the main differences between the direct, step-down, and reciprocal-services methods of service department cost allocation.

16–4. How does the managerial accountant determine the de-partment sequence in the step-down method? How are ties handled?

16–5. Why does the dual-allocation approach improve the re-sulting cost allocation?

16–6. What potential behavioural problem can result when the dual approach is used?

16–7. Should actual or budgeted service department costs be allocated? Why?

16–8. Explain the difference between two-stage allocation with departmental overhead rates and activity-based costing. Which approach generally results in more ac-curate product costs?

16–9. Define the following terms: joint production process , joint costs , joint products , split-off point , incremental costs , and by-product .

16–10. Briefly explain how to use the physical-units method of joint cost allocation.

16–11. Describe the relative-sales-value method of joint cost allocation.

16–12. Define the term net realizable value , and explain how this concept can be used to allocate joint costs.

16–13. Are joint cost allocations useful? If they are, for what purpose?

16–14. For what purpose should the managerial accountant be careful not to use joint cost allocations?

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Victoria Community College enrols students in two departments, Liberal Arts and Sciences. The college also has two service departments, the Library and the Computing Services Department. The usage of these two service departments’ output for the year is as follows:

Provider of Service

User of Service Library Computing Services

Library ..................................................................................................... — 20%

Computing Services .................................................................................. — —

Liberal Arts ............................................................................................... 60% 30%

Sciences .................................................................................................. 40% 50%

The budgeted costs in the two service departments for the year are as follows:

Library ................................................................................................................................................. $900,000

Computing Services .............................................................................................................................. 360,000

Required:

1. Use the direct method to allocate the budgeted costs of the Library and Computing Services Department to the college’s Liberal Arts and Sciences departments.

2. Build a spreadsheet: Construct an Excel spreadsheet to solve the preceding requirement. Show how the solution will change if the following information changes: the budgeted costs of the Library and Computing Services are $890,000 and $340,000, respectively.

Refer to the data given in the preceding exercise.

Required:

1. Use the step-down method to allocate Victoria Community College’s service department costs to the Liberal Arts and Sciences departments.

2. Build a spreadsheet: Construct an Excel spreadsheet to solve the preceding requirement. Show how the solution will change if the following information changes: the budgeted costs of the Library and Computing Services are $890,000 and $340,000, respectively.

Fraser Bank has two service departments, the Human Resources (HR) Department and the Computing Department. The bank has two other departments that directly service customers, the Deposit Depart-ment and the Loan Department. The usage of the two service departments’ output for the year is as follows:

Provider of Service

User of Service HR Computing

HR ............................................................................................................................ — 15%

Computing ............................................................................................................... 10% —

Deposit .................................................................................................................... 60% 50%

Loan ........................................................................................................................ 30% 35%

The budgeted costs in the two service departments for the year are as follows:

HR ................................................................................................................................................... $459,000

Computing ....................................................................................................................................... 688,500

Required: Use the direct method to allocate the budgeted costs of the HR and Computing departments to the Deposit and Loan departments.

■ Exercise 16–16

Step-Down Method of Service

Department Cost Allocation;

College

(LO 1)


Direct Method of Service


Bank

(LO 1)

Exercises


Direct Method of Service


College

(LO 1)




Required: Use the step-down method to allocate the budgeted costs of the HR and Computing depart-ments to the Deposit and Loan departments. Fraser Bank allocates the costs of the Personnel Department first.

Refer to the data given in Exercise 16–17.

Required: Use the reciprocal-services method to allocate the budgeted costs of the HR and Comput-ing departments to the Deposit and Loan departments.

Visit the Web site of one of the following organizations, or a different organization of your choosing:

Manulife www.manulife.ca

Mission Hill Winery www.missionhillwinery.com

The Montreal General Hospital www.muhc.ca

Sheraton Hotels www.sheraton.com

Walt Disney Studios www.disney.com

Required: Read about the organization’s activities and operations. Then list three activities that you think the organization would need that would likely be established as service departments. For what purposes would it be relevant to allocate those service department costs to nonservice departments within the organization?

