11th Edition

Chapter 15

McGrawHill/Irwin

Copyright2006,TheMcGrawHillCompanies,Inc.

Service Department
Costing: An Activity
Approach
Chapter Fifteen

McGrawHill/Irwin

Copyright2006,TheMcGrawHillCompanies,Inc.

Reasons for Allocating Service

Department Costs
To
To encourage
encourage operating
operating
departments
departments to
to wisely
wisely
use
use service
service department
department
resources.
resources.

To
To provide
provide operating
operating
departments
departments with
with more
more
complete
complete cost
cost data
data
for
for making
making decisions.
decisions.

To
To help
help measure
measure the
the
profitability
profitability of
of operating
operating
departments.
departments.

To
To create
create incentive
incentive
for
for service
service departments
departments
to
to operate
operate efficiently.
efficiently.

To
To value
value inventory
inventory for
for
external
external financial
financial
reporting
reporting purposes.
purposes.

To
To include
include all
all overhead
overhead
in
in the
the cost
cost base
base when
when
cost-plus
cost-plus pricing
pricing is
is used.
used.

McGrawHill/Irwin

Copyright2006,TheMcGrawHillCompanies,Inc.

Selecting Allocation Bases

The
The allocation
allocation bases
bases used
used should
should
drive
drive the
the cost
cost being
being allocated.
allocated.
For
For example,
example, when
when allocating
allocating costs
costs
of
of the
the employee
employee cafeteria,
cafeteria, the
the number
number
of
of meals
meals served
served would
would be
be aa good
good
choice
choice for
for the
the allocation
allocation base.
base.
Service
Departments
McGrawHill/Irwin

Operating
Departments
Copyright2006,TheMcGrawHillCompanies,Inc.

Selecting Allocation Bases

AAservice
servicedepartments
departmentscosts
costsmay
maybe
be
allocated
allocatedusing
usingmore
more than
than one
onebase.
base.
For
Forexample,
example, aaportion
portion of
of the
thehuman
human resource
resource department
department
costs
costsmight
mightbe
beallocated
allocatedbased
basedon
onthe
thenumber
numberof
of employees
employees
in
ineach
eachoperating
operatingdepartment
department and
and another
another portion
portion might
might be
be
allocated
allocatedbased
basedon
onhours
hoursspent
spent in
intraining
trainingemployees
employeesin
in
each
eachoperating
operatingdepartment.
department.

Service
Departments
McGrawHill/Irwin

Operating
Departments
Copyright2006,TheMcGrawHillCompanies,Inc.

Examples of Allocation Bases

Service Department
Laundry
Airport Ground Services
Cafeteria
Medical Facilities
Materials Handling
Information Technology
Custodial Services
Cost Accounting
Power
Human Resources
Receiving, Shipping, and Stores
Factory Administration
Maintenance
McGrawHill/Irwin

Exh.
15-1

Allocation Bases
Pounds of laundry
Number of flights
Number of meals
Cases handled; number of employees;
hours worked
Hours of service; volume handled
Number of personal computers;
applications installed
Square footage occupied
Labor hours; customers served
KWH used; capacity of machines
Number of employees; training hours
Units handled; number of requisitions;
space occupied
Total labor hours
Machine hours
Copyright2006,TheMcGrawHillCompanies,Inc.

Interdepartmental Services
Problem
Problem
Allocating
Allocating costs
costs when
when service
service departments
departments
provide
provide services
services to
to each
each other
other
Solutions
Direct Method
Step Method
Reciprocal Method
McGrawHill/Irwin

Copyright2006,TheMcGrawHillCompanies,Inc.

Direct Method

Interactions
between service
departments are
ignored and all
costs are
allocated directly
to operating
departments.

McGrawHill/Irwin

Service
Department
(Cafeteria)

Operating
Department
(Machining)

Service
Department
(Custodial)

Operating
Department
(Assembly)

Copyright2006,TheMcGrawHillCompanies,Inc.

Direct Method Example

Departmental costs
before allocation
Number of employees
Square feet occupied

McGrawHill/Irwin

Service Departments

Operating Departments

Cafeteria

Custodial

Machining

Assembly

$ 360,000
15
5,000

$ 90,000
10
2,000

$ 400,000
20
25,000

$ 700,000
30
50,000

Service
Service Department
Department

Allocation
Allocation Base
Base

Cafeteria
Cafeteria
Custodial
Custodial

Number
Number of
of employees
employees
Square
Square feet
feet occupied
occupied

Copyright2006,TheMcGrawHillCompanies,Inc.

