Service Department Costing: An Activity
Approach
Chapter 15
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
The Need for Cost Allocations
OperatingDepartments
Carry out the central purposes
of an organization
ServiceDepartments
Provide supportto the
operatingdepartments
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
First, we identify the factor that drives costs in the
service department.
This cost driver is usedas the allocation base.
The Need for Cost Allocations
How are servicedepartment costs
charged to operatingdepartments?
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
The Need for Cost Allocations
Second, we measure theconsumption of the
allocation base in theoperating departments.
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
The Need for Cost Allocations
Third, we allocatethe service
department costbased on the
relative amount of the allocation base
used in eachoperating department.
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
What happens toservice department
costs after theyare allocated to
operatingdepartments?
The Need for Cost Allocations
Allocated service departmentcosts become a part ofthe overhead in each
operating department.
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
The Need for Cost Allocations
I get it. They becomea part of the overhead
that is applied toproducts with apredeterminedoverhead rate.
That’s right. Take a lookat this flow chart.
I think it will summarizeour discussion of theallocation process.
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
The Need for Cost Allocations
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
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
The Need for Cost Allocations
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.
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Guidelines for Cost Allocation
OperatingDepartments
ServiceDepartments
1. Allocation bases
2. Interdepartmental services
3. Allocating costs by behavior
4. Allocation pitfalls to avoid
5. Allocation of actual or budgeted costs
$
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Selecting Allocation Bases
Personnel:Number ofemployees
Receiving:Units
handled
Security:Squarefootage
Power:Kilowatt
hours
Cafeteria:Number ofemployees
Custodial:Squarefootage
Accounting:Staffhours
Criteria
Easiest
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Selecting Allocation Bases
Availabilityof space orequipment
Personnel:Number ofemployees
Receiving:Units
handled
Security:Squarefootage
Power:Kilowatt
hours
Cafeteria:Number ofemployees
Custodial:Squarefootage
Accounting:Staffhours
Criteria
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Selecting Allocation Bases
Benefits receivedby the operating
department
Personnel:Number ofemployees
Receiving:Units
handled
Security:Squarefootage
Power:Kilowatt
hours
Cafeteria:Number ofemployees
Custodial:Squarefootage
Accounting:Staffhours
Criteria
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Selecting Allocation Bases
Consumption ofresources
Personnel:Number ofemployees
Receiving:Units
handled
Security:Squarefootage
Power:Kilowatt
hours
Cafeteria:Number ofemployees
Custodial:Squarefootage
Accounting:Staffhours
Criteria
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
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
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Direct Method
Service Department(Cafeteria)
Service Department(Custodial)
Operating Department(Machining)
Operating Department(Assembly)
Interactionsbetween servicedepartments areignored and all
costs areallocated directly
to operatingdepartments.
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Direct Method Example
Service Department Allocation Base
Cafeteria Number of employeesCustodial Square feet occupied
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Direct Method Example
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Direct Method Example
Allocation base: Number of employees
$360,000 ×20
20 + 30= $144,000
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Direct Method Example
Allocation base: Number of employees
$360,000 ×30
20 + 30= $216,000
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Direct Method Example
$90,000 ×25,000
25,000 + 50,000 = $30,000
Allocation base: Square feet occupied
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Direct Method Example
Allocation base: Square feet occupied
50,000
25,000 + 50,000$90,000 × = $60,000
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
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)
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Step Method
Service Department(Cafeteria)
Service Department(Custodial)
Operating Department(Machining)
Operating Department(Assembly)
Custodial willhave a new
total to allocateto operating
departments; itsown costs plus
those costsallocated fromthe cafeteria.
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
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.
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Step Method Example
Allocate Cafeteria costs first sinceit provides more service than Custodial.
Allocate Cafeteria costs first sinceit provides more service than Custodial.
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Step Method Example
$360,000 ×10
10 + 20 + 30= $60,000
Allocation base: Number of employees
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Step Method Example
$360,000 ×20
10 + 20 + 30= $120,000
Allocation base: Number of employees
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Step Method Example
$360,000 ×30
10 + 20 + 30= $180,000
Allocation base: Number of employees
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Step Method Example
New total = $90,000 original custodial cost plus $60,000 allocated from the cafeteria.
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Step Method Example
$150,000 ×25,000
25,000 + 50,000 = $50,000
Allocation base: Square feet occupied
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Step Method Example
$150,000 ×50,000
25,000 + 50,000 = $100,000
Allocation base: Square feet occupied
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
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.
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Comparison of Methods
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Quick Check Data
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.
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Quick Check
How much cost will be allocated from Administration to Accounting?
a. $ 36,000
b. $144,000
c. $180,000
d. $ 27,000
How much cost will be allocated from Administration to Accounting?
a. $ 36,000
b. $144,000
c. $180,000
d. $ 27,000
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
How much cost will be allocated from Administration to Accounting?
a. $ 36,000
b. $144,000
c. $180,000
d. $ 27,000
How much cost will be allocated from Administration to Accounting?
a. $ 36,000
b. $144,000
c. $180,000
d. $ 27,000
Quick Check
$180,000 ×20
20 + 80= $36,000
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Quick Check
How much total cost will be allocated from ADMIN and BACS combined to the Accounting Department?
a. $ 52,500
b. $135,000
c. $270,000
d. $ 49,500
How much total cost will be allocated from ADMIN and BACS combined to the Accounting Department?
a. $ 52,500
b. $135,000
c. $270,000
d. $ 49,500
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Quick Check
How much total cost will be allocated from ADMIN and BACS combined to the Accounting Department?
a. $ 52,500
b. $135,000
c. $270,000
d. $ 49,500
How much total cost will be allocated from ADMIN and BACS combined to the Accounting Department?
a. $ 52,500
b. $135,000
c. $270,000
d. $ 49,500
$90,000 ×18
18 + 102= $13,500
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
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.