Breakfasttime Cereal Company manufactures two breakfast cereals in a joint process. Cost and quantity information is as follows:

Joint Cost Cereal Quantity at Split-Off Point Sales Price per Kilogram

$90,000Yummies ................................ 12,000 kilograms ................................. $6.00

Crummies ............................... 8,000 kilograms ................................. 7.50

Required: Use the physical-units method to allocate the company’s joint production cost between Yummies and Crummies.


Required: Use the relative-sales-value method to allocate Breakfasttime Cereal Company’s joint pro-duction cost between Yummies and Crummies.

Refer to the data given in Exercise 16–21. Breakfasttime Cereal Company has an opportunity to process its Crummies further into a mulch for ornamental shrubs. The additional processing operation costs $1.50 per kilogram, and the mulch will sell for $10.50 per kilogram. The quantities of mulch will be the same as that of the Yummies.

Required:

1. Should Breakfasttime’s management decide to process Crummies into the mulch? Why?

2. Suppose the company does process Crummies into the mulch. Use the net-realizable-value method to allocate the joint production cost between the mulch and the Yummies.


Step-Down Method of Service


Bank

(LO 1)


Reciprocal-Services Method;

Bank

(LO 2)


Service Department Cost

Allocation; Use of Internet

(LO 1)


Physical-Units Method; Joint

Cost Allocation

(LO 5)


Relative-Sales-Value Method;

Joint Cost Allocation

(LO 5)


Net-Realizable-Value Method;

Joint Cost Allocation

(LO 5)



Celestial Artistry Company is developing departmental overhead rates based on direct-labour hours for its two production departments, Etching and Finishing. The Etching Department employs 20 people and the Finishing Department employs 80 people. Each person in these two departments works 2,000 hours per year. The production-related overhead costs for the Etching Department are budgeted at $400,000, and the Finishing Department costs are budgeted at $640,000. Two service departments, Maintenance and Computing, directly support the two production departments. These service departments have bud-geted costs of $96,000 and $500,000, respectively. The production departments’ overhead rates cannot be determined until the service departments’ costs are allocated. The following schedule reflects the use of the Maintenance Department’s and Computing Department’s output by the various departments.

Using Department

Service Department Maintenance Computing Etching Finishing

Maintenance (maintenance hours) ................ 0 1,000 1,000 8,000

Computing (minutes) ..................................... 240,000 0 840,000 120,000

Required:

1. Calculate the overhead rates per direct-labour hour for the Etching Department and the Finishing Department. Use the direct method to allocate service department costs.

2. Calculate the overhead rates per direct-labour hour for the Etching Department and the Finishing Department. Use the step-down method to allocate service department costs. Allocate the Computing Department’s costs first.

(CMA, adapted)

Refer to the data given in the preceding problem.

Required:

1. Calculate the overhead rates per direct-labour hour for the Etching Department and the Finishing Department. Use the reciprocal-services method to allocate service department costs.

2. Which of the three methods of service department cost allocation results in the most accurate over-head rates? Why?

York Instrument Company manufactures gauges for construction machinery. The company has two pro-duction departments: Machining and Finishing. There are three service departments: Maintenance, Human Resources (HR), and Design. The budgeted costs in York Instrument Company’s service depart-ments during the year are as follows:

HR Maintenance Design

Variable .......................................................................... $ 50,000 $ 80,000 $ 50,000

Fixed .............................................................................. 200,000 150,000 300,000

Total .............................................................................. $250,000 $230,000 $350,000

The usage of these service departments’ output during the year just completed is as follows:

Provision of Service Output (in hours of service)

Provider of Service

User of Service HR Maintenance Design

HR ..................................................................................... — — —

Maintenance ...................................................................... 500 — —

Design ............................................................................... 500 500 —

Machining .......................................................................... 4,000 3,500 4,500

