The stand-alone method may use selling price or unit costs to allocate revenues.

CHAPTER 15

ALLOCATION OF SUPPORT-DEPARTMENT COSTS,

COMMON COSTS, AND REVENUES

15-1 The single-rate (cost-allocation) method makes no distinction between fixed costs and variable costs in the cost pool. It allocates costs in each cost pool to cost objects using the same rate per unit of the single allocation base. The dual-rate (cost-allocation) method classifies costs in each cost pool into two pools—a variable-cost pool and a fixed-cost pool—with each pool using a different cost-allocation base.

15 The dual-rate method provides information to division managers about cost behavior. Knowing how fixed costs and variable costs behave differently is useful in decision making.

15 Budgeted cost rates motivate the manager of the support department to improve efficiency because the support department bears the risk of any unfavorable cost variances.

15-4 Examples of bases used to allocate support department cost pools to operating departments include the number of employees, square feet of space, number of direct labor hours, and machine-hours.

15-5 The use of budgeted indirect cost allocation rates rather than actual indirect rates has several attractive features to the manager of a user department: a. the user knows the costs in advance and can factor them into ongoing operating choices, b. the cost allocated to a particular user department does not depend on the amount of resources used by other user departments, and c. inefficiencies at the department providing the service do not affect the costs allocated to the user department.

15 Disagree. Allocating costs on “the basis of estimated long-run use by user department managers” means department managers can lower their cost allocations by deliberately underestimating their long-run use (assuming all other managers do not similarly underestimate their usage).

15-7 The three methods differ in how they recognize reciprocal services among support departments: a. The direct (allocation) method ignores any services rendered by one support department to another; it allocates each support department’s costs directly to the operating departments. b. The step-down (allocation) method allocates support-department costs to other support departments and to operating departments in a sequential manner that partially recognizes the mutual services provided among all support departments. c. The reciprocal (allocation) method allocates support-department costs to operating departments by fully recognizing the mutual services provided among all support departments.

15-8 The reciprocal method is theoretically the most defensible method because it fully recognizes the mutual services provided among all departments, irrespective of whether those departments are operating or support departments.

15-9 The stand-alone cost-allocation method uses information pertaining to each user of a cost object as a separate entity to determine the cost-allocation weights. The incremental cost-allocation method ranks the individual users of a cost object in the order of users most responsible for the common costs and then uses this ranking to allocate costs among those users. The first-ranked user of the cost object is the primary user and is allocated costs up to the costs of the primary user as a stand-alone user. The second-ranked user is the first incremental user and is allocated the additional cost that arises from two users instead of only the primary user. The third-ranked user is the second incremental user and is allocated the additional cost that arises from three users instead of two users, and so on. The Shapley Value method calculates an average cost based on the costs allocated to each user as first the primary user, the second-ranked user, the third-ranked user, and so on.

15-10 All contracts with U. government agencies must comply with cost accounting standards issued by the Cost Accounting Standards Board (CASB).

15-11 Areas of dispute between contracting parties can be reduced by making the “rules of the game” explicit and in writing at the time the contract is signed.

15-12 Companies increasingly are selling packages of products or services for a single price. Revenue allocation is required when managers in charge of developing or marketing individual products in a bundle are evaluated using product-specific revenues.

15-13 The stand-alone revenue-allocation method uses product-specific information on the products in the bundle as weights for allocating the bundled revenues to the individual products. The incremental revenue allocation method ranks individual products in a bundle according to criteria determined by management—such as the product in the bundle with the most sales—and then uses this ranking to allocate bundled revenues to the individual products. The first-ranked product is the primary product in the bundle. The second-ranked product is the first incremental product, the third-ranked product is the second incremental product, and so on.

15-14 Managers typically will argue that their individual product is the prime reason why consumers buy a bundle of products. Evidence on this argument could come from the sales of the products when sold as individual products. Other pieces of evidence include surveys of users of each product and surveys of people who purchase the bundle of products.

15-15 A dispute over allocation of revenues of a bundled product could be resolved by (a) having an agreement that outlines the preferred method in the case of a dispute, or (b) having a third party (such as the company president or an independent arbitrator) make a decision.

15-17 (20–25 min.) Single-rate method, budgeted versus actual costs and quantities.

