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Sociology
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SOC 506
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Margaret Buckby
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Fall

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Chapter 8: Measuring and Assigning Support Department Cos77 Chapter 8 Measuring andAssigning Support Department Costs LEARNING OBJECTIVES Chapter 8 addresses the following questions: LO1 Define support departments, and explain why their costs are allocated to other departments. LO2 Explain the process that is used to allocate support department costs. LO3 Explain how the direct method is used to allocate support costs to operating departments; calculate cost allocations using the direct method. LO4 Explain how the step-down method is used to allocate support costs to operating departments; calculate cost allocations using the step-down method. LO5 Explain how the reciprocal method is used to allocate support costs to operating departments; calculate cost allocations using the reciprocal method. LO6 Explain the difference between single-and dual-rate allocations. LO7 Identify how support cost allocations and information quality impact management decision-making. These learning questions (LO1 through LO7) are cross-referenced in the textbook to individual exercises and problems. © 2012 John Wiley and Sons Canada, Ltd. 78 Cost Management QUESTIONS 8.1 Similarities: • All of the methods allocate support department costs to operating departments • All of the methods rely on allocation bases to assign costs of support departments to operating departments. • All of the methods result in a total allocated cost per unit • All of the methods use cost pools, and those are usually departments. Differences: • Direct method ignores all interactions among support departments. • The step-down method takes into account some of the interactions among support departments. • The reciprocal method takes into account all of the interactions among support departments. 8.2 Support department costs are direct costs of the department, but indirect costs when allocated to other departments. Manufacturing overhead is a direct cost of the production process but it becomes an indirect cost when it is allocated to units. 8.3 Management's objectives should be the determining factor, tempered by the availability of the data and the cost of performing the allocation. For example, if the primary purpose is cost control, a method that recognizes interdepartmental relationships is appropriate. If the firm has a computer and appropriate software, the reciprocal allocation method is preferred. If the primary purpose is product costing and the firm has a manual system, the direct method may be preferred. Following are other factors to consider in choosing an appropriate allocation method: • As the number of cost pools increase, calculations become more complex under the reciprocal method, • When there are four or more support cost pools, software is needed to perform the reciprocal method calculations • The degree of interaction among support departments; fewer interactions result in fewer differences in allocation amounts 8.4 Costs that include support department allocations using a single cost pool and single allocation base for both fixed and variable costs would overstate the incremental costs used in short-term decisions. This limits the use of these costs for decision-making. However, when a dual rate system is developed, the variable costs are more likely to be relevant information for short-term decision-making. © 2012 John Wiley and Sons Canada, Ltd. Chapter 8: Measuring and Assigning Support Department Costs 79 8.5 Following are factors to consider in choosing an allocation base • Costs and benefits of the information gathered • Does one of the bases better reflect the use of the support department resources? • Will the allocation base be easy to measure and apply? • Are data available for the allocation base? How accurate are the data? 8.6 Department 1 is an operating department because it works directly on the firm's final product. 8.7 Operating departments manufacture goods or produce services that are sold to customers. Support departments interact primarily with operating departments and other support departments, and not with outside customers. Support departments provide operating departments with internal services such as accounting, research and development, maintenance, and so on. 8.8 The dual rate separates fixed and variable support costs. When this is done, the variable rate can be used as information for making decisions that require incremental costs, such as transfer prices and insource and outsource decisions. A single rate includes both fixed and variable costs and cannot be used for any type of decision making. Another advantage of the dual rate method is that the allocations more accurately represent the flow of resources because fixed and variable costs are separated and usually allocated using different allocation bases or actual usage of some sort. 8.9 Several problems can arise when allocated costs are used to charge for support services. Relevant support costs are often difficult to measure, so the allocations are often used instead of relevant cost analysis. Support cost allocations also tend to be inaccurate when measuring relevant costs for operating department decisions. Transfer prices are frequently used to charge user departments for the cost of support services, however these prices are often based on fully allocated costs and therefore include fixed support department costs as well as allocations from other support departments. As a result the transfer prices can be high, which can encourage user departments to outsource the support services. Support cost allocations are subject to the same uncertainties as other types of cost allocations. The process of measuring and allocating support costs is uncertain and requires judgment. Allocated support cost information can be low quality. 8.10 Because they include fixed costs and costs allocated from other departments, support department allocations result in high charges for services. Because they are high, sub- optimal behavior occurs, such as managers duplicating services either by purchasing them from outside the organization or providing them in their own departments. Often support departments are then underused, but the organization still incurs their costs. In addition, extra costs are incurred because internal services are duplicated. 