189 CHAPTER 7 SUPPORT-DEPARTMENT COST ALLOCATION QUESTIONS FOR WRITING AND DISCUSSION 1. Stage one assigns support-department costs to producing departments. Costs are assigned using factors that reflect the con- sumption of the services by each producing department. Stage two allocates the costs assigned to the producing departments (in- cluding service costs and direct costs) to the products passing through the producing de- partments. 2. Support-department costs are part of the cost of producing a product. Knowing the in- dividual product costs is helpful for develop- ing bids and cost-plus prices. 3. GAAP require that all manufacturing costs be assigned to products for inventory valua- tion. 4. Allocating support-department costs makes users pay attention to the level of service ac- tivity consumed and also provides an incen- tive for them to monitor the efficiency of the support departments. 5. Without any allocation of support- department costs, users may view services as a free good and consume more of the service than is optimal. Allocating support- department costs would encourage manag- ers to use the service until such time as the marginal cost of the service is equal to the marginal benefit. 6. Since the user departments are charged for the services provided, they will monitor the performance of the support department. If the service can be obtained more cheaply externally, then the user departments will be likely to point this out to management. Knowing this, a manager of a support de- partment will exert effort to maintain a com- petitive level of service. 7. The identification and use of causal factors ensures that support-department costs are accurately assigned to users. This increases the legitimacy of the control function and enhances product costing accuracy. 8. a. Number of employees; b. Square foo- tage; c. Pounds of laundry; d. Orders processed; e. Maintenance hours worked; f. Number of employees; and g. Number of transactions processed. 9. Allocating actual costs passes on the effi- ciencies or inefficiencies of the support de- partment, something which the manager of the producing department cannot control. Al- locating budgeted costs avoids this problem. 10. The direct method allocates the direct costs of each support department directly to the producing departments. No consideration is given to the fact that other support depart- ments may use services. The sequential method allocates support-department costs sequentially. First, the costs of the center providing the greatest service to all user de- partments, including other support depart- ments, are allocated. Next the costs of the second greatest provider of services are al- located to all user departments, excluding any department(s) that has already allocated costs. This continues until all support- department costs have been allocated. The principal difference in the two methods is the fact that the sequential method considers some interactions among support depart- ments and the direct method ignores inte- ractions. 11. Yes, the reciprocal method is more accurate because it fully considers interactions among support departments. However, the reciprocal method is much more complex and can be difficult for managers to under- stand. If the results are similar, the simpler method should be used. 12. A joint cost is a cost incurred in the simulta- neous production of two or more products. At least one of these joint products must be a main product. It is possible for the joint production process to produce a product of relatively little sales value relative to the main product(s); this product is known as a by-product. 13. Joint costs occur only in cases of joint pro- duction. A joint cost is a common cost, but a common cost is not necessarily a joint cost. Many overhead costs are common to the products manufactured in a factory but do not signify a joint production process.
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118899
CHAPTER 7 SUPPORT-DEPARTMENT COST ALLOCATION
QUESTIONS FOR WRITING AND DISCUSSION
1. Stage one assigns support-department costs to producing departments. Costs are assigned using factors that reflect the con-sumption of the services by each producing department. Stage two allocates the costs assigned to the producing departments (in-cluding service costs and direct costs) to the products passing through the producing de-partments.
2. Support-department costs are part of the cost of producing a product. Knowing the in-dividual product costs is helpful for develop-ing bids and cost-plus prices.
3. GAAP require that all manufacturing costs be assigned to products for inventory valua-tion.
4. Allocating support-department costs makes users pay attention to the level of service ac-tivity consumed and also provides an incen-tive for them to monitor the efficiency of the support departments.
5. Without any allocation of support-department costs, users may view services as a free good and consume more of the service than is optimal. Allocating support-department costs would encourage manag-ers to use the service until such time as the marginal cost of the service is equal to the marginal benefit.
6. Since the user departments are charged for the services provided, they will monitor the performance of the support department. If the service can be obtained more cheaply externally, then the user departments will be likely to point this out to management. Knowing this, a manager of a support de-partment will exert effort to maintain a com-petitive level of service.
