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# MANAGEMENT ACCOUNTING

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Chapter Seven

## Support Department Cost Allocation

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Learning Objectives

## departments and producing departments.

Calculate single charging rates for a support

department.

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## departments using the direct, sequential, and reciprocal methods.

Calculate departmental overhead rates.

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## Support and Producing Departments

Support departments are units within an organization that provide essential support services for producing departments.
Examples: maintenance, grounds, engineering, housekeeping, personnel, and stores

Producing departments are units within an organization that are directly responsible for creating the products or services sold to customers.
Examples: Services: auditing, tax, management advisory Manufacturing: grinding and assembly PPT 7 -5

Definitions
Mutually beneficial costs, which occur when the same resource is used in the output of two or more services or products, are common costs.
Example: security guard wages at a factory

Causal factors are variables or activities within a producing department that provoke the incurrence of service costs.

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## Steps in Allocating Support Department Costs to Producing Departments

1. Departmentalize the firm. 2. Classify each department as a support or a producing department. 3. Trace all overhead costs in the firm to a support or producing department.

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## Steps in Allocating Support Department Costs to Producing Departments

4. Allocate support-department costs to the producing departments. 5. Calculate predetermined overhead rates for producing departments. 6. Allocate overhead costs to the units of individual products through the predetermined overhead rates.
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Objectives of Allocation
Objectives
To obtain a mutually agreeable price. To compute product-line profitability. To predict the economic effects of planning

and control.
To value inventory.
To motivate managers.
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## Examples of Cost Drivers for Support Departments

Support Department
Accounting Cafeteria Engineering Maintenance Payroll Personnel

Possible Driver
Number of transactions Number of employees Number of change orders Machine hours Number of employees Number of new hires

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## A Single Charging Rate Example

A firm developed an in-house photocopying department

to serve its three producing departments (audit, tax, and management advisory systems or MAS).
The costs of the photocopying department include fixed

costs of \$26,190 per year and variable costs of \$0.023 per page copied.
Estimated usage in pages by the three producing

departments is as follows:
Audit department Tax department MAS department Total 94,500 67,500 108,000 270,000 ======
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## A Single Charging Rate (continued)

Total costs = \$26,190 + (270,000 x \$0.023) = \$32,400 Overhead rate = \$32,400 270,000 = \$0.12 per page Suppose the actual usage per department is:

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## A Single Charging Rate (continued)

The total photocopying department charges would be as shown: Total # of Pages OH rate Charges Audit Tax MAS Total 92,000 65,000 115,000 272,000 ====== \$0.12 \$0.12 \$0.12 \$11,040 7,800 13,800 \$32,640 ======
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## Budgeted Versus Actual Usage

When we allocate support-department costs to the producing departments, should we allocate actual or budgeted costs? Budgeted costs

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## Budgeted Versus Actual Usage (continued)

There are two basic reasons for allocating supportdepartment costs. 1. To calculate unit costs

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## Choosing A Service Department Cost Allocation Method

The three methods for allocating service department costs to producing departments are:
The Direct Method The Sequential Method The Reciprocal Method

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## Service Department Allocation An Example

Support Departments Producing Departments Power Direct Costs* Normal Activity: Kilowatt-hours Maintenance hours ----1,000 200,000 ----600,000 4,500 200,000 4,500 \$250,000 Maint. \$160,000 Grinding \$100,000 Assembly \$ 60,000

*For a producing department, direct costs refer only to overhead costs that are directly traceable to the department.
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## Service Department Allocation Direct Method

Support Departments Producing Departments Power Direct Costs Power Maintenance Total \$250,000 (250,000 ) -------\$ 0 ======= Maint. \$160,000 -------(160,000 ) \$ 0 ======= Grinding \$100,000 187,500 80,000 \$367,500 ======= Assembly \$ 60,000 62,500 80,000 \$202,500 =======

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## Service Department Allocation Sequential Method

Support Departments Producing Departments Power Direct Costs Power Maintenance Total \$250,000 (250,000 ) --\$ 0 ======= Maint. \$160,000 50,000 (210,000 ) \$ 0 ====== Grinding \$100,000 150,000 105,000 \$355,000 ======= Assembly \$ 60,000 50,000 105,000 \$215,000 =======

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Reciprocal Method

The reciprocal method of allocation recognizes all interactions among support departments.

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## Reciprocal Method (continued)

Support Departments Producing Departments Power Maint. \$100,000 60,000 \$160,000 ======= Maint. Grinding \$ 80,000 20,000 \$100,000 ======= Grinding Assembly \$50,000 10,000 \$60,000 ====== Assembly

Direct Costs:
Fixed Variable Total \$200,000 50,000 \$250,000 ======= Power Allocation Ratios:

Power
Maintenance

--0.10

0.20
---

0.60
0.45

0.20
0.45
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## Reciprocal Method (continued)

The cost equation for each support department can be expressed as follows: P = Direct costs + Share of Maintenances cost

P = \$250,000 + 0.1(M)
M = Direct costs + Share of Powers costs M = \$160,000 + 0.2P

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## Reciprocal Method (continued)

Substituting the Power equation into the Maintenance equation, we get: M = \$160,000 + 0.2 (\$250,000 + 0.1M)

## M = \$160,000 + \$50,000 + 0.02M

0.98M = \$210,000 M = \$214,286

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## Reciprocal Method (continued)

Substituting the value for M into the Power equation we get: P = \$250,000 + 0.1 (\$214,286) P = \$250,000 + \$21,429

P = \$271,429

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## Reciprocal Method (continued)

Support Departments Producing Departments Power Direct Costs Power \$250,000 (271,429) Maint. \$160,000 54,286 Grinding \$100,000 162,857 Assembly \$ 60,000 54,286

Maintenance
Total

21,429
\$ 0 =======

(214,286)
\$ 0 =======

96,429
\$359,286 =======

96,429
\$210,715 =======

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## Departmental Overhead Rates

The overhead rate for the grinding department is computed as follows (assuming the normal level of activity is 71,000 MH): OH rate = \$359,286 71,000 = \$5.06 per MH The overhead rate for the assembly department is computed as follows (assuming the normal level of activity is 107,500 DLH): OH rate = \$210,715 107,500 = \$1.96 per DLH

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End of Chapter 7

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