Direct Method Example

Service Departments

Operating Departments

Cafeteria

Custodial

Machining

Assembly

Departmental costs
before allocation

$ 360,000

$ 90,000

$ 400,000

$ 700,000

Cafeteria allocation

Custodial allocation
Total after allocation

McGrawHill/Irwin

Copyright2006,TheMcGrawHillCompanies,Inc.

Direct Method Example

Departmental costs
before allocation
Cafeteria allocation

Service Departments

Operating Departments

Cafeteria

Custodial

Machining

Assembly

$ 360,000

$ 90,000

$ 400,000

$ 700,000

(360,000)

Custodial allocation
Total after allocation

144,000

20
$360,000
= $144,000
20 + 30
Allocation base: Number of employees
McGrawHill/Irwin

Copyright2006,TheMcGrawHillCompanies,Inc.

Direct Method Example

Departmental costs
before allocation
Cafeteria allocation

Service Departments

Operating Departments

Cafeteria

Custodial

Machining

Assembly

$ 360,000

$ 90,000

$ 400,000

$ 700,000

144,000

216,000

(360,000)

Custodial allocation
Total after allocation

$360,000

30
= $216,000
20 + 30

Allocation base: Number of employees

McGrawHill/Irwin

Copyright2006,TheMcGrawHillCompanies,Inc.

Direct Method Example

Departmental costs
before allocation
Cafeteria allocation

Service Departments

Operating Departments

Cafeteria

Custodial

Machining

Assembly

$ 360,000

$ 90,000

$ 400,000

$ 700,000

144,000

216,000

(360,000)

Custodial allocation
Total after allocation

(90,000)
$

25,000
$90,000
25,000 + 50,000

30,000

$ 574,000

= $30,000

Allocation base: Square feet occupied

McGrawHill/Irwin

Copyright2006,TheMcGrawHillCompanies,Inc.

Direct Method Example

Departmental costs
before allocation
Cafeteria allocation

Service Departments

Operating Departments

Cafeteria

Custodial

Machining

Assembly

$ 360,000

$ 90,000

$ 400,000

$ 700,000

144,000

216,000

30,000

60,000

$ 574,000

$ 976,000

(360,000)

Custodial allocation
Total after allocation

(90,000)
$

50,000
$90,000
25,000 + 50,000

= $60,000

Allocation base: Square feet occupied

McGrawHill/Irwin

Copyright2006,TheMcGrawHillCompanies,Inc.

Step Method

Once a service
departments costs
are allocated,
other service
department costs
are not allocated
back to it.

McGrawHill/Irwin

Service
Department
(Cafeteria)

Operating
Department
(Machining)

Service
Department
(Custodial)

Operating
Department
(Assembly)

Copyright2006,TheMcGrawHillCompanies,Inc.

Step Method
There 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.
McGrawHill/Irwin

Copyright2006,TheMcGrawHillCompanies,Inc.

Step Method Example

We will use the same data used
in the direct method example.

Departmental costs
before allocation
Number of employees
Square feet occupied

McGrawHill/Irwin

Service Departments

Operating Departments

Cafeteria

Custodial

Machining

Assembly

$ 360,000
15
5,000

$ 90,000
10
2,000

$ 400,000
20
25,000

$ 700,000
30
50,000

Service Department

Allocation Base

Cafeteria
Custodial

Number of employees
Square feet occupied
Copyright2006,TheMcGrawHillCompanies,Inc.

Step Method Example

Service Departments

Operating Departments

Cafeteria

Custodial

Machining

Assembly

Departmental costs
before allocation

$ 360,000

$ 90,000

$ 400,000

$ 700,000

Cafeteria allocation

Custodial allocation
Total after allocation

Allocate
Allocate Cafeteria
Cafeteria costs
costs first
first since
since
itit provides
provides more
more service
service than
than Custodial.
Custodial.
McGrawHill/Irwin

Copyright2006,TheMcGrawHillCompanies,Inc.

