11 th Edition Chapter 15
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Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
11th EditionChapter 15
Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Service Department Costing: An Activity
Approach
Chapter Fifteen
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Reasons for Allocating Service Department Costs
To encourage operatingdepartments to wisely
use service departmentresources.
To encourage operatingdepartments to wisely
use service departmentresources.
To provide operatingdepartments with more
complete cost datafor making decisions.
To provide operatingdepartments with more
complete cost datafor making decisions.
To help measure theprofitability of operating
departments.
To help measure theprofitability of operating
departments.
To create incentivefor service departments
to operate efficiently.
To create incentivefor service departments
to operate efficiently.
To value inventory for external financial
reporting purposes.
To value inventory for external financial
reporting purposes.
To include all overheadin the cost base when
cost-plus pricing is used.
To include all overheadin the cost base when
cost-plus pricing is used.
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$
Selecting Allocation Bases
OperatingDepartments
ServiceDepartments
The allocation bases used should“drive” the cost being allocated.
For example, when allocating costsof the employee cafeteria, the number
of meals served would be a goodchoice for the allocation base.
The allocation bases used should“drive” the cost being allocated.
For example, when allocating costsof the employee cafeteria, the number
of meals served would be a goodchoice for the allocation base.
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Selecting Allocation Bases
OperatingDepartments
ServiceDepartments
$
A service department’s costs may beallocated using more than one base.
For example, a portion of the human resource departmentcosts might be allocated based on the number of employeesin each operating department and another portion might be
allocated based on hours spent in training employees ineach operating department.
A service department’s costs may beallocated using more than one base.
For example, a portion of the human resource departmentcosts might be allocated based on the number of employeesin each operating department and another portion might be
allocated based on hours spent in training employees ineach operating department.
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Examples of Allocation Bases
Service Department Allocation BasesLaundry Pounds of laundryAirport Ground Services Number of flightsCafeteria Number of mealsMedical Facilities Cases handled; number of employees;
hours workedMaterials Handling Hours of service; volume handledInformation Technology Number of personal computers;
applications installedCustodial Services Square footage occupiedCost Accounting Labor hours; customers servedPower KWH used; capacity of machinesHuman Resources Number of employees; training hoursReceiving, Shipping, and Stores Units handled; number of requisitions;
space occupiedFactory Administration Total labor hoursMaintenance Machine hours
Exh.15-1
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Interdepartmental Services
Problem
Allocating costs when service departmentsprovide services to each other
Problem
Allocating costs when service departmentsprovide services to each other
Solutions
Direct Method
Step Method
Reciprocal Method
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Direct Method
Service Department(Cafeteria)
Service Department(Custodial)
Operating Department(Machining)
Operating Department(Assembly)
Interactionsbetween servicedepartments areignored and all
costs areallocated directly
to operatingdepartments.
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Direct Method Example
Service Department Allocation Base
Cafeteria Number of employeesCustodial Square feet occupied
Service Department Allocation Base
Cafeteria Number of employeesCustodial Square feet occupied
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Direct Method Example
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Direct Method Example
Allocation base: Number of employees
$360,000 ×20
20 + 30= $144,000
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Direct Method Example
Allocation base: Number of employees
$360,000 ×30
20 + 30= $216,000
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Direct Method Example
Allocation base: Square feet occupied
$90,000 ×25,000
25,000 + 50,000 = $30,000
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Direct Method Example
Allocation base: Square feet occupied
50,000
25,000 + 50,000$90,000 × = $60,000
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Operating Department(Machining)
Operating Department(Assembly)
Step Method
Once a servicedepartment’s costs
are allocated, other service
department costsare not allocated
back to it.
Service Department(Cafeteria)
Service Department(Custodial)
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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.
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Step Method Example
Service Department Allocation Base
Cafeteria Number of employeesCustodial Square feet occupied
We will use the same data used in the direct method example.
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Step Method Example
Allocate Cafeteria costs first sinceit provides more service than Custodial.
Allocate Cafeteria costs first sinceit provides more service than Custodial.
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Step Method Example
$360,000 ×10
10 + 20 + 30= $60,000
Allocation base: Number of employees
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Step Method Example
$360,000 ×20
10 + 20 + 30= $120,000
Allocation base: Number of employees
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Step Method Example
$360,000 ×30
10 + 20 + 30= $180,000
Allocation base: Number of employees
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Step Method Example
New total = $90,000 original Custodial cost plus $60,000 allocated from the Cafeteria.
