Support Department and Joint Cost Allocation ( discussion )

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Chapter 5

Support Department and Joint Cost Allocation

Support Departments (slide 1 of 3)

A support department provides a necessary service to produce a product, but is not directly involved in the production process.

For example, Janitorial and Maintenance departments are necessary for production, but are not directly involved in production.

Support departments are sometimes called service departments because they provide services to other departments.

Support departments are normally accounted for as a cost or responsibility center. All direct costs of the support department are accumulated in the center.

Support Departments (slide 2 of 3)

Because support department costs are only indirectly related to production, they are difficult to apply to products.

However, it is difficult, if not impossible, to find an appropriate cost driver for applying these costs to a product.

Some companies consider support department costs to be facility-level costs and do not apply them to products.

Support Departments (slide 3 of 3)

This approach ignores the fact that support department services may be used more heavily by some products than others, which can result in inaccurate product costs.

Hence, guidance for incorporating support department cost allocation into a product costing system is provided in the following slides.

Single Plantwide Rate (slide 1 of 2)

When a single plantwide overhead rate is used to apply overhead to products, support department costs are simply combined with all other overhead costs.

The total overhead cost is then applied to the products using a single cost driver.

Because a single driver is used for all overhead costs, it is unlikely that the driver selected is appropriate for every type of overhead.

Single Plantwide Rate (slide 2 of 2)

This method ignores the fact that the processes used in manufacturing a product may differ from those used for other products.

As a result, using a single plantwide rate may result in inaccurate product costs.

Multiple Production Department Rates

When multiple production department rates are used to apply overhead to products, overhead costs are first directly traced or distributed to support and production departments.

Support department costs are then allocated to production departments based on the amount of support activity used by each production department.

After support department costs are allocated to the production departments, production department costs are then applied to the products using cost drivers for each production department.

Activity-Based Costing (slide 1 of 2)

When activity-based costing (ABC) is used to apply overhead to products, support department costs are referred to as support activity costs.

The process for allocating support activity costs is similar to that used with multiple production department rates.

Overhead costs are directly traced or distributed to support and production activities.

Support activity costs are allocated to production activities.

Production activity costs are applied to the products using cost drivers for each production activity.

Activity-Based Costing (slide 2 of 2)

The terms assign, distribute, apply, and allocate are often used when referring to manufacturing costs and the transfer of these costs to departments and products.

Transferring overhead costs to support and production departments is referred to as distributing overhead costs.

Transferring costs to products is referred to as applying costs to products or the application of costs.

Allocating costs or cost allocation may be used in a variety of ways.

Allocating Support Department Costs to Production Departments

The Direct Method

Using the Direct Method – Decker Tables (slide 1 of 6)

Step 1 - The costs for each department are determined by identifying costs that can be traced to a specific department.

	Janitorial Department	Cafeteria Department	Cutting Department	Assembly Department
Department costs	$310,000	$169,000	$1,504,000	$680,000

Using the Direct Method – Decker Tables (slide 2 of 6)

Step 2 - An appropriate cost driver is determined for each support department.

The more square footage that needs to be the cleaned, the higher the Janitorial costs.

Step 3 - The usage of the support department cost drivers by each department is determined.

Support Department	Cost Driver
Janitorial Department	Square footage to be serviced
Cafeteria Department	Number of employees

Cost Driver	Janitorial Department	Cafeteria Department	Cutting Department	Assembly Department
Square feet	50	5,000	1,000	4,000
Number of employees	10	3	30	10

Using the Direct Method – Decker Tables (slide 3 of 6)

Step 4 - The percentage usage of support department cost drivers by the production departments is determined.

Determining the percentage usage based on square footage

Using the Direct Method – Decker Tables (slide 4 of 6)

Determining the percentage based on the number of employees

Step 5 - Support department costs are allocated to the production departments by multiplying the percentage usage of each production department by the total support department costs.

Using the Direct Method – Decker Tables (slide 5 of 6)

The Cafeteria costs of $126,750 are allocated $161,250 to the Cutting Department and $42,250 to the Assembly Department, as follows:

Department	Janitorial Department Costs
Cutting Department	$ 62,000 ($310,000 × 20%)
Assembly Department	248,000 ($310,000 × 80%)
Total	$310,000

Department	Cafeteria Department Costs
Cutting Department	$126,750 ($169,000 × 75%)
Assembly Department	42,250 ($169,000 × 25%)
Total	$169,000

Using the Direct Method – Decker Tables (slide 6 of 6)

The support department costs are added to any costs that were directly traced or distributed to the production departments in Step 1.