1.a rate =

Budgeted indirect costs Budgeted trips

= $115,000/50 trips = $2,300 per round-trip

Indirect costs allocated to Dark C. Division = $2,300 per round-trip 30 budgeted round trips = $69,

Indirect costs allocated to Milk C. Division = $2,300 per round-trip 20 budgeted round trips = $46,

b rate = $2,300 per round-trip

Indirect costs allocated to Dark C. Division = $2,300 per round-trip 30 actual round trips = $69,

Indirect costs allocated to Milk C. Division = $2,300 per round-trip 15 actual round trips = $34,

c. Actual rate =

Actual indirect costs Actual trips = $96,750/ 45 trips = $2,150 per round-trip

Indirect costs allocated to Dark C. Division = $2,150 per round-trip 30 actual round trips = $64,

Indirect costs allocated to Milk C. Division = $2,150 per round-trip 15 actual round trips = $32,

  1. When budgeted rates/budgeted quantities are used, the Dark Chocolate and Milk Chocolate Divisions know at the start of 2012 that they will be charged a total of $69,000 and $46,000 respectively for transportation. In effect, the fleet resource becomes a fixed cost for each division. Then, each may be motivated to over-use the trucking fleet, knowing that their 2012 transportation costs will not change. When budgeted rates/actual quantities are used, the Dark Chocolate and Milk Chocolate Divisions know at the start of 2012 that they will be charged a rate of $2,300 per round trip, i., they know the price per unit of this resource. This enables them to make operating decisions knowing the rate they will have to pay for transportation. Each can still control its total transportation costs by minimizing the number of round trips it uses. Assuming that the budgeted rate was based on honest estimates of their annual usage, this method will also provide an estimate of the excess trucking capacity (the portion of fleet costs not charged to either division). In contrast, when actual costs/actual quantities are used, the two divisions must wait until year- end to know their transportation charges. The use of actual costs/actual quantities makes the costs allocated to one division a function of the actual demand of other users. In 2012, the actual usage was 45 trips, which is 5 trips below the 50 trips budgeted. The Dark Chocolate Division used all the 30 trips it had budgeted. The Milk Chocolate Division used only 15 of the 20 trips budgeted. When costs are

allocated based on actual costs and actual quantities, the same fixed costs are spread over fewer trips resulting in a higher rate than if the Milk Chocolate Division had used its budgeted 20 trips. As a result, the Dark Chocolate Division bears a proportionately higher share of the fixed costs. Using actual costs/actual rates also means that any efficiencies or inefficiencies of the trucking fleet get passed along to the user divisions. In general, this will have the effect of making the truck fleet less careful about its costs, although in 2012, it appears to have managed its costs well, leading to a lower actual cost per roundtrip relative to the budgeted cost per round trip. For the reasons stated above, of the three single-rate methods suggested in this problem, the budgeted rate and actual quantity may be the best one to use. (The management of Chocolat would have to ensure that the managers of the Dark Chocolate and Milk Chocolate divisions do not systematically overestimate their budgeted use of the fleet division in an effort to drive down the budgeted rate).

15-18 (20 min.) Dual-rate method, budgeted versus actual costs, and practical capacity versus actual quantities (continuation of 15-17).

  1. Charges with dual rate method.

Variable indirect cost rate = $1,350 per trip

Fixed indirect cost rate = $47,500 budgeted costs/ 50 round trips budgeted = $950 per trip

Dark Chocolate Division Variable indirect costs, $1,350 × 30 $40, Fixed indirect costs, $950 × 30 2 8 , $ 69 , Milk Chocolate Division Variable indirect costs, $1,350 × 15 $20, Fixed indirect costs, $950 × 20 1 9 , $ 3 9 ,

  1. The dual rate changes how the fixed indirect cost component is treated. By using budgeted trips made, the Dark Chocolate Division is unaffected by changes from its own budgeted usage or that of other divisions. When budgeted rates and actual trips are used for allocation (see requirement 1. of problem 15-17), the Dark Chocolate Division is assigned the same $28, for fixed costs as under the dual-rate method because it made the same number of trips as budgeted. However, note that the Milk Chocolate Division is allocated $19,000 in fixed trucking costs under the dual-rate system, compared to $950  15 actual trips = $14,250 when actual trips are used for allocation. As such, the Dark Chocolate Division is not made to appear disproportionately more expensive than the Milk Chocolate Division simply because the latter did not make the number of trips it budgeted at the start of the year.