Step Method Example

Departmental costs
before allocation
Cafeteria allocation

Service Departments

Operating Departments

Cafeteria

Custodial

Machining

Assembly

$ 360,000

$ 90,000

$ 400,000

$ 700,000

(360,000)

Custodial allocation
Total after allocation

60,000

10
$360,000
10 + 20 + 30

= $60,000

Allocation base: Number of employees

McGrawHill/Irwin

Copyright2006,TheMcGrawHillCompanies,Inc.

Step Method Example

Departmental costs
before allocation
Cafeteria allocation

Service Departments

Operating Departments

Cafeteria

Custodial

Machining

Assembly

$ 360,000

$ 90,000

$ 400,000

$ 700,000

60,000

120,000

(360,000)

Custodial allocation
Total after allocation

20
$360,000
10 + 20 + 30

= $120,000

Allocation base: Number of employees

McGrawHill/Irwin

Copyright2006,TheMcGrawHillCompanies,Inc.

Step Method Example

Departmental costs
before allocation
Cafeteria allocation

Service Departments

Operating Departments

Cafeteria

Custodial

Machining

Assembly

$ 360,000

$ 90,000

$ 400,000

$ 700,000

60,000

120,000

180,000

(360,000)

Custodial allocation
Total after allocation

30
$360,000
10 + 20 + 30

= $180,000

Allocation base: Number of employees

McGrawHill/Irwin

Copyright2006,TheMcGrawHillCompanies,Inc.

Step Method Example

Departmental costs
before allocation
Cafeteria allocation

Service Departments

Operating Departments

Cafeteria

Custodial

Machining

Assembly

$ 360,000

$ 90,000

$ 400,000

$ 700,000

60,000

120,000

180,000

(360,000)

Custodial allocation
Total after allocation

(150,000)
$

New total = $90,000 original Custodial cost

plus $60,000 allocated from the Cafeteria.

McGrawHill/Irwin

Copyright2006,TheMcGrawHillCompanies,Inc.

Step Method Example

Departmental costs
before allocation
Cafeteria allocation

Service Departments

Operating Departments

Cafeteria

Custodial

Machining

Assembly

$ 360,000

$ 90,000

$ 400,000

$ 700,000

60,000

120,000

180,000

(150,000)

50,000

$ 570,000

(360,000)

Custodial allocation
Total after allocation

25,000
$150,000
25,000 + 50,000

= $50,000

Allocation base: Square feet occupied

McGrawHill/Irwin

Copyright2006,TheMcGrawHillCompanies,Inc.

Step Method Example

Departmental costs
before allocation
Cafeteria allocation

Service Departments

Operating Departments

Cafeteria

Custodial

Machining

Assembly

$ 360,000

$ 90,000

$ 400,000

$ 700,000

60,000

120,000

180,000

(150,000)

50,000

100,000

$ 570,000

$ 980,000

(360,000)

Custodial allocation
Total after allocation

50,000
$150,000
25,000 + 50,000

= $100,000

Allocation base: Square feet occupied

McGrawHill/Irwin

Copyright2006,TheMcGrawHillCompanies,Inc.

Reciprocal Method

Interdepartmental
services are given
full recognition
rather than partial
recognition as with
the step method.

Service
Department
(Cafeteria)

Operating
Department
(Machining)

Service
Department
(Custodial)

Operating
Department
(Assembly)

Because of its mathematical complexity,

the reciprocal method is rarely used.
McGrawHill/Irwin

Copyright2006,TheMcGrawHillCompanies,Inc.

Revenue Producing
Service Departments

If a service department
generates revenue, such as a
cafeteria that charges for the service it
provides, the revenue generated should
be offset against the costs incurred.
Only the remaining net amount
of costs should be allocated
to other departments.

McGrawHill/Irwin

Copyright2006,TheMcGrawHillCompanies,Inc.

Quick Check Data

for Direct and Step Methods
Service Departments
Departmental costs
before allocation
Number of employees
Number of PCs

Operating Departments

ADMIN

BACS

Accounting

Others

$ 180,000
15
12

$ 90,000
5
20

$ 190,000
20
18

$ 900,000
80
102

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

McGrawHill/Irwin

Copyright2006,TheMcGrawHillCompanies,Inc.

Quick Check
How
How much
much cost
cost will
will be
be allocated
allocated from
from
Administration
Administration to
to Accounting?
Accounting?
a.
a. $$ 36,000
36,000
b.
b. $144,000
$144,000
c.
c. $180,000
$180,000
d.
d. $$ 27,000
27,000

McGrawHill/Irwin

Copyright2006,TheMcGrawHillCompanies,Inc.