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Step Method Example
$150,000 ×25,000
25,000 + 50,000 = $50,000
Allocation base: Square feet occupied
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Step Method Example
$150,000 ×50,000
25,000 + 50,000 = $100,000
Allocation base: Square feet occupied
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Reciprocal Method
Interdepartmentalservices are given
full recognitionrather than partialrecognition as withthe step method.
Service Department(Cafeteria)
Service Department(Custodial)
Operating Department(Machining)
Operating Department(Assembly)
Because of its mathematical complexity,
the reciprocal method is rarely used.
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Revenue Producing Service Departments
If a service departmentgenerates revenue, such as a
cafeteria that charges for the service itprovides, the revenue generated should
be offset against the costs incurred.Only the remaining net amount
of costs should be allocated to other departments.
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Quick Check Datafor Direct and Step Methods
Allocation bases:Business school administration costs (ADMIN): Number of employees
Business Administration computer services (BACS): Number of personal computers
The direct method of allocation is used.
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Quick Check
How much cost will be allocated from Administration to Accounting? a. $ 36,000b. $144,000c. $180,000d. $ 27,000
How much cost will be allocated from Administration to Accounting? a. $ 36,000b. $144,000c. $180,000d. $ 27,000
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How much cost will be allocated from Administration to Accounting? a. $ 36,000b. $144,000c. $180,000d. $ 27,000
How much cost will be allocated from Administration to Accounting? a. $ 36,000b. $144,000c. $180,000d. $ 27,000
Quick Check
$180,000 ×20
20 + 80= $36,000
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Quick Check
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
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
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Quick Check
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
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 ×18
18 + 102= $13,500
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Quick Check Data
Allocation bases:Business school administration costs (ADMIN): Number of employees
Business administration computer services (BACS): Number of personal computers
The step method of allocation is used.
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Quick Check
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
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
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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
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
Quick Check
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Allocating Costs by Behavior
When possible,variable and fixed
service department costsshould be allocated
separately.
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Variable servicedepartment costs should be
allocated to consuming departmentsaccording to the activity
causing incurrence of the cost.
Allocating Costs by Behavior
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Allocate fixed service department costs to consuming departments in predeterminedlump-sum amounts that are based on theconsuming departments’ peak or long-run
average needs. Fixed cost allocations:
Allocate fixed service department costs to consuming departments in predeterminedlump-sum amounts that are based on theconsuming departments’ peak or long-run
average needs. Fixed cost allocations:
Are based on amounts ofcapacity each consuming
department requires.
Should not vary fromperiod to period.
Allocating Costs by Behavior
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Allocating Costs by Behavior
Budgeted variableand fixed service departmentcosts should be allocated to
operating departments.
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Allocating Costs by Behavior
If variable cost allocations are made at thebeginning of the year, the budgeted variable
rate should be multiplied by the budgetedactivity level of each consuming department.
If variable cost allocations are made at thebeginning of the year, the budgeted variable
rate should be multiplied by the budgetedactivity level of each consuming department.
Allocations madeat the beginning of theyear provide data for
pricing and otherdecisions.
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Allocating Costs by Behavior
If variable cost allocations are made at theend of the year, the budgeted variablerate should be multiplied by the actual
activity level of each consuming department.
If variable cost allocations are made at theend of the year, the budgeted variablerate should be multiplied by the actual
activity level of each consuming department.
Allocations made atthe end of the year provide
data for performanceevaluation.
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SimCo has a maintenance department and two operatingdepartments: cutting and assembly. Variable maintenance
costs are budgeted at $0.60 per machine hour. Fixedmaintenance costs are budgeted at $200,000 per year.
Data relating to the current year are:
Allocate maintenance costs to the two operating departments.
SimCo: An Example
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Hours planned
SimCo: Beginning of the Year
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Percent of peak-period capacity.
SimCo: Beginning of the Year
Hours planned
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Hours used
SimCo: End of the Year
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Percent of peak-period capacity.
SimCo: End of the Year
Hours used
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Fixed cost allocations are the same at the end and at the beginning because they are
based on capacity instead of usage.
Fixed cost allocations are the same at the end and at the beginning because they are
based on capacity instead of usage.
SimCo: Comparison of Results
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SimCo: Comparison of Results
Only budgeted variable and fixed servicedepartment 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.
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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:
Percent ofPeak-Period Capacity Miles Miles
Hospitals Required Planned UsedMercy 45% 15,000 16,000 Northside 55% 17,000 17,500 Total 100% 32,000 33,500
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Quick Check
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
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
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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
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
Quick Check
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Quick Check
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
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
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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
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
Quick Check
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Effect of Allocations onOperating Departments
Once service department costallocations are completed, they areincluded in operating departments’:
Once service department costallocations are completed, they areincluded in operating departments’:
Performanceevaluations
Performanceevaluations
Profitabilitydetermination
Profitabilitydetermination
Overhead rate computations
Overhead rate computations
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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
Effect of Allocations onOperating Departments
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Service Department(Cafeteria)
Service Department(Accounting)
Service Department(Personnel)
Operating Department(Machining)
Operating Department(Assembly)
The Products
Second Stage Allocations
Operating department overhead costs and allocated service department costs are
applied to products.