  2. Three criteria that could determine the sequence in the step-down method are:

a. Allocate support departments on a ranking of the percentage of their total services provided to other support departments. 1. Administrative Services 25% 2. Information Systems 10%

b. Allocate support departments on a ranking of the total dollar amount in the support departments. 1. Information Systems $2,400, 2. Administrative Services $ 600,

c. Allocate support departments on a ranking of the dollar amounts of service provided to other support departments

  1. Information Systems (0  $2,400,000) = $240,
  2. Administrative Services (0  $600,000) = $150,

The approach in (a) above typically better approximates the theoretically preferred reciprocal method. It results in a higher percentage of support-department costs provided to other support departments being incorporated into the step-down process than does (b) or (c), above.

15-20 (50 min.) Support-department cost allocation, reciprocal method (continuation of 15-19). 1a.

Support Departments Operating Departments AS I S Govt. Corp. Costs $600,000 $2,400, Alloc. of AS costs (0, 0, 0) (861,538) 215,385 $ 344,615 $ 301, Alloc. of IS costs (0, 0, 0) 261,538 (2,615,385) 784,616 1,569, $ 0 $ 0 $1,129,231 $1,870,

Reciprocal Method Computation AS = $600,000 + 0 IS IS = $2,400,000 + 0 IS = $2,400,000 + 0 ($600,000 + 0 IS) = $2,400,000 + $150,000 + 0 IS 0 = $2,550, IS = $2,550,000 ÷ 0. = $2,615, AS = $600,000 + 0 ($2,615,385) = $600,000 + $261,

= $861,

1b.

Support Departments Operating Departments AS I S Govt. Corp. Costs $600,000 $2,400, 1 st Allocation of AS (0, 0, 0) (600,000) 150,000 $ 240,000 $ 210, 2,550, 1 st Allocation of IS (0, 0, 0) 255,000 (2,550,000) 765,000 1,530, 2 nd Allocation of AS (0, 0, 0) (255,000) 63,750 102,000 89, 2 nd Allocation of IS (0, 0, 0) 6,375 (63,750) 19,125 38, 3rd Allocation of AS (0, 0, 0) (6,375) 1,594 2,550 2, 3 rd Allocation of IS (0, 0, 0) 160 (1,594) 478 956 4 th Allocation of AS (0, 0, 0) (160) 40 64 56 4 th Allocation of IS (0, 0, 0) 4 (40) 12 24 5 th Allocation of AS (0, 0, 0) (4) 1 2 1 5 th Allocation of IS (0, 0, 0) 0 (1 ) 0 1 Total allocation $ 0 $ 0 $1,129,231 $1,870,

2.

Govt. Consulting Corp. Consulting a. Direct $1,120,000 $1,880, b. Step-Down (AS first) 1,090,000 1,910, c. Step-Down (IS first) 1,168,000 1,832, d. Reciprocal 1,129,231 1,870,

The four methods differ in the level of support department cost allocation across support departments. The level of reciprocal service by support departments is material. Administrative Services supplies 25% of its services to Information Systems. Information Systems supplies 10% of its services to Administrative Services. The Information Department has a budget of $2,400, that is 400% higher than Administrative Services. The reciprocal method recognizes all the interactions and is thus the most accurate. This is especially clear from looking at the repeated iterations calculations.

15-21 (40 min.) Direct and step-down allocation.

  1. Support Departments Operating Departments HR Info. Systems Corporate Consumer Total Costs Incurred $72,700 $234,400 $ 998,270 $489,860 $1,795, Alloc. of HR costs (42/70, 28/70) (72,700) 43,620 29, Alloc. of Info. Syst. costs (1,920/3,520, 1,600/3,520) ______ (234,400 ) 127,855 106,545 ________ $ 0 $ 0 $1,169,745 $625,485 $1,795,

  2. Rank on percentage of services rendered to other support departments.

Step 1: HR provides 23% of its services to information systems:

42 28 21

21   = 91

21 = 23% This 23% of $72,700 HR department costs is $16,777.