Quick Check
How
How much
much cost
cost will
will be
be allocated
allocated from
from
Administration
Administration to
to Accounting?
Accounting?
a.
a. $$ 36,000
36,000
b.
b. $144,000
$144,000
Service Departments
Operating Departments
c.
c. $180,000
$180,000
ADMIN
BACS
Accounting
Others
d.
$
27,000
d. $ 27,000
Departmental
costs
before allocation
ADMIN allocation

$ 180,000
(180,000)

$ 90,000

$ 190,000
36,000

$ 900,000
144,000

20
$180,000
= $36,000
20 + 80
McGrawHill/Irwin

Copyright2006,TheMcGrawHillCompanies,Inc.

Quick Check

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

McGrawHill/Irwin

Copyright2006,TheMcGrawHillCompanies,Inc.

Service Departments
Quick
Check Operating Departments
ADMIN

BACS

Accounting

Others

Departmental costs
before allocation
$ 180,000 $ 90,000
$ 190,000 $ 900,000
ADMIN
allocation
(180,000)
36,000 from
How
much
cost
How
much total
total
cost will
will be
be allocated
allocated
from144,000
BACS allocation
(90,000)
13,500
76,500

ADMIN
ADMIN and
and BACS
BACS combined
combined to
to the
the
Total after allocation $
$
$ 239,500
Accounting
Department?
Accounting Department?
a.
a. $$ 52,500
52,500
b.
b. $135,000
$135,000
c.
c. $270,000
$270,000
d.
d. $$ 49,500
49,500
$90,000

McGrawHill/Irwin

$ 1,120,500

18
= $13,500
18 + 102
Copyright2006,TheMcGrawHillCompanies,Inc.

Quick Check Data

Service Departments
Departmental costs
before allocation
Number of employees
Number of PCs

Operating Departments

ADMIN

BACS

Accounting

Others

$ 180,000
15
12

$ 90,000
5
20

$ 190,000
20
18

$ 900,000
80
102

The step method of allocation is used.

Allocation bases:
Business school administration costs (ADMIN):
Number of employees
Business

administration computer services

(BACS): Number of personal computers

McGrawHill/Irwin

Copyright2006,TheMcGrawHillCompanies,Inc.

Quick Check
How
How much
much total
total cost
cost will
will be
be allocated
allocated from
from
ADMIN
ADMIN and
and BACS
BACS combined
combined to
to the
the
Accounting
Accounting Department?
Department?
a.
a. $35,250
$35,250
b.
b. $49,072
$49,072
c.
c. $18,000
$18,000
d.
d. $26,333
$26,333

McGrawHill/Irwin

Copyright2006,TheMcGrawHillCompanies,Inc.

Quick Check
How
How much
much total
total cost
cost will
will be
be allocated
allocated from
from
ADMIN
ADMIN and
and BACS
BACS combined
combined to
to the
the
Accounting
Accounting Department?
Department?
a.
a. $35,250
$35,250
b.
b. $49,072
$49,072
c.
c. $18,000
$18,000 Service Departments Operating Departments
BACS
Accounting
Others
d.
d. $26,333
$26,333 ADMIN

Departmental costs
before allocation
ADMIN allocation
BACS allocation

Total after allocation

McGrawHill/Irwin

$ 180,000
(180,000)
-

$ 90,000
8,571
(98,571)

$ 190,000
34,286
14,786

$ 239,071

$ 1,120,929

900,000
137,143
83,786

Copyright2006,TheMcGrawHillCompanies,Inc.

Allocating Costs by Behavior

When possible,
variable and fixed
service department costs
should be allocated
separately.

McGrawHill/Irwin

Copyright2006,TheMcGrawHillCompanies,Inc.

Allocating Costs by Behavior

Variable service
department costs should be
allocated to consuming departments
according to the activity
causing incurrence
of the cost.

McGrawHill/Irwin

Copyright2006,TheMcGrawHillCompanies,Inc.

Allocating Costs by Behavior

Allocate
Allocate fixed
fixed service
service department
department costs
costs to
to
consuming
consuming departments
departments in
in predetermined
predetermined
lump-sum
lump-sum amounts
amounts that
that are
are based
based on
on the
the
consuming
consuming departments
departments peak
peak or
or long-run
long-run
average
average needs.
needs. Fixed
Fixed cost
cost allocations:
allocations:
Are based on amounts of
capacity each consuming
department requires.
McGrawHill/Irwin

Should not vary from

period to period.
Copyright2006,TheMcGrawHillCompanies,Inc.