7. The identification and use of causal factors ensures that support-department costs are accurately assigned to users. This increases the legitimacy of the control function and enhances product costing accuracy.
8. a. Number of employees; b. Square foo-tage; c. Pounds of laundry; d. Orders processed; e. Maintenance hours worked; f. Number of employees; and g. Number of transactions processed.
9. Allocating actual costs passes on the effi-ciencies or inefficiencies of the support de-partment, something which the manager of the producing department cannot control. Al-locating budgeted costs avoids this problem.
10. The direct method allocates the direct costs of each support department directly to the producing departments. No consideration is given to the fact that other support depart-ments may use services. The sequential method allocates support-department costs sequentially. First, the costs of the center providing the greatest service to all user de-partments, including other support depart-ments, are allocated. Next the costs of the second greatest provider of services are al-located to all user departments, excluding any department(s) that has already allocated costs. This continues until all support-department costs have been allocated. The principal difference in the two methods is the fact that the sequential method considers some interactions among support depart-ments and the direct method ignores inte-ractions.
11. Yes, the reciprocal method is more accurate because it fully considers interactions among support departments. However, the reciprocal method is much more complex and can be difficult for managers to under-stand. If the results are similar, the simpler method should be used.
12. A joint cost is a cost incurred in the simulta-neous production of two or more products. At least one of these joint products must be a main product. It is possible for the joint production process to produce a product of relatively little sales value relative to the main product(s); this product is known as a by-product.
13. Joint costs occur only in cases of joint pro-duction. A joint cost is a common cost, but a common cost is not necessarily a joint cost. Many overhead costs are common to the products manufactured in a factory but do not signify a joint production process.
119900
EXERCISES
7–1
a. support b. support c. producing d. producing e. support f. support g. producing h. producing
i. support j. support k. producing l. support m. producing n. support o. support
7–2
a. support b. support c. support d. support e. support f. producing g. producing h. support
i. support j. producing k. producing l. support m. support n. support o. support
7–3
a. direct labor hours; number of employees b. number of processing hours c. labor hours; units produced d. number of orders; materials cost e. materials cost; orders received f. orders shipped g. number of employees
h. square feet i. square feet j. kilowatt-hours k. number of employees; direct labor cost l. square feet m. machine hours; number of repair jobs n. cubic feet
119911
7–4
1. Charging rate = ($80 × 100 hours)/400 units = $20 per apartment unit 2. Amount charged = ($80 × 130 hours) = $10,400
Amount actually charged apartment building owners:
Number of Charge Total Units × per Unit = Charges The Roost 130 $20 $ 2,600 Magnolia House 70 20 1,400 Oak Park 120 20 2,400 Wisteria Lane 50 20 1,000 Elm Street 30 20 600 Total 400 $ 8,000 Number of Charge Total Hours × per Hour = Charges The Roost 35 $80 $ 2,800 Magnolia House 10 80 800 Oak Park 45 80 3,600 Wisteria Lane 15 80 1,200 Elm Street 25 80 2,000 Total 130 $ 10,400
3. The use of number of legal hours as the charging base is much better than the
number of apartment units. The number of legal hours is directly associated with the attorney’s charges. The number of units is, apparently, a poor proxy for the use of legal services. Two problems are immediately evident. First, the use of the unit charge means that Stewart will only be charging actual legal fees when the number of units times the per-unit rate happens to equal the number of hours times the per-hour rate. In this case, he will not recoup all of his spending on le-gal fees. That occurred here, where Stewart charged the owners only $8,000 for legal fees, but paid the attorney $10,400. In other years, the amount charged the apartment owners will be more than the amount charged by the attorney. Second, it is possible for apartment owners to have a smaller or larger proportion of units than of hours. Even in the example above, we can see that Elm Street has a small percentage of units, but causes a larger proportion of legal fees.