Thus, the total costs of the Cutting and Assembly departments are as follows:

The Sequential Method or Step-Down Method

The Sequential Method (slide 1 of 7)

Under the sequential method, support department costs are never allocated back to a support department whose costs have already been allocated.

As a result, the sequential method captures some, but not all, of the inter-support-department services.

The Sequential Method – Allocation of Costs

The Sequential Method (slide 2 of 7)

There may be a conflict in the preceding factors.

For example, the support department with the highest costs may serve the fewest number of other support departments.

As a result, managers often make subjective assessments about the order of allocating support departments.

Steps 1 to 3 of the sequential method are the same as for the direct method.

Production Departments

Support Departments

Specifics	Janitorial	Cafeteria	Cutting	Assembly
Square feet	50	5,000	1,000	4,000
Number of employees	10	3	30	10
Department costs	$310,000	$169,000	$1,504,000	$680,000

The Sequential Method (slide 3 of 7)

In Step 4, the proportional usage of each support department’s cost driver by the other departments to which its costs are to be allocated is determined.

Assume that Decker Tables decides to allocate Janitorial costs first, followed by Cafeteria costs.

Department	Square Feet	Usage Percent
Cafeteria	5,000	50%
Cutting	1,000	10
Assembly	4,000	40
Totals	10,000	100%

Janitorial Department Usage

The Sequential Method (slide 4 of 7)

The proportional usage of Cafeteria services by the Cutting and Assembly departments is as follows:

The usage of the Cafeteria Department by the Janitorial Department is not considered.

This is because the Cafeteria Department costs are allocated after the Janitorial Department.

Once a support department’s costs are allocated under the sequential method, it is not allocated any additional costs.

Cafeteria Department Usage

Department	Square Feet	Usage Percent
Cafeteria	5,000	50%
Cutting	1,000	10
Assembly	4,000	40
Totals	10,000	100%

The Sequential Method (slide 5 of 7)

In Step 5, each support department’s costs are allocated to other departments.

The support department’s total costs are multiplied by the proportional usage of the departments to which costs are allocated.

Under the sequential method, the total support department costs to be allocated will also include any costs that were allocated to that support department from other support departments.

This is a major difference between the sequential method and the direct method.

The Sequential Method (slide 6 of 7)

To illustrate, the Janitorial Department’s costs of $310,000 are allocated to the Cafeteria, Cutting, and Assembly departments by multiplying $310,000 by each department’s proportional usage, as follows:

Department	Janitorial Department Costs ($)	×	Usage Percent (%)	=	Allocated Cost ($)
Cafeteria Department	$310,000	×	50%	=	$155,000
Cutting Department	310,000	×	10	=	31,000
Assembly Department	310,000	×	40	=	124,000
Totals			100%		$310,000

The Sequential Method (slide 7 of 7)

The total Cafeteria Department costs of $324,000 ($169,000 + $155,000) are allocated to the Cutting and Assembly departments as follows:

The support department cost allocations using the sequential method for Decker Tables are summarized in the next slide.

Department	Cafeteria Department Costs ($)	×	Usage Percent (%)	=	Allocated Cost ($)
Cutting Department	$324,000	×	75%	=	$243,000
Assembly Department	324,000	×	25	=	81,000
Totals			100%		$324,000

The Reciprocal Services Method (slide 1 of 10)

The Reciprocal Services Method (slide 2 of 10)

Steps 1 to 3 of the reciprocal method are the same as for the direct and sequential methods.

Support departments never allocate their own costs to themselves.

The two cells shaded in the table are not needed.

These drivers represent services the support departments used within their departments.

Specifics	Janitorial	Cafeteria	Cutting	Assembly
Square feet	50	5,000	1,000	4,000
Number of employees	10	3	30	10
Department cost	$310,000	$169,000	$1,504,000	$680,000

The Reciprocal Services Method (slide 3 of 10)

In Step 4, the proportional usage of each support department’s cost driver by the other departments to which its costs are to be allocated is determined.

The proportional usages of Janitorial services are the same as those indicated with the sequential method.

Janitorial Department Usage

Department	Square Feet	Usage Percent
Cafeteria	5,000	50%
Cutting	1,000	10
Assembly	4,000	40
Totals	10,000	100%

Cafeteria Department Usage

Department	Number of employees	Usage Percent
Janitorial	10	20%
Cutting	30	60
Assembly	10	20
Totals	50	100%

The Reciprocal Services Method (slide 4 of 10)

In Step 5, support department costs are allocated simultaneously among the departments.