Allocating Costs by Behavior

Budgeted variable
and fixed service department
costs should be allocated to
operating departments.

McGrawHill/Irwin

Copyright2006,TheMcGrawHillCompanies,Inc.

Allocating Costs by Behavior

IfIf variable
variable cost
cost allocations
allocations are
are made
made at
at the
the
beginning
beginning of
of the
the year,
year, the
the budgeted
budgeted variable
variable
rate
rate should
should be
be multiplied
multiplied by
by the
the budgeted
budgeted
activity
activity level
level of
of each
each consuming
consuming department.
department.
Allocations made
at the beginning of the
year provide data for
pricing and other
decisions.
McGrawHill/Irwin

Copyright2006,TheMcGrawHillCompanies,Inc.

Allocating Costs by Behavior

IfIf variable
variable cost
cost allocations
allocations are
are made
made at
at the
the
end
end of
of the
the year,
year, the
the budgeted
budgeted variable
variable
rate
rate should
should be
be multiplied
multiplied by
by the
the actual
actual
activity
activity level
level of
of each
each consuming
consuming department.
department.

Allocations made at
the end of the year provide
data for performance
evaluation.
McGrawHill/Irwin

Copyright2006,TheMcGrawHillCompanies,Inc.

SimCo: An Example
SimCo has a maintenance department and two operating
departments: cutting and assembly. Variable maintenance
costs are budgeted at $0.60 per machine hour. Fixed
maintenance costs are budgeted at $200,000 per year.
Data relating to the current year are:

Operating
Departments
Cutting
Assembly
Total hours

Percent of
Peak-Period
Capacity
Required
60%
40%
100%

Hours
Planned
75,000
50,000
125,000

Hours
Used
80,000
40,000
120,000

Allocate maintenance costs to the two operating departments.

McGrawHill/Irwin

Copyright2006,TheMcGrawHillCompanies,Inc.

SimCo: Beginning of the Year

Hours planned
Cutting
Department
Variable cost allocation:
$0.60 75,000 hours
$0.60 50,000 hours
Fixed cost allocation:

Assembly
Department

45,000
$

30,000

Total allocated cost

McGrawHill/Irwin

Copyright2006,TheMcGrawHillCompanies,Inc.

SimCo: Beginning of the Year

Hours planned
Cutting
Department
Variable cost allocation:
$0.60 75,000 hours
$0.60 50,000 hours
Fixed cost allocation:
60% of $200,000
40% of $200,000
Total allocated cost

Assembly
Department

45,000
$

30,000

80,000
110,000

120,000
$

165,000

Percent of peak-period capacity.

McGrawHill/Irwin

Copyright2006,TheMcGrawHillCompanies,Inc.

SimCo: End of the Year

Hours used
Cutting
Department
Variable cost allocation:
$0.60 80,000 hours
$0.60 40,000 hours
Fixed cost allocation:

Assembly
Department

48,000
$

24,000

Total allocated cost

McGrawHill/Irwin

Copyright2006,TheMcGrawHillCompanies,Inc.

SimCo: End of the Year

Hours used
Cutting
Department
Variable cost allocation:
$0.60 80,000 hours
$0.60 40,000 hours
Fixed cost allocation:
60% of $200,000
40% of $200,000
Total allocated cost

Assembly
Department

48,000
$

24,000

80,000
104,000

120,000
$

168,000

Percent of peak-period capacity.

McGrawHill/Irwin

Copyright2006,TheMcGrawHillCompanies,Inc.

SimCo: Comparison of Results

Allocation Based on
Beginning-of-Period
Planned Activity
Cutting
Assembly

Cost
Type
Variable
Fixed

Allocation Based on
End-of-Period
Actual Activity
Cutting
Assembly

$ 45,000

$ 30,000

$ 48,000

$ 24,000

120,000

80,000

120,000

80,000

$ 165,000

$ 110,000

$ 168,000

$ 104,000

Fixed
Fixed cost
cost allocations
allocations are
are the
the same
same at
at the
the
end
end and
and at
at the
the beginning
beginning because
because they
they are
are
based
based on
on capacity
capacity instead
instead of
of usage.
usage.
McGrawHill/Irwin

Copyright2006,TheMcGrawHillCompanies,Inc.

