15 - 1©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Allocation of Support DepartmentCosts, Common Costs, and
RevenuesChapter 15
15 - 2©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Learning Objective 1
Differentiate the single-ratefrom the dual-rate
cost-allocation method.
15 - 3©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Single-Rate andDual-Rate Methods
The single-rate cost allocation methodpools together all costs in a cost pool.The dual-rate cost allocation methodclassifies costs in each cost pool intotwo cost pools – a variable-cost cost
pool and a fixed-cost cost pool.
15 - 4©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Learning Objective 2
Understand how the uncertaintyuser managers face is affected
by the choice between budgetedand actual cost-allocation rates.
15 - 5©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Budgeted versus Actual Rates
Budgeted rates let the user department know inadvance the cost rates they will be charged.
During the budget period, the supplier department,not the user departments, bears the risk of any
unfavorable cost variances.
Why?
15 - 6©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Budgeted versus Actual Rates
– because the user departments do not pay forany costs that exceed the budgeted rates
When actual rates are used for cost allocation,managers do not know the rates to be used
until the end of the budget period.
15 - 7©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Budgeted versus ActualUsage Allocation Bases
Organizations commit to infrastructure costs onthe basis of a long-run planning horizon.
The use of budgeted usage to allocate these fixedcosts is consistent with the long-run horizon.
15 - 8©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Learning Objective 3
Allocate support department costsusing the direct, step-down,
and reciprocal methods.
15 - 9©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Allocating SupportDepartments Costs
An operating department (a productiondepartment in manufacturing companies)
adds value to a product or service.A support department (service department)
provides the services that assist other operatingand support departments in the organization.
15 - 10©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Allocating SupportDepartments Costs
Direct method:Allocates support department costs to operating
departments only.Step-down (sequential allocation) method:
Allocates support department costs to other supportdepartments and to operating departments.
Reciprocal allocation method:Allocates costs by services provided among all
support departments.
15 - 11©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Allocating SupportDepartments Costs
The Canton Division of Smith Corporation has twooperating departments and two support departments.
Assemblyand
Finishing
Maintenanceand
Human Resources
15 - 12©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Allocating SupportDepartments Costs
Total square feet = 255,000Total number of employees = 95
Maintenance is allocated using square feet.Human Resources is allocated using
number of employees.
15 - 13©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Allocating SupportDepartments Costs
Human Maintenance Resources Budgeted costs before allocations: $300,000 $2,160,000 Square feet: 5,000 30,000 Number of employees: 8 15
15 - 14©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Allocating SupportDepartments Costs
Assembly Finishing Budgeted costs before allocations: $1,700,000$900,000 Square feet: 110,000 110,000 Number of employees: 48 24
15 - 15©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Direct MethodSupport Departments Operating Departments
$1,700,000Assembly
$900,000Finishing
110/220
48/72
24/72
0% 0% 110/220
Maintenance$300,000
HumanResources$2,160,000
15 - 16©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Direct MethodSupport Departments Operating Departments
$1,700,000Assembly
$900,000Finishing
$150,000
$1,440,000
$720,000
0% 0% $150,000
Maintenance$300,000
HumanResources$2,160,000
15 - 17©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Direct Method
Assembly FinishingOriginal costs: $1,700,000$ 900,000Maintenance Allocated: 150,000 150,000Human Resources Allocated: 1,440,000 720,000Total $3,290,000$1,770,000
15 - 18©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Step-Down Method
Which support department should be allocated first?Maintenance provides 12% of its services
to Human Resources.Human Resources provides 10% of its
services to Maintenance.Maintenance to Human Resources:
30,000 ÷ 250,000 (or 12%) × $300,000 = $36,000
15 - 19©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Step-Down Method
Maintenance to Assembly:110,000 ÷ 250,000 (or 44%) × $300,000 = $132,000
Maintenance to Finishing:110,000 ÷ 250,000 (or 44%) × $300,000 = $132,000
15 - 20©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Step-Down Method
Costs before Allocated allocation costs
Maintenance: $ 300,000 ($300,000)Human Resources:$2,160,000$ 36,000Assembly: $1,700,000$132,000Finishing: $ 900,000$132,000
15 - 21©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Step-Down Method
Human Resources costs to be allocated become$2,160,000 + $36,000 = $2,196,000.