Finishing ............................................................................ 5,000 4,000 1,500

Total ................................................................................... 10,000 8,000 6,000

■ Problem 16–24


Allocation

(LO 1)

1. Service department costs

allocated to Etching: $448,167

2. Service department costs

allocated to Etching: $371,778

■ Problem 16–25

Reciprocal-Service Method

(LO 2)

1. “Total” cost of Computing

Department: $520,000

1. Overhead rate per hour,

Etching: $19.60

■ Problem 16–26

Direct and Step-Down

Methods of Service

Department Cost Allocation

(LO 1)

1. Total cost allocated to

Finishing: $349,056

3. Total cost allocated to

Finishing: $340,664

Problems



Required:

1. Use the direct method to allocate York Instrument Company’s service department costs to its production departments.

2. Determine the proper sequence to use in allocating the firm’s service department costs by the step-down method.

3. Use the step-down method to allocate the company’s service department costs.

4. Build a spreadsheet : Construct an Excel spreadsheet to solve requirements (1) and (3) above. Show how the solution will change if the following information changes: the budgeted variable costs in the three departments are $60,000, $70,000, and $55,000, for Human Resources, Maintenance, and Design, respectively.

Refer to the data given in the preceding problem. When York Instrument Company established its service departments, the following long-run needs were anticipated.

Long-Run Service Needs (in hours of service)

Provider of Service

User of Service HR Maintenance CAD

HR ................................................................................... — — —

Maintenance .................................................................... 500 — —

Design ............................................................................. 1,000 800 —

Machining ......................................................................... 3,500 4,800 4,800

Finishing .......................................................................... 5,000 2,400 1,200

Total ................................................................................. 10,000 8,000 6,000

Required: Use the dual approach in conjunction with each of the following methods to allocate York Instrument Company’s service department costs: (1) direct method and (2) step-down method.

Refer to the data for Riverside Clinic given in Exhibits 16–2 and 16–6.

Required: Use the reciprocal-services method in combination with the dual-allocation approach to allocate Riverside’s service department costs. Hint: You will need to apply the reciprocal-services method twice. First, allocate the three service departments’ variable costs using the short-run usage proportions in Exhibit 16–2 (panel A). Second, allocate the three service departments’ fixed costs using the long-run average usage proportions in Exhibit 16–6. Finally, add the variable costs and fixed costs allocated to each direct-patient-care department.

Travelcraft, Inc. manufactures a complete line of fibreglass suitcases and attaché cases. The firm has three manufacturing departments: Moulding, Component, and Assembly. There are also two service departments: Power and Maintenance.

The sides of the cases are manufactured in the Moulding Department. The frames, hinges, and locks are manufactured in the Component Department. The cases are completed in the Assembly Department. Varying amounts of materials, time, and effort are required for each of the cases. The Power Department and Maintenance Department provide services to the three manufacturing departments.

Travelcraft has always used a plantwide overhead rate. Direct-labour hours are used to assign over-head to products. The predetermined overhead rate is calculated by dividing the company’s total esti-mated overhead by the total estimated direct-labour hours to be worked in the three manufacturing departments.

Karen Mason, director of cost management, has recommended that Travelcraft use departmental overhead rates. The planned operating costs and expected levels of activity for the coming year have been developed by Mason and are presented by department in the following schedules. (All numbers are in thousands.)

