Week 4

Week 3

Week 41Allocation of Support-Department Costs,Common Costs,and RevenuesORS - http://www.dailymotion.com/video/x1ql7m9_ors-group-business-process-outsourcing-explained_techXEROX - http://www.services.xerox.com/business-process-outsourcing/enus.htmlhttps://www.youtube.com/watch?v=DCOQqvBFV_A

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Lesson PlanPresentationsYoutube video comments SIGN UP FOR Google AccountChptr 15 SD CostsFeedback on Tables2

3Week 4: Learning objective summaryService cost allocation basisWhy are service dept cost allocations important?What are service departmentsReasons for allocating service department costsPitfalls to avoid

Single vs. Dual rate methodLearning objective 1: Distinguish the single-rate method from the dual-rate method

Budgeted vs. Actual cost allocationLearning objective 2: Understand how the choice between allocation based on budgeted and actual rates and between budgeted and actual usage can affect the incentives of division managers

Direct / Step-down method Learning objective 3: Allocation support-department costs using the direct method, the step-down method and the reciprocal method

Other cost allocation issuesLearning objective 4: Allocate common costs using the stand-alone method and the incremental methodLearning objective 5: Explain the importance of explicit agreement between contracting parties when the reimbursement amount is based on costs incurredLearning objective 6: Understand how bundling of products causes revenue-allocation issues and the methods managers use to allocate revenues

Other cost allocation issues

Service cost allocation basis

Budgeted/ Actual cost allcoation

Single/Dual rate methodDirect/ Step-down method

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VideosHKU Xerox Websitehttps://www.youtube.com/watch?v=HO5Uy26VgQ0&index=21&list=PL64E49EE5F8646716Tale of two factoriesPQI4

Tale of Two Factories

Doing Business with China and Chinese suppliers | #

Operating Department(Machining)Operating Department(Assembly)The Products

Service Department(Cafeteria)Service Department(Accounting)Service Department(Personnel)

The big picture

OVERHEAD- Pricing- Value engineering

Operating Dept OverheadPlanning(resource, capacity)- Control (efficiency, performance evaluation)Planning (resources, capacity)- Control (efficiency, performance evaluation)Service Dept O/Hhttp://www.realbusiness.com/?cmp=xrb001#/ready-for-businesshttps://www.youtube.com/watch?v=DCOQqvBFV_Ahttp://www.services.xerox.com/business-process-outsourcing/enus.html6

66In the second stage of cost allocations, operating department overhead costs and allocated service department costs become the total amount of overhead that is applied to products and services using departmental predetermined overhead rates.6

7Seminar Task Top 8 Industries in Hong Kong (Persons employed - 2005)Real estateBanking & InsuranceEducation servicesImport & export tradeTransportation, storage, postal and courier servicesMedical, dental, other health & vet servicesRetailBusiness servicesRestaurants

------------------------------------7T



Budgeted/ Actual cost allocation


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Top 10 industries in Hong Kong(Persons employed June 2005 2010)




Single/Dual rate methodDirect/ Step-down method Import & export tradeRetailBusiness services Professional, scientific and technical serviceBusiness services Administration and support ServicesRestaurantsBanking and InsuranceEducation serviceTransportationMedical, dental, other health & vet servicesReal estate WholesaleSanitary & similar servicesWelfare institutionsPrinting $ publication (Manufacturing)Building construction sites: private sectionCommunication servicesLand passenger transport507, 403224,618207,756111,192188,173103,710131,604122,22676,01592,865

802,957240,803141,976161,753247,464190,839166,078160,409148,195110,068

54.24%90.73%-31/66%45.47%31.50%84.01%26.19%31.23%94.95%18.52%

2005 2010 % change71,66456,78051,37736,74931,26631,17931,093 63825/289672069431819/42236 -10.93%/-43.61%43.68%1.76%/35.83% 8

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9Top 8 Industries in Hong Kong(Persons employed June 2005 - 2010)20052010 Import & export trade 507,403562,154 Retail 224,618240,803 Business services - Professional, scientific and technical service 207,756141,976 Business services - Administration and Support services 111,192161,753 Restaurants 188,173247,464 Banking & Insurance 103,710190,839 Education services 131,604166,078 Transportation, storage, postal and courier services 122,226160,409 Medical, dental, other health & vet services 76,015148,195 Real estate 92,865110,068 Wholesale 71,664 Sanitary & similar services 56,780 Welfare institutions 51,377 Printing & publication (Manufacturing) 36,749 Building construction sites: private section 31,266 Communication services 31,179





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10Why? Business Process Outsourcing10




Single/Dual rate methodDirect/ Step-down methodORS - http://www.dailymotion.com/video/x1ql7m9_ors-group-business-process-outsourcing-explained_tech

XEROX - http://www.services.xerox.com/business-process-outsourcing/enus.html

https://www.youtube.com/watch?v=DCOQqvBFV_A

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11Why? - Real World #1(source: CIO Mar 1, 2003)11Richard Scannell Senior IT Manager MotorolaChargeback at Motorola was based on headcount. That works in theory, says Scannell, but in practice quickly turns sour.

