Chapter 17

Allocation of
Support Activity
Costs and Joint
Costs

McGraw-Hill/Irwin

Copyright 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Learning Objective 1

17-2
17-2

Service Department Cost

Allocation
How are service
department costs
charged to production
departments?

First, we identify the factor

that drives costs in the
service department.
This cost driver is called
the allocation base.

17-3

Service Department Cost

Allocation
Service
Departments

Production
Departments

support
Provide support
that facilitates the
activities of production
departments.

Carry out the

central purposes
of an organization.

17-4

Service Department Cost

Allocation
How are service
department costs
charged to production
departments?

Well, we measure the

consumption of the
allocation base in the
production departments.

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Service Department Cost

Allocation
How are service
department costs
charged to production
departments?

Third, we allocate the service

department cost based on
the relative amount of the
allocation base consumed in
each production department.

17-6

Service Department Cost

Allocation
What happens to
service department
costs after they are
allocated to
production
departments?

Allocated service department

costs become a part of the
manufacturing overhead in
each production department.

17-7

Service Department Cost

Allocation
I get it. They become
a part of the overhead
that is applied to
products with a
predetermined
overhead rate.

Allocated service department

costs become a part of the
manufacturing overhead in
each production department.

17-8

Service Department Cost

Allocation
So, the costs become
a part of the finished
product via the
application of the predetermined factory
overhead rate.

Exactly. Take a look at

this flow chart.
I think it will summarize
our discussion of the
allocation process.

17-9

Service Department Cost Allocation

Service
Department
(Cafeteria)
Service
Department
(Accounting)
Service
Department
(Personnel)

First Stage Allocations

Service department costs are allocated
to production departments.

Production
Department
(Machining)
Production
Department
(Assembly)

The
Product

Second Stage Allocations

Production department overhead costs, plus allocated service department costs, are
applied to products using departmental predetermined overhead rates.
17-10

Selecting Allocation Bases

Personnel:
Number of
employees

Typical
Allocation
Bases

Receiving:
Units
handled
Security:
Square
footage

Custodial:
Square
footage
Cafeteria:
Number of
employees

Accounting:
Staff
hours

Power:
Kilowatt
hours
17-11

Selecting Allocation Bases

Personnel:
Number of
employees
Receiving:
Units
handled
Security:
Square
footage

Criteria for
selection
Simplicity
Availability
of space or
equipment
Benefits received
by the production
department

Accounting:

Staff
hours

Custodial:
Square
footage
Cafeteria:
Number of
employees
Power:
Kilowatt
hours
17-12

Interdepartmental Services
Service
Department
(Cafeteria)

Production
Department
(Machining)

POWER DEPARTMENT

Service
Department
(Custodial)

Production
Department
(Assembly)

17-13

Interdepartmental Services
Problem
Allocating costs when service departments
provide services to each other

Solutions
Direct Method
Step-Down Method

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Direct Method
Cost of services
between service
departments are
ignored and all
costs are
allocated directly
to production
departments.

Service
Department
(Cafeteria)

Production
Department
(Machining)

Service
Department
(Custodial)

Production
Department
(Assembly)

For an example please see the textbook.

17-15

Step-Down Method
Service department
costs are allocated
to other service
departments and
to production
departments, usually
starting with the
service department
that serves the
largest number of
other service
departments.

Service
Department
(Cafeteria)

Production
Department
(Machining)

Service
Department
(Custodial)

Production
Department
(Assembly)

17-16

Step-Down Method
Once a service
departments costs
are allocated,
other service
departments costs
are not allocated
back to it.

Service
Department
(Cafeteria)

Production
Department
(Machining)

Service
Department
(Custodial)

Production
Department
(Assembly)

17-17

Step-Down Method
Custodial will
have a new
total to allocate
to production
departments: its
own costs plus
those costs
allocated from
the cafeteria.

Service
Department
(Cafeteria)

Production
Department
(Machining)

Service
Department
(Custodial)

Production
Department
(Assembly)

For an example please see the textbook.

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Learning Objective 2

17-19

Fixed Versus Variable Costs

Problem
Allocating common
fixed costs using a
variable activity
allocation base

Result
When one department
decreases activity to
reduce allocations, all
departments are penalized
because the charge
per use increases.
Remember, total fixed
costs do not change as
activity changes.
17-20

Fixed Versus Variable Costs

Problem
Allocating common
fixed costs using a
variable activity
allocation base

Solution
Use dual allocation
method, allocating
fixed and variable
costs separately.

17-21

Dual Cost Allocation

Charge to
production
departments at a
budgeted rate times
actual short-run usage of
the allocation base.

Allocate
budgeted amounts
to operating departments
in proportion to the
long-run average
usage of the
allocation base.

Budgeted costs should be allocated to avoid passing on inefficiencies

from the service departments.
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Dual Cost Allocation

Example
SimCo has a maintenance department and two production
departments: cutting and assembly. Variable maintenance
costs 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:

Production
Departments
Cutting
Assembly
Total

Long-run
Maintenance
Usage as a
% of Total
60%
40%
100%

Actual
Hours
Used
80,000
40,000
120,000

Allocate maintenance costs to the two operating departments.

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Dual Cost Allocation

Example
Cutting
Department
Variable cost allocation:
$0.60 80,000 hours used
$0.60 40,000 hours used
Fixed cost allocation
60% of $200,000
40% of $200,000
Total allocated cost

Assembly
Department

48,000
$

24,000

80,000
104,000

120,000
$

168,000

Variable costs are allocated based on hours used.