119922
7–5
1. Single charging rate = ($320,000 + $400,000)/24,000 = $30/DLH 2. Charge to the Used Car Sales Dept. = $517 + ($30 × 12 DLH) = $877 3. Actual DLH × Charging Rate + DM = Total Charges New Car Sales 1,000 $30 $ 3,100 $ 33,100 Used Car Sales 4,700 30 7,860 148,860 Service 19,400 30 86,300 668,300 Total 25,100 $97,260 $850,260
1. $460 = $46 × number of hours of maintenance Number of hours of maintenance = 10 hours
The controller must have looked up the usage of maintenance by the Assembly Department, found that it had used 10 hours, and multiplied those hours by the single charging rate of $46. In that case, $460 would be correct.
New charge for Assembly Department = $24 × 10 routine hours = $240 3. When single charging rates are used by companies, they must be aware that
changes in the way work is performed may require changes in the charging rate(s). In this case, the additional complexity caused by the computer-controlled equipment means that a single charging rate does not adequately control for the differences in cost caused by different departments. Multiple charging rates do a better job of charging the using department for the resources provided by the support departments.
119944
7–8
1. Allocation ratios for S1 based on number of employees:
Direct costs $ 90,000 $167,000 $84,000 $ 72,000 $230,000 General Factory1: (0.05 × $167,000) 8,350 (8,350) (0.15 × $167,000) (25,050) 25,050 (0.60 × $167,000) (100,200) 100,200 (0.20 × $167,000) (33,400) 33,400 Power2: (0.20 × $98,350) (19,670) 19,670 (0.16 × $98,350) (15,736) 15,736 (0.64 × $98,350) (62,944) 62,944 Human Resources: (0.71 × $128,720) (91,391) 91,391 (0.29 × $128,720) (37,329) 37,329 Total $ 0 $ 0 $ 0 $279,327 $363,673 1based on square feet: Power = 2,000/(2,000+6,000+24,000+8,000) HR = 6,000/(2,000+6,000+24,000+8,000) Shaping = 24,000/(2,000+6,000+24,000+8,000) Firing = 8,000/(2,000+6,000+24,000+8,000) 2based on kilowatt hours : HR = 25,000/(25,000+20,000+80,000) Shaping = 20,000/(25,000+20,000+80,000) Firing = 80,000/(25,000+20,000+80,000) Allocation Ratios for HR department based on direct labor hours : Shaping 10,000/(10,000+4,000) Firing 4,000/(10,000+4,000) 2. Shaping: $279,327/10,000 = $27.93 per DLH* Firing: $403,576/4,000 = $90.92 per DLH*
*Rounded
119999
7-14 Units Percent × Joint Cost = Allocated Joint Cost Andol 1,000 0.1250 $100,000 $12,500 Incol 1,500 0.1875 100,000 18,750 Ordol 2,500 0.3125 100,000 31,250 Exsol 3,000 0.3750 100,000 37,500 Total 8,000 $100,000 7-15 Price at Market Value Joint Allocated Units Split-off at Split-off Percent Cost Cost Andol 1,000 $20.00 $ 20,000 0.0556 $100,000 $ 5,560 Incol 1,500 75.00 112,500 0.3125 100,000 31,250 Ordol 2,500 64.00 160,000 0.4444 100,000 44,440 Exsol 3,000 22.50 67,500 0.1875 100,000 18,750 Total 8,000 $360,000 $100,000 7-16 1. Eventual Separable Hypothetical Units Price Market Value Costs Market Value Percent Ups 39,000 $2.00 $78,000 $18,000 $60,000 0.60 Downs 21,000 2.18 45,780 5,780 40,000 0.40 Total $100,000 Ups Downs Joint cost $42,000 $42,000 × Percent of hypothetical market value × 0.60 × 0.40 Allocated joint cost $25,200 $16,800 2. Value of ups at split-off (39,000 × $1.80) $70,200 Value of ups when processed further $78,000 Less: Further processing cost 18,000 Incremental value of further processing $60,000 Ups should NOT be processed further as there will $10,200 more profit if sold at split-off.