"If the electric company turned around and said, There's 2,000 people in your town, and we're going to divide the town's usage by 2,000 and charge each of you a two-hundredth of the total, then you'd likely object," he says. "If it doesn't work with power, why should it work with IT?"





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12Why? - Real World #2(source: CIO Mar 1, 2003)12Nordin, vice president and CIO of specialty metals manufacturer A.M. Castle

it's way too much work..[to allocate every $IT to producing depts.]. It's a never-ending debate over what constitutes a fair share. In the end, it comes down to this: What am I being paid to do? And I think I'm being paid to do more that just debate MIPS and CPU cycles."





13Why? - Real World #2(source: CIO Mar 1, 2003)13

Business applications, on the other hand, reside at the center on a number of servers and are not charged out. "We tend to bring that sort of expense up to the top, and call it IT Budget,"





14Why? - Real World #3(source: CIO Mar 1, 2003)14

Keith Kaczanowski, vice president of process improvement at Brady Corp. of Milwaukee, a manufacturer of signs, labels and associated printing equipment.

"If all you do is reshuffle costs within the company, then chargeback probably isn't worth it," he says. "But if you think that people will make better decisions by being forced to confront the cost, then there is value.





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What are service departments?

Examples of Departmentalization15




Single/Dual rate methodDirect/ Step-down methodhttp://www.services.xerox.com/business-process-outsourcing/enus.html

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16Week 4: Learning objective summaryService cost allocation basisWhy are service dept cost allocations important?What are service departmentsReasons for allocating service department costsPitfalls to avoid








Single/Dual rate methodDirect/ Step-down methodALearning objective A:Understand the reasons for allocating service dept costs and the pitfalls to avoid

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Once service department costallocations are completed, they areincluded in operating departments:PerformanceevaluationsProfitabilitydetermination Overhead rate computations17Why? - Effect of allocations on operating departments




Single/Dual rate methodDirect/ Step-down methodPRD

1717Once service department costs are allocated to operating departments, they are typically included in the: Performance evaluations of operating departments. Determination of the operating departments profitability. Overhead rate computations of the operating departments.

18Reasons for allocating service department costsTo encourage operatingdepartments to wiselyuse service departmentresources.To provide operatingdepartments with morecomplete cost datafor making decisions.To help measure theprofitability of operatingdepartments.To create incentivefor service departmentsto operate efficiently. To value inventory for external financialreporting purposes. To include all overheadin the cost base when cost-plus pricing is used.PPDRRDWHY





1818Service department costs are allocated to operating departments to: Encourage operating departments to wisely use service department resources. Provide operating departments with more complete cost data for making decisions. Help measure the profitability of operating departments. Create incentive for service departments to operate efficiently. Value inventory for external financial reporting purposes. Include all overhead in the cost base when cost-plus pricing is used.

First Stage AllocationsService department costs are allocated to operating departments.Service Department(Cafeteria)Service Department(Accounting)Service Department(Personnel)Operating Department(Machining)Operating Department(Assembly)

The Products

19Effect of allocations on operating departments





1919In the first stage of cost allocations, service department costs are allocated to operating departments and then become a part of the overhead costs of those operating departments. The ultimate objective is to determine the costs of products and services.

Service Department(Cafeteria)Service Department(Accounting)Service Department(Personnel)Operating Department(Machining)Operating Department(Assembly)The Products

Second Stage AllocationsOperating department overhead costs and allocated service department costs are applied to products.20Effect of allocations on operating departments





2020In the second stage of cost allocations, operating department overhead costs and allocated service department costs become the total amount of overhead that is applied to products and services using departmental predetermined overhead rates.

Operating Department(Machining)Operating Department(Assembly)The Products

Service Department(Cafeteria)Service Department(Accounting)Service Department(Personnel)

21The big picture

OVERHEAD- Pricing- Value engineering

Operating Dept OverheadPlanning(resource, capacity)- Control (efficiency, performance evaluation)Planning (resources, capacity)- Control (efficiency, performance evaluation)Service Dept O/H21

2121In the second stage of cost allocations, operating department overhead costs and allocated service department costs become the total amount of overhead that is applied to products and services using departmental predetermined overhead rates.21

22 In practice - benefits received and cause-effect are widely used for a couple of reasons:Fairness or equity is difficult to agree onAbility to bear criterion raises issues related to cross- subsidization across users of resources in an organization.

Thus you could argue that there are three types:benefits/cause and effect, fairnessability to bear

Recall - Basis of cost allocation?22





23Examples of Allocation BasesExh.15-1





2323Several examples of service departments and possible allocation bases are shown on your screen.

