Blueprint Problem: Support Department Cost Allocation TheDifference Between Support Departments and Producing DepartmentsWhen a firm decides that a plant wide overhead rate is notsufficient (perhaps it makes multiple products and the variousproducts go through some processes but not all), it may decide todepartmentalise. The factory is divided into departments and costsare accumulated within the departments. When that is done, thereare basically two types of departments: producing departments thatactually make units of product, and support departments that do notmake the product but assist or support the producing departments.Costs of support departments are allocated to producing departmentsfor the following reasons: inventory valuation, product-lineprofitability, pricing, and planning and control. From the listbelow, determine which of the following are producing departments:Departments Is it a producing department? Assembly Yes HumanResources No Industrial engineering (in a bread factory) No Baking(in a bread factory) Yes Packaging Yes Accounting (in a paintfactory) No Welding (in a auto manufacture) Yes Maintenance NoMixing (in a food factory) Yes Some costs are hard to associatewith a single department, so a final catch-all department may becreated called General Factory. This department includes alloverhead costs that could not be traced to the other departments.For example, the salary of the plant superintendent and the cost oflandscaping and grounds keeping may be included in General Factory.Once the factory is departmentalized, the costs of each departmentare traced to that department. All costs in the support departmentsare overhead costs. Costs in the producing departments can includedirect overhead. For example, overhead cost directly traced to aproducing department may include depreciation on machinery and thesalary of the departmental supervisor. Feedback Correct Single andDual Charging Rates A support department may develop a chargingrate that is used to charge other departments that use the service.This is similar to an overhead rate. For example, Davis Company'sinformation technology (IT) department is in charge of purchasing,installing and assisting other departments with computers and otherforms of information technology. The IT department may develop asingle charging rate by determining all budgeted costs for the yearand dividing by the budgeted hours of IT personnel usage. Supposethe budgeted costs of the Davis Company IT Department for thecoming year equal $240,000 and budgeted hours of service providedequal 5,000. What is the charging rate for the coming year? $/service hour. If the Payroll Department uses 30 hours of ITservice next year, how much is that department charged by IT? $Notice that the charging rate is computed using budgeted numbers,but that the actual charge is the predetermined rate times actualusage of IT service hours. At the end of the year, the total amountcharged out is compared to the total actual cost of the ITdepartment to determine its efficiency/inefficiency. Dual chargingrates require the department to separate fixed from variable costsand develop charging rates for each. In this way, the userdepartments are charged for their original capacity requirementthrough the fixed allocation and then charged for their actualusage of variable costs through the variable rate. Suppose that theDavis Company IT Department serves four other departments: Payroll,Factory, Human Resources, and Engineering. When the IT Departmentwas organized, those using departments said they would need thefollowing hours of IT service in a year: Estimated Hours of ITService Percentage of IT Service Payroll 100 2.00% Factory 2,00040.00% Human Resources 1,500 30.00% Engineering 1,400 28.00% Total5,000 100.00% Davis' IT Department estimated that it would requirebudgeted fixed cost of $120,000 and variable costs of $20 perservice hour. Calculate the fixed cost to be allocated to each ofthe four using departments and the variable costs to be assignedusing the variable rate. What is the total amount charged to eachdepartment using these dual rates? (Fill in the following table.)Estimated Hours of IT Service Percentage of IT Service Fixed ITCost Allocated Actual Hours of IT Service Used Variable CostAllocated Using $20 Rate Total IT Cost Allocated Payroll 100 % $ 30$ $ Factory 2,000 % 2,200 Human Resources 1,500 % 1,200 Engineering1,400 % 1,400 Total 5,000 % $ 4,830 $ $ Why was less charged intotal than the budgeted amount of $240,000? Less variable cost wascharged because total actual hours were less than total budgetedhours. Is it possible to allocate more IT cost to the four userdepartments than budgeted? Yes, because increased actual hours willlead to more variable cost allocated to the user departments.Feedback Partially correct Support Department Cost Allocation Usingthe Direct Method Factory accountants usually allocate supportdepartment costs to the producing departments using one of threemethods: the direct method, the sequential (or step) method, or thealgebraic (or reciprocal) method. The objective is simple - to getall factory costs into the producing departments in order tocalculate overhead rates and apply them to units produced. Whycan't support departments allocate overhead costs to unitsproduced? Support departments don't make the product that thecompany is in business to produce and sell - only producingdepartments do that. The direct method involves allocating overheadcost from the support departments to the producing departments. Thedirect method never allocates cost from one support department toanother support department. As a result, it is the easiest of thethree methods. Let's use Porter Company, as an example. Porter hastwo producing departments - Fabricating and Assembly - and threesupport departments - Maintenance, Human Resources (HR) and GeneralFactory (GF). Porter provided the following information on the fivedepartments: Maintenance HR GF Fabricating Assembly Direct overheadcost $80,000 $120,000 $260,000 $93,400 $56,700 Machine hours 1,0003,000 5,000 12,000 3,000 Direct labor hours 4,000 5,000 8,00010,000 30,000 Square footage 500 2,500 10,000 12,000 18,000 Porteruses the direct method of support department cost allocation.Maintenance is allocated based on machine hours, HR on the basis ofdirect labor hours, and GF on the basis of square footage. TheFabricating overhead rate is based on machine hours and theAssembly overhead rate is based on direct labor hours. Fill in thefollowing table to