SimCo: Comparison of Results

Only budgeted variable and fixed service
department costs were allocated to the
two operating departments.
The cost of service department inefficiencies,
contained in the actual costs, should not
be passed along to operating departments.

McGrawHill/Irwin

Copyright2006,TheMcGrawHillCompanies,Inc.

Quick Check:
Allocating Costs by Behavior
Foster 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:

Hospitals
Mercy
Northside
Total
McGrawHill/Irwin

Percent of
Peak-Period
Capacity
Required
45%
55%
100%

Miles
Planned
15,000
17,000
32,000

Miles
Used
16,000
17,500
33,500

Copyright2006,TheMcGrawHillCompanies,Inc.

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

McGrawHill/Irwin

Copyright2006,TheMcGrawHillCompanies,Inc.

Quick Check
How
How much
much ambulance
ambulance service
service cost
cost will
will be
be
allocated
allocated to
to Mercy
Mercy Hospital
Hospital at
at the
the beginning
beginning
of
of the
the year?
year?
a.
a. $117,000
$117,000
b.
b. $254,400
$254,400
Mercy
Northside
Variable
cost allocation:
c.
$114,480
c.
$114,480
$4.20 15,000 miles
$
63,000
d.
$4.20 17,000 miles
$
71,400
d. $119,250
$119,250
Fixed cost allocation
45% of $120,000
55% of $120,000
Total allocated cost
McGrawHill/Irwin

54,000
$

117,000

66,000
137,400

Copyright2006,TheMcGrawHillCompanies,Inc.

Quick Check

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

Copyright2006,TheMcGrawHillCompanies,Inc.

Quick Check
Mercy

Northside

Variable cost allocation:

$4.20 16,000 miles
$
67,200
$4.20
17,500
miles
$ will
73,500
How
much
ambulance
service
cost
be
How
much
ambulance
service
cost
will
be
Fixed cost allocation
allocated
to
at
allocated
to Mercy
Mercy Hospital
Hospital54,000
at the
the end
end of
of the
the
45% of $120,000
year?
55% of $120,000
66,000
year?
Total allocated cost
$ 121,200
$ 139,500

a.
a. $114,000
$114,000
b.
b. $118,800
$118,800
c.
c. $110,400
$110,400
d.
d. $121,200
$121,200

McGrawHill/Irwin

Copyright2006,TheMcGrawHillCompanies,Inc.

Effect of Allocations on
Operating Departments
Once
Once service
service department
department cost
cost
allocations
allocations are
are completed,
completed, they
they are
are
included
included in
in operating
operating departments:
departments:

Performance
Performance
evaluations
evaluations

McGrawHill/Irwin

Profitability
Profitability
determination
determination

Overhead
Overhead rate
rate
computations
computations

Copyright2006,TheMcGrawHillCompanies,Inc.

Effect of Allocations on
Operating Departments

Service
Department
(Cafeteria)
Service
Department
(Accounting)
Service
Department
(Personnel)
McGrawHill/Irwin

First Stage Allocations

Service department costs are
allocated to operating departments.

Operating
Department
(Machining)
Operating
Department
(Assembly)

The
Products

Copyright2006,TheMcGrawHillCompanies,Inc.

Effect of Allocations on
Operating Departments

Service
Department
(Cafeteria)
Service
Department
(Accounting)
Service
Department
(Personnel)
McGrawHill/Irwin

Second Stage Allocations

Operating department overhead costs and
allocated service department costs are
applied to products.

Operating
Department
(Machining)
Operating
Department
(Assembly)

The
Products

Copyright2006,TheMcGrawHillCompanies,Inc.

Allocation Pitfalls to Avoid

Pitfall 1
Allocating fixed
costs using a variable
allocation base

McGrawHill/Irwin

Result
Fixed costs
allocated to one
department are
heavily influenced by
what happens in
other departments.

Copyright2006,TheMcGrawHillCompanies,Inc.