24Examples of Allocation Bases

Exh.15-1





2424Several examples of service departments and possible allocation bases are shown on your screen.

25Allocation pitfalls to avoid

Pitfall: Allocating fixed costs using a variableallocation baseResult: Fixed costsallocated to onedepartment areheavily influenced bywhat happens in other departments.





2525Rather than allocating service department fixed costs to operating departments in predetermined lump-sum amounts, some companies allocate them using a variable allocation base that fluctuates from period to period. This is a pitfall because it creates a situation where the fixed costs allocated to one operating department are heavily influenced by what happens in other operating departments.

Methods to Allocate Support Department CostsSingle-rate method one rate for allocating costs in a cost poolsimple to implement, but treats fixed costs in a manner similar to variable costs

Dual-Rate method segregates costs within each cost pool into two segments: a variable-cost pool and a fixed-cost pool. Each pool uses a different cost-allocation basetreats fixed and variable costs more realistically, but is more complex to implementWhen possible, variable and fixed service department costs should be allocatedseparately.Variable service department costs should be allocated to consuming departments according to the activity causing incurrence of the cost.




Single/Dual rate methodDirect/ Step-down methodLearning objective 1:Distinguish the single-rate methodone rate for allocating costs in a cost pool

From the dual-rate method two rates for allocating costs in a cost pool-one for variable costs and one for fixed costs 126

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Learning Objective 1SingleDualBudget Rate(decision-making)Fairness / ControllabilityCapacity PlanningDecision MakingActual Rate(performance evaluation) Relevant CostsEfficiency Accuracy

Support Department Cost Allocation - choice of rates27Learning Objective 2





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1. Single/Dual rate method

Single rate (versus nothing)BenefitsControl service (indirectly the user dept might complain about the service if they are being charged) Dual rate (versus single rate)BenefitsControl service (indirectly the user dept might complain about the service if they are being charged) Signal relevant costs to user dept for decision making (assuming users can go elsewhere)Example 1 Sand Hill company

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Example 1: Sand Hill Company Assume Fixed costs are assigned on basis of budgeted usage Central Computer Department of Sand Hill Company (SHC) has two users, both operating divisions: the Microcomputer Division and the Peripheral Equipment Division. The following data related to the 2009 budget:Practical capacity18,750 hoursFixed costs of operating the computer facility in the 6,000-hour to 18,750-hour relevant range ($160 - $500 per hour)$3,000,000Budgeted long-run usage (quantity) in hours ($250 per hour): Microcomputer Division8,000 hours Peripheral Equipment Division4,000 hours Total 12,000 hoursBudgeted variable cost per hour in the 6,000-hour to 18,750-hour relevant range$200 per hour usedActual usage in 2009 in hours: Microcomputer Division9,000 hours Peripheral Equipment Division3,000 hours Total12,000 hours




Single/Dual rate methodDirect/ Step-down method29

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SINGLE RATEVS DUAL RATE




Single/Dual rate methodDirect/ Step-down methodINSIDE SERVICE$450

USERdeptOUTSIDE SERVICE$250

$250WHO LOSES?30

3030

SINGLE RATEVS DUAL RATE




Single/Dual rate methodDirect/ Step-down methodINSIDE$200Variable

USERdeptOUTSIDE$250

$250FIXED

$250FIXED

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Example 1: Sand Hill CompanyBenefits - Assume Fixed costs are assigned on basis of budgeted usage1.Decision service efficiency user depts become customers - - Control service put pressure on service dept to provide value for money!! 2.Decision Signal relevant costs to user dept A. Single rate method User depts might incorrectly view the variable cost as a relevant cost and seek cheaper services outside anywhere between $200 and $450 per hour$200 (VC) ---------------$450 (TC) per hour

B.Dual rate method User depts see the relevant costs for alternative supply assessment (ie cause & effect)- $200 (VC) Plus FIXED COSTS





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Example 1: Sand Hill CompanyAllocation based on the Demand for (or Usage of ) computer servicesSingle-rate method

Budgeted usage12,000 hoursBudgeted total cost pool: $3,000,000 + (12,000hours * $200/hour)$5,400,000Budgeted total rate per hour: $5,400,000 / 12,000 hours$450 per hour usedAllocation rate for Microcomputer Division$450 per hour usedAllocation rate for Peripheral Equipment Division$450 per hour used

The support cost allocated to the two divisions under single-rate method: Microcomputer Division: 9,000 hours * $450 per hour$4,050,000Peripheral Equipment Division: 3,000 hours* $450 per hour$1,350,000





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Example 1: Sand Hill Company Allocation based on the Demand for (or Usage of ) computer services Dual-rate method

Given the budgeted usage of 8,000 hours for the Microcomputer Division and 4,000 hours for the Peripheral Equipment Division, the budgeted fixed-cost rate is $250 per hour ($3,000,000 / 12,000 hours).