This is done by using multiple algebraic equations with variables for unknown quantities.

To illustrate, costs are allocated from Janitorial to Cafeteria, Cutting, and Assembly by multiplying the total Janitorial costs by the proportional usage of the other departments.

The total Janitorial costs, however, include an unknown amount for costs related to its employees’ use of the cafeteria.

Thus, the total of the Janitorial costs is expressed by the unknown, J.

The Reciprocal Services Method (slide 5 of 10)

Costs are allocated from Cafeteria to Janitorial, Cutting, and Assembly by multiplying the total Cafeteria costs by the proportional usage of the other departments.

But again, the total Cafeteria costs will include an unknown amount for costs related to the Cafeteria Department’s use of the Janitorial Department’s services.

Thus, the total of the Cafeteria costs is expressed by the unknown, C.

The Reciprocal Services Method (slide 6 of 10)

The total costs of the Janitorial Department will include 20% of the Cafeteria Department’s costs, which is the percent usage of the cafeteria by the Janitorial Department.

The total costs of the Cafeteria Department will include 50% of the Janitorial Department’s costs, which is the percent usage of Janitorial services by the Cafeteria Department.

The Reciprocal Services Method (slide 7 of 10)

The preceding yields two equations with two unknowns, as follows:

Equation 2 can be rewritten in terms of J.

The Reciprocal Services Method (slide 8 of 10)

J in Equation 1 can then be replaced, resulting in the following equation:

Solving Equation 3 for C yields the following:

The Reciprocal Services Method (slide 9 of 10)

Adding the value of C to Equation 1 results in the following:

The total Janitorial Department cost and the total Cafeteria Department cost can now be allocated to the other departments based on the percentage usages, as shown in the next slide.

The Reciprocal Services Method (slide 10 of 10)

Departments	Janitorial Department Costs ($)	×	Usage Percent (%)	=	Allocated Cost($)
Cafeteria Department	382,000	×	50	=	191,000
Cutting Department	382,000	×	10	=	38,000
Assembly Department	382,000	×	40	=	152,000
Totals			100		382,000

Departments	Cafeteria Department Costs ($)	×	Usage Percent (%)	=	Allocated Cost($)
Janitorial Department	360,000	×	20	=	72,000
Cutting Department	360,000	×	60	=	216,000
Assembly Department	360,000	×	20	=	72,000
Totals			100		360,000

Comparison of Support Department Cost Allocation Methods

The total costs allocated to the Cutting and Assembly departments are different depending on which of the three support department allocation methods is used, as shown in the next slide.

Joint Costs

Allocating Joint Costs

Physical units method

Weighted average method

Market value at split-off method

Net realizable value method

Physical Units Method (slide 1 of 3)

The physical units method allocates joint costs using a physical measure of the products at the split-off point, such as pounds, gallons, or inches.

Physical Units Method (slide 2 of 3)

The joint costs per batch of mud are as follows:

Assume that at the split-off point, there are the following quantities of products:

Specifics	Amount ($)
Direct materials	17,750
Direct labor	2,300
Overhead	213,790
Total costs	233,840

Specifics	Quantity (pounds)
Skin cream	200
Shampoo	150
Soap	150
Total	500

Physical Units Method (slide 3 of 3)

Using the physical units method, the total joint costs of $233,840 are allocated using the pounds of products at the split-off point.

Product	Split-Off Quantity (pounds)	Percent at Split-Off	×	Joint Cost	=	Joint Cost Allocation
Skin cream	200	40	×	$233,840	=	$ 93,536
Shampoo	150	30	×	233,840	=	70,152
Soap	150	30	×	233,840	=	70,152
Totals	500	100				$233,840

The Weighted Average Method (slide 1 of 3)

The weighted average method allocates joint costs based on weight factors for each product.

The weight factors are multiplied by physical units to arrive at weighted physical units.

These weighted physical units are then used to allocate the joint costs to the products.

The weight factors can be based on a variety of factors, such as the type of labor needed for each product, the difficulty of producing each product, and the estimated wear and tear on machines caused by each product.

The Weighted Average Method (slide 2 of 3)

Assume that Davis Pharmaceuticals allocates joint costs based on the mixing times of each product.

The mixing speed for shampoo is three times that of cream and soap.

Thus, management applies a weighting factor of 3 to shampoo and a weighting factor of 1 to skin cream and soap.