8.11 Better short-term decisions would be made using the dual rate method because the variable costs of the support departments would be easy to use in decision-making. It would depend on the type of long term decision being made whether either method would provide useful information. © 2012 John Wiley and Sons Canada, Ltd. 80 Cost Management 8.12 Estimated (budgeted) cost rates provide information for managers to use in budgeting and some of their decision-making. Managers can predict charges as they use the service. In addition, each department’s charges are not affected by other departments’ use of service. A disadvantage of budgeted rates is that user departments have little incentive to use resources efficiently because their charge is already known, and will not change with usage, if it is based on a fixed rate. 8.13 Accounting department costs could be allocated using number of employees, departmental direct costs, or time spent on activities for individual departments. An advantage of number of employees is that it would be simple to use in calculations. A disadvantage is that it probably does not reflect the use of the department by other departments. An advantage of departmental direct costs is that accounting activities probably increase as direct costs increase, and direct costs are fairly easy to measure. A disadvantage is that there are some accounting activities that do not vary with direct costs. And advantage of time spent on accounting activities for every department is that it is probably most accurately reflects the use of accounting by other departments, but it would be hard to track, and there is likely measurement error when time is not recorded as used, but estimated or recorded after the fact. 8.14 a. GAAP requires manufacturing overhead to be allocated to units of product or service, generally using a traditional cost accounting method such as job costing or process costing. b. Under GAAP, costs for departments that directly support the manufacturing function, such as material handling are allocated. However, costs of departments that provide non-manufacturing support, such as accounting and human resources are not allocated to units or services, they are expensed as period costs. 8.15 If allocations are used as part of a planning activity, such as estimating budgets, then estimated costs should be used to incorporate any expected cost changes. If managers want to understand the actual use of support department resources, then actual values are used. If allocations of cost to departments are based on estimated volumes, then managers have little incentive to use resources efficiently because the estimate amount is set. However, if actual values are used, managers are penalized by higher allocations when one or more departments use less of the support department resources than expected. 8.16 A cafeteria in a university can be both a support department and a revenue-generating department. However, the type of department depends on whether the university subsidizes employee meals. If employees pay the full cost of meals, then the cafeteria it is a revenue-generating department. If an employee discount is given, but employees pay only part of the cost, and studetns also use the cafeteria, it is both a revenue-generating and a support department. © 2012 John Wiley and Sons Canada, Ltd. Chapter 8: Measuring and Assigning Support Department Costs 81 MULTIPLE CHOICE QUESTIONS 8.17 A business uses the step-down method to allocate service department costs to the manufacturingdepartments. Assume that there are two service departments and two manufacturing departments,as shown here: Service Departments Manufacturing Departments Plant Administration Custodial Services Cutting Polishing Costs $360,000 $90,000 $261,000 $689,000 Labour hours 25,000 6,000 18,000 30,000 Space occupied (m2) 10,000 1,000 5,000 45,000 Plant administration costs are allocated based on labour hours, and custodial services costs areallocated based on space occupied. The total costs of the cutting and polishing departments(rounded to the closest 1,000), after allocating all the service department costs, starting withthe largest service provider, are: a) Cutting, $396,000, and polishing, $914,000 b) Cutting, $405,000, and polishing, $995,000 c) Cutting, $381,000, and polishing, $889,000 d) Cutting, $394,000, and polishing, $1,006,000 e) Cutting, $380,000, and polishing, $892,000 Ans: D 1 Plant Administration is allocated to Custodial Services $40,000 (6,000/54,000*$360,000), Cutting $120,000 (18,000/54,000*$360,000) and nd Polishing $200,000 (30,000/54,000*$360,000); 2 Custodial Services new balance of $130,000($90,000+$40,000) is allocated to Cutting $13,000 (5,000/50,000*$130,000) and Polishing $117,000 (45,000/50,000*$130,000) 8.18 The managers of ACME Manufacturing are discussing ways to allocate the cost of service departments,such as quality control and maintenance, to the production departments. To aid themin this discussion, the controller has provided the following information: Quality Control Maintenance Machining Assembly Total Budgeted overhead costs beforeAllocation $350,000 $200,000 $400,000 $300,000 $1,250,000 Budgeted machine hours — — 50,000 — 50,000 Budgeted direct labour hours — — — 25,000 25,000 Budgeted hours of service: Quality control — 7,000 21,000 7,000 35,000 Maintenance 10,000 — 18,000 12,000 40,000 Using the direct allocation method, the total amount of overhead allocated to each machine hour would be: a) $9.35 b) $5.25 c) $2.40 d) $8.00 e) $15.65 © 2012 John Wiley and Sons Canada, Ltd. 82 Cost Management Ans: E Quality Control is allocated to Machining $262,500 (21,000/28,000*$350,000) and Assembly $87,500 (7,000/28,000*$350,000); Maintenance is allocated to Machining $120,000 (18,000/30,000*$200,000) and Assembly $80,000 (12,000/30,000*$200,000); total Machining costs ($400,000 + $262,500 + $120,000)/ 50,000 = $15.65 8.19 Which of the following methods of allocating service department costs results in the most accurateproduct cost? a) Direct method b) Step-down method c) Reciprocal method d) Activity-based costing method Ans: C 8.20 Which service department should be allocated first, using the step-down method of allocation? a) Department A b) Department B c) Department C d) Department X or Y Ans: A 8.21 Assume that the service departments’ costs were allocated in alphabetical order. What is the approximate overhead rate for Department C? a) $1,860 b) $2,308 c) $2,429 d) $2,516 Ans: D Department A allocated $5,714 ($800,000*500/70,000) to Department C and $13,714 ($800,000*1,200/70,000) to Department B. Department B allocated $14,429 [($650,000+$13,714) *1,000/46,000); Department C approximate overhead rate is ($400,000 + $5,714 + $14,429)/(147+20) = $2,516 © 2012 John Wiley and Sons Canada, Ltd. Chapter 8: Measuring and Assigning Support Department Costs 83 EXERCISES 8.22 Estimated versus Actual Allocation Rates A. Estimated costs = $40,000 + $12(5,000) = $100,000 Estimated allocation rate = $100,000/5,000 hours = $20/hour B. Estimated cost at actual output = $40,000 + $12(4,900) = $98,800 Actual rate = $98,800/4,900 hours = $20.1633/hour C. An advantage of using an estimated allocation rate is that managers know in advance what their costs will be. A disadvantage is that there is no incentive to use custodial hours wisely because the costrate is known and will not change during the period. An advantage for using an actual allocation rate is that managers have a better idea about the effects of their use of custodial services on costs. A disadvantage is that they do not know their costs ahead of time, and they may have little control over whether the rate is higher or lower than expected. 