■ Problem 16–27

Dual Allocation of Service

Department Costs

(LO 1, 3)

1. Total variable cost allocated

to Finishing: $82,945

2. Total variable cost allocated

to Finishing: $80,664

■ Problem 16–28

Reciprocal-Services Method;

Dual Allocation

(LO 2, 3)

1. “Total” variable cost of HR:

$17,551 (rounded)

2. “Total” fixed cost of HR:

$59,848 (rounded)

■ Problem 16–29


Allocation; Plantwide versus

Departmental Overhead

Rates; Cost Drivers

(LO 1, 2)

1. Total manufacturing depart-

ment overhead: $119,600

1. Total estimated overhead,

service departments:

$164,400



Manufacturing Departments

Moulding Component Assembly

Department activity measures:

Direct-labour hours .................................................................... 500 2,000 1,500

Machine hours .......................................................................... 875 125 –0–

Departmental costs:

Direct material ........................................................................... $24,800 $ 60,000 $ 2,500

Direct labour ............................................................................. 7,000 40,000 24,000

Variable overhead ...................................................................... 7,000 20,000 33,000

Fixed overhead .......................................................................... 35,000 12,400 12,200

Total departmental costs ............................................................ $73,800 $132,400 $71,700

Use of service departments:

Maintenance:

Estimated usage in labour hours

for the coming year ........................................................ 90 25 10

Power (in kilowatt-hours):

Estimated usage for the coming year ...................................... 360 320 120

Maximum allotted capacity .................................................... 500 350 150

Service Departments

Power Maintenance

Departmental activity measures:

Maximum capacity .............................................................................. 1,000 kilowatt-hours Adjustable

Estimated usage for the coming year ................................................... 800 kilowatt-hours 125 hours

Departmental costs:

Materials and supplies ........................................................................ $10,000 $3,000

Variable labour .................................................................................... 2,800 4,500

Fixed overhead ................................................................................... 24,000 500

Total service department costs ............................................................. $36,800 $8,000

Required:

1. Calculate the plantwide overhead rate for Travelcraft Company for the coming year using the same method as used in the past.

2. Karen Mason has been asked to develop departmental overhead rates for comparison with the plantwide rate. The following steps are to be followed in developing the departmental rates:

a. The Maintenance Department costs should be allocated to the three manufacturing depart-ments using the direct method.

b. The Power Department costs should be allocated to the three manufacturing departments using the dual method combined with the direct method. Fixed costs are to be allocated according to maximum allotted capacity, and variable costs are to be allocated according to planned usage for the coming year.

c. Calculate departmental overhead rates for the three manufacturing departments using a machine-hour cost driver for the Moulding Department and a direct-labour-hour cost driver for the Component and Assembly departments.

3. As Karen Mason’s assistant, draft a memo for her to send to Travelcraft’s president recommending whether the company should use a plantwide rate or departmental rates to assign overhead to products.

(CMA, adapted)



Le Monde Company is a manufacturer of chemicals for various purposes. One of the processes used by Le Monde produces HTP-3, a chemical used in hot tubs and swimming pools; PST-4, a chemical used in pes-ticides; and RJ-5, a product that is sold to fertilizer manufacturers. Le Monde uses the net-realizable-value method to allocate joint production costs. The ratio of output quantities to input quantities of direct material used in the joint process remains consistent from month to month. Le Monde Company uses FIFO (first-in, first-out) in valuing its finished-goods inventories.

Data regarding Le Monde’s operations for the month of October are as follows. During this month, Le Monde incurred joint production costs of $1,360,000 in the manufacture of HTP-3, PST-4, and RJ-5.

HTP-3 PST-4 RJ-5

Finished goods inventory in litres (October 1) ................................. 18,000 52,000 3,000

October sales in litres ................................................................... 650,000 325,000 150,000

October production in litres ........................................................... 700,000 350,000 170,000

Additional processing costs .......................................................... $699,200 $652,800 $48,000

Final sales value per litre .............................................................. $ 3.20 $ 4.80 $ 4.00

Required:

1. Determine Le Monde Company’s allocation of joint production costs for the month of October. (Carry calculation of relative proportions to four decimal places.)

2. Determine the dollar values of the finished-goods inventories for HTP-3, PST-4, and RJ-5 as of October 31. (Round the cost per litre to the nearest cent.)

3. Suppose Le Monde Company has a new opportunity to sell PST-4 at the split-off point for $3.04 per litre. Prepare an analysis showing whether the company should sell PST-4 at the split-off point or continue to process this product further.