220000
7–17
1. HR Power Mixing Packaging HR1 — 0.3000 0.3500 0.3500 Power2 0.0769 — 0.2308 0.6923 1based on payroll: 90,000/(90,000+105,000+105,000) 105,000/(90,000+105,000+105,000) 105,000/(90,000+105,000+105,000) 2based on kilowatt hours: 5,000/(5,000+15,000+45,000) 15,000/(5,000+15,000+45,000) 45,000/(5,000+15,000+45,000) P = $150,000 + 0.3HR P = $150,000 + 0.3($110,000 + 0.0769P) P = $150,000 + $33,000 + 0.0231P
Human Resources Power Mixing Packaging Direct overhead costs $110,000 $150,000 $100,000 $280,000 Allocated from: HR (124,405) 37,321 43,542 43,542 Power 14,409 (187,327) 43,235 129,686 Total $ 0 $ (5)* $186,777 $453,228
*Difference due to rounding. 2. Mixing: $186,777/20,000 = $9.34 per DLH Packaging: $453,228/30,000 = $15.11 per DLH
220011
7–18
1. Support Departments Producing Departments HR Power Mixing Packaging Direct overhead $110,000 $150,000 $100,000 $280,000 Allocate HR1 (110,000) - 55,000 55,000 Allocate Power - (150,000) 37,500 112,500 Total $ 0 $ 0 $192,500 $447,500 1 based on payroll: Mixing = 105,000/(105,000+105,000) = 0.50 Packaging = 105,000/(105,000+105,000) = 0.50
2 based on kilowatt hours: Mixing = 15,000/(15,000+45,000) = 0.25 Packaging = 45,000/(15,000+45,000) = 0.75 2. Mixing: $192,500/20,000 = $9.63 per DLH Packaging: $447,500/30,000 = $14.92 per DLH
The reciprocal method is more accurate because support-department costs are allocated to other support departments. Using the direct method, Human Re-sources and Power do not receive any other support department costs. How im-portant the increased accuracy is for this example is not clear. Some might argue that the departmental rates do not differ enough to justify using the more compli-cated reciprocal method.
220022
7–19
1. Support Departments Producing Departments HR Power Mixing Packaging Direct overhead $110,000 $150,000 $100,000 $280,000 Allocate HR1 (110,000) 33,000 38,500 38,500 Allocate Power2 - (183,000) 45,750 137,250 Total $ 0 $ 0 $184,250 $455,750 1 based on payroll: Power = 90,000/(90,000+105,000+105,000) = 0.30 Mixing = 105,000/(90,000 + 105,000+105,000) = 0.35 Packaging = 105,000/(90,000 + 105,000+105,000) = 0.35
2 based on kilowatt hours: Mixing = 15,000/(15,000+45,000) = 0.25 Packaging = 45,000/(15,000+45,000) = 0.75
2. Mixing: $184,250/20,000 = $9.21 per DLH Packaging: $455,750/30,000 = $15.19 per DLH
The sequential method is more accurate than the direct method and less accurate than the reciprocal method. The reason is that at least some support-department reciprocity is accounted for using the sequential method, while none is recog-nized under the direct method.
220033
7–20
A = $35,000 + 0.3B B = $40,000 + 0.2A
A = $35,000 + 0.3($40,000 + 0.2A) A = $47,000 + 0.06A 0.94A = $47,000 A = $50,000
B = $40,000 + 0.2($50,000) B = $50,000
Allocation ratios (ratios for D obtained by “plugging”):
Dept. A Dept. B Dept. C Dept. D Dept. A — 0.2 0.2 0.6* Dept. B 0.3 — 0.4 0.3** *(1.0 – 0.2 – 0.2)
Drilling: $487,000/30,000 = $16.23 per MHr (rounded) Assembly: $486,000/40,000 = $12.15 per DLH
Prime costs $1,817.00 Drilling (2 × $16.23) 32.46 Assembly (50 × $12.15) 607.50 Total cost $2,456.96 Markup (15%) 368.54 Bid price $2,825.50 2. Yes, there is a difference in the bids. Ranking Maintenance first results in a higher
dollar allocation to Power ($120,000) than the allocation from Power to Mainten-ance ($40,000). Then, the greater usage of Power by Assembly results in a higher allocation to Assembly when Maintenance is ranked first. Thus, the ranking of Maintenance first gives a greater chance for support-department interaction to be reflected in the ultimate overhead rates. (These results can be compared with the results using the reciprocal method in Problem 7–26.)
