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15

AllocationofSupport-DepartmentCosts,CommonCosts,andRevenues

TRANSITIONNOTES

Thischapterincludesarewrittensectiondealingwithbudgetedversusactualusagewithexpandedmaterialonallocationbases.Thereisexpandedmaterialexplainingtheuseofbudgetedratesforallocatingsupportdepartmentcosts.Thesectiononallocatingcommoncostshasbeenstreamlined.Mostend-of-chapterproblemmaterialisneworhasbeenrevised.

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I.LEARNINGOBJECTIVES

1.Distinguishthesingle-ratemethodfromthedual-ratemethod

2.Understandhowtheuncertaintyusersfaceisaffectedbythechoicebetweenbudgetedandactualcost-allocationrates

3.Allocatesupport-departmentcostsusingthedirectmethod,thestep-downmethod,andthereciprocalmethod

4.Allocatecommoncostsusingthestand-alonemethodandtheincrementalmethod

5.Explaintheimportanceofexplicitagreementbetweencontractingpartieswhenthereimbursementamountisbasedoncostsincurred

6.Understandhowbundlingofproductsgivesrisetorevenue-allocationissues

7.Allocatetherevenuesofabundledproducttotheindividualproductsinthatbundle

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II.CHAPTERSYNOPSIS

Allocationofindirectcostsisanareaofconstantdiscussioninmanycompanies,withdivision,department,andproductmanagersoftenquestioningtheamountofindirectcostsallocatedtotheirrespectivesections.Thischapterdiscussesallocationofsupportdepartmentcostsusingthedirectmethod,thestep-downmethod,andthereciprocalmethod.Thechapterpresentsthestand-alonemethodandtheincrementalmethodastechniquesforallocationofcommoncosts.Theconceptofbundledproductsandallocationofbundledproductrevenuesisalsointroduced.Costreimbursementbasedoncontractprovisionsisalsodiscussed.

III.POINTSOFEMPHASIS

1.Itisimportantthatthestudentsgraspallocationissuesincludingsinglevs.dualrateallocationbeforemovingintothemethodsforallocatingcoststotheservicedepartments.

2.Likewise,studentsneedtoseethevaryingeffectsofactualvs.budgetedcostallocations.

3.Workthrougheachofthemethodsforallocatingcostswithmultiplesupportdepartments—direct,step-down,andreciprocal.Illustratethedifferencesobtainedundereachmethod.Ifthedifferencesaresmall,pointoutthatthesimplestmethodwouldworkbestintheparticularcase.

4.Allocatingcommoncostsandallocatingrevenuesofbundledproductsarereallytwosidesofthesameprocess.Ifthestudentsgraspallocatingcommoncostsearly,allocatingbundledrevenuesshouldbefairlysimple.

IV.CHAPTEROUTLINE

1

Distinguishthesingle-ratemethod

...onerateforallocatingcostsinacostpool

fromthedual-ratemethod

...tworatesforallocatingcostsinacostpoo—l

oneforvariablecostsandoneforfixedcosts

1.1Companiesdistinguishoperatingdepartmentsfromsupportdepartments.Anoperatingdepartment,whichisalsocalledaproductiondepartment,isonethatdirectlyaddsvaluetotheproductorservice.Asupportdepartment,whichisalsocalledaservicedepartment,providessupportandassistsoperatingdepartmentsandotherservicedepartments.

202

TEACHINGPOINT.Ifstudentsdonotgraspthedifferenceinoperatingdepartmentsandsupportdepartmentsearly,theywillnotlearnthematerialinthischapter.Identifyseveraldepartmentsthatmightbefoundinatypicalmanufacturingorganization,andhavethestudentsidentifythemasoperatingorsupportdepartments.

1.2Costsincurredinthesupportdepartmentsmustbeallocatedultimatelytotheoperatingdepartmentsandeventuallytothefinalcostobject.Apredeterminedrateisnormallyutilizedtomaketheallocationstotheoperatingdepartments.Asingle-rateoradual-ratemethodmaybeutilized.

1.3Thesingle-ratemethodmakesnodistinctionbetweenfixedandvariablecosts.Itallocatescostsineachcostpooltocostobjectsusingthesamerateperunitofasingleallocationbase.

1.4Thedual-ratemethoddividesthecostsofeachsupportdepartmentintotwopools—avariable-costpoolandafixed-costpool.