The costs allocated to the Microcomputer Division in 2009:

The cost allocated to the Peripheral Equipment Division in 2009:Fixed costs: $250 per hour * 8,000 (budgeted ) hours$2,000,000Variable costs: $200 per hour * 9,000 (actual) hours 1,800,000Total costs$3,800,000

Fixed costs: $250 per hour * 4,000 (budgeted ) hours$1,000,000Variable costs: $200 per hour * 3,000 (actual) hours 600,000Total costs$1,600,000





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Allocation BasesUnder either method, allocation of support costs can be based on one of the three following scenarios:Budgeted overhead rate and budgeted hoursBudgeted overhead rate and actual hoursActual overhead rate and actual hours

Choosing between actual and budgeted rates: budgeted is known at the beginning of the period, while actual will not be known with certainty until the end of the period




Single/Dual rate methodDirect/ Step-down methodLearning objective 2:Understand how the choice between allocation based on budgeted and actual ratesbudgeted rates provide certainty to users about charges and motivate the support division to engage in cost control

And between budgeted and actual usage can affect the incentives of division managers

---budgeted usage helps in planning and efficient utilization of fixed resources; actual usage controls consumption of variable resouces 235

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2. Budgeted/Actual cost allocation (fixed costs only)Budget/Actual cost allocation ratesBenefitsControl service (indirectly the user dept might complain about the service if they are being charged) Signal relevant costs to user dept for decision making (assuming users can go elsewhere)Control user efficiency (directly actual rate) Actual rates leave costs associated with inefficiencies in the service depts but create incentives for user depts to be more efficient (and only use the amount of service that they need). We have a problem whereby a user dept may use the same amount of resources but get charged more.Controlling capacity who should be responsible for excess capacity?

Example 2 Sand Hill company

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Example 2: Sand Hill Company Assume Fixed costs are assigned on basis of budgeted usage




Single/Dual rate methodDirect/ Step-down method Central Computer Department of Sand Hill Company (SHC) has two users, both operating divisions: the Microcomputer Division and the Peripheral Equipment Division. The following data related to the 2009 budget:Practical capacity18,750 hoursFixed costs of operating the computer facility in the 6,000-hour to 18,750-hour relevant range$3,000,000Budgeted long-run usage (quantity) in hours: Microcomputer Division8,000 hours Peripheral Equipment Division4,000 hours Total 12,000 hoursBudgeted variable cost per hour in the 6,000-hour to 18,750-hour relevant range$200 per hour usedActual usage in 2009 in hours: Microcomputer Division9,000 hours Peripheral Equipment Division3,000 hours Total12,000 hours

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Example 2: Sand Hill Company Comparative Allocation Bases




Single/Dual rate methodDirect/ Step-down methodCompare 1, 2 and 3:Budget rates provide certainty for capacity planningCompare 1 with 2 or 3:Actual rates provide incentives for efficient use of servicesBased on $3 Million / 18,750 hours - provide incentives for service division to efficiency plan for capacity38

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Example 2: Sand Hill Company Assume Fixed costs are assigned on basis of budgeted usage




Single/Dual rate methodDirect/ Step-down methodControlling capacity who should be responsible for excess capacity? Budget capacity fixed rate = $250 per hour (12,000 hours)

Practical capacity fixed rate = $160 per hour (18,750 hours)

18,750 hours 12,000 hours = 6,750 hours * $160 = $1,080,000)

If Actual usage (10,000) < budget (12,000) then allocate to user dept (make user dept responsible!)If Actual usage (12,000) = budget (12,000) < practical capacity (18,750) then ask service dept why they have unused capacity (6,750 hours) (make the service dept responsible)39

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Example 2: Sand Hill Company Allocation based on the Supply of Capacity




Single/Dual rate methodDirect/ Step-down method Using 18,750 hours of practical capacity of the Central Computer Department, the budgeted rate is as follows:

Microcomputer Division: $360 per hour * 9,000 (actual) hours$3,240,000Peripheral Equipment Division: $360 per hour * 3,000 (actual) hours 1,080,000Fixed costs of unused computer capacity: $160 per hour * 6,750 hours $1,080,000

Budgeted fixed-cost rate per hour, $3,000,000 / 18,750 hours$160 per hourBudgeted variable-cost rate per hour 200 per hourBudgeted total-cost rate per hour 360 per hour

Single-rate method

6,750 hours = Practical capacity of 18,750 ( 9,000 hours used by Microcomputer Division + 3,000 hours used by Peripheral Equipment Division)

Be careful - ConfusingRecall Example 2 - $160 per hour is based on $3 Million / 18,750 hours - provide incentives for service division to efficiency plan for capacity should plan for 12,000 hours40

