Manerial accounting 11e garrison noreen brewer chap015

11th Edition
Chapter 15

McGraw-Hill/Irwin

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Service Department
Costing: An Activity
Approach
Chapter Fifteen

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Copyright © 2006, The McGraw-Hill Companies, Inc.


Reasons for Allocating Service
Department Costs
To
To encourage
encourage operating
operating
departments
departments to
to wisely
wisely
use
use service
service department

department
resources.
resources.

To
To provide
provide operating
operating
departments
departments with
with more
more
complete
complete cost
cost data
data
for
for making
making decisions.
decisions.

To
To help
help measure
measure the
the
profitability
profitability of
of operating
operating

departments.
departments.

To
To create
create incentive
incentive
for
for service
service departments
departments
to
to operate
operate efficiently.
efficiently.

To
To value
value inventory
inventory for
for
external
external financial
financial
reporting
reporting purposes.
purposes.

To
To include

include all
all overhead
overhead
in
in the
the cost
cost base
base when
when
cost-plus
cost-plus pricing
pricing is
is used.
used.

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Selecting Allocation Bases
The
The allocation
allocation bases
bases used
used should
should
“drive”
“drive” the
the cost

cost being
being allocated.
allocated.
For
For example,
example, when
when allocating
allocating costs
costs
of
of the
the employee
employee cafeteria,
cafeteria, the
the number
number
of
of meals
meals served
served would
would be
be aa good
good
choice
choice for
for the
the allocation
allocation base.
base.
Service

Departments
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$

Operating
Departments
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Selecting Allocation Bases
AAservice
servicedepartment’s
department’scosts
costsmay
maybe
be
allocated
allocatedusing
usingmore
morethan
thanone
onebase.
base.
For
For example,
example,aaportion
portionof
ofthe
thehuman

humanresource
resourcedepartment
department
costs
costsmight
mightbe
beallocated
allocatedbased
basedon
onthe
thenumber
number of
ofemployees
employees
in
ineach
each operating
operatingdepartment
department and
andanother
anotherportion
portionmight
might be
be
allocated
allocatedbased
basedon
onhours
hours spent
spent in

intraining
trainingemployees
employeesin
in
each
eachoperating
operatingdepartment.
department.

Service
Departments
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$

Operating
Departments
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Examples of Allocation Bases
Service Department
Laundry
Airport Ground Services
Cafeteria
Medical Facilities
Materials Handling
Information Technology
Custodial Services
Cost Accounting

Power
Human Resources
Receiving, Shipping, and Stores
Factory Administration
Maintenance
McGraw-Hill/Irwin

Exh.
15-1

Allocation Bases
Pounds of laundry
Number of flights
Number of meals
Cases handled; number of employees;
hours worked
Hours of service; volume handled
Number of personal computers;
applications installed
Square footage occupied
Labor hours; customers served
KWH used; capacity of machines
Number of employees; training hours
Units handled; number of requisitions;
space occupied
Total labor hours
Machine hours
Copyright © 2006, The McGraw-Hill Companies, Inc.

Interdepartmental Services
Problem
Problem
Allocating
Allocating costs
costs when
when service
service departments
departments
provide
provide services
services to
to each
each other
other
Solutions
Direct Method
Step Method
Reciprocal Method
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Direct Method

Interactions
between service
departments are
ignored and all

costs are
allocated directly
to operating
departments.

McGraw-Hill/Irwin

Service
Department
(Cafeteria)

Operating
Department
(Machining)

Service
Department
(Custodial)

Operating
Department
(Assembly)

Copyright © 2006, The McGraw-Hill Companies, Inc.


Direct Method Example

Departmental costs
before allocation

Number of employees
Square feet occupied

McGraw-Hill/Irwin

Service Departments

Operating Departments

Cafeteria

Custodial

Machining

Assembly

$ 360,000
15
5,000

$ 90,000
10
2,000

$ 400,000
20
25,000

$ 700,000

30
50,000

Service Department

Allocation Base

Cafeteria
Custodial

Number of employees
Square feet occupied

Copyright © 2006, The McGraw-Hill Companies, Inc.