8.23 Allocating Support Costs to Units Monthly occupancy = 120 beds*0.8*30 days = 2,880 patient days Monthly costs = $240,000 + $90*2,880 = $499,200 Average daily charge = $499,200/2,880 = $173.33 8.24 Direct Method – Cedar Hill Manufacturing A. Using the direct method: a. From Administration: To Cutting: $160,000 x (30,000/80,000) = $60,000 To Assembly: $160,000 x (50,000/80,000) = $100,000 b. From Custodial Services: To Cutting: $100,000 x (20,000/50,000) = $40,000 To Assembly: $100,000 x (30,000/50,000) = $60,000 © 2012 John Wiley and Sons Canada, Ltd. 84 Cost Management B. Calculate the total costs: Cutting Assembly Direct Costs $345,000 $731,000 Allocated Costs: Administration 60,000 100,000 Custodial 40,000 60,000 Total Costs $445,000 $891,000 C. Calculate cost per unit: Cutting Assembly Total Costs $445,000 $891,000 # units produced 50,000 90,000 Cost per unit $8.90 $9.90 8.25 Step-Down method– Cedar Hill Manufacturing A. Using the step-down method: a. From Administration: To Custodial Services: $160,000 x (10,000/90,000) = $17,777.78 To Cutting: $160,000 x (30,000/90,000) = $53,333.33 To Assembly: $160,000 x (50,000/90,000) = $88,888.89 b. From Custodial Services: Custodial Services costs: $100,000 + $17,777.78 = $117,777.78 To Cutting: $117,777.78 x (20,000/50,000) = $47,111.11 To Assembly: $117,777.78 x (30,000/50,000) = $70,666.67 B. Calculate the total costs: Cutting Assembly Direct Costs $345,000 $731,000 Allocated Costs: Administration 53,333.33 88,888.89 Custodial 47,111.11 70,666.67 Total Costs $445,444.44 $890,555.56 C. Calculate cost per unit: Cutting Assembly Total Costs $445,444.44 $890,555,56 # units produced 50,000 90,000 © 2012 John Wiley and Sons Canada, Ltd. Chapter 8: Measuring and Assigning Support Department Costs 85 Cost per unit $8.91 $9.90 8.26 Direct Method – Staffordshire Brothers From Payroll/Tax Reporting Services: To Pet Store: $60,000 x (5/12) = $25,000 To Pet Grooming: $60,000 x (7/12) = $35,000 From Custodial Services: To Pet Store: $40,000 x (3,000/8,000) = $15,000 To Pet Grooming: $40,000 x (5,000/8,000) = $25,000 Pet Store Pet Grooming Direct Costs $72,000 $90,000 Allocated Costs: Payroll/Tax Reporting 25,000 35,000 Custodial Services 15,000 25,000 Total Costs $112,000 $150,000 ÷ 12 months per year $9,333 $12,500 8.27 Step-Down Method – Staffordshire Brothers A. From Payroll/Tax Reporting Services: To Custodial: $60,000 x (3/15) = $12,000 To Pet Store: $60,000 x (5/15) = $20,000 To Pet Grooming: $60,000 x (7/15) = $28,000 Custodial costs: $40,000 + $12,000 = $52,000 From Custodial Services: To Pet Store: $52,000 x (3,000/8,000) = $19,500 To Pet Grooming: $52,000 x (5,000/8,000) = $32,500 Pet Store Pet Grooming Direct Costs $72,000 $90,000 Allocated Costs: Payroll/Tax Reporting Services 20,000 28,000 Custodial Services 19,500 32,500 Total Costs $111,500 $150,500 Monthly costs $9,291.67 $12,541.67 B. From Custodial Services: To Payroll/Tax Reporting: $40,000 x (1,000/9,000) = $4,444.44 To Pet Store: $40,000 x (3,000/9,000) = $13,333.33 To Pet Grooming: $40,000 x (5,000/9,000) = $22,222.22 Payroll/Tax Reporting Services costs: $60,000 + $4,444.44 = $64,444.44 From Payroll/Tax Reporting Services: © 2012 John Wiley and Sons Canada, Ltd. 86 Cost Management To Pet Store: $64,444.44 x (5/12) = $26,851.85 To Pet Grooming: $64,444.44 x (7/12) = $37,592.59 Pet Store Pet Grooming Direct Costs $72,000 $90,000 Allocated Costs: Payroll/Tax Reporting Services 13,333.33 22,222.22 Custodial Services 26,851.85 37,592.59 Total Costs $112,185.18 $149,814.81 Monthly costs $9,348.77 $12,484.57 8.28 Direct and Step-Down Methods – Donaldson Company Direct Allocation Method: Step-Down Allocation Method: 8.29 Single-Rate versus Dual-Rate A. First, use the cost function to calculate total cafeteria costs for July: Total cafeteria costs = $12,000 + [$2.50 × (3,200+1,000)] = $22,500 © 2012 John Wiley and Sons Canada, Ltd. Chapter 8: Measuring and Assigning Support Department Costs 87 Second, determine the single-rate allocation per meal: Single-rate allocation per meal = $22,500 / (3,200+1,000) = $5.3571 per meal Finally, allocate costs using the direct method: Allocation to administration (3,200 meals × $5.3571) $17,143 Allocation to factory (1,000 meals × $5.3571) 5,357 Total cost allocated $22,500 B. First, determine the fixed and variable allocation rates: Fixed cost allocation rate = $12,000/(3,200+1,000) = $2.8571 per meal Variable cost allocation rate (given) = $2.50 per meal Allocations to administration: Fixed (3,200 × $2.8571) $9,143 Variable (3,200 × $2.50) 8,000 $17,143 Allocation to factory: Fixed (1,000 × $2.8571) $2,857 Variable (1,000 × $2.50) 2,500 5,357 Total cost allocated $22,500 Notice that the costs allocated in Part B are the same as in Part A. This result occurred ONLY because the same allocation base (actual number of meals) was used to allocate both fixed and variable costs. Under the dual-rate method, different allocation bases are often used for fixed and variable costs. However, even if the same allocation base is used, the dual-rate method provides managers with separate rates for fixed and variable costs, which can be useful for decision making. Alternatively, estimated volume of the allocation base may be used for fixed costs, while actual volume of the allocation base is used for variable costs. See Part E, below. C. Pros for the single rate method: • It is simple to calculate. • It provides the same result as the dual-rate method in cases where the same allocation base is identified for both fixed and variable costs. Cons for the single rate method: • Because fixed and variable costs are combined, the cost rate does not provide managers with an estimate of incremental costs for decision making. D. For this company, because actual meals were used as the allocation base for both methods, there is no difference. If a different allocation base such as the number of employees had been used for the fixed costs, then the methods would have resulted in a more favorable allocation for one of the departments. In general, a department would prefer the method that is considered to be fairer or that allocates a smaller cost to the department. © 2012 John Wiley and Sons Canada, Ltd. 88 Cost Management E. Because the company was closed for retooling in July and far fewer meals were served than usual, the cost allocation to administration would be considerably higher than usual. In other words, the fixed costs would be spread over a smaller than usual number of meals served, leading to a higher fixed cost rate than normal. It would be fairer to the administration department to allocate costs based on either the average number of employees or the typical number of meals served rather than based on actual meals served during July. The additional fixed costs that would normally be allocated to the factory could be assigned to general overhead. 