Human Resources to Assembly:48 ÷ 72 × $2,196,000 = $1,464,000
Human Resources to Finishing:24 ÷ 72 × $2,196,000 = $732,000
15 - 22©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Step-Down Method
Costs before AllocatedAllocated allocation costscosts
HumanResources: $2,160,000 $ 36,000 ($2,196,000)Assembly: $1,700,000 $132,000 $ 1,464,000Finishing: $ 900,000 $132,000 $ 732,000
15 - 23©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Step-Down Method
Total cost after allocation:Assembly Department:
$1,700,000 + $132,000 + $1,464,000 = $3,296,000Finishing Department:
$900,000 + $132,000 + $732,000 = $1,764,000
15 - 24©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Reciprocal
M HR A FMaintenance – 12% 44% 44%Human Resources 10% – 60% 30%
Maintenance cost = $300,000 + .10PHuman Resource cost = $2,160,000 + .12M
15 - 25©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Reciprocal
Maintenance cost (M)= $300,000 + .10($2,160,000 + .12M)
M = $300,000 + $216,000 + .012M.988M = $516,000 M = $522,267HR = $2,160,000 + .12($522,267)
HR = $2,160,000 + $62,672 = $2,222,672
15 - 26©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Reciprocal
M HR A FBeforeallocation: $300,000 $2,160,000 $1,700,000 $ 900,000Allocation: (522,267) 62,672 229,797 229,797Allocation: 222,267 ($2,222,672) 1,333,603 666,802Total $3,263,400 $1,796,599
Total cost Assembly Department: $3,263,400Total cost Finishing Department: $1,796,599
15 - 27©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Overview of Methods
Overhead rate for the Assembly Department isdetermined using direct labor cost as a denominator.
Overhead rate for the Finishing Department isdetermined using machine-hours as the denominator.
15 - 28©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Comparison of Methods
Assembly FinishingDirect labor cost: $698,880 $349,440Machine-hours: 24,000 23,500
What are the various overhead rates using the three methods?
15 - 29©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Overhead Rates Direct Method
Assembly:$3,290,000 ÷ $698,880 direct labor costs
= 471% of direct labor costsFinishing:
$1,770,000 ÷ 23,500 = $75.32 per machine-hour
15 - 30©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Overhead RatesStep-Down Method
Assembly:$3,296,000 ÷ $698,880 direct labor costs
= 472% of direct labor costFinishing:
$1,764,000 ÷ 23,500 = $75.06 per machine-hour
15 - 31©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Overhead Rates Reciprocal
Assembly:$3,263,400 ÷ $698,880 direct labor costs
= 467% of direct labor costFinishing:
$1,796,599 ÷ 23,500 = $76.45 per machine-hour
15 - 32©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Comparison of Rates
Assembly FinishingDirect method: 471% $75.32Step-down method: 472% $75.06Reciprocal method: 467% $76.45
15 - 33©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Learning Objective 4
Allocate common costsusing either the stand-alone
or incremental method.
15 - 34©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Allocating Common Costs
Two methods for allocating common cost are:
1. Stand-alone costallocation method
2. Incremental costallocation method
15 - 35©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Stand-Alone Example
A consultant in Tampa is planning to go toChicago and meet with an international client.
The round-trip Tampa/Chicago/Tampaairfare costs $540.
The consultant is also planning to attenda business meeting with a North Carolina
client in Durham.
15 - 36©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Stand-Alone Example
The round-trip Tampa/Durham/Tampaairfare costs $360.
The consultant decides to combine the twotrips into a Tampa/Durham/Chicago/Tampa
itinerary that will cost $760.
15 - 37©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Stand-Alone Example
How much should the consultant chargeto the North Carolina client?$360 ÷ ($360 + $540) = .40
.40 × $760 = $304
How much to the international client?$760 – $304 = $456
15 - 38©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Incremental Cost Example
Assume that the business meeting in Chicagois viewed as the primary party.
What would be the cost allocation?International client (primary) $540Durham client (incremental) $760 – $540 = $220
15 - 39©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Learning Objective 5
Explain the importance ofexplicit agreement betweencontracting parties whenreimbursement is based
on costs incurred.
15 - 40©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Cost Allocation and Contracts
Many commercial contracts include clauses thatrequire the use of cost accounting information.Contract disputes arise with some regularity,
often with respect to cost allocation.Cost assignment rules should be as explicit as
possible (and in writing).