allocate support department costs to theproducing departments. (Round all allocation ratios to foursignificant digits and all allocated amounts to the nearest dollar.If an amount box does not require an entry, leave it blank or enter"0".) Maintenance HR GF Fabricating Assembly Direct overhead cost$80,000 $120,000 $260,000 $93,400 $56,700 Allocate: MaintenanceHuman Resources General Factory Total after allocation $ $ $ $ $Notice that after allocation, zero dollars remain in the supportdepartments and all overhead cost has been allocated to theproducing departments. As a check on your work, add up all directoverhead costs from the first line - it equals $610,100. Then addthe totals after allocation - again, it equals $610,100. Finally,calculate the overhead rates (rounded to the nearest cent) forFabricating and Assembly. Fabricating overhead rate $ per machinehour Assembly overhead rate $ per direct labor hour Suppose thatthe square footage for Fabricating and Assembly were equal at12,000 each. How would that affect the allocation of the following:Maintenance: there would be no change Human Resources: there wouldbe no change General Factory: increase amount allocated toFabricating and decrease amount allocated to Assembly FeedbackPartially correct Support Department Cost Allocation Using the Stepor Sequential Method The step or sequential method requires thatsupport departments be ranked and that the highest ranking supportdepartment be allocated first to all lower ranking supportdepartments and the producing departments. Then the highest rankingsupport department is closed and the second-highest ranking supportdepartment is allocated to lower ranking support departments andthe producing departments. This continues until all supportdepartment cost has been allocated to the producing departments.The sequential method takes partial account of support departmentreciprocity. Reciprocity occurs when one support department usesthe services of another support department. For example,Maintenance uses HR and HR may use the services of Maintenance. Thesequential method does not take full account of reciprocity becauselower ranking support department costs are never allocated tohigher ranking support departments. Let's use Porter Company, as anexample. Porter has two producing departments (Fabricating andAssembly) and three support departments (Maintenance, HumanResources (HR) and General Factory (GF)). Porter provided thefollowing information on the five departments: Maintenance HR GFFabricating Assembly Direct overhead cost $80,000 $120,000 $260,000$93,400 $56,700 Machine hours 1,000 3,000 5,000 12,000 3,000 Directlabor hours 4,000 5,000 8,000 10,000 30,000 Square footage 5002,500 10,000 12,000 18,000 Porter uses the sequential method ofsupport department cost allocation, and support departments areranked in order of direct overhead cost (from high to low).Maintenance is allocated based on machine hours, HR on direct laborhours, and GF on the basis of square footage. The Fabricatingoverhead rate is based on machine hours and the Assembly overheadrate is based on direct labor hours. Calculate the allocationratios to five significant digits and fill them into the followingtable (If an amount box does not require an entry, leave it blankor enter "0".) : Maintenance HR GF Fabricating Assembly GeneralFactory Human Resources Maintenance Using the allocation ratios,fill in the following table to allocate support department costs tothe producing departments. (Round all allocated amounts to thenearest dollar. Leave cells blank that do not require an entry.)Maintenance HR GF Fabricating Assembly Direct overhead cost $80,000$120,000 $260,000 $93,400 $56,700 Allocate: Maintenance HumanResources General Factory Total after allocation Notice that afterallocation, zero dollars remain in the support departments and alloverhead cost has been allocated to the producing departments. As acheck on your work, add all direct overhead costs from the firstline - it equals $610,100. Then add the totals after allocation -again, it equals $610,100. Finally, calculate the overhead rates(rounded to the nearest cent) for Fabricating and Assembly.Fabricating overhead rate $ per machine hour Assembly overhead rate$ per direct labor hour Feedback Partially correct SupportDepartment Cost Allocation Using the Algebraic or Reciprocal MethodThe algebraic or reciprocal method takes full account of supportdepartment reciprocity. This method requires the solution of asystem of simultaneous equations to determine the total supportdepartment costs to be allocated. In practice, relatively fewcompanies use the reciprocal method. Let's use Anders Company, asan example. Anders has two producing departments - Cutting andSewing - and two support departments - Maintenance and GeneralFactory (GF). Anders provided the following information on the fourdepartments: Maintenance GF Cutting Sewing Direct overhead cost$10,000 $270,000 $56,400 $75,000 Machine hours 459 2,000 9,0009,000 Square footage 2,500 3,418 5,000 8,500 Anders uses thealgebraic method of support department cost allocation. Maintenanceis allocated based on machine hours, and GF on the basis of squarefootage. Calculate the allocation ratios to five significant digitsand fill them into the following table (Leave cells blank that donot require an entry.): Maintenance GF Cutting Sewing GeneralFactory Maintenance Using the allocation ratios, solve a system ofsimultaneous equations for support department cost as follows.Maintenance = $100,000 + 0.15625 GF GF = $270,000 + 0.1 MaintenanceSubstituting Maintenance into the equation for GF and solving forGF: GF = $270,000 + 0.1 ($100,000 + 0.15625 GF) GF = $270,000 +$10,000 + 0.015625 GF 0.984375 GF = $280,000 GF = $284,444 Then,Maintenance = $100,000 + 0.15625 ($284,444) = $144,444 Using thenewly calculated amounts for GF and Maintenance and the allocationratios, fill in the following table to allocate support departmentcosts to the producing departments. (Round all allocated amounts tothe nearest dollar. Leave cells blank that do not require anentry.) Maintenance GF Cutting Sewing Direct overhead cost $100,000$270,000 $56,400 $75,000 Allocate: General Factory MaintenanceTotal after allocation Notice that after allocation, zero dollarsremain in the support departments and all overhead cost has beenallocated to the producing departments. As a check on your work,add all direct overhead costs from the first line - it equals$501,400. Then add the totals after allocation - again, it equals$501,400.