8.30 Stand-Alone and Incremental Cost Methods, Fairness A. Stand-alone method, based on the cost of separate travel to each school: State University: Allocation percent ($400/$1,400) 28.57% Allocated cost (28.57% × $864) $246.86 City College: Allocation percent ($200/$1,400) 14.29% Allocated cost (14.29% × $864) 123.43 Private University: Allocation percent ($800/$1,400) 57.14% Allocated cost (57.14% × $864) 493.71 Totals 100.00% $864.00 B. Incremental method, using number of days to determine degree of responsibility and using actual cost for separate travel: Most responsible is State University, at 3 days of travel time $400.00 Next most responsible is Private University, at 2 days ($864 – $400) 464.00 Least responsible is city College, at 1 day ($864 – $400 – $464) 0.00 Total $864.00 Alternatively, degree of responsibility could be based on the relative cost of traveling separately to each school: Most responsible is Private University at cost of $800 $800.00 Next most responsible is State University at cost of $400: (864 – $800) 64.00 Least responsible is City College, at cost of $200: ($864 – $800 – $64)) 0.00 Total $864.00 C. The stand-alone method is most fair in this situation. It does not seem fair that City College pays no travel costs under the two versions of the incremental method. Also, it does not seem fair that the cost allocated to Private University and State University should vary widely depending on how the degree of responsibility is determined. © 2012 John Wiley and Sons Canada, Ltd. Chapter 8: Measuring and Assigning Support Department Costs 89 8.31 Single-Rate versus Dual-Rate, Estimated and Actual Volumes A. Allocation of housekeeping costs using the single-rate method: Single rate based on estimated hours: Fixed costs: $40,000/5,000 hours $ 8.00 per hour Variable costs 12.00 per hour Single rate $20.00 per hour The single rate could also be calculated by first estimating the total housekeeping costs per month, and then dividing by estimated hours: Total costs [$40,000 + (5,000 hours × $12.00 per hour)] $100,000 Estimated hours ÷ 5,000 Single rate $20.00 per hour Allocations based on estimated hours: Department A (1,600 hours × $20) $ 32,000 Department B (1,400 hours × $20) 28,000 Department C (2,000 hours × $20) 40,000 Total $100,000 B. For the dual-rate method, see the calculations in Part A for the fixed and variable cost rates per hour. The following dual-rate allocations are based on estimated hours for fixed costs and actual hours for variable costs. Department A: (1,600 estimated hrs × $8) + (1,500 actual hrs × $12) $30,800 Department B: (1,400 estimated hrs × $8) + (1,600 actual hrs × $12) 30,400 Department C: (2,000 estimated hrs × $8) + (1,800 actual hrs × $12) 37,600 Total $98,800 Notice that the total cost allocated of $98,800 is not equal to the estimated cost of $100,000 (see Part A). The difference arises because variable costs are allocated based on actual instead of estimated hours. Because total variable costs are expected to vary based on actual number of hours, total actual costs are expected to be different than total estimated costs. C. Below are a number of advantages and disadvantages. Students may think of others. Advantages of single-rate method with allocation based on estimated volume: • The single-rate method does not require accurate estimation of the cost function for support services. • The single-rate method involves simpler calculations. • Using estimated rates and estimated hours helps managers plan departmental costs because they know ahead of time what the total cost will be. © 2012 John Wiley and Sons Canada, Ltd. 90 Cost Management Disadvantages of single-rate method with allocation based on estimated volume: • Managers may overuse support resources because their charges are at a fixed amount that will not change with the volume of resources used. • Support cost allocations may be unfair to managers who accurately estimate their use of support services. • Support department managers may have difficulty planning operations because user departments have an incentive to underestimate resource use. Advantages of dual-rate method with allocation based on estimated volume for fixed costs and actual volume for variable costs: • Using estimated rate and estimated hours for fixed support costs helps managers plan departmental costs because the allocation will not be affected by the volume of resources used by all of the user departments. • Using actual volume for variable costs most accurately holds departments responsible for the use of resources, discouraging managers from overusing support services. • Because they will be charged fixed costs based on estimated volume, department managers are encouraged to accurately estimate their use of support services. In turn, more accurate estimates improve planning in the support departments. Disadvantage of dual-rate method with allocation based on estimated volume for fixed costs and actual volume for variable costs: • Department managers who improve their efficiency in the use of support services will still be allocated the estimated amount for fixed resources. • Allocations to user departments may be unfair if the cost function for the support department is estimated inaccurately. 8.32 Direct Method Using Estimated Costs, Benchmarking - Devon A. Direct method allocation using direct labour hours: Support Departments Operating Departments Dept. A Dept. B Dept. C Casting Machining Total Allocation Base: Direct labour hours 6,000 4,000 10,000 60% 40% 100% Costs: Direct costs $88,000 $63,000 $40,000 $191,000 Department A (88,000) $ 52,800 $35,200 0 Department B (63,000) 37,800 25,200 0 Department C (40,000) 24,000 16,000 0 Total allocated cost $ 0 $ 0 $ 0 $114,600 $76,400 $191,000 © 2012 John Wiley and Sons Canada, Ltd. Chapter 8: Measuring and Assigning Support Department Costs 91 Direct method allocation using costs to purchase outside: Support Departments Operating Departments Dept. A Dept. B Dept. C Casting Machining Total Allocation Bases: Department A outside costs $50,000 $60,000 $110,000 45.45% 54.55% 100% Department B outside costs $40,000 $20,000 $60,000 66.67% 33.33% 100% Department C outside costs $30,000 $30,000 $50,000 50.00% 50.00% 100% Costs: Direct costs $88,000 $63,000 $40,000 $191,000 Department A (88,000) $40,000 $48,000 0 Department B (63,000) 42,000 21,000 0 Department C (40,000) 20,000 20,000 0 Total allocated cost $ 0 $ 0 $ 0 $102,000 $89,000 $191,000 B. Devon could use the cost of purchasing outside as a benchmark for both departments, but there are some advantages and disadvantages. Using the direct method, no interactions of support department services are reflected. This might understate the cost of services. However, fixed costs are included, and many of these may be sunk costs, for example depreciation expense. These could overstate the support department costs. If the costs for internal and external support services are similar, the cost to purchase outside might provide a good benchmark if it is equal to or less than the cost of internally providing the support. However, if the outside cost is more, incentive exists for increasing both the cost and use of services, which may be inefficient for the company overall. Alternatively, if the outside cost is much less, departments may begin to outsource the services and this duplicates services and may be inefficient for the overall company as well. 8.33 Direct and Step-Down Methods with Dual Rates - Petro-X A. Direct Method Allocation Support Departments Operating Departments Physical Equipment Plant Maintenance Dept. X Dept. Y Total Fixed Cost Allocation: Allocation bases: Square metres 5,000 8,000 13,000 