221122
7–28
1. Units Percent × Joint Cost = Allocated Joint Cost Two Oil 300,000 0.4545 $10,000,000 $4,545,000 Six Oil 240,000 0.3636 10,000,000 3,636,000 Distillates 120,000 0.1818 10,000,000 1,818,000 Total 660,000 $9,999,000 2. Price at Market Value Joint Allocated Units Split-off at Split-off Percent Cost Cost
Two Oil 300,000 $20 $6,000,000 0.4000 $10,000,000 $4,000,000
Six Oil 240,000 30 7,200,000 0.4800 10,000,000 4,800,000 Distillates 120,000 15 1,800,000 0.1200 10,000,000 1,200,000 Total 660,000 $15,000,000 $10,000,000
*Note: Items are used to allocate accounting costs; machine hours to allocate maintenance; square feet to allocate custodial services; and employees to allo-cate both personnel costs and cafeteria costs.
Note 1: Custodial services was not included as it had no direct variable costs.
Note 2: The order of allocation was based on the magnitude of direct variable costs as follows: maintenance, cafeteria, personnel, and cost accounting.
Note 3: Employees is the base for allocating cafeteria and personnel. Employees (1) pertains to cafeteria and employees (2) to personnel.
The methods assign costs differently and produce different prices for the batch of chocolate bars. The difference in price is over $500. This amount could be sig-nificant, depending on the competitive conditions facing the firm. Assuming that the sequential method provides more accurate cost assignments, this method should be used if the increased accuracy is important for the firm’s well-being. Otherwise, the firm should use the much simpler direct method.
Variable Cost + Fixed Cost = Total Baton Rouge ($18)(1,475) = $26,550 + $10,500 = $37,050 Kilgore ($18)(1,188) = $21,384 + $11,200 = $32,584 Longview ($18)(500) = $9,000 + $14,000 = $23,000 Paris ($18)(525) = $9,450 + $17,500 = $26,950 Shreveport ($18)(562) = $10,116 + $16,800 = $26,916 3. Method 2 allocates cost on the basis of the cost driver which causes it and would
be more likely to encourage managers to use Purchasing Department time effi-ciently. Method 1 assigns purchasing costs according to a base that may not be causally related. Therefore, an apartment complex with stable rentals from one year to the next may still experience wild fluctuations in allocated cost due to changing rental patterns of other apartment complexes.
222222
7–31
1. Department A Department B Direct overhead $200,000 $ 800,000 Maintenance: (1/8)($500,000) 62,500 (7/8)($500,000) 437,500 Power: (1/6)($225,000) 37,500 (5/6)($225,000) 187,500 Setups: (40/200)($150,000) 30,000 (160/200)($150,000) 120,000 General Factory: (0.272)($625,000) 170,000 (0.728)($625,000) 455,000 Total $500,000 $ 2,000,000
Dept. A overhead rate: $500,000/200,000 = $2.50 per DLH Dept. B overhead rate: $2,000,000/120,000 = $16.67 per MHr (rounded)
222233
7–31 Continued
2. Allocation order: General Factory, Maintenance, Power, Setups, A, and B
Allocation Ratios Alloc. from: G.F. Maint. Power Setups Dept. A Dept. B G.F. — 0.125 0.200 0.025 0.177 0.473 Maint. — — 0.150 0.050 0.100 0.700 Power — — — — 0.167 0.833 Setups — — — — 0.200 0.800 G.F. Maint. Power Setups Dept. A Dept. B Direct $ 625,000 $ 500,000 $ 225,000 $ 150,000 $200,000 $ 800,000 G.F. (625,000) 78,125 125,000 15,625 110,625 295,625 Maint. — (578,125) 86,719 28,906 57,813 404,687 Power — — (436,719) — 72,932 363,787 Setups — — — (194,531) 38,906 155,625 Total $ 0 $ 0 $ 0 $ 0 $480,276 $2,019,724
Dept. A overhead rate: ($480,276/200,000) = $2.40 per DLH* Dept. B overhead rate: ($2,019,724/120,000) = $16.83 per MHr*
Although the difference is small, it appears to make the bids more attractive. 3. The use of the sequential method to allocate support-department costs to produc-
ing departments gives more accurate overhead rates. 4. If the best competing bid was $4.10 lower than the original bid, then it would be
$14.65. In this case, the sequential method of allocating overhead costs would provide a bid ($14.63) that is just below the competing bid. Since the sequential method is more accurate, the $14.63 bid is a good one.