1.5Whenusingeitherthesingle-rateordual-ratemethod,managersmayallocatecostsbasedupon:

a.Budgetedratesandbudgetedhours

b.Budgetedratesandactualhours

c.Actualratesandactualhours—Thisapproachisnotoftenusedinpractice.

TEACHINGPOINT.Itwillbehelpfulifthestudentscanvisualizetheseconceptsinaction.Exercise15-16isagoodillustrationofdifferentapproachestoallocation.

RefertoQuizQuestion1

Exercise15-16and15-17

2

Understandhowtheuncertaintyusersfaceis

affectedbythechoicebetweenbudgetedcost-

allocationrates

...thereisnouncertaintybecauseusersknowthe

ratesatthestartoftheperiod

andactualcost-allocationrates

...thereisuncertaintybecauseusersdon’tknow

theratesuntiltheendoftheperiod

203

2.1Oncethedecisionhasbeenmaderegardingsingle-ordual-rateallocation,themanagermustnextturntotheissueofchoosingbetweenallocatingbudgetedoractualcosts.

2.2Whenallocationsarebasedonbudgetedusageuserdivisionsknowinadvancetheirallocatedcosts.Thiscanbeofbenefitinshort-termandlong-termplanning.

2.3Adisadvantageofusingbudgetedcostsisthatthereisanincentiveformanagerstounderestimatetheirplannedusage,thusbeingassignedalowerpercentageofallocatedcosts.Thiscanbeovercomeinpartbyassessingahigherchargeforexceedingbudgetedusage.

2.4Allocatingcostsbasedonactualusagegiveamoreaccurateallocationbasedonactualcostsandusage.

2.5Actualallocationshaveseveraldisadvantages:alackoftimelyinformation,reducedincentivesforsupporttomanagecosts,andincreasedaccountingcosts.

2.6Athirdapproachistoallocatefixedcostsonthebasisofpracticalcapacitysupplied.Thisapproachwillchargeeachdivisionwithservicesactuallyused.Inaddition,variationsinactualusageinonedivisionwillnotaffectallocationsinotherdivisions.Finally,thecostsofunusedcapacityarehighlightedandnotallocatedtodivisions.

TEACHINGPOINT.Thisisanexcellenttimetodiscuss“gameplaying”withstudentstoshowhowadepartmentmanagercanlowertheamountbeingallocatedtothedepartmentbylow-ballingestimatedusage(whenbudgetedcapacityisused).Likewise,youcanillustratethelackofincentiveonthepartofsupplyingdepartmentstocontrolcostsifactualcostsareusedforallocation.Enterintoadiscussionofhowtheproblemspresentedbythesetwoapproachesmightberesolved.

2.7Generally,itisfoundtobepreferabletoallocatefixedcostsbasedoncapacity,undertheapproachthatfixedcostsprovidecapacityandvariablecostsallocatedbasedonactualusage.

(Exhibit15-1displaystheimpactofvariationsinactualusageondivisioncostallocations.)

RefertoQuizQuestion2

Exercise15-18and

Problem15-27

204

3

Allocatesupport-departmentcostsusingthedirect

method

...allocatesupport-departmentcostsdirectlyto

operatingdepartments

thestep-downmethod

...partiallyallocatessupport-departmentcoststo

othersupportdepartments

andthereciprocalmethod

...fullyallocatessupport-departmentcoststo

othersupportdepartments

3.1Whenallocatingcostsfrommultiplesupportdepartments,anewsetofproblemsarise.Theseproblemsarisebecausesupportdepartmentsutilizetheservicesofothersupportdepartmentsanditmustbedecidedhowtohandletheseallocations.Therearethreeapproachesthatmaybeutilized.

?Thedirectmethodallocatessupportdepartmentcoststooperatingdepartmentsonly,ignoringusageofasupportdepartmentbyothersupportdepartments.

?Thestep-downmethodorsequentialallocationmethodallocatessupport-departmentcoststoothersupportdepartmentsandtooperatingdepartmentsinaprescribedsequencethatgivespartialrecognitionofthemutualservicesprovidedamongsupportdepartments.

oAcommonstep-downsequencebeginswiththesupportdepartmentthatrendersthehighestpercentageofitstotalservicestoothersupportdepartments.Anotherapproachistobeginwiththedepartmentprovidingthehighestdollaramounttoothersupportdepartments.

oOncecostsareallocatedoutofasupportdepartmentunderthestep-downmethod,noadditionalcostsareallocatedtothatdepartment.