(CMA, adapted)

Gleed Company manufactures products Alpha, Beta, and Gamma from a joint process. Production, sales, and cost data for July follow.

Alpha Beta Gamma Total

Units produced ................................................................. 4,000 2,000 1,000 7,000

Joint cost allocation .......................................................... $46,800 ? ? $ 78,000

Sales value at split-off ....................................................... ? ? $19,500 $130,000

Additional costs if processed further ................................... $ 9,100 $ 6,500 $ 3,900 $ 19,500

Sales value if processed further ......................................... $91,000 $32,500 $26,000 $149,500

Required:

1. Assuming that joint costs are allocated using the relative-sales-value method, what were the joint costs allocated to products Beta and Gamma?

2. Assuming that joint costs are allocated using the relative-sales-value method, what was the sales value at split-off for product Alpha?

3. Use the net-realizable-value method to allocate the joint production costs to the three products.

(CPA, adapted)

Snake River Sawmill manufactures two lumber products from a joint milling process. The two products developed are mine support braces (MSB) and unseasoned commercial building lumber (CBL). A stan-dard production run incurs joint costs of $750,000 and results in 60,000 units of MSB and 90,000 units of CBL. Each MSB sells for $5, and each unit of CBL sells for $10.

Required:

1. Calculate the amount of joint cost allocated to commercial building lumber (CBL) on a physical-units basis.

■ Problem 16–30

Joint Costs; Allocation and

Production Decisions

(LO 5, 6)

1. Allocation of joint cost,

HTP-3: $654,840

2. October production cost per

litre, HTP-3: $1.93

2. October 31 inventory,

HTP-3: $131,240

3. Incremental sales value:

$1,76 per litre

■ Problem 16–31

Joint Cost Allocation; Missing

Data

(LO 5)

1. Gamma’s joint cost

allocation: $11,700

2. Alpha’s sales value at

split-off: $78,000

■ Problem 16–32

Joint Costs

(LO 5, 6)

1. Allocation of joint cost, MSB:

$300,000

3. Allocation of joint cost, MSB:

$250,000



2. Calculate the amount of joint cost allocated to the mine support braces (MSB) on a relative-sales-value basis.

3. Assume the commercial building lumber is not marketable at split-off but has to be further planed and sized at a cost of $1,000,000 per production run. During this process, 10,000 units are un-avoidably lost; these spoiled units have no value. The remaining units of commercial building lumber are saleable at $25.00 per unit. The mine support braces, although saleable immediately at the split-off point, are coated with a tar-like preservative that costs $250,000 per production run. The braces are then sold for $12.50 each. Using the net-realizable-value basis, compute the com-pleted cost assigned to each unit of commercial building lumber.

4. If Snake River Sawmill chose not to process the mine support braces beyond the split-off point, the contribution from the joint milling process would increase or decrease by what amount?

5. Did you use the joint cost allocation results in answering requirement (4)? If so, how? Why did you use or not use the allocation results?

(CMA, adapted)

Wyalusing Chemicals uses a joint process to produce MJ-4, a chemical used in the manufacture of paints and varnishes; HD-10, a chemical used in household cleaning products; and FT-5, a by-product that is sold to fertilizer manufacturers. Joint production costs are allocated to the main products on the basis of net re-alizable value. The by-product is inventoried at its net realizable value, and this value is used to reduce the joint production cost before allocation to the main products.

During the month of November, Wyalusing incurred joint production costs of $3,136,000. Data regarding Wyalusing’s November operations are as follows:

MJ-4 HD-10 FT-5

November production in litres ........................................................... 600,000 320,000 85,000

Sales value per litre at split-off .......................................................... None $6.00 $1.80*

Incremental processing cost ............................................................. $1,440,000 $1,840,000 None

Final sales value per litre ................................................................... $8.00 $12.75 None

Finished-goods inventory in litres on

November 30 (all produced during November) ............................... 9,000 26,000 1,500

*Disposal costs of $.20 per litre will be incurred in order to sell the by-product.