Fixed costs are allocated based long-run average usage.
17-24

A Behavioral Problem
Problem

Solution

Department managers
may underestimate
long-run average usage
to reduce fixed cost
allocations.

Reward managers for

making accurate estimates
of long-run average
service department needs.

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Learning Objective 3

17-26

The New Manufacturing

Environment
More
More accurate
accurate cost
cost tracing
tracing systems
systems
reduce
reduce the
the need
need for
for allocation
allocation
of
of indirect
indirect costs.
costs.

17-27

The Rise of Activity-Based

Costing
Service
Department
(Cafeteria)
Service
Department
(Accounting)
Service
Department
(Personnel)

First stage allocations are to

activities, not departments.
Activity
One
The
Product

Activity
Two

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Learning Objective 4

17-29

Joint Product Cost Allocation

Product

Joint Product
Costs

Product

Product
17-30

Joint Product Cost Allocation

Concept:
In some industries, a number of products are

produced from a single raw material input.

Key terms:
Joint products products resulting from a process

with a common input.

Split-off point the stage of processing where

joint products are separated.

Joint product cost costs of processing joint

products prior to the split-off point.

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Joint Product Cost Allocation

Consider the following
example of an oil
refinery.
We will assume only
two products,
gasoline and oil.

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Joint Product Cost Allocation

Joint
Product
Costs
Joint
Input

Oil

Joint
Production
Process

Final
Sale

Separate
Processing Costs

Gasoline

Split-Off
Point

Separate
Processing

Separate
Processing

Final
Sale

Separate
Processing Costs
17-33

Learning Objective 5

17-34

Allocating Joint Costs

Physical-Units
Method

Joint Product
Costs

RelativeSales-Value
Method
Net-RealizableValue Method
17-35

Allocating Joint Costs

Physical-Units
Method

Allocation based on a
physical measure of the
joint products at the
split-off point.

Relative-SalesValue Method

Allocation based on
the relative values
of the products at
the split-off point.

Net-RealizableValue Method

Allocation based on
final sales values less
separable processing
costs.
17-36

Allocating Joint Costs

Lets look at an
example illustrating
the joint cost
allocation methods.

17-37

Physical-Units Method
Joint conversion
cost = $225,000

Joint material
cost = $275,000

Oil

240,000 gallons

Joint
Production
Process

Gasoline

360,000 gallons

Split-Off
Point
17-38

Physical-Units Method
Product
Oil
Output quantities in gallons
Proportionate share:
240,000 600,000
360,000 600,000
Allocated joint costs:
$500,000 40%
$500,000 60%

240,000

Gasoline
360,000

Total
600,000

40%
60%
$ 200,000
$ 300,000

$225,000 joint conversion cost plus

$275,000 joint material cost
17-39

Relative-Sales-Value Method
Joint conversion
cost = $225,000

Joint material
cost = $275,000

Oil

$200,000
sales value at
split-off point

Gasoline

$600,000
sales value at
split-off point

Joint
Production
Process

Split-Off
Point
17-40

Relative-Sales-Value Method
Product
Oil
Sales value at split-off point
Proportionate share:
$200,000 $800,000
$600,000 $800,000
Allocated joint costs:
$500,000 25%
$500,000 75%

Gasoline

Total

$ 200,000 $ 600,000 $ 800,000

25%
75%
$ 125,000
$ 375,000

$225,000 joint conversion cost plus

$275,000 joint material cost
17-41

Net-Realizable-Value Method
If products require further processing
beyond the split-off point before they
are marketable, it may be necessary to
estimate the net realizable value (NRV)
at the split-off point.

Estimated
NRV

Final
Sales
Value

Added
Processing
Costs
17-42

Net-Realizable-Value Method
Joint conversion
cost = $225,000

Joint material
cost = $275,000

Oil

Joint
Production
Process

Separate
Processing Costs
$200,000
Gasoline

Split-Off
Point, Sales
Value Unknown

Sales
Value
$500,000

Separate
Processing

Separate
Processing

Sales
Value
$1,200,000

Separate
Processing Costs
$500,000
17-43

Net-Realizable-Value Method
Product
Oil
Sales value
Less additional processing costs
Estimated NRV at split-off point
Proportionate share:
$300,000 $1,000,000
$700,000 $1,000,000
Allocated joint costs:
$500,000 30%
$500,000 70%

Gasoline

Total

$ 500,000 $ 1,200,000 $ 1,700,000

200,000
500,000
700,000
$ 300,000 $ 700,000 $ 1,000,000
30%
70%
$ 150,000
$ 350,000

17-44

By-Products
Joint
Costs

Joint
Input

Joint
Production
Process

Major
Product

Major
Product

By-products

Relatively low
value or quantity
when compared to
major products

Split-Off
Point
17-45

Two commonly used

methods of accounting
for by-products are . . .

By-Products

1. By-product NRV is
deducted from cost of
joint process before
allocation.

2. By-product NRV is
deducted from cost of
main product.
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Learning Objective 6

17-47

Reciprocal-Services Method
Fully accounts for reciprocal services
More accurate
Can be combined with dual allocation

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av
ai
la
bl
e

52

tim

35
20 %
12 %
33 %
%

W
ee
kly

17

Bi
M ol o
Fr ath gy
Ac en
co ch
un
t in
g

ho
ur
s

End of Chapter 17

17-49