38.462% 61.538% 100.00% Machine hours 10,000 15,000 25,000 40.00% 60.00% 100.00% Fixed costs: $39,000 $75,000 $114,000 Physical plant (39,000) $15,000 $ 24,000 0 Equipment maintenance (75,000) 30,000 45,000 0 Allocated fixed cost 0 0 45,000 69,000 114,000 © 2012 John Wiley and Sons Canada, Ltd. 92 Cost Management Variable Cost Allocation: Allocation bases: # of employees 40 50 90 44.444% 55.556% 100.00% Maintenance hours 200 400 600 33.333% 66.667% 100.00% Variable costs: 18,000 60,000 78,000 Physical plant (18,000) 8,000 10,000 0 Equipment maintenance (60,000) 20,000 40,000 0 Allocated variable cost 0 0 28,000 50,000 78,000 Total allocated cost (fixed + variable) $ 0 $ 0 $73,000 $119,000 $192,000 B. Step-down method allocation, with physical plant costs allocated first Support Departments Operating Departments Physical Equipment Plant Maintenance Dept. X Dept. Y Total Fixed Cost Allocation: Allocation bases: Square metres 3,900 5,000 8,000 16,900 23.077% 29.586% 47.337% 100.00% Machine hours 10,000 15,000 25,000 40% 60% 100.00% Fixed costs: $39,000 $75,000 $114,000 Step 1: Physical plant (39,000) 9,000 $11,538 $ 18,462 0 Step 2: Equip. maint. (84,000) 33,600 50,400 0 Allocated fixed cost 0 0 45,138 68,862 114,000 Variable Cost Allocation: Allocation bases: # of employees 12 40 50 102 11.76% 39.22% 49.02% 100.00% Maintenance hours 200 400 600 33.333% 66.667% 100.00% Variable costs: 18,000 60,000 78,000 Step 1: Physical plant (18,000) 2,118 7,059 8,823 0 Step 2: Equip. maint. (62,118) 20,706 41,412 0 Allocated variable cost 0 0 27,765 50,235 78,000 Total allocated cost (fixed + variable) $ 0 $ 0 $72,903 $119,097 $192,000 © 2012 John Wiley and Sons Canada, Ltd. Chapter 8: Measuring and Assigning Support Department Costs 93 C. Step-down method allocation, with equipment maintenance costs allocated first Support Departments Operating Departments Physical Equipment Plant Maintenance Dept. X Dept. Y Total Fixed Cost Allocation: Allocation bases: Machine hours 0 10,000 15,000 25,000 0.00% 40% 60% 100.00% Square metres 5,000 8,000 13,000 38.462% 61.538% 100.00% Fixed costs: $39,000 $75,000 $114,000 Step 1: Equip. maint. 0 (75,000) $30,000 $ 45,000 0 Step 2: Physical plant (39,000) 15,000 24,000 0 Allocated fixed cost 0 0 45,000 69,000 114,000 Variable Cost Allocation: Allocation bases: Maintenance hours 10 200 400 610 1.639% 32.787% 65.574% 100.00% # of employees 40 50 90 44.44% 55.56% 100.00% Variable costs: 18,000 60,000 78,000 Step 1: Equip. maint. 984 (60,000) 19,672 39,344 0 Step 2: Physical plant (18,984) 0 8,437 10,547 0 Allocated variable cost 0 0 28,109 49,891 78,000 Total allocated cost (fixed + variable) $ 0 $ 0 $73,109 $118,891 $192,000 D. Ideally, departments should be allocated in the order their services are used, with departments providing more services to other departments according to their rank of services provided. Because services can be difficult to measure, direct costs are often used as a measure of services provided. © 2012 John Wiley and Sons Canada, Ltd. 94 Cost Management 8.34 Reciprocal Method - Brown and Brinkley Brokerage A sample spreadsheet using Excel Solver for this problem is available on the Instructor’s web site for the textbook (available at www.wiley.com/canada/eldenburg). Below are manual calculations. Manual Calculations using Simultaneous Equations: Support Departments Operating Departments Research Administration Institutional Retail Total Allocation Bases: Research hours 200 500 300 1,000 20% 50% 30% 100% Number of employees 7 8 10 25 28% 32% 40% 100.00% Department costs: Payroll costs $350,000 $300,000 $400,000 $550,000 $1,600,000 Other costs 230,000 150,000 120,000 240,000 740,000 Total department costs $580,000 $450,000 $520,000 $790,000 $2,340,000 Given the above calculations, create simultaneous equations for the support costs: Research = $580,000 + 28% * Administration Administration = $450,000 + 20% * Research Set the two equations equal to each other and solve for the fully allocated cost of one support department: Research = $580,000 + 28% * ($450,000 + 20% * Research) Research = $580,000 + $126,000 + 5.6% * Research 94.4% * Research = $706,000 Research = $706,000/94.4% = $747,881 Then solve for the fully allocated cost of the other support department: Administration = $450,000 + 20% * Research = $450,000 + 20% * $747,881 = $450,000 + $149,576 = $599,576 © 2012 John Wiley and Sons Canada, Ltd. Chapter 8: Measuring and Assigning Support Department Costs 95 Finally, allocate the full cost of each support department to all departments: Support Departments Operating Departments Research Administration Institutional Retail Total Allocation Bases: Research hours 200 500 300 1,000 20% 50% 30% 100% Number of employees 7 8 10 25 28% 32% 40% 100.00% Total department costs $580,000 $450,000 $ 520,000 $ 790,000 $2,340,000 Cost allocations: Research (747,881) 149,576 373,941 224,364 0 Administration 167,881 (599,576) 191,864 239,831 0 Total allocated costs $ 0 $ 0 $1,085,805 $1,254,195 $2,340,000 8.35 Reciprocal Method - Paul’s Valley Protection Service A sample spreadsheet using Solver for this problem is available on the Instructor’s web site for the textbook (available at www.wiley.com/canada/eldenburg). Below are manual calculations. Manual Calculations using Simultaneous Equations: Let S1, S2 and S3 represent the full cost of providing each department's service. The simultaneous equations for support department costs are: S1 = $30,000 + 0.1*S2 + 0.2*S3 S2 = $20,000 + 0.4*S1 + 0.2*S3 S3 = $40,000 + 0.1*S1 + 0.2*S2 Substitute S1 into the equation for S2 and solve for S2: S2 = $20,000 + 0.4($30,000 + 0.1*S2 + 0.2*S3) + 0.2*S3 S2 = $20,000 + $12,000 + 0.04*S2 + 0.08*S3 + 0.2*S3 S2 = $32,000 + 0.04*S2 + 0.28*S3 0.96*S2 = $32,000 + 0.28*S3 S2 = ($32,000/0.96) + (0.28/0.96)*S3 S2 = $33,333.33 + 0.291667*S3 Substitute S1 into the equation for S3: S3 = $40,000 + 0.1($30,000 + 0.1*S2 + 0.2*S3) + 0.2*S2 S3 = $40,000 + $3,000 + 0.01*S2 + 0.02*S3 + 0.20*S2 S3 = $43,000 + 0.21*S2 + 0.02*S3 0.98*S3 = $43,000 + 0.21*S2 © 2012 John Wiley and Sons Canada, Ltd. 96 Cost Management Substitute S2 into the equation for S3 and solve for S3: 0.98*S3 = $43,000 + 0.21($33,333.33 + 0.291667*S3) 0.98*S3 = $43,000 + $7,000 + 0.0613*S3 0.91875*S3 = $50,000 S3 = $54,422 Substitute S3 back into the equation for S2 and solve for S2: S2 = $33,333.33 + 0.291667*$54,422 S2 = $49,206 Substitute S2 and S3 back into the equation for S1 and solve for S1: S1 = $30,000 + 0.1*$49,206 + 0.2*$54,422 S1 = $45,805 Finally, support costs are allocated to all of the departments: Support Departments Operating Departments S1 S2 S3 P1 P2 P3 Total S1 40% 10% 20% 20% 10% 100% S2 10% 20% 20% 50% 100% S3 20% 20% 10% 40% 10% 100% Department Costs $30,000 $20,000 $40,000 $90,000 Cost Allocations: S1 (45,805) 18,322 4,581 $ 9,161 $ 9,161 $ 4,581 $ 0 S2 4,921 (49,206) 9,841 9,841 0 24,603 0 S3 10,884 10,884 (54,422) 5,442 21,769 5,442 0 Total Allocated Cost $ 0 $ 0 $ 0 $24,444 $30,930 $34,625 $90,000 8.36 Step-Down, Direct, and Reciprocal Methods, Accuracy of Allocation - Software Plus Corporation A sample spreadsheet showing the calculations for this problem under the direct, step-down, and reciprocal methods is available on the