Required:

1. Define the terms joint costs and split-off point.

2. Determine the dollar values of Wyalusing Chemicals’ finished-goods inventories on November 30 for MJ-4 and HD-10.

3. Wyalusing Chemicals has an opportunity to sell HD-10 for its sales value at the split-off point. Determine if Wyalusing should sell HD-10 at the split-off point or continue to process it further.

(CPA, adapted)

Chemco, Inc. manufactures two products out of a joint process: Compod and Ultrasene. The joint costs incurred are $750,000 for a standard production run that generates 120,000 litres of Compod and 80,000 litres of Ultrasene. Compod sells for $6 per litre while Ultrasene sells for $9.75 per litre.

Required:

1. If there are no additional processing costs incurred after the split-off point, calculate the amount of joint cost of each production run allocated to Compod on a physical-units basis.

2. If there are no additional processing costs incurred after the split-off point, calculate the amount of joint cost of each production run allocated to Ultrasene on a relative-sales-value basis.

3. Suppose the following additional processing costs are required beyond the split-off point in order to obtain Compod and Ultrasene: $.30 per litre for Compod and $3.30 per litre for Ultrasene.

a. Calculate the amount of joint cost of each production run allocated to Ultrasene on a physical-units basis.

b. Calculate the amount of joint cost of each production run allocated to Compod on a net-realizable-value basis.

■ Problem 16–33

Joint Products; Sell or

Process Further

(LO 5, 6)

2. Joint cost allocation, MJ-4:

$1,800,000

3. Incremental sales value per

litre: $6.75

■ Problem 16–34

Joint Costs; Allocation and

Production Decisions; Ethics

(LO 5, 6)


Compod: $450,000


Compod: $427,500



4. Assuming the same data as in requirement (3), suppose Compod can be processed further into a product called Compodalene, at an additional cost of $1.20 per litre. Compodalene will be sold for $7.80 per litre by independent distributors. The distributors’ commission will be 10 percent of the sales price. Should Chemco sell Compod or Compodalene?

5. Independent of your answer to requirement (4), suppose Christine Dalton, the assistant controller, has completed an analysis showing that Compod should not be processed further into Compodalene. Before presenting her analysis to top management, however, she got a visit from Jack Turner, Chemco’s director of research. Turner was upset upon learning that Compodalene, a product he had personally developed, would not be manufactured.

Turner: The company’s making a big mistake if it passes up this opportunity. Compodalene will be a big seller and get us into new markets.

Dalton: But the analysis shows that we’d be losing money on every litre of Compod that we process further.

Turner: I know, Christine, but that’s a temporary problem. Eventually, we’ll bring down the cost of making Compodalene.

Dalton: Can you find me some estimates on the cost reduction you expect?

Turner: I don’t have a crystal ball, Christine. Look, if you could just fudge the numbers a little bit to help me get approval to produce some Compodalene, I can get this product off the ground. I know the cost reduction will come.

Comment on the ethical issues in this scenario. What should Christine Dalton do?

6. Assume the same data as given in requirements (3) and (4). The industrial chemical industry has experienced a downturn, which has left Chemco with idle capacity. Suppose Chemco can sell only half of the Compod made in each production run, but the remainder could be sold as Compodalene. Should Chemco process the remaining Compod into Compodalene?

(CMA, adapted)

Cases

Tropics Fruit Company, based on Oahu, grows, processes, cans, and sells three main pineapple prod-ucts: sliced, crushed, and juice. The outside skin is cut off in the Cutting Department and processed as animal feed. The feed is treated as a by-product. The company’s production process is as follows:

• Pineapples first are processed in the Cutting Department. The pineapples are washed and the outside skin is cut away. Then the pineapples are cored and trimmed for slicing. The three main products (sliced, crushed, juice) and the by-product (animal feed) are recognizable after process-ing in the Cutting Department. Each product then is transferred to a separate department for final processing.