4040

Example 2: Sand Hill Company Allocation based on the Supply of Capacity




Single/Dual rate methodDirect/ Step-down methodMicrocomputer Division Fixed costs: $160 per hour * 8,000 (budgeted) hours$1,280,000 Variable cost: $200 per hour * 9,000 (actual) hours 1,800,000 Total costs$3,080,000Peripheral Equipment Division Fixed costs: $160 per hour * 4,000 (budgeted) hours$ 640,000 Variable cost: $200 per hour * 3,000 (actual) hours 600,000 Total costs$1,240,000Fixed costs of unused computer capacity: $160 per hour * 6,750 hours $1,080,000

Dual-rate method

6,750 hours = Practical capacity of 18,750 ( 8,000 hours budgeted to be used by Microcomputer Division + 4,000 hours budgeted to be used by Peripheral Equipment Division)

Be careful - Confusing

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4141

2. Budgeted/Actual cost allocation (fixed costs only)BenefitsControl service (indirectly the user dept might complain about the service if they are being charged) Signal relevant costs to user dept for decision making (assuming users can go elsewhere)Control user efficiency (directly actual rate) Actual rates leave costs associated with inefficiencies in the service depts but create incentives for user depts to be more efficient (and only use the amount of service that they need). We have a problem whereby a user dept may use the same amount of resources but get charged more.Controlling capacity who should be responsible for excess capacity?

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43Quiz 1: Allocating costs by behaviorFoster City has an ambulance service that is used by the two public hospitals in the city. Variable ambulance costs are budgeted at $4.20 per mile. Fixed ambulance costs are budgeted at $120,000 per year. Data relating to the current year are:





4343Now we will look at a couple of questions where we will allocate costs by behavior. On your screen, you see information for both questions. You will probably want to refer back to this screen as you work through the questions.

44Quiz 1How much ambulance service cost will be allocated to Mercy Hospital at the beginning of the year?a. $117,000b. $254,400c. $114,480d. $119,250





4444Here is your first question asking for allocations at the beginning of the year.

45Quiz 1

How much ambulance service cost will be allocated to Mercy Hospital at the beginning of the year?a. $117,000b. $254,400c. $114,480d. $119,250





4545Variable cost allocations are made at the beginning of the year by multiplying the budgeted variable rate of four dollars twenty cents per mile times the planned number of miles for each hospital. Fixed service department costs are allocated to the hospitals by multiplying the percent of peak-period capacity required by each hospital times the one hundred twenty thousand dollars of budgeted fixed costs.

46Quiz 1How much ambulance service cost will be allocated to Mercy Hospital at the end of the year?a. $114,000b. $118,800c. $110,400d. $121,200





4646Here is your second question asking for allocations at the end of the year.

47Quiz 1

How much ambulance service cost will be allocated to Mercy Hospital at the end of the year?a. $114,000b. $118,800c. $110,400d. $121,200





4747Variable cost allocations are made at the end of the year by multiplying the budgeted variable rate of four dollars twenty cents per mile times the actual number of miles for each hospital. Fixed service department costs are again allocated to the hospitals by multiplying the percent of peak-period capacity required by each hospital times the one hundred twenty thousand dollars of budgeted fixed costs.

Methods of Allocating Support Costs to Production DepartmentsDirectStep-DownReciprocal




Single/Dual rate methodDirect/ Step-down methodLearning objective 3:Allocation multiple support-department costs using the direct method, allocate support-department costs directly to operating departments

The step-down method,partially allocates support-department costs to other support departments

And the reciprocal methodfully allocates support-department costs to other support departments348

48

49Interdepartmental services

Problem

Allocating costs

when service

departments

provide services

to each other

Solutions

Direct Method

Step Method

Reciprocal Method





4949Service provided between service departments are known as interdepartmental or reciprocal services. Three approaches may be used to allocate the costs of service departments to other departments. These approaches are known as the direct method, the step method, and the reciprocal method.

Direct Method

Allocates support costs only to Operating Departments No Interaction between Support Departments prior to allocation





50

51Direct MethodService Department(Cafeteria)Service Department(Custodial)Operating Department(Machining)

Operating Department(Assembly)

Interactionsbetween servicedepartments areignored and allcosts areallocated directlyto operatingdepartments.





5151The direct method is the simplest of the three cost allocation methods because it ignores the services provided by a service department to other service departments. Interactions between service departments are ignored and all costs of each service department are allocated directly to operatingdepartments.

Example 3: Castleford Engineering Data Used in Cost Allocation Illustrations





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Example 3: Castleford Engineering Direct Allocation Method Illustrated





53

Operating Department(Machining)Operating Department(Assembly)54Step-Down Method

Once a servicedepartments costsare allocated, other servicedepartment costsare not allocatedback to it.

Service Department(Cafeteria)Service Department(Custodial)





5454The step method provides for the allocation of a service departments costs to other service departments, as well as to operating departments. It is a sequential allocation procedure, and the sequence usually begins with the service department that provides the greatest amount of service to other service departments. Once a service departments costs have been allocated to other departments, other service department costs are not allocated back to it.