Kolby Products: An Example

Kolby
Kolby Products
Products has
has two
two sales
sales territories,
territories,
the
the Eastern
Eastern Territory
Territory and
and the
the Western
Western Territory.
Territory.
Both
Both sales
sales territories
territories are
are serviced
serviced by
by one
one auto
auto
service
service center
center whose
whose costs
costs are
are all
all fixed.
fixed. Contrary
Contrary
to
to good
good practice,
practice, Kolby
Kolby allocates
allocates the
the fixed
fixed service
service
center
center costs
costs to
to the
the sales
sales territories
territories on
on the
the basis
basis
of
of actual
actual miles
miles driven
driven (a
(a variable
variable base).
base).

McGrawHill/Irwin

Copyright2006,TheMcGrawHillCompanies,Inc.

Kolby Products: An Example

Year 1
$ 120,000

Year 2
$ 120,000

Miles driven
Western sales territory
Eastern sales territory

1,500,000
1,500,000

1,500,000
900,000

Total miles driven

3,000,000

2,400,000

Auto service center costs (all fixed)

Allocation rate per mile

0.04

0.05

$120,000 3,000,000 miles

$120,000 2,400,000 miles
McGrawHill/Irwin

Copyright2006,TheMcGrawHillCompanies,Inc.

Kolby Products:
Firstyear Allocations

Western
Western sales
salesterritory
territory
1,500,000
1,500,000 miles
miles @
@ $0.04
$0.04 per
per mile
mile

$$

Eastern
Eastern sales
salesterritory
territory
1,500,000
1,500,000 miles
miles @
@ $0.04
$0.04 per
per mile
mile
Total
Total cost
cost allocated
allocated

60,000
60,000
60,000
60,000

$$ 120,000
120,000

The two sales territories share the service

centers costs equally because the miles
driven in each territory are equal.
McGrawHill/Irwin

Copyright2006,TheMcGrawHillCompanies,Inc.

Kolby Products:
Secondyear Allocation

Western
Western sales
salesterritory
territory
1,500,000
1,500,000 miles
miles @
@ $0.05
$0.05 per
per mile
mile
Eastern
Eastern sales
salesterritory
territory
900,000
900,000 miles
miles @
@ $0.05
$0.05 per
per mile
mile
Total
Total cost
cost allocated
allocated

$$

75,000
75,000
45,000
45,000

$$ 120,000
120,000

Western territory has the same number of miles as

last year, but $15,000 more cost allocated
because Easterns miles declined in year 2.
McGrawHill/Irwin

Copyright2006,TheMcGrawHillCompanies,Inc.

Allocation Pitfalls to Avoid

Pitfall 2
Using sales
dollars as an
allocation base

Result
Sales of one department
influence the service
department costs
allocated to other
departments.

McGrawHill/Irwin

Copyright2006,TheMcGrawHillCompanies,Inc.

Clothier Inc. An Example

Clothier
Clothier Inc.,
Inc., aa mens
mens clothing
clothing store
store has
has one
one
service
service department
department and
and three
three sales
sales departments,
departments,
Suits,
Suits, Shoes,
Shoes, and
and Accessories.
Accessories. Service
Service department
department
costs
costs total
total $60,000
$60,000 for
for both
both years
years in
in the
the example.
example.
Contrary
Contrary to
to good
good practice,
practice, Clothier
Clothier allocates
allocates the
the
service
service department
department costs
costs based
based on
on sales.
sales.

McGrawHill/Irwin

Copyright2006,TheMcGrawHillCompanies,Inc.

Clothier Inc. First-year Allocation

$260,000 $400,000

65% of $60,000

In
In the
the next
next year,
year, the
the manager
manager of
of the
the Suit
Suit Department
Department
increased
increased sales
sales by
by $100,000.
$100,000. Sales
Sales in
in the
the other
other departments
departments
are
are unchanged.
unchanged. Lets
Lets allocate
allocate the
the $60,000
$60,000 service
service department
department
cost
cost for
for the
the second
second year
year given
given the
the sales
sales increase.
increase.
McGrawHill/Irwin

Copyright2006,TheMcGrawHillCompanies,Inc.

Clothier Inc. Second-year Allocation

$360,000 $500,000

72% of $60,000

IfIf you
you were
were the
the suit
suit department
department manager,
manager, would
would
you
you be
be happy
happy with
with the
the increased
increased service
service department
department
costs
costs allocated
allocated to
to your
your department?
department?
McGrawHill/Irwin

Copyright2006,TheMcGrawHillCompanies,Inc.

End of Chapter 15

McGrawHill/Irwin

Copyright2006,TheMcGrawHillCompanies,Inc.