• The trimmed pineapples are sent to the Slicing Department, where the pineapples are sliced and canned. Any juice generated during the slicing operation is packed in the cans with the slices.

• The pieces of pineapple trimmed from the fruit are diced and canned in the Crushing Depart-ment. Again, the juice generated during this operation is packed in the can with the crushed pineapple.

• The core and surplus pineapple generated from the Cutting Department are pulverized into a liquid in the Juicing Department. There is an evaporation loss equal to 8 percent of the weight of the good output produced in this department that occurs as the juices are heated.

• The outside skin is chopped into animal feed in the Feed Department.

Tropics Fruit Company uses the net-realizable-value method to assign the costs of the joint pro-cess to its main products. The net realizable value of the by-product is subtracted from the joint cost before the allocation.

A total of 540,000 kilograms were entered into the Cutting Department during June. The follow-ing schedule shows the costs incurred in each department, the proportion by weight transferred to the four final processing departments, and the selling price of each end product.

■ Case 16–35

Joint Cost Allocation;

By-Product

(LO 5)

1. Juice, net kilograms:

135,000

2. Slices, net realizable value:

$208,000



Processing Data and Costs for June

Department

Costs

Incurred

Proportion of

Product by Weight

Transferred to Departments

Selling Price

per Kilogram of

Final Product

Cutting ................................. $240,000 ...................................... — ........................................... —

Slicing .................................... 18,800 ...................................... 35% ........................................... $1.20

Crushing ............................... 42,320 ...................................... 28 ........................................... 1.10

Juicing .................................. 13,000 ...................................... 27 ........................................... .60

Animal feed ........................... 2,800 ...................................... 10 ............................................ .20

Total ................................. $316,920 ...................................... 100%

Required: Compute each of the following amounts:

1. The number of kilograms of pineapple that result as output for pineapple slices, crushed pineapple, pineapple juice, and animal feed

2. The net realizable value at the split-off point of the three main products

3. The amount of the cost of the Cutting Department allocated to each of the three main products

(CMA, adapted)

Edmonton Chemical Company manufactures two industrial chemical products in a joint process. In May, 10,000 litres of input costing $180,000 were processed at a cost of $450,000. The joint process resulted in 8,000 kilograms of Resoline and 2,000 kilograms of Krypto. Resoline sells for $75 per kilogram, and Krypto sells for $150 per kilogram. Management generally processes each of these chemicals further in separable processes to produce more refined chemical products. Resoline is processed separately at a cost of $15 per kilogram. The resulting product, Resolite, sells for $105 per kilogram. Krypto is pro-cessed separately at a cost of $45 per kilogram. The resulting product, Kryptite, sells for $285 per kilogram.

Required:

1. Draw a diagram similar to Exhibit 16–9 to depict Edmonton Chemical Company’s joint production process.

2. Allocate the company’s joint production costs for May using:

a. The physical-units method b. The relative-sales-value method c. The net-realizable-value method

Note that further refining does not change the quantities.

3. Edmonton’s management is considering an opportunity to process Kryptite further into a new product called Omega. The incremental processing will cost $120 per kilogram. Packaging costs for Omega are projected to be $18 per kilogram, and the anticipated sales price is $390 per kilogram. Should Kryptite be processed further into Omega? Why?

4. In answering requirement (3), did you use your joint cost allocation from requirement (2)? If so, how did you use it?

5. Build a spreadsheet: Construct an Excel spreadsheet to solve requirements (2) and (3) above. Show how the solution will change if the following information changes: the joint cost is $460,000, and the sales price of Omega is $375 per kilogram.

■ Case 16–36

Comprehensive Case on Joint

Cost Allocation

(LO 5, 6)

1. Resolite, sales value:

$840,000

2 a . Allocation of joint cost,

Resoline: $504,000


Documents

Chapter Sixteen Allocation of Support Activity Costs and Joint Costs