55 There are three key points to understand regarding the step-down method: In both the direct and step methods, any amount of the allocation base attributable to the service department whose cost is being allocated is always ignored.

Any amount of the allocation base that is attributable to a service department whose cost has already been allocated is ignored.

Each service department assigns its own costs to operating departments plus the costs that have been allocated to it from other service departments.Step-Down Method





5555There are three key points to understand regarding the step method: In both the direct and step methods, any amount of the allocation base attributable to the service department whose cost is being allocated is always ignored. Any amount of the allocation base that is attributable to a service department whose cost has already been allocated is ignored. Each service department assigns its own costs to operating departments plus the costs that have been allocated to it from other service departments.

Step-Down Method





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Example 3 : Castleford Engineering Step-Down Allocation Method





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Example 3 : Castleford Engineering Step-Down Allocation Method





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Reciprocal MethodAllocates support department costs to operating departments by fully recognizing the mutual services provided among all support departmentsFull Two-Way Interaction between Support Departments prior to allocation





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Choosing Between MethodsReciprocal is the most preciseDirect and Step-Down are simple to compute and understandDirect Method is widely used





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61Quiz 2: Data for Direct and Step Methods

The direct method of allocation is used.Allocation bases:Business school administration costs (ADMIN): Number of employees

Business Administration computer services (BACS): Number of personal computers





6161On your screen, you see information for a series of questions. The first cost allocation questions use the direct method. You will probably want to refer back to this screen as you work through the questions.

62Quiz 2How much cost will be allocated from Administration to Accounting?

a. $ 36,000b. $144,000c. $180,000d. $ 27,000





6262Heres your first question using the direct method of service department cost allocation.

63

$180,000 2020 + 80

= $36,000

How much cost will be allocated from Administration to Accounting?

a. $ 36,000b. $144,000c. $180,000d. $ 27,000Quiz 2





6363The total number of employees in the allocation base is one hundred, twenty in Accounting plus eighty others. Recall that we ignore the number of employees in BACS as it is a service department and using the direct method, we only allocate to operating departments. The allocation percentage is calculated by dividing the number of employees in an operating department by the total number of employees in the allocation base. For Accounting, the allocation percentage is twenty percent, obtained by dividing twenty employees by one hundred employees. Next we multiply the allocation percentage times the service department cost. To allocate ADMIN costs to Accounting we multiply twenty percent times one hundred eighty thousand dollars and get thirty-six thousand dollars.

64How much total cost will be allocated from ADMIN and BACS combined to the Accounting Department?a. $ 52,500b. $135,000c. $270,000d. $ 49,500Quiz 2





6464Heres your second question using the direct method of service department cost allocation.

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How much total cost will be allocated from ADMIN and BACS combined to the Accounting Department?a. $ 52,500b. $135,000c. $270,000d. $ 49,500

$90,000 1818 + 102= $13,500

Quiz 2





6565We will allocate BACS costs to Accounting and add the result to the answer for the previous question. BACS is allocated on the basis of the number of personal computers in each operating department. The total number of personal computers in the allocation base is one hundred twenty, eighteen for Accounting plus one hundred two others. The allocation percentage is calculated by dividing the number of personal computers in an operating department by the total number of personal computers in the allocation base. For Accounting, the allocation percentage is fifteen percent, obtained by dividing eighteen personal computers by one hundred twenty personal computers. To allocate BACS costs to Accounting, we multiply fifteen percent times ninety thousand dollars and get thirteen thousand five hundred dollars. The total amount allocated to Accounting is the sum of thirty-six thousand dollars and thirteen thousand five hundred dollars for a total of forty-nine thousand five hundred dollars.

66How much total cost will be allocated from ADMIN and BACS combined to the Accounting Department?

a. $35,250b. $49,072c. $18,000d. $26,333Quiz 2





6666Heres your question using the step method of service department cost allocation.

67

How much total cost will be allocated from ADMIN and BACS combined to the Accounting Department?