15 - 41©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Learning Objective 6
Understand how bundlingof products gives rise to
revenue-allocation issues.
15 - 42©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Revenues and Bundled Products
A bundled product is a package of two or moreproducts (or services) sold for a single price.
Bundled product sales are also referred toas “suite sales.”
The individual components of the bundle alsomay be sold as separate items at their own
“stand-alone” prices.
15 - 43©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Revenues and Bundled Products
What businesses provide bundled products?
Banks Hotels Tours Checking Safety deposit boxes Investment advisory
Lodging Food and beverage services Recreation
Transportation Lodging Guides
15 - 44©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Learning Objective 7
Allocate the revenues ofa bundled package to
the individual productsin that package.
15 - 45©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Revenue Allocation Methods
English Languages Institute buys Englishlanguage software programs locally and
then sells them in Mexico and Central America.English sells the following programs:
Grammar, Translation, and CompositionThese programs are offered stand-alone
or in a bundle.
15 - 46©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Revenue Allocation Methods
Stand-alone PriceGrammar $255Translation $ 85Composition $185
Purchasing these softwareprograms costs English
the following:Grammar $180Translation $ 45Composition $ 95
15 - 47©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Revenue Allocation Methods
Bundle (Suites) PriceGrammar + Translation $290Grammar + Composition $350Grammar + Translation + Composition $410
15 - 48©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Revenue Allocation Methods
The two main revenue allocation methods are:
1. The stand-alonemethod
2. The incrementalmethod
15 - 49©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Stand-Alone RevenueAllocation Method
There are four types of weights for thestand-alone revenue allocation method.
1. Selling prices 2. Unit costs
3. Physical units 4. Stand-aloneproduct revenues
15 - 50©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Stand-Alone RevenueAllocation Method
Consider the Grammar and Translationsuite, which sells for $290 per day.How much weight should English
Languages Institute assign to each item?
15 - 51©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Stand-Alone RevenueAllocation Method
Selling prices:The individual selling prices are $255 for
Grammar and $85 for Translation.Grammar:
$255 ÷ $340 = 0.75, $290 × 0.75 = $217.50Translation:
$85 ÷ $340 = 0.25, $290 × 0.25 = $72.50
15 - 52©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Stand-Alone RevenueAllocation Method
Unit costs:This method uses the costs of the individual
products to determine the weights for therevenue allocations.
Grammar:$180 ÷ $225 = 0.80, $290 × 0.80 = $232
Translation:$45 ÷ $225 = 0.20, $290 × 0.20 = $58
15 - 53©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Stand-Alone RevenueAllocation Method
Physical units:This method gives each product unit in the
suite the same weight when allocatingsuite revenue to individual products.With two products in the suite, each
product is allocated 50% of suite revenues.1 ÷ (1 + 1) = 0.50
$290 × 0.50 = $145
15 - 54©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Stand-Alone RevenueAllocation Method
Stand-alone product revenues:This method captures the quantity of eachproduct sold as well as their selling prices.
Assume that the stand-alone revenues in 2003are Grammar $734,400, Translation $81,600,
and Composition $133,200.What are the weights for the Grammar
and Translation suite?
15 - 55©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Stand-Alone RevenueAllocation Method
Grammar:$734,400 ÷ $816,000 = 0.90, $290 × 0.90 = $261
Translation:$81,600 ÷ $816,000 = 0.10, $290 × 0.10 = $29
15 - 56©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Stand-Alone RevenueAllocation Method
Revenue Allocation Weights Grammar Translation
Selling prices $217.50 $ 72.50Unit costs 232.00 58.00Physical units 145.00 145.00Stand-alone product revenues 261.00 29.00
15 - 57©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Incremental RevenueAllocation Method
The first-ranked product is termed theprimary product in the bundle.
The second-ranked product is termedthe first incremental product.
The third-ranked product is the secondincremental product, and so on.
15 - 58©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Incremental RevenueAllocation Method
Assume that Grammar is designatedas the primary product.
If the suite selling price exceeds the stand-alone price of the primary product, the
primary product is allocated 100%of its stand-alone revenue.
15 - 59©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Incremental RevenueAllocation Method
Grammar and Translation suite selling price= $290 per day
Allocated to Grammar: $255Remaining to be allocated: ($290 – $255) = $35
Allocated to Translation: $35
15 - 60©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
End of Chapter 15