The weighted pounds for shampoo is 450 pounds.

The weighted pounds for skin cream is 200 pounds.

The weighted pounds for soap is 150 pounds.

The Weighted Average Method (slide 3 of 3)

The joint cost allocations for all three products are shown below.

Product	Split-Off Quantity (pounds)	Mixing Time Weight Factor	Weighted Pounds of Mixing Time (pounds)	Weighted Percent of Mixing Time (%)	×	Joint Cost ($)	=	Joint Cost Allocation($)
Skin cream	200	1	200	25.00	×	$233,840	=	$ 58,460
Shampoo	150	3	450	56.25	×	233,840	=	131,535
Soap	150	1	150	18.75	×	233,840	=	43,845
Totals	500	5	800	100.00				$233,840

The Market Value at Split-Off Method (slide 1 of 3)

The market value at split-off method allocates joint costs using each product’s total market value at the split-off point.

Products that have a higher market value are allocated more joint costs.

To use the market value at split-off method, an estimate of the market value at split-off must be available.

If a product is sold at the split-off point, its actual sales price is used.

The Market Value at Split-Off Method (slide 2 of 3)

Assume that Davis Pharmaceuticals can sell skin care cream and shampoo at the split-off point.

At split-off point, skin care cream and shampoo sell for $540 per pound and $480 per pound, respectively.

Though soap requires additional processing to be sold, management estimates a market value of $400 per pound for soap at the split-off point.

Skin cream ($540 × 200 pounds)	$108,000
Skin cream ($480 × 150 pounds)	72,000
Soap ($400 × 150 pounds)	60,000
Total market value	$240,000

The Market Value at Split-Off Method (slide 3 of 3)

Using the market value at split-off method, the joint cost allocations for all three products are shown below.

Product	Split-Off Quantity (pounds)	×	Estimated Selling Price per Pound at Split-Off ($)	=	Total Market Value at Split-Off ($)	Percent of Total Market Value at Split-Off (%)	×	Joint Cost ($)	=	Joint Cost Allocation ($)
Skin cream	200	×	$ 540	=	$108,000	45	×	233,840	=	$105,228
Shampoo	150	×	480	=	72,000	30	×	233,840	=	70,152
Soap	150	×	400	=	60,000	25	×	233,840	=	58,460
Totals	500	×	$1,420		$240,000	100				$233,840

The Net Realizable Value Method (slide 1 of 5)

The net realizable value method allocates joint costs using each product’s estimated net realizable value after it is fully processed.

Products that have a higher net realizable value are allocated more joint costs.

Some products can be sold at the split-off point or be processed further and sold for a higher price.

Net realizable value is the estimated selling price of a product less any costs necessary to further process the product beyond the split-off point.

The Net Realizable Value Method (slide 2 of 5)

For products processed beyond the split-off point, net realizable value is computed as follows:

For products not processed beyond the split-off point, the net realizable value is computed as follows:

The Net Realizable Value Method (slide 3 of 5)

To illustrate, assume the following for Davis Pharmaceuticals’ three products:

Davis Pharmaceuticals must decide which products to process further and which to sell at split-off.

Products	Selling Price at Split-Off Point ($)	Additional Processing Costs ($)	Selling Price after Further Processing ($)
Skin cream	540	2,000 per batch	730
Shampoo	420	4,000 per batch	425
Soap	None	6,000 per batch	520

The Net Realizable Value Method (slide 4 of 5)

Given the preceding decisions on further processing, the percentages of total net realizable value of the three products are as follows:

Product	Net Realizable Value ($)	Percent of Total Net Realizable Value (%)
Skin cream	$144,000	50%
Shampoo	72,000	25
Soap	72,000	25
Totals	$288,000	100%

The Net Realizable Value Method (slide 5 of 5)

Using the net realizable value method, the joint costs of $233,840 are allocated as follows:

Product	Percent of Total Net Realizable Value (%)	×	Joint Cost ($)	=	Joint Cost Allocation ($)
Skin cream	50%	×	233,840	=	$116,920
Shampoo	25	×	233,840	=	58,460
Soap	25	×	233,840	=	58,460
Totals	100%				$233,840

Comparison of Joint Cost Allocation Methods (slide 1 of 2)

None of the four methods is more accurate than any other method because they all allocate costs that are, by definition, inseparable.

Thus, a subjective determination must be made as to the most appropriate method to use.