Direct Method Example
Service Departments

Operating Departments

Cafeteria

Custodial

Machining

Assembly

Departmental costs

before allocation

$ 360,000

$ 90,000

$ 400,000

$ 700,000

Cafeteria allocation

?

?

?

?

?

?

?

?

?

Custodial allocation
Total after allocation

McGraw-Hill/Irwin

?

Copyright © 2006, The McGraw-Hill Companies, Inc.


Direct Method Example

Departmental costs
before allocation
Cafeteria allocation

Service Departments

Operating Departments

Cafeteria

Custodial

Machining

Assembly

$ 360,000

$ 90,000

$ 400,000

$ 700,000

(360,000)

Custodial allocation
Total after allocation

$

0

144,000

?

?

?

?

?

?

?

20
$360,000 ×
= $144,000
20 + 30
Allocation base: Number of employees
McGraw-Hill/Irwin

Copyright © 2006, The McGraw-Hill Companies, Inc.


Direct Method Example

Departmental costs
before allocation
Cafeteria allocation

Service Departments

Operating Departments

Cafeteria

Custodial

Machining

Assembly

$ 360,000

$ 90,000

$ 400,000

$ 700,000

144,000

216,000

(360,000)

Custodial allocation
Total after allocation

$

$360,000 ×

0

?

?

?

?

?

?

30
= $216,000
20 + 30

Allocation base: Number of employees
McGraw-Hill/Irwin

Copyright © 2006, The McGraw-Hill Companies, Inc.


Direct Method Example

Departmental costs
before allocation
Cafeteria allocation

Service Departments

Operating Departments

Cafeteria

Custodial

Machining

Assembly

$ 360,000

$ 90,000

$ 400,000

$ 700,000

144,000

216,000

(360,000)

Custodial allocation
Total after allocation

(90,000)
$

0

$

0

25,000
$90,000 ×

25,000 + 50,000

30,000

?

$ 574,000

?

= $30,000

Allocation base: Square feet occupied
McGraw-Hill/Irwin

Copyright © 2006, The McGraw-Hill Companies, Inc.


Direct Method Example

Departmental costs
before allocation
Cafeteria allocation

Service Departments

Operating Departments

Cafeteria

Custodial

Machining

Assembly

$ 360,000

$ 90,000

$ 400,000

$ 700,000

144,000

216,000

30,000

60,000

$ 574,000

$ 976,000

(360,000)

Custodial allocation
Total after allocation

(90,000)
$

0

$

0

50,000
$90,000 ×
25,000 + 50,000

= $60,000

Allocation base: Square feet occupied
McGraw-Hill/Irwin

Copyright © 2006, The McGraw-Hill Companies, Inc.


Step Method

Once a service
department’s costs
are allocated,
other service
department costs
are not allocated

back to it.

McGraw-Hill/Irwin

Service
Department
(Cafeteria)

Operating
Department
(Machining)

Service
Department
(Custodial)

Operating
Department
(Assembly)

Copyright © 2006, The McGraw-Hill Companies, Inc.


Step Method
There are three key points to understand
regarding the step method:
 In both the direct and step methods, any amount of

the allocation base attributable to the service
department whose cost is being allocated is always

ignored.
 Any amount of the allocation base that is
attributable to a service department whose cost has
already been allocated is ignored.
 Each service department assigns its own costs to
operating departments plus the costs that have
been allocated to it from other service departments.
McGraw-Hill/Irwin

Copyright © 2006, The McGraw-Hill Companies, Inc.


Step Method Example
We will use the same data used
in the direct method example.

Departmental costs
before allocation
Number of employees
Square feet occupied

McGraw-Hill/Irwin

Service Departments

Operating Departments

Cafeteria

Custodial

Machining

Assembly

$ 360,000
15
5,000

$ 90,000
10
2,000

$ 400,000
20
25,000

$ 700,000
30
50,000

Service Department

Allocation Base

Cafeteria
Custodial

Number of employees
Square feet occupied

Copyright © 2006, The McGraw-Hill Companies, Inc.


Step Method Example
Service Departments

Operating Departments

Cafeteria

Custodial

Machining

Assembly

Departmental costs
before allocation

$ 360,000

$ 90,000

$ 400,000

$ 700,000

Cafeteria allocation

?