Effect of Allocations onOperating Departments
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Pitfall 1
Allocating fixed costs using a variable
allocation base
Allocation Pitfalls to Avoid
Result
Fixed costsallocated to onedepartment are
heavily influenced bywhat happens in
other departments.
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Kolby Products: An Example
Kolby Products has two sales territories,the Eastern Territory and the Western Territory. Both sales territories are serviced by one auto
service center whose costs are all fixed. Contraryto good practice, Kolby allocates the fixed servicecenter costs to the sales territories on the basis
of actual miles driven (a variable base).
Kolby Products has two sales territories,the Eastern Territory and the Western Territory. Both sales territories are serviced by one auto
service center whose costs are all fixed. Contraryto good practice, Kolby allocates the fixed servicecenter costs to the sales territories on the basis
of actual miles driven (a variable base).
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Kolby Products: An Example
Year 1 Year 2Auto service center costs (all fixed) 120,000$ 120,000$
Miles driven Western sales territory 1,500,000 1,500,000 Eastern sales territory 1,500,000 900,000
Total miles driven 3,000,000 2,400,000
Allocation rate per mile 0.04$ 0.05$
$120,000 ÷ 3,000,000 miles
$120,000 ÷ 2,400,000 miles
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Kolby Products:First–year Allocations
Western sales territory1,500,000 miles @ $0.04 per mile 60,000$
Eastern sales territory1,500,000 miles @ $0.04 per mile 60,000
Total cost allocated 120,000$
Western sales territory1,500,000 miles @ $0.04 per mile 60,000$
Eastern sales territory1,500,000 miles @ $0.04 per mile 60,000
Total cost allocated 120,000$
The two sales territories share the servicecenter’s costs equally because the miles
driven in each territory are equal.
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Kolby Products:Second–year Allocation
Western sales territory1,500,000 miles @ $0.05 per mile 75,000$
Eastern sales territory900,000 miles @ $0.05 per mile 45,000
Total cost allocated 120,000$
Western sales territory1,500,000 miles @ $0.05 per mile 75,000$
Eastern sales territory900,000 miles @ $0.05 per mile 45,000
Total cost allocated 120,000$
Western territory has the same number of miles aslast year, but $15,000 more cost allocated
because Eastern’s miles declined in year 2.
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Pitfall 2
Using salesdollars as an
allocation base
Allocation Pitfalls to Avoid
Result
Sales of one departmentinfluence the service
department costsallocated to other
departments.
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Clothier Inc. – An Example
Clothier Inc., a men’s clothing store has oneservice department and three sales departments,
Suits, Shoes, and Accessories. Service departmentcosts total $60,000 for both years in the example.Contrary to good practice, Clothier allocates the
service department costs based on sales.
Clothier Inc., a men’s clothing store has oneservice department and three sales departments,
Suits, Shoes, and Accessories. Service departmentcosts total $60,000 for both years in the example.Contrary to good practice, Clothier allocates the
service department costs based on sales.
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Clothier Inc. – First-year Allocation
Suits Shoes Accessories TotalSales by department 260,000$ 40,000$ 100,000$ 400,000$ Percentage of total sales 65% 10% 25% 100%Allocation of service department costs 39,000$ 6,000$ 15,000$ 60,000$
Departments
$260,000 ÷ $400,000 65% of $60,000
In the next year, the manager of the Suit Departmentincreased sales by $100,000. Sales in the other departmentsare unchanged. Let’s allocate the $60,000 service department
cost for the second year given the sales increase.
In the next year, the manager of the Suit Departmentincreased sales by $100,000. Sales in the other departmentsare unchanged. Let’s allocate the $60,000 service department
cost for the second year given the sales increase.
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Clothier Inc. – Second-year Allocation
Suits Shoes Accessories TotalSales by department 360,000$ 40,000$ 100,000$ 500,000$ Percentage of total sales 72% 8% 20% 100%Allocation of service department costs 43,200$ 4,800$ 12,000$ 60,000$
Departments
$360,000 ÷ $500,000 72% of $60,000
If you were the suit department manager, wouldyou be happy with the increased service department
costs allocated to your department?
If you were the suit department manager, wouldyou be happy with the increased service department
costs allocated to your department?
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End of Chapter 15
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