Step 2: Information systems provides 8% of its services to HR:

,1 920 ,1 600 320

320   = ,3 840

320 = 8%

This 8% of $234,400 information systems department costs is $19,533.

Support Departments Operating Departments HR Info. Systems Corporate Consumer Total Costs Incurred $72,700 $234,400 $ 998,270 $489,860 $1,795, 0 Alloc. of HR costs (21/91, 42/91, 28/91) (72,700 ) 16,777 33,554 22, $ 0 251, Alloc. of Info. Syst. costs (1,920/3,520, 1,600/3,520) (251,177 ) 137,006 114, $ 0 $1,168,830 $626,400 $1,795, 0

  1. An alternative ranking is based on the dollar amount of services rendered to other support departments. Using numbers from requirement 2, this approach would use the following sequence:

Step 1:Allocate Information Systems first ($19533 provided to HR).

Step 2: Allocate HR second ($16777 provided to Information Systems).

15-22 (30 min.) Reciprocal cost allocation (continuation of 15-21).

  1. The reciprocal allocation method explicitly includes the mutual services provided among all support departments. Interdepartmental relationships are fully incorporated into the support department cost allocations.

  2. HR = $72,700 + .08333 IS IS = $234,400 + .23077 HR HR = $72,700 + [.08333($234,400 + .23077 HR)] = $72,700 + [$19,532 + 0 HR] 0 HR = $92,232. HR = $92,232  0. = $94, IS = $234,400 + (0  $94,041) = $256, Support Depts. Operating Depts. HR Info. Systems Corporate Consumer Total Costs Incurred $72,700 $234,400 $ 998,270 $489,860 $1,795, Alloc. of HR costs (21/91, 42/91, 28/91) (94,041) 21,702 43,404 28,

Alloc. of Info. Syst. costs (320/3,840, 1,920/3,840, 1,600/3,840) 21,341 (256,102 ) 128,051 106,710 _________ $ 0 $ 0 $1,169,725 $625,505 $1,795,

Solution Exhibit 15-22 presents the reciprocal method using repeated iterations.

15-23 (2025 min.) Allocation of common costs.

  1. Three methods of allocating the $55 are: Ben Gary Stand-alone Incremental (Gary primary) Incremental (Ben primary) Shapley value

$

15

60

55

$

50

5

10

a. Stand-alone cost allocation method.

Ben:

$

$60 + $

 $65 =

4

5

 $65 = $

Gary:

$

$60 + $

 $65 =

1

5

 $65 = $

b. Incremental cost allocation method.

Assume Gary (the owner) is the primary user and Ben is the incremental user:

User

Costs Allocated

Cumulative Costs Allocated Gary Ben Total

$

50 ($65 – $15)

$ 65

$

$

This method may generate some dispute over the ranking. Notice that Ben pays only $ despite his prime interest in the more expensive Internet access package. Gary could make the argument that if Ben were ranked first he would have to pay $60 since he is the major Internet user. Then, Gary would only have to pay $5!

Assume Ben is the primary user and Gary is the incremental user:

User

Costs Allocated

Cumulative Costs Allocated Ben Gary Total

$

5 ($65 – $60)

$ 6 5

$

$

c. Shapley value (average over costs allocated as the primary and incremental user).

User

Costs Allocated Ben Gary

($50 + $60)  2 = $

($15 + $5)  2 = $

  1. The Shapley value approach is recommended. It is fairer than the incremental method because it avoids considering one user as the primary user and allocating more of the common costs to that user. It also avoids disputes about who is the primary user. It allocates costs in a manner that is close to the costs allocated under the stand-alone method but takes a more comprehensive view of the common cost allocation problem by considering primary and incremental users that the stand-alone method ignores.

More generally, other criteria to guide common cost allocations include the following:

a. Cause and effect. It is not possible to trace individual causes (either Internet access or phone services) to individual effects (uses by Ben or Gary). The $65 total package is a bundled product.

b. Benefits received. There are various ways of operationalizing the benefits received:

(i) Monthly service charge for their prime interest––Internet access for Ben ($60), and phone services for Gary ($15). This measure captures the services available to each person.