The physical units method is the easiest to use and allocates more costs to skin cream than to shampoo and soap because more pounds of skin cream were produced in the joint process.

Comparison of Joint Cost Allocation Methods (slide 2 of 2)

If management wants joint cost allocations to reflect the difficulty with which products are made, the weighted average method is most appropriate.

If management wants joint cost allocations to reflect the final market value of products, the net realizable value method is ideal.

By-Products (slide 1 of 2)

By-products are goods of low value that are produced from a joint production process.

Because of their low value, it is not worth the effort to develop separate product costs for by-products.

Instead, the revenues from by-products are often used to offset the cost of the joint production process.

Alternatively, the sale of by-products is sometimes reported as other revenue on the income statement with no related cost of goods sold.

By-Products (slide 2 of 2)

Assume that an early step in the joint production of skin cream, shampoo, and soap for Davis Pharmaceuticals is the removal of small amounts of mercury from the mud.

Rather than incur the costs of further processing the mercury or disposing of the mercury in an environmentally safe manner, Davis Pharmaceuticals sells it to Knight Manufacturing.

Each batch produces $320 worth of mercury by-product.

Davis Pharmaceuticals subtracts the $320 of mercury revenues from the joint production overhead costs.

Analysis for Decision Making (slide 1 of 5)

Allocating support department costs and joint costs has important implications for product costing.

Some product costs are easy to identify and trace directly to the products

For example, it is easy to identify and trace direct materials in a product that is not a joint product, or to identify and trace direct materials for a joint product after the split-off point.

Production employee performance is often evaluated based on product costs.

For example, production manager bonuses may be tied to decreasing product costs.

Analysis for Decision Making (slide 2 of 5)

Consider the performance report of three general managers who oversee three separate chemical lines.

Analysis for Decision Making (slide 3 of 5)

All GMs were over their cost targets. Ranking the managers based on total costs:

McKenna performed closest to her targets, over by $42,350, followed by Jenn, over by $123,600, and Jeff, over by $148,700.

Thus, the company president may believe that McKenna is the strongest GM of the group

However, closer examination reveals a more complex story.

Analysis for Decision Making (slide 4 of 5)

McKenna missed her target primarily because her direct materials costs were too high.

This could be because of wasted materials in the production process or some other cause.

Jeff missed his performance target primarily because of a higher-than-expected allocation of support costs.

This could be due to overuse of support activities.

But since these costs are allocated based on square feet and number of employees, Jeff may not be responsible for the higher costs.

Analysis for Decision Making (slide 5 of 5)

Jenn missed her performance target primarily because of the allocation of joint product costs.

These costs are allocated based on the net realizable value of the chemical produced, Drison.

Drison generates significantly higher margins than the other two lines.

As a result, Jenn’s product line received a much higher allocation of joint costs.

Jenn, however, has no oversight over the joint production process, and is not responsible for the higher costs.

1,000

Cutting Department: 20% of Janitorial S

ervices

1,000 + 4,000

4,000

Assembly Department: 80% of Janitorial

Services

1,000 + 4,000

Cutting Department: 75% of Janitorial S

ervices

30 + 10

Assembly Department: 25% of Cafeteria S

ervices

30 + 10

Cutting Department

$1,504,000 (from Step 1) + $62,000 (from

Step 5) + $126,750 (from Step 5) = $1,6

92,750

Assembly Department

$680,000 (from Step 1) + $248,000 (from

Step 5) + 42,250 (from Step 5) = $970,25

J = $310,000 + (0.20 C)

C = $169,000 + (0.50 J)

Equation 1: J = $310,000 + (0.20 C)

Equation 2: C = $169,000 + (0.50 J)

C = $169,000 + (0.50 J)

C – $169,000 = 0.50 J

C–$169,000

0.50

C – $169,000

Equation 3: = $310,000 + (0.20C)

0.50

C – $169,000

= $310,000 + (0.20 C)

0.50

C – $169,000 = (0.50$310,000) + (0.500.2

0C)

C = $169,000 + (0.50$310,000) + (0.500.2

0C)

C = $169,000 + $155,000 + (0.10C)

C – (0.10C) = $169,000 + $155,00

´´´

0.90 C = $324,000

$324,000

C =

0.90

C = $360,000

J = $310,000 + (0.20 C)

= $310,000 + (0.20 $360,000)

= $310,000 + $72,000

= $382,000

Net Realizable Value = (Final Selling Pr

ice × Quantity) – Additional Processing

Costs

Net Realizable Value = Selling Price at

Split-Off Quantity