?Thereciprocalmethodfullyrecognizesthemutualservicesprovidedamongallsupportdepartments.Theseallocationscanbeperformedbyusingrepeatediterationsofallocationsorbyformulatingandsolvinglinearequationsexpressingtherelationshipsamongthedepartments.

oTherearethreestepsinvolvedinthereciprocalmethod.

Step1:Expresssupportdepartmentcostsandreciprocal

relationshipsintheformoflinearequations.

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Step2:Solvethesetoflinearequationstoobtainthe

completereciprocatedcostsofeachsupportdepartment.

Step3:Allocatethecompletereciprocatedcostsofeach

supportdepartmenttoallotherdepartmentsbasedontheusagepercentages.

TEACHINGPOINT.Workthroughexercises,suchas15-19and15-20thatillustrateeachoftheseapproaches.Dothestep-downmethodusingoneapproach,andthenhavethestudentsdoitusingtheotherapproach.Discussthe

differencesobtainedusingthevariousmethods.

3.2Thedirectandstep-downmethodshavetheadvantageofsimplicity.Thereciprocalmethodistheoreticallythemostprecise,butisdifficulttoimplement,especiallywithalargenumberofsupportdepartments.However,thisdifficultyisbeinglessenedbytheuseofcomputers.Indeterminingwhichmethodtoutilize,thecompanyshouldconsidertheamountofdifferencesobtainedundereachoftheapproaches.

(Exhibits15-2to15-6illustrateallocationofsupportdepartmentcosts.)

RefertoQuizQuestions3,4,and5Exercises15-19,15-20.15-21,and15-22.

4

Allocatecommoncostsusingthestand-alone

method

...usescostinformationofeachuserasa

separateentitytoallocatecommoncosts

andtheincrementalmethod

...allocatescommoncostsprimarilytooneuser

andtheremaindertootherusers

4.1CommonCostsarecoststhataresharedbytwoormoreusers.Thesecanbethecostsofoperatingafacility,anactivity,orothercostobjects.

4.2Thesecommoncostsmustbeallocatedinsomeequitablefashion.Twomethodsthatarefrequentlyusedfortheseallocationsarethestand-alonecost-allocationmethodandtheincrementalcost-allocationmethod.

206

TEACHINGPOINT.Brainstormwiththestudentsforexamplesofcommoncosts.Forexample,softwarethatstudentsbuyforcollegeisacommoncostforallclassesinwhichtheyusethecomputer.Togetintotheallocationissue,tellthemtheymustpurchaseExcelforuseintheCostAccountingclass.Afterpurchasingit,however,theyfinduseforitinthreeotherclasses.Iftheyaretryingtodeterminethecostofeachclass,howshouldthecostofthesoftwarebeallocated?Pursueothersimilarsituations.

4.3Thestand-alonecost-allocationmethoddeterminestheweightsforcostallocationbyconsideringeachuserofthecostasaseparateentity.Thecostisallocatedamongtheusersbaseduponthetotalcostforeachseparately.

4.4Theincrementalcost-allocationmethodrankstheindividualusersofthecostobjectintheorderofusersmostresponsibleforthecommoncostandusesthisrankingtoallocatecostamongthoseusers.Thefirstrankeduseristheprimaryuserandisassignedallocatedcostsuptothecostasastand-aloneuser.Thesecondrankeduseristhefirstincrementaluserandisassignedcostequaltotheadditionalcostthatarisesfromhavingtwousers.Thiscontinuesuntilcostshavebeenassignedtoallusers.

TEACHINGPOINT.Illustratethesetwomethodswithaproblem.Exercise15-23isagoodexampletowalkthroughwiththestudents.

RefertoQuizQuestion6

Exercises15-23and15-24

5

Explaintheimportanceofexplicitagreement

betweencontractingpartieswhenthe

reimbursementamountisbasedoncostsincurred

...toavoiddisputesregardingallowablecost

itemsandhowindirectcostsshouldbeallocated

5.1Frequently,thepricepaidonacontractmaybebasedonsomedefinitionofcost.Inordertobillthepricecorrectly,theremustbeexplicitagreementaboutthedefinitionsofcost,andwhatcanbeincludedandexcluded.

5.2Contractdisputesoftenarisewithrespecttocostallocation.Thishighlightstheimportanceofexplicitdefinitionsofthecontractterms.

