two problems on Costing allocation and Planning&Budgeting

Cost Allocation

Lecture 25

Chapter 11 * Modified from PPT slides of McGraw-Hill/Irwin

Overview:

1. Explain why service costs are allocated.

2. Allocate service department costs using the direct method.

3. Allocate service department costs using the step method.

4. Allocate service department costs using the reciprocal method.

5. Explain why joint costs are allocated.

6. Allocate joint costs using the net realizable value method.

7. Allocate joint costs using the physical quantities method.

Service Department Cost Allocation

Service Department Cost Allocation

Department that uses the

functions of service departments.

Department that provides service

to other subunits in the

organization.

Cost center whose costs are

charged to other departments in

the organization.

Service Department User Department

Intermediate Cost Center

Cost center, such as a production

department, whose costs are not

allocated to another cost center.

Final Cost Center

Service Department Cost Allocation, Continued. . .

Product costing

Service Department Cost Allocation, Continued. . .

Carlyle Coal Company (CCC)

Service Department:

Information Systems (S1)

Service and User Departments of

Service Department:

Administration (S2)

User Department:

Hilltop Mine (P1)

User Department:

Pacific Mine (P2)

Service Department Cost Allocation, Continued. . .

Carlyle Coal Company Information Systems (S1)

Total S1 Costs $800,000

Allocation Base: Computer Hours

User Department Number of Hours Used

Administration (S2) 100,000

Hilltop Mine (P1) 20,000

Pacific Mine (P2) 80,000

Totals 200,000

Number of Hours Used Percent of Total

50%

10%

40%

100%

Service Department Cost Allocation, Continued. . .

Carlyle Coal Company Administration (S2)

Total S2 Costs $5,000,000

Allocation Base: Employees User Department Employees

Information Systems (S1) 2,000

Hilltop Mine (P1) 5,000

Pacific Mine (P2) 3,000

Totals 10,000

Percent of Total

20%

50%

30%

100%

Service Department Allocation Method:

1. Direct method.

2. Step method.

3. Reciprocal method.

Direct Method

Charges costs of service departments to

user departments without making

allocations between or among service

departments.

Direct Method:

S1 S2

P1 P2

Service Department Cost Allocation, Continued. . .

Carlyle Coal Company Information Systems (S1)

Total S1 Costs $800,000

Allocation Base: Computer Hours

User Department Number of Hours Used

Administration (S2) 100,000 Hilltop Mine (P1) 20,000

Pacific Mine (P2) 80,000

Totals 100,000

Number of Hours Used Percent of Total

50%

10% 20%

40% 80%

100%

Service Department Cost Allocation, Continued. . .

Carlyle Coal Company Administration (S2)

Total S2 Costs $5,000,000

Allocation Base: Employees User Department Employees

Information Systems (S1) 2000 Hilltop Mine (P1) 5,000

Pacific Mine (P2) 3,000

Totals 8,000

Employees Percent of Total

20%

50% 62.5%

30% 37.5%

100%

Cost Allocation: Direct Method

Service Department Cost Allocation

a 20% = 20,000 hours/(20,000 hours + 80,000 hours)

b 62.5% = 5,000 employees/(5,000 employees + 3,000 employees)

Service Department Direct Cost P1 P2 Total

S1 800,000$ 20.0% a

80.0% 100.0%

S2 5,000,000 62.5% b

37.5% 100.0%

Percent Allocable to

S1 800,000$ 160,000$ c

640,000$ 800,000$

S2 5,000,000 3,125,000 d

1,875,000 5,000,000

Total allocated 5,800,000$ 3,285,000$ 2,515,000$ 5,800,000$

c $160,000 = 20% x $800,000

d $3,125,000 = 62.5% x $5,000,000

Step Method

The step method allocates some service department

costs to other service departments.

Once an allocation is made from a service department no further

allocations are made back to that service department. Generally

allocate in order of proportion of services provided to other service

departments.

S1 S2

P1 P2

Cost Allocation: Step Method

Service Department Cost Allocation

Service Department Direct Cost S1 S2 P1 P2 Total

S1 800,000$ 0% 50% a

10.0% b

40.0% c

100.0%

S2 5,000,000 0% 0% 62.5% d

37.5% e

100.0%

Percent Allocable to

From S1 S2 P1 P2 Total

800,000$ 5,000,000$ 5,800,000$

S1 (800,000) 400,000 f

80,000 g

320,000 h

-0-

S2 -0- (5,400,000) 3,375,000 i

2,025,000 j

-0-

Total $ -0- $ -0- 3,455,000$ 2,345,000$ 5,800,000$

To

Reciprocal Method

Recognizes all services provided by any service department,

including services provided to other service departments

The reciprocal method accounts for cost

flows among service departments

providing services to each other.

It requires a

simultaneous equation

solution.

S1 S2

P1 P2

The Simultaneous Equation

1. Write the costs of each service

department in equation form.