a. $35,250b. $49,072c. $18,000d. $26,333

Quiz 2





6767ADMIN provides more services than BACS so we allocate it first. The total number of employees in the allocation base is one hundred five, five for BACS, plus twenty for Accounting, plus eighty others. The allocation percentage is calculated by dividing the number of employees in a department by the total number of employees in the allocation base. For Accounting, the allocation percentage is found by dividing twenty employees by one hundred five employees. Next we multiply the allocation percentage times the service department cost. To allocate ADMIN costs to Accounting we multiply the allocation percentage times one hundred eighty thousand dollars and get thirty-four thousand two hundred eighty-six dollars.We must also allocate ADMIN costs to BACS. The allocation percentage is found by dividing five employees by one hundred five employees. Next we multiply the allocation percentage times the service department cost. To allocate ADMIN costs to BACS, we multiply the allocation percentage times one hundred eighty thousand dollars and get eight thousand five hundred seventy-one dollars.The new amount to be allocated from BACS is the original ninety thousand dollars plus the eight thousand five hundred seventy-one dollars, for a total of ninety-eight thousand five hundred seventy-one dollars.Now we can allocate BACS costs to Accounting. For BACS, the allocation percentage of fifteen percent is found by dividing eighteen computers by one hundred twenty computers. Next we multiply the allocation percentage times the service department cost. To allocate BACS costs to Accounting, we multiply fifteen percent times ninety-eight thousand five hundred seventy-one dollars and get fourteen thousand seven hundred eighty-six dollars. The total amount allocated to Accounting is the sum of thirty-four thousand two hundred eighty-six dollars plus fourteen thousand seven hundred eighty-six dollars.

Allocating Common CostsCommon Cost the cost of operating a facility, activity, or like cost object that is shared by two or more users at a lower cost than the individual cost of the activity to each user




Single/Dual rate methodDirect/ Step-down methodLearning objective 4:Allocate common costs using the stand-alone methoduses cost information of each user as a separate entity to allocated common costs

And the incremental methodallocates common costs primarily to one user and the remainder to other users468

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Methods of Allocating Common CostsStand-Alone Cost-Allocation Method uses information pertaining to each user of a cost object as a separate entity to determine the cost-allocation weights

Individual costs are added together and allocation percentages are calculated from the whole, and applied to the common cost





69

Methods of Allocating Common CostsIncremental Cost-Allocation Method ranks the individual users of a cost object in the order of users most responsible for a common cost and then uses this ranking to allocate the cost among the usersThe first ranked user is the Primary User and is allocated costs up the cost as a stand-alone user (typically gets the highest allocation of the common costs)The second ranked user is the First Incremental User and is allocated the additional cost that arises from two users rather than oneSubsequent users handled in the same manner as the second ranked user





70

Cost Allocations and ContractingThe US government reimburses most contractors in either of two main ways:The contractor is paid a set price without analysis of actual contract cost data.The contractor is paid after an analysis of actual contract cost data. In some cases, the contract will state that the reimbursement amount is based on actual allowable costs plus a fixed fee (cost-plus contract)





Learning objective 5:Explain the importance of explicit agreement between contracting parties when the reimbursement amount is based on costs incurredto avoid disputes regarding allowable cost items and how indirect cost should be allocated 571

71

Revenue Allocation and Bundled ProductsRevenue Allocation occurs when revenues are related to a particular revenue object but cannot be traced to it in an economically feasible mannerRevenue Object anything for which a separate measurement of revenue is desiredBundled Product a package of two or more products or services that are sold for single price, but individual components of the bundle also may be sold as separate items at their own stand-alone prices





Learning objective 6:Understand how bundling of products two or more product sold for a single-price

Causes revenue allocation issues

---allocating revenues to each product in the bundle to evaluate managers of individual products

And the methods managers use to allocate revenues

---using the stand alone method or the incremental method672

72

Methods to Allocate Revenue to Bundled ProductsStand-Alone (separate) Revenue Allocation Method uses product-specific information on the products in the bundle as weights for allocating the bundled revenues to the individual products. Three types of weights may be used:Selling PricesUnit CostsPhysical Units





Learning objective 6:Allocate the revenues of a bundle product to the individual products in that bundleusing the stand-alone method, the incremental method, or management judgment673

73

Methods to Allocate Revenue to Bundled ProductsIncremental Revenue-Allocation Method ranks individual products in a bundle according to criteria determined by management and then uses this ranking to allocate bundled revenues to individual products (similar to earlier discussed Incremental Cost-Allocation Method)The first-ranked product is the primary productThe second-ranked product is the first incremental productThe third-ranked product is the second incremental product, etc





74

74

Summary: Objectives of Service Dept Cost Allocation Compute product profitability --- Cost allocation

Predict economic effects for planning and controlService capacity planningService productivity/effectiveness improvement

Motivate managersthrough the use of incentives and rewardsIncreased effortGoal congruenceto use resources responsibly7575





76Summary: Conflicting objectives How to balance capacity and demand?

Functional departments demand more IS services when they are cheaper leading to overuse of capacityIf IS service depts. charge more, demand will decrease, leading to underuse of capacity





77Summary: Conflicting Objectives Solutions77

Use dual rate for more accurate cost allocation

Use budgeted data and have depts mutually agree on price (process) (prevent transfer of inefficiencies between depts)

Have more flexible system for innovative depts strategic priority > cost recovery (in the short term).





78Summary: The Basis of Cost Allocation?78

In practice - benefits received and cause-effect are widely used for a couple of reasons:Fairness or equity is difficult to agree onAbility to bear criterion raises issues related to cross-subsidization across users of resources in an organization.