222244
MANAGERIAL DECISION CASES
7–32
1. Emma’s argument about the arbitrary nature of allocations has little merit. Even if the allocation is arbitrary, changing it to exploit a customer is wrong. Many allo-cations, however, are based on causal factors and reflect the consumption of re-sources. If we accept cause and effect as a reasonable criterion for allocation, then switching to a factor that is less related to overhead consumption certainly will increase the inaccuracy of the product cost. Emma should price the new or-der using the most accurate cost information available. Thus, the current alloca-tion scheme should be maintained.
2. The controller (Lenny) should refuse to change the allocation method and make
every attempt to tactfully convince Emma of the impropriety of the recommended action. Often, a simple comment questioning the propriety of an action is suffi-cient to dissuade. According to the IMA Statement of Ethical Professional Prac-tice, accountants should “refrain from engaging in any conduct that would preju-dice carrying out duties ethically.” (III-2) The accountant should also abstain from engaging in or supporting any activity that might discredit the profession. (III-3) By changing allocation procedures, the controller would obtain personal gain (a bonus) from unethical means. Furthermore, Lenny has an obligation to communi-cate information fairly and objectively (IV-1). Choosing an allocation method that is known to be less accurate is not consistent with this requirement.
3. Lenny should pursue all levels of internal review until a satisfactory resolution is
achieved. Then, after exhausting all levels of internal review, Lenny should sub-mit his resignation.
4. Reacting with anger and contacting the customer was not an appropriate action
(as defined by the code for management accountants). According to the code, “Except where legally prescribed, communication of such problems to authorities or individuals not employed or engaged by the organization is not considered ap-propriate.”
*Total direct fixed costs/Flying hours **Total direct variable costs/Flying hours
Original expected profit (uses the original hours and the above bid prices and unit variable costs):
Revenues: 1,200 × $243.42 = $292,104 ,600 × $218.52 = 349,632 900 × $478.15 = 430,335 $ 1,072,071 Less variable costs 414,903 Contribution margin $ 657,168 Less direct fixed expenses (363,315) Less indirect fixed expenses (154,000) Income before taxes $ 139,853
Note: The answer can also be obtained by multiplying the profit per hour for each helicopter by the original hours and summing. (Any slight difference is due to rounding error.)
*Rounded
222277
7–33 Continued
2. The actual revenues earned (for the first six months) were as follows: 299 × $243.42 = $ 72,783 160 × $218.52 = 34,963 204 × $478.15 = 97,543 $205,289
Actual costs incurred: 500D 206B 206L-1 Total Direct costs—fixed* $46,623 $47,100 $87,935 $181,658 Direct costs—variable** 7,636 3,834 22,497 33,967 Overhead—variable*** 19,934 10,667 13,601 44,202 Indirect fixed costs* 77,000 Total $336,827
*Half of total annual costs **Per-unit variable costs × Actual flying hours
***Per-unit variable cost ($66.67) × Actual flying hours
Revenues needed = (1 + m)(Total costs for revised hours) = (1 + m)($754,741) $894,594 = (1 + m)($754,741) 1 + m = $894,594/$754,741 1 + m = 1.185 m = 0.185
Thus, the revised prices are as follows: 500D: (1.185)($386.26) = $457.72* per hour 206B: (1.185)($331.14) = $392.40* per hour 206L-1: (1.185)($477.80) = $566.19* per hour