Total Service

Department

Direct cost of the

service

department

Cost allocated from

other service

departments

2. Solve equations

simultaneously using

matrix algebra.

= +

Cost Allocation: Reciprocal Method

S2 = $5,000,000 + $400,000 + 0.10 S2

S2 = $6,000,000

1. S1 = $800,000 + 0.20 S2

2. S2 = $5,000,000 + 0.50 S1

S2 = $5,000,000 + 0.50 $800,000 + 0.20 S2

.90 S2 = $5,400,000

Example: Reciprocal Method

S1 = $800,000 + 0.20 $6,000,000

S1 = $2,000,000

Example: Reciprocal Method, Continued. . .

Service Department Cost Allocation

Service Department Total Costs S1 S2 P1 P2 Total

S1 2,000,000$ 0% 50% a

10.0% b

40.0% c

100.0%

S2 6,000,000 20% d

0% 50.0% e

30.0% f

100.0%

Percent Allocable to

User Department Number of Hours Used

Administration (S2) 100,000

Hilltop Mine (P1) 20,000

Pacific Mine (P2) 80,000

Totals 200,000

Number of Hours Used Percent of Total

50%

10%

40%

100%

User Department Employees Percent of Total

Information Systems (S1) 2,000 20%

Hilltop Mine (P1) 5,000 50%

Pacific Mine (P2) 3,000 30%

Totals 10,000 100%

Example: Reciprocal Method, Continued. . .

Service Department Cost Allocation

Service Department Total Costs S1 S2 P1 P2 Total

S1 2,000,000$ 0% 50% a

10.0% b

40.0% c

100.0%

S2 6,000,000 20% d

0% 50.0% e

30.0% f

100.0%

Percent Allocable to

From S1 S2 P1 P2 Total

Direct costs 800,000$ 5,000,000$ $ -0- $ -0- 5,800,000$ i

S1 a

1,000,000 b

200,000 c

800,000 d

-0-

S2 1,200,000 e f

3,000,000 g

1,800,000 h

-0-

Total $ -0- $ -0- 3,200,000$ 2,600,000$ 5,800,000$ i

To

i $5,800,000 of service

department costs were

ultimately allocated to

production departments.

(2,000,000)

(6,000,000)

Comparison of Direct, Step, and Reciprocal Method

Method Hilltop Mine Pacific Mine Total

Direct 3,285,000$ 2,515,000$ 5,800,000$

Step 3,455,000 2,345,000 5,800,000

Reciprocal 3,200,000 2,600,000 5,800,000

Cost Allocated to

Joint Cost Allocation

Overview:

1. Explain why service costs are allocated.

2. Allocate service department costs using the direct method.

3. Allocate service department costs using the step method.

4. Allocate service department costs using the reciprocal method.

5. Explain why joint costs are allocated.

6. Allocate joint costs using the net realizable value method.

7. Allocate joint costs using the physical quantities method.

Joint Cost

Joint Products

Split-Off Point

Cost of a manufacturing process

with two or more outputs

Outputs from a common input

and common production process

Stage of processing that

separates two or more products

Joint Cost

Joint Cost

Upstream

Costs:

$XXXXXX

Split-off

Point

Gasoline

Diesel Oil

Benzene

Jet A-1

Kerosene

Crude Oil

Joint Cost, Continued. . .

Joint Cost Flows

Mining Costs:

$270,000

Split-off

Point Hi-Grade Coal: 15,000 units

Sales Value $300,000

Lo-Grade Coal: 30,000 units

Sales Value $450,000

Carlyle Coal Company

Allocation of Joint Costs

Evaluating executive performance

Valuing products

Net realizable value method

Physical quantities method

Allocation of Joint Costs

Net realizable value (NRV)

Sales value of each product at the split-off point.

Net realizable value method

Joint cost allocation based on the proportional values of

the products at the split-off point.

Estimated net realizable value

Sales price of a final product minus additional processing

costs necessary to prepare a product for sale.

Example: NRV Method

Carlyle Coal Company Joint Cost Allocation NRV Method; no additional processing costs

Hi-Grade Lo-Grade Total

Final sales value 300,000$ 450,000$ 750,000$

Less additional processing costs -0- -0- -0-

Net realizable value at split-off point 300,000$ 450,000$ 750,000$

Porportionate share

$300,000/$750,000 40%

$450,000/$750,000 60%

Allocated joint costs

$270,000 x 40% 108,000$

$270,000 x 60% 162,000$

Example: NRV Method, Continued. . .

Hi-Grade Lo-Grade Total

Sales value 300,000$ 450,000$ 750,000$

Less allocated joint costs 108,000 162,000 270,000

Gross margin 192,000$ 288,000$ 480,000$

Gross margin as a percent of sales 64% 64% 64%

Carlyle Coal Company Gross Margin Computations