207

TEACHINGPOINT.Inadditiontoexplicitcontractterms,thebuyerneedssomeoversightorcontrolovercostsincurred.Inonecase,thetermsofthecontractrequiredthatallcheckstobechargedtothecontractbesignedbythebuyer.Thisprovedtobeaneffectivecontrolinthiscase,asthebuilderofahotel“gave”thecompanycoffeemugsfortherestaurant,onlytofindthatwewerebilledforthem,plusapercentage.Inthesamecontract,thebuilderfencedthebackyardathispersonalresidence,andtriedtoincludeitasacostofthecontract.

5.3IncontractingwiththeU.S.Government,mostcontractorsarereimbursedinoneoftwoways:

?Thecontractorispaidasetpricewithoutanalysisofactualcontractcostdata.Thismethodfrequentlyaccompaniescompetitivebidding,wherethereareestablishedpricesfortheitemssoldinsubstantialquantitiestothegeneralpublic.

?Thecontractorispaidafteranalysisofactualcontractcostdata.Theseareoftencontractsthatstatereimbursementwillbebasedonallowablecostsplusafixedfee,otherwiseknownasacost-pluscontract.

5.4Inmanygovernmentcontractsthereisagreatdealofuncertaintyaboutthefinalcosttoproducenewequipment.Thisisespeciallytrueindefensedepartmentcontracting.Duetotheuncertaintyinvolved,thesecontractsarerarelysubjectedtocompetitivebidding.

5.5Tobefairtoallinthepricingofthemerchandise,thegovernmentwillassumeashareoftheriskofpotentiallyhighcostswithacost-pluscontract.

5.6Anallowablecostisacostthatthecontractpartiesagreetoincludeinthecoststobereimbursed.

TEACHINGPOINT.Thisisagoodpointforadiscussiononprofessionalethics.Governmentcontractsareknownforcostoverrunsandoutlandishpricing.Whatistheroleofthecostaccountantinthesecases?Discussthisstatementthatblamestheaccountingsystem:“Asforthe$1,000hammer.Inmanycasesthisisthefaultoftheaccountingsystem.Whenavendordeliversanairplanetothemilitary,thereisafixedcostandavariablecostassignedtoeachpart.Thevariablecostistheactualcostoftheitemasdeliveredfromavendor(thehardwarestore).Inthecaseofthehammerthiswouldbe$10.Thefixedcostiscalculatedbydividingalloftheoverheadbythenumberofparts.Iftheoverheadis$990,000,000andthereare1,000,000parts,eachisascribedafixedcostof$990.Thusthe$1,000hammer.”

RefertoQuiz

Question7

Problem15-37

208

6

Understandhowbundlingofproducts

...twoormoreproductssoldforasingle-price

givesrisetorevenue-allocationissues

...allocatingrevenuestoeachproductinthe

bundletoevaluatemanagersofindividualproducts

6.1Notonlydoissuesariseincostallocations,therecanbeallocationissueswithrevenuesaswell.

6.2Whenmultipleproductsaresoldasaunit(bundled)andsoldatasingleprice,theremustbeanallocationofrevenuestotheproductsincludedinthebundle.

6.3Revenueallocationoccurswhenrevenuesarerelatedtoaparticularrevenueobjectbutcannotbetracedtoitinaneconomicallyfeasiblemanner.

6.4Arevenueobjectisanythingforwhichaseparatemeasurementofrevenuesisdesired.

6.5Abundledproductisapackageoftwoormoreproductsorservicesthatissoldforasingleprice,butwhoseindividualcomponentsmaybesoldasseparateitemsattheirownstand-aloneprices.

TEACHINGPOINT.Discussexamplesofbundledproductsorservicesandwhycompaniesselltheminthismanner.Exampleswouldincludeacomputerandprinter;avacationpackagethatincludesairfare,hotelroom,andrentalcar.

RefertoQuizQuestion8

7

Allocatetherevenuesofabundledproducttothe

individualproductsinthatbundle

...usingthestand-alonemethod,theincremental

method,ormanagementjudgment

7.1Therearetwomethodsfrequentlyusedtoallocaterevenuefrombundledproducts:thestand-alonerevenue-allocationmethodandtheincrementalrevenue-allocationmethod.

209

7.2Underthestand-alonerevenueallocationmethodtheindividualpricesofeachproductareusedasweightstoassignrevenuetotheproduct.

Revenueasastandaloneproduct

Totalstandaloneproductrevenues×sellingpriceofbundle=Revenueassignedtoproduct

7.3Undertheincrementalrevenue-allocationmethod,ranksoftheindividualproductsareassignedbymanagement.Thisrankingisusedtoallocatebundledrevenuestoindividualproducts.Thefirstranked,orprimary,productisassigneditsfullamountofrevenues,followedbythesecondranked,orfirstincrementalproduct,andsoon.