Instructor’s web site for the textbook (available at www.wiley.com/canada/eldenburg). A. Software Plus has been using the step-down method that reflects half of the support department interactions. The costs of support departments are allocated one at a time. Once the costs of a particular support department are allocated, that department does not receive allocations from the remaining support departments. B. The direct method ignores all of the support department interactions. The costs of all support departments are allocated directly to operating departments. No support department costs are allocated to other support departments. © 2012 John Wiley and Sons Canada, Ltd. Chapter 8: Measuring and Assigning Support Department Costs 97 C. The reciprocal method uses all of the support department interactions. The costs of support departments are allocated simultaneously to each other, and then support department costs are allocated to operating departments. D. The following solution for the step-down method allocates the costs of Information Systems first. This department was chosen because it is largest with respect to direct support department costs. The costs of Information Systems are allocated to the other departments based on the percentages given in the problem. Administration is the next largest support department, so it is allocated second. When reviewing the allocation for Administration, remember that Information Systems is now out of the allocation, so the allocation percentages need to be adjusted. The percentage of Administration service remaining is (100%-50%), or 50%. To allocate Administration’s cost to Maintenance, divide 10% by 50%, so Maintenance receives 1/5, or 20% of Administration cost. Also note that the total cost allocated for Administration is $50,000, which is equal to the direct cost of $40,000 plus the $10,000 allocated from Information Systems. The final support department allocated is Maintenance. Because costs for all other support departments have already been allocated, Maintenance costs are allocated only to the operating departments. The total cost allocated is $34,000, which is the sum of Maintenance direct costs ($20,000) plus the costs allocated from Information Systems ($2,500) and Administration ($11,500). Support Departments Operating Departments Admin. Maint. Info.Sys. Games Simulation Total Allocation Percentages: Step 1: Information Systems 35% 5% — 40% 20% 100% Step 2: Administration — 10%/50% — 10%/50% 30%/50% 100% Step 3: Maintenance — — — 40%/70% 30%/70% 100% Direct Support Costs $40,000 $20,000 $50,000 $110,000 Allocations: Step 1: Information Systems 17,500 2,500 (50,000) 20,000 10,000 0 Step 2: Administration (57,500) 11,500 0 11,500 34,500 0 Step 3: Maintenance 0 (34,000) 0 19,429 14,571 0 Total Allocated Costs $ 0 $ 0 $ 0 $50,929 $59,071 $110,000 E. When Administration is allocated using the direct method, only the percentages from Games and Simulations departments are used. So, Games receives 10%/(10%+30%) ,or 1/4 of Administration’s cost, and Simulations receives the remaining 3/4 of cost. For the allocation of Maintenance, 40%/(40%+30%), or 57.143% goes to Games and the remaining 42.857% goes to Simulations. Information Systems costs are allocated in a similar manner. © 2012 John Wiley and Sons Canada, Ltd. 98 Cost Management Support Departments Operating Departments Admin. Maint. Info.Sys. Games Simulation Total Allocation Percentages: Administration 10%/40% 30%/40% 100% Maintenance 40%/70% 30%/70% 100% Information Systems 40%/60% 20%/60% 100% Direct Support Costs $40,000 $20,000 $50,000 $110,000 Allocations: Administration (40,000) 0 0 $10,000 $30,000 0 Maintenance 0 (20,000) 0 11,429 8,571 0 Information Systems 0 0 (50,000) 33,333 16,667 0 Total Allocated Costs $ 0 $ 0 $ 0 $54,762 $55,238 $110,000 F. Below is the solution under the reciprocal method. This solution was obtained using Solver with the following simultaneous equations: Admin = $40,000 + 20%Maint + 35%Info Maint = $20,000 + 10%Admin + 5%Info Info = $50,000 + 50%Admin + 10%Maint Support Departments Operating Departments Admin. Maint. Info.Sys. Games Simulation Total Use of Services: Administration — 10% 50% 10% 30% 100% Maintenance 20% — 10% 40% 30% 100% Information Systems 35% 5% — 40% 20% 100% Direct Support Costs $40,000 $20,000 $50,000 $110,000 Allocations: Administration (78,964) 7,896 39,482 7,896 23,689 0 Maintenance 6,507 (32,533) 3,253 13,013 9,760 0 Information Systems 32,457 4,637 (92,735) 37,094 18,547 0 Total Allocated Costs $ 0 $ 0 $ 0 $58,004 $51,996 $110,000 G. The direct method does not reflect any of the interactions among support departments. The step-down method improves upon this by allocating the costs of each support department to other support departments and operating departments, starting with the department that provides the most service (sometimes measured by the total direct costs assuming that larger departments provide more services to other departments). After each department’s cost is allocated, that department drops out of the allocation scheme, so that not all interactions are reflected, but at least some of them are. H. The reciprocal method improves upon the step-down method by reflecting all of the support department interactions. © 2012 John Wiley and Sons Canada, Ltd. Chapter 8: Measuring and Assigning Support Department Costs 99 8.37 Direct, Step-Down, and Reciprocal Methods, Assigning Costs to Departments – Pelham Town Library A sample spreadsheet for this problem is available on the Instructor’s web site for the textbook (available at www.wiley.com/canada/eldenburg). A. The only cost not already assigned is the building lease cost of $24,000. Either number of employees or square metres can be used as an allocation base. Square metres is a more logical base, reflecting the amount of space each department occupies. For example, the Janitorial department occupies 500/2,500 square metres, so it is allocated 20% of the lease cost. Total costs assigned to each department are computed by adding direct costs to allocated lease costs. Below is an excerpt from the sample spreadsheet for this problem: Problem 8.37: Pelham Town Library Direct Costs Janitorial Administration Books Other Media Total Salaries $20,000 $40,000 $50,000 $70,000 $180,000 Supplies 5,000 5,000 15,000 25,000 50,000 Other Costs Building lease 24,000 Total Costs $254,000 Allocation Base Volumes Square metres 50 50 120 30 250 Number of employees 1 1 2 1 5 Building Lease Allocation: % square metres 20% 20% 48% 12% 100% Allocation $4,800 $4,800 $11,520 $2,880 $24,000 Total Assigned Costs $29,800 $49,800 $76,520 $97,880 $254,000 B. This problem is very similar to direct method problems illustrated in the chapter. However, students need to identify the departments that provide support services (administration and janitorial) and the operating departments (books and other media). The solution shown below assumes that janitorial services are allocated using square metres and administration is allocated using number of employees. Here is an excerpt from the sample spreadsheet for this problem: © 2012 John Wiley and Sons Canada, Ltd. 100 Cost Management DIRECT METHOD ALLOCATION Support Departments Operating