Thus you could argue that there are three types:benefits/cause and effect, fairnessability to bear





79SummaryService cost allocation basisWhy are service dept cost allocations important?What are service departmentsReasons for allocating service department costsPitfalls to avoid









7979

Sheet1Service DepartmentAllocation BasesLaundrySquare footage occupiedAirport Ground ServicesCases handled; number of employees;Cafeteriahours workedMedical FacilitiesLabor hours; customers servedMaterials HandlingNumber of personal computers;applications installedInformation TechnologyHours of service; volume handledNumber of mealsCustodial ServicesKWH used; capacity of machinesCost AccountingUnits handled; number of requisitions;Powerspace occupiedHuman ResourcesNumber of flightsReceiving, Shipping, and StoresNumber of employees; training hoursPounds of laundryFactory AdministrationMachine hoursMaintenanceTotal labor hours

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Sheet1Service DepartmentAllocation BasesLaundryPounds of laundryAirport Ground ServicesNumber of flightsCafeteriaNumber of mealsMedical FacilitiesCases handled; number of employees;hours workedMaterials HandlingHours of service; volume handledInformation TechnologyNumber of personal computers;applications installedCustodial ServicesSquare footage occupiedCost AccountingLabor hours; customers servedPowerKWH used; capacity of machinesHuman ResourcesNumber of employees; training hoursReceiving, Shipping, and StoresUnits handled; number of requisitions;space occupiedFactory AdministrationTotal labor hoursMaintenanceMachine hours

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Sheet1Percent ofPeak-PeriodCapacityMilesMilesHospitalsRequiredPlannedUsedMercy45%15,00016,000Northside55%17,00017,500Total100%32,00033,500

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Sheet1OperatingHours of CapacityDepartmentsRequiredUsedCutting90,00080,000Assembly60,00040,000Total hours150,000120,000

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Sheet2MercyNorthsideVariable cost allocation:$4.20 15,000 miles$ 63,000$4.20 17,000 miles$ 71,400Fixed cost allocation45% of $120,00054,00055% of $120,00066,000Total allocated cost$ 117,000$ 137,400

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Sheet1OperatingHours of CapacityDepartmentsRequiredUsedCutting90,00080,000Assembly60,00040,000Total hours150,000120,000

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Sheet2MercyNorthsideVariable cost allocation:$4.20 16,000 miles$ 67,200$4.20 17,500 miles$ 73,500Fixed cost allocation45% of $120,00054,00055% of $120,00066,000Total allocated cost$ 121,200$ 139,500

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Manufacturing

Information Systems

Accounting

Packaging

Support Departments

Production Departments

Support Departments


Support Departments


Support Departments


Support Departments


Manufacturing

Information Systems

Accounting

Packaging

Support Departments


Support Departments


Support Departments


Support Departments


Support Departments


Manufacturing

Information Systems

Accounting

Packaging

Support Departments


Support Departments


Support Departments


Support Departments


Support Departments


Sheet1Service DepartmentsOperating DepartmentsADMINBACSAccountingOthersDepartmental costsbefore allocation$ 180,000$ 90,000$ 190,000$ 900,000Number of employees1552080Number of PCs122018102

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Sheet1Service DepartmentsOperating DepartmentsAdmin.BACSAccountingOthersDepartmental costsbefore allocation$ 180,000$ 90,000$ 190,000$ 900,000Number of employees1552080Number of PCs122018102Service DepartmentsOperating DepartmentsADMINBACSAccountingOthersDepartmental costsbefore allocation$ 180,000$ 90,000$ 190,000$ 900,000ADMIN allocation(180,000)36,000144,000

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Sheet1Service DepartmentsOperating DepartmentsAdmin.BACSAccountingOthersDepartmental costsbefore allocation$ 180,000$ 90,000$ 190,000$ 900,000Number of employees1552080Number of PCs122018102Service DepartmentsOperating DepartmentsADMINBACSAccountingOthersDepartmental costsbefore allocation$ 180,000$ 90,000$ 190,000$ 900,000ADMIN allocation(180,000)36,000144,000BACS allocation- 0(90,000)13,50076,500Total after allocation$ - 0$ - 0$ - 0$ - 0$ 239,500$ - 0$ 1,120,500

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Sheet1Service DepartmentsOperating DepartmentsAdmin.BACSAccountingOthersDepartmental costsbefore allocation$ 180,000$ 90,000$ 190,000$ 900,000Number of employees1552080Number of PCs122018102Service DepartmentsOperating DepartmentsADMINBACSAccountingOthersDepartmental costsbefore allocation$ 180,000$ 90,000$ 190,000$ 900,000ADMIN allocation(180,000)8,571- 034,286- 0137,143BACS allocation- 0(98,571)14,78683,786Total after allocation$ - 0$ - 0$ - 0$ - 0$ 239,071$ - 0$ 1,120,929

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