7.4Rankingsofproductscanbebasedonstand-aloneunitsales,importanceofeachoftheindividualproducts,ormanagerialintuition.

TEACHINGPOINT.Youcanrelateallocationofbundledrevenuestotheallocationofcommoncostscoveredearlierinthechapter.Exercise15-25isagoodillustrationofthisconceptandwillhelptoreinforcethisprocedure.

RefertoQuizQuestions9and10Exercise15-25andProblem15-34

V.OTHERRESOURCES

Pleasevisitthetextbookcompanionwebsiteat.Todownloadtheseandotherresources,visittheInstructor’sResourceCenteroraccessthemontheInstructor’sResourceDVD(IR-DVD).

ThefollowingexhibitswerementionedinthischapteroftheInstructor’sManual,andhavebeenincludedinthePowerPointLecturepresentationcreatedspecificallyforthischapter.YoumayusethePowerPointLecturepresentations“asis”,ormodifythemtosuityourindividualneeds.

Exhibit15-1displaystheimpactofvariationsinactualusageondivisioncostallocations.Exhibits15-2to15-6illustrateallocationofsupportdepartmentcosts.

DownloadpdfimagesoftextbookillustrationsandexhibitsfromtheImageLibraryoraccessthemviayourIR-DVD.

SolutionstoSelectEnd-of-ChapterProblemsmentionedinthischapter,whichhavebeenfullyworkedoutinPowerPoint,areavailablefordownloadandincludedontheIR-

DVD.

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CHAPTER15QUIZ

1.Theuseofadual-ratecost-allocationmethodrecognizes

a.theimprovementsintechnologyallowingforuseofmultiplecostpools.

b.theneedtousebothbudgetedandactualcostrateswhenallocating.

c.theneedtousebothbudgetedandactualusageofquantitieswhenallocating.

d.thebehavioraspectofcosts.

2.Managersareaffectedbyriskstheyhavetotakeandwouldprefertouse

a.actualratesforcostallocationbecausetheratesarecalculatedfromrealamounts.

b.actualratesforcostallocationbecauseactualratesareeasiertojustifytousers.

c.budgetedratesforcostallocationbecausetheratesareknowninadvance.

d.budgetedratesforcostallocationbecauseanyvariancesaretransferredtousers.

Thefollowingdataapplytoquestions3–5.

BillyStone,Inc.budgetsthefollowingamountsforitsBuildings&GroundsandComputerServicesDepartmentsinservicingeachotherandthetwomanufacturingdivisionsofSignsand

Mailers:

UsedBy

SuppliedByBuilding&GroundsComputerServicesSignsMailersBuildings&Grounds—0.200.600.20ComputerServices0.15—0.300.55

Theactualresultsforthetimeperiodwereasfollows:

UsedBy

SuppliedByBuilding&GroundsComputerServicesSignsMailers

Buildings&Grounds

—

ComputerServices

0.25

Actualcostdataforeachdepartmentare:

Buildings&Grounds

ComputerServices

0.10

0.300.40

—

0.60

0.35

Fixed

Variable

$50,000$100,000

$90,000$21,000

3.

TotalfixedcostsallocatedfromBuildings&GroundstotheSignsDepartment,usingthepreferredallocationbasis,bythedirectallocationmethodare

$37,500.$33,333.$30,000.$25,000.

a.

b.

c.

d.

211

4.TotalvariablecostsallocatedfromComputerServicestoMailersDepartment,usingthepreferredallocationbasis,bythestep-downallocationmethod(beginwithBuilding&Grounds)are

a.$8,400.

b.$12,000.

c.$16,000.

d.$25,235.

5.TheequationtodeterminethetotalvariablecostsofComputerServicesusingthepreferredallocationbasisforthereciprocalallocationmethodis

a.CS=$21,000+0.25B&G.

b.CS=$21,000+0.20B&G.

c.CS=$21,000+0.15B&G.

d.CS=$21,000+0.10B&G.

6.Ifacostisincurredformorethanoneuser,thatcostisconsidereda(n)

a.homogeneouscost.

b.commoncost.

c.stand-alonecost.

d.incrementalcost.

7.Whichofthefollowingisoftenthemostbasiccauseofcontractdisputes?

a.Allowablecosts

b.Cost-allocationissu