?

?

?

?

?

?

?

?

?

Custodial allocation
Total after allocation

?

Allocate
Allocate Cafeteria
Cafeteria costs
costs first
first since
since

itit provides
provides more
more service
service than
than Custodial.
Custodial.
McGraw-Hill/Irwin

Copyright © 2006, The McGraw-Hill Companies, Inc.


Step Method Example

Departmental costs
before allocation
Cafeteria allocation

Service Departments

Operating Departments

Cafeteria

Custodial

Machining

Assembly

$ 360,000

$ 90,000

$ 400,000

$ 700,000

?

?

?

?

?

?

?

?

(360,000)

Custodial allocation
Total after allocation

$

0

60,000

10
$360,000 ×
10 + 20 + 30

= $60,000

Allocation base: Number of employees
McGraw-Hill/Irwin

Copyright © 2006, The McGraw-Hill Companies, Inc.


Step Method Example

Departmental costs
before allocation
Cafeteria allocation

Service Departments

Operating Departments

Cafeteria

Custodial

Machining

Assembly

$ 360,000

$ 90,000

$ 400,000

$ 700,000

60,000

120,000

(360,000)

Custodial allocation
Total after allocation

$

0

?

?

?

?

?

?

?

20
$360,000 ×
10 + 20 + 30

= $120,000

Allocation base: Number of employees
McGraw-Hill/Irwin

Copyright © 2006, The McGraw-Hill Companies, Inc.


Step Method Example

Departmental costs
before allocation
Cafeteria allocation

Service Departments

Operating Departments

Cafeteria

Custodial

Machining

Assembly

$ 360,000

$ 90,000

$ 400,000

$ 700,000

60,000

120,000

180,000

(360,000)

Custodial allocation
Total after allocation

$

0

?

?

?

?

?

?

30
$360,000 ×
10 + 20 + 30

= $180,000

Allocation base: Number of employees
McGraw-Hill/Irwin

Copyright © 2006, The McGraw-Hill Companies, Inc.


Step Method Example

Departmental costs
before allocation

Cafeteria allocation

Service Departments

Operating Departments

Cafeteria

Custodial

Machining

Assembly

$ 360,000

$ 90,000

$ 400,000

$ 700,000

60,000

120,000

180,000

(360,000)

Custodial allocation
Total after allocation

(150,000)
$

0

$

0

?

?

?

?

New total = $90,000 original Custodial cost
plus $60,000 allocated from the Cafeteria.

McGraw-Hill/Irwin

Copyright © 2006, The McGraw-Hill Companies, Inc.


Step Method Example

Departmental costs
before allocation
Cafeteria allocation

Service Departments

Operating Departments

Cafeteria

Custodial

Machining

Assembly

$ 360,000

$ 90,000

$ 400,000

$ 700,000

60,000

120,000

180,000

(150,000)

50,000

?

$ 570,000

?

(360,000)

Custodial allocation
Total after allocation

$

0

$

0

25,000
$150,000 ×
25,000 + 50,000

= $50,000

Allocation base: Square feet occupied

McGraw-Hill/Irwin

Copyright © 2006, The McGraw-Hill Companies, Inc.


Step Method Example

Departmental costs
before allocation
Cafeteria allocation

Service Departments

Operating Departments

Cafeteria

Custodial

Machining

Assembly

$ 360,000

$ 90,000

$ 400,000

$ 700,000

60,000

120,000

180,000

(150,000)

50,000

100,000

$ 570,000

$ 980,000

(360,000)

Custodial allocation
Total after allocation

$

0

$

0

50,000
$150,000 ×
25,000 + 50,000

= $100,000

Allocation base: Square feet occupied
McGraw-Hill/Irwin

Copyright © 2006, The McGraw-Hill Companies, Inc.


Reciprocal Method

Interdepartmental
services are given
full recognition
rather than partial
recognition as with
the step method.

Service
Department
(Cafeteria)

Operating
Department
(Machining)

Service

Department
(Custodial)

Operating
Department
(Assembly)

Because of its mathematical complexity,
the reciprocal method is rarely used.
McGraw-Hill/Irwin

Copyright © 2006, The McGraw-Hill Companies, Inc.