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Quick Check
How much total cost will be allocated from ADMIN and BACS combined to the Accounting Department?
a. $35,250
b. $49,072
c. $18,000
d. $26,333
How much total cost will be allocated from ADMIN and BACS combined to the Accounting Department?
a. $35,250
b. $49,072
c. $18,000
d. $26,333
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
How much total cost will be allocated from ADMIN and BACS combined to the Accounting Department?
a. $35,250
b. $49,072
c. $18,000
d. $26,333
How much total cost will be allocated from ADMIN and BACS combined to the Accounting Department?
a. $35,250
b. $49,072
c. $18,000
d. $26,333
Quick Check
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
But that would not be beneficial to the
company; most of those costs are fixed.
What if we charged a flat annual fee for the service?
Allocating Fixed Costs
My performance lookedgood until they
allocated those service department costs, so I’m not going to use
the service again.
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Allocating Fixed Costs
That sounds better.
If the fee is fixed,the more I use the
service the lower myaverage cost per
use will be.
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Allocating Costs by Behavior
VariableCosts
Charge tooperating
departments at abudgeted rate times
the usage of theallocation base.
FixedCosts
Allocatebudgeted amounts
to operating departmentsin proportion to the
peak-period capacityrequired by the
operating department.
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
VariableCosts
Charge tooperating
departments at abudgeted rate times
the usage of theallocation base.
FixedCosts
Allocatebudgeted amounts
to operating departmentsin proportion to the
peak-period capacityrequired by the
operating department.
Allocating Costs by Behavior
Budgeted costs should be allocatedto avoid passing on inefficiencies
from the service departments.
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Allocations are made at the beginning of theperiod to provide data for predetermined
overhead rates and flexible budgets.
Allocations are made at the end of the period to provide data for comparing actual
performance to planned performance.
Allocations are made at the beginning of theperiod to provide data for predetermined
overhead rates and flexible budgets.
Allocations are made at the end of the period to provide data for comparing actual
performance to planned performance.
Allocating Costs by Behavior
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Allocating Costs by BehaviorExampleSimCo has a maintenance department and two operating
departments: cutting and assembly. Variable maintenancecosts 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:
Allocate maintenance costs to the two operating departments.
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Allocating Costs by BehaviorExample: Beginning of the Period
Cutting AssemblyDepartment Department
Variable cost allocation: $0.60 × 75,000 hours 45,000$ $0.60 × 50,000 hours 30,000$ Fixed cost allocation
Total allocated cost
Hours planned
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Allocating Costs by BehaviorExample: Beginning of the Period
Cutting AssemblyDepartment Department
Variable cost allocation: $0.60 × 75,000 hours 45,000$ $0.60 × 50,000 hours 30,000$ Fixed cost allocation 60% of $200,000 120,000 40% of $200,000 80,000 Total allocated cost 165,000$ 110,000$
Percent of peak-period capacity.
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Hours used
Allocating Costs by BehaviorExample: End of the Period
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Percent of peak-period capacity.
Allocating Costs by BehaviorExample: End of the Period
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
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.
Allocating Costs by BehaviorExample
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Quick Check Data
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:
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Quick Check
How much ambulance service cost will be allocated to Mercy Hospital at the beginning of the year?
a. $117,000
b. $254,400
c. $114,480
d. $119,250
How much ambulance service cost will be allocated to Mercy Hospital at the beginning of the year?
a. $117,000
b. $254,400
c. $114,480
d. $119,250
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
How much ambulance service cost will be allocated to Mercy Hospital at the beginning of the year?
a. $117,000
b. $254,400
c. $114,480
d. $119,250
How much ambulance service cost will be allocated to Mercy Hospital at the beginning of the year?
a. $117,000
b. $254,400
c. $114,480
d. $119,250
Quick Check
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Quick Check
How much ambulance service cost will be allocated to Mercy Hospital at the end of the year?
a. $114,000
b. $118,800
c. $110,400
d. $121,200
How much ambulance service cost will be allocated to Mercy Hospital at the end of the year?
a. $114,000
b. $118,800
c. $110,400
d. $121,200
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
How much ambulance service cost will be allocated to Mercy Hospital at the end of the year?
a. $114,000
b. $118,800
c. $110,400
d. $121,200
How much ambulance service cost will be allocated to Mercy Hospital at the end of the year?
a. $114,000
b. $118,800
c. $110,400
d. $121,200
Quick Check
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Pitfall 1
Using salesdollars as an
allocation base
Allocation Pitfalls to Avoid
Result
Departments thatincrease revenues arepenalized by receivingmore allocated costs.
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Pitfall 2
Allocating fixed costs using a variable
activity allocationbase
Allocation Pitfalls to Avoid
Result
Total fixed costs do notchange, but departmentsthat increase activities to
support increasedrevenues are penalized
by receiving moreallocated costs.
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
End of Chapter 15