Departments Janitorial Administration Books Other Media Total Allocation Bases: Square metres 120 30 150 80.00% 20.00% 100% Number of employees 2 1 3 66.67% 33.33% 100% TotalAssigned Costs $29,800 $49,800 $76,520 $97,880 $254,000 Allocations: Janitorial (29,800) 0 23,840 5,960 0 Administration 0 (49,800) 33,200 16,600 0 TotalAllocated Costs $0 $0 $133,560 $120,440 $254,000 C. Under the step-down method, it is necessary to identify the support department that provides the most services. Because Administration is the largest department when comparing support department costs, it will be allocated first. Below is an excerpt from the sample spreadsheet for this problem. STEP-DOWN METHOD ALLOCATION Support Departments Operating Departments Janitorial Administration Books Other Media Total Allocation Bases: Square metres 120 30 150 80.00% 20.00% 100% Number of employees 1 2 1 4 25% 50% 25% 100% TotalAssigned Costs $29,800 $49,800 $76,520 $97,880 $254,000 Allocations: Administration 12,450 (49,800) 24,900 12,450 0 Janitorial (42,250) 0 33,800 8,450 0 TotalAllocated Costs $0 $0 $135,220 $118,780 $254,000 D. Under the reciprocal method, the simultaneous equations for the support department allocations are developed first. Simultaneous equations: Admin = $49,800 + (50/200 square metres) * Janitor Janitor = $29,800 + (1/4 employees) * Admin © 2012 John Wiley and Sons Canada, Ltd. Chapter 8: Measuring and Assigning Support Department Costs 101 Here are calculations for solving the simultaneous equations manually. First substitute the Janitor equation into the Admin equation and solve for Admin: Admin = $49,800 + (50/200) * [$29,800 + (1/4) * Admin] Admin = $49,800 + 0.25* $29,800 + 0.25 * 0.25 * Admin Admin = $49,800 + $7,450 + 0.0625*Admin Admin = $57,250 + 0.0625*Admin 0.9375*Admin = $57,250 Admin = $57,250/0.9375 Admin = $61,067 Now substitute Admin into the Janitor equation and solve for Janitor: Janitor = $29,800 + (1/4) x $61,067 = $45,067 Below is an excerpt from the sample spreadsheet for this problem. It shows the results using Excel Solver to solve the simultaneous equations and allocate the support department costs. Square metres 50 120 30 200 25% 60% 15% 100% Number of employees 1 2 1 4 25% 50% 25% 100% TotalAssigned Costs $29,800 $49,800 $76,520 $97,880 $254,000 Allocations: Administration 15,267 (61,067) 30,533 15,267 0 Janitorial (45,067) 11,267 27,040 6,760 0 TotalAllocated Costs $0 $0 $134,093 $119,907 $254,000 8.38 Stand-alone and Incremental Cost Allocation Methods - Monty A. Under the stand-alone method, the Frankfurt outlet would pay €250/(€250+€200)* €300 = €167, and Paris would pay the remaining €133. B. Under the incremental cost-allocation method the cost to Frankfurt’s outlet would be €250, and the cost to the Paris outlet would be €50 (€300-€250). C. A criterion is needed to evaluate fairness. In this particular problem, the perception of fairness probably depends on each individual manager’s view. From the perspective of the Frankfurt manager, the difference between the two costs depended only on who called first. If Paris had called at a later time, after the airfare to Frankfurt had already been booked, the cost to Paris would have been the complete round trip fare from London. Thus, the Frankfurt managers would consider the stand-alone method to be © 2012 John Wiley and Sons Canada, Ltd. 102 Cost Management fairer than the incremental cost-allocation method. However, the Paris manager would probably argue the other way around. Another way to split the cost between the two outlets would be for each outlet to pay 50% of the total fare. This may be perceived as the most fair. For this specific problem, the differences in amounts that each outlet pays are small, so fairness may not be an issue. However, when differences are larger, perceptions of fairness become more important. 8.39 Step-Down and Reciprocal Methods, Uncertainties, Pricing - Kovacik A sample spreadsheet for this problem is available on the Instructor’s web site for the textbook (available at www.wiley.com/canada/eldenburg). A. Under the step-down method, the direct costs of Information Systems are allocated first because they are larger than the direct costs for the other support department (Engineering). In the first step, Information Systems costs are allocated to all other departments using the percent of services used as given in the problem. In the second step, the percentages for Engineering and Design must be adjusted to remove the percent of services used by Information Systems. Thus, the percent allocated to the Plain Bank department is 40%/(100%-10%), or 44.444%. The percent allocated to the Metallic Bank department is 50%/(100%-10%), or 55.5556%. The total cost allocated in step 2 of $4,300 is equal to the Engineering and Design direct costs of $2,700 plus $1,600 in costs allocated from Information Systems. Support Departments Operating Departments Engineering Information and Design Systems Plain Bank Metallic Bank Total Allocation Bases: Information systems 20% 30% 50% 100% Engineering and design 44.4444% 55.5556% 100% Direct Costs $2,700 $8,000 $10,000 $20,000 $40,700 Allocations: Step 1: Information systems 1,600 (8,000) 2,400 4,000 0 Step 2: Engineering and design (4,300) 0 1,911 2,389 0 Total Allocated Costs $ 0 $ 0 $14,311 $26,389 $40,700 B. Calculation of estimated total allocated cost per unit using costs calculated under the step-down method: Allocated Cost/Production Volume Allocated Cost Per Unit Plain bank $14,311/8,000 units $1.789 Metallic bank $26,389/4,000 units $6.597 C. Actual total allocated costs will be different than budgeted total allocated costs because budgets never exactly predict costs or production levels. Production levels change because of unanticipated changes in product demand, unexpected production stoppages, © 2012 John Wiley and Sons Canada, Ltd. Chapter 8: Measuring and Assigning Support Department Costs 103 delays in receipt of materials, and so on. There are many reasons for actual costs differing from budgeted costs, such as: * There can be unexpected inflation or deflation in the costs of materials, labour, supplies, etc. * Employment levels fluctuate because employees leave unexpectedly, it takes longer than expected to hire new employees, or management decides to change the number or types of employees. * Unanticipated new types of materials, designs, or technologies can be adopted, altering production costs. * Capacity constraints occur if demand is higher than usual. As organizations near their capacity levels, costs of congestion increase and money may be spent to relax the constraint. * Changes in product design or the manufacturing process affect the amount and cost of materials and labour. D. Under the reciprocal method, the simultaneous equations for the two support departments are: Engineer = $2,700 + 20%* Info Info = $8,000 + 10% * Engineer Substituting Engineer into the Info equation and solving for Info: Info = $8,000 + 10% * ($2,700 + 20% * Info) Info = $8,000 + 270 + 0.10 * 0.20 * Info Info = $8,270 + 0.02 * Info 0.98 * Info = $8,270 Info = $8,270 / 0.98 Info = $8,439 Substituting Info back into the equation for Engineer: Engineer = $2,700 + 20% * $8,439 = $4,388 © 2012 John Wiley and Sons Canada, Ltd. 104 Cost Management The cost allocations are performed as follows: Support Departments Operating Departments Engineering Information and Design Systems Plain Bank Metallic Bank Total Services used: Engineering and design 10% 40% 50% 100% Information systems 20% 30% 50% 100% Direct Costs $2,700 $8,000 $10,000 $20,000 $40,700 Allocations: Engineering and design (4,388) 439 1,755 2,194 0 Information systems 1,688 (8,439) 2,532 4,219 0 Total Allocated Costs $ 0 $ 0 $14,287 $26,413 $40,700 E. Calculation of estimated total allocated cost per unit using costs calculated under the reciprocal method: Allocated Cost/Production Volume Allocated Cost Per Unit Plain bank $14,287/8,000 units $1.786 Metallic bank $26,413/4,000 units $6.603 © 2012 John Wiley and Sons Canada, Ltd. Chapter 8: Measuring and Assigning Support Department Costs 105 PROBLEMS 8.40 Department Allocations, Decision Making – Haley’s Department Store [Note: This problem requires application of knowledge from Chapter 4.] A. Because the firm allocated store maintenance costs to only three departments, the confectionery shop did not receive an allocation. Accordingly, store maintenance costs were allocated as follows: Allocation rate = $95,000/950 m = $100 per m 2 Building costs allocated to departments: Clothing (600 m × $100) $60,000 2 Bedding (150 m × $100) 15,000 Jewellery (200 m × $100) 20,000 Total allocation $95,000 Earnings after allocation of building costs: Clothing ($72,000 – $60,000) $12,000 Bedding ($19,500 – $15,000) 4,500 Jewelry (40,000 – $20,000) 20,000 Confections (4,000 – $0) 4,000 B. Earnings per m : 2 2 2 Clothing ($12,000/600 m )2 $20 per m 2 Bedding ($4,500/150 m ) $30 per m Jewellery ($20,000/200 m ) 2 $100 per m 2 2 2 Confections ($4,000/50 m ) $80 per m Jewelry would be expanded, and Clothing would be reduced or dropped. C. Contribution margin per square metre: Clothing ($72,000/600 m ) 2 $120 per m 2 2 2 Bedding ($19,500/150 m ) $130 per m Jewellery ($40,000/200 m ) 2 $200 per m 2 Confections ($4,000/50 m ) 2 $80 per m 2 Jewelry would be expanded and Confections would be reduced or dropped. D. Allocations of the building costs reflect unavoidable costs that should not be used in decision making. That is, these costs will be incurred no matter what product mix is used in the space. Therefore, the contribution margins per square metre in Part C are the better for decision making. © 2012 John Wiley and Sons Canada, Ltd. 106 Cost Management Several qualitative factors may enter into this decision. It is possible that customers such as families come into the store to purchase confections and then buy other products. It is also possible that increasing the square metres for one product will not increase sales because the store has regular customers who purchase a specific mix of these products. Students may think of other qualitative factors. 8.41 Single VersusDual Rates, Manager Incentives, Transfer Pricing – Cheng and Gonzales A. Total budgeted hours = 300+350+400 = 1,050 Total budgeted maintenance costs = $16,000 + ($35 × 1,050 hours) = $52,750 Single rate based on budgeted hours = $52,750/1,050 = $50.2381 per hour Single-rate allocation of maintenance costs using budgeted hours: West Coast (300 × $50.2381) $15,072 Midwest (350 × $50.2381) 17,583 East Coast (400 × $50.2381) 20,095 Total allocation $52,750 B. Total actual hours = 270 + 380 + 400 = 1,050 Total allocated maintenance costs = $16,000 + ($35 × 1,050 hours) = $52,750 Single rate based on actual hours = $52,750/1,050 = $50.2381 per hour Single-rate allocation of maintenance costs using actual hours: West Coast (270 × $50.2381) $13,564 Midwest (380 × $50.2381) 19,091 East Coast (400 × $50.2381) 20,095 Total allocation $52,750 C. Fixed cost rate based on budgeted hours = $16,000/1,050 = $15.2381 per hour Variable rate = $35 per hour Dual-rate allocation using budgeted hours for fixed costs and actual hours for variable costs: West Coast (300 × $15.2381) + (270 × $35) $14,022 Midwest (350 × $15.2381) + (380 × $35) 18,633 East Coast (400 × $15.2381 + (400 × $35) 20,095 Total allocation $52,750 D. The optimal use of the maintenance department would be to keep the trucks washed, serviced and repaired in a manner to achieve the highest margins from trucking operations, which means achieving the minimum amount of breakdowns with the least cost possible. Each trucking department would use the maintenance resources to minimize downtime and cost. © 2012 John Wiley and Sons Canada, Ltd. Chapter 8: Measuring and Assigning Support Department Costs 107 E. 1. If a single rate method with budgeted hours is used, managers would tend to underestimate the amount of hours that would be used and then use more hours than budgeted. 2. If a single rate method with actual hours is used, managers would tend to focus on controlling maintenance costs. 3. If a dual rate method is used, managers would have an incentive to estimate maintenance hours needed more accurately and to control their use of variable maintenance costs. F. Cheng and Gonzales may want to set transfer prices so that the maintenance services will be used optimally. They may want to set a price per task and keep prices low on tasks that will reduce costs in the long run, such as oil changes, but increase the price on services that do not affect the life of the trucks, such as a thorough cleaning of the truck cab. Repairs could be charged out at variable cost so that they are always done in a timely manner. Advantages of this system are that managers will use the resources more optimally. A big disadvantage is the time and cost needed to determine the prices and change them over time as costs change. 8.42 Step-Down and Reciprocal Methods, Choosing Methods, Cost Pools, Uncertainties - Physician Brother A. Both methods are appropriate for allocating support department costs to health program departments. The step-down method ranks support departments in order of service provided and then allocates their costs to other departments according to a cascading method. The support department providing most services is allocated first to all other departments, and is then dropped from the allocation process. Next, the support department providing the second-most services is allocated to the remaining departments, and then it drops out, and so on until all support department costs are allocated. Therefore, this method partially takes into account the fact that the support departments provide services for each other. The reciprocal method uses simultaneous equations to reflect all of the services provided among the support departments. Therefore, the reciprocal method more accurately measures support department costs before those costs are allocated to the health program departments. B. Here are some factors that the physician should consider to choose the best allocation method and best allocation bases. Choosing the allocation method: If you only have a few support activities, the two methods are likely to produce similar allocations. However, the step-down method is easier to calculate and understand, so you may prefer that method. Alternatively, if the
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