(ii) Actual usage by each person. This would involve keeping a record of usage by each person and then allocating the $65 on a percent usage time basis. This measure captures the services actually used by each person, but it may prove burdensome and it would be subject to honest reporting by Ben and Gary.

c. Ability to pay. This criterion requires that Ben and Gary agree upon their relative ability to pay.

d. Fairness or equity. This criterion is relatively nebulous. One approach would be to split the $65 equally among the two users.

comprehensive view of the common cost allocation problem by considering primary and incremental users, which the stand-alone method ignores. The Shapley value (or the stand-alone cost allocation method) would be the preferred methods if Gunn was to send the travel expenses to the Baltimore and Chicago clients before deciding which engagement to accept. Other factors such as whether to charge the Chicago client more because Gunn is accepting the Chicago engagement or the Baltimore client more because Gunn is not going to work for them can be considered if Gunn sends in her travel expenses after making her decision. However, each company would not want to be considered as the primary party and so is likely to object to these arguments.

  1. A simple approach is to split the $80 equally between the two clients. The limousine costs at the Sacramento end are not a function of distance traveled on the plane.

An alternative approach is to add the $80 to the $1,600 and repeat requirement 1:

a. Stand-alone cost allocation method.

Baltimore client

 

$1,

$1,280 $880  $1,680 = $995.

Chicago client

 

$

$1,280 $880  $1,680 = $684.

b. Incremental cost allocation method.

With Baltimore client as the primary party: Baltimore client $1, Chicago client 400 $1,

With Chicago client as the primary party: Chicago client $ 880 Baltimore client 800 $1,

c. Shapley value. Baltimore client: ($1,280 + $800) ÷ 2 = $1, Chicago client: ($400 + $880) ÷ 2 = $ 640

As discussed in requirement 2, the Shapley value or the stand-alone cost allocation method would be the preferred approaches.

Note: If any students in the class have faced this situation when visiting prospective employers, ask them how they handled it.

15-25 (20 min.) Revenue allocation, bundled products.

1a. Under the stand alone revenue-allocation method based on selling price, Monaco will be allocated 30% of all revenues, or $39 of the bundled selling price, and Innocence will be allocated 70% of all revenues, or $91 of the bundled selling price, as shown below.

Stand-alone method, based on selling prices Monaco Innocence Total Selling price $48 $112 $ Selling price as a % of total ($48  $160; $112  $160) 30% 70% 100% Allocation of $130 bundled selling price (30%  $130; 70%  $130) $39 $91 $

1b. Under the incremental revenue-allocation method, with Monaco ranked as the primary product, Monaco will be allocated $48 (its own stand-alone selling price) and Innocence will be allocated $82 of the $130 selling price, as shown below.

Incremental Method (Monaco rank 1) Monaco Innocence Selling price $48 $ Allocation of $130 bundled selling price ($48; $82 = $130 – $48) $48 $

1c. Under the incremental revenue-allocation method, with Innocence ranked as the primary product, Innocence will be allocated $112 (its own stand-alone selling price) and Monaco will be allocated $18 of the $130 selling price, as shown below.

Incremental Method (Innocence rank 1) Monaco Innocence Selling price $48 $ Allocation of $130 bundled selling price ($18 = $130 – $112; $112) $18 $

1d. Under the Shapley value method, each product will be allocated the average of its allocations in 1b and 1c, i., the average of its allocations when it is the primary product and when it is the secondary product, as shown below.

Shapley Value Method Monaco Innocence Allocation when Monaco = Rank 1; Innocence = Rank 2 (from 1b.) $48 $ 82 Allocation when Innocence = Rank 1; Monaco = Rank 2 (from 1c.) $18 $ Average of allocated selling price ($48 + $18)  2; ($82 + $112)  2 $33 $ 97

15-26 (20-25 min. ) Allocation of Common Costs

  1. a. Dandridge’s method based on number of cars sold: Sales Location

Number of cars sold Percentage

Joint Cost Allocation East 3,150 3,150÷ 9,000=0 $1,800,000 $ 630, West 1,080 1,080 ÷9,000=0 1,800,000 216, North 2,250 2,250 ÷9,000=0 1,800,000 450, South 2,520 2,520 ÷9,000=0 1,800,000 504, 9,000 $1,800,

  1. b. Stand-alone method: Sales Location

Stand-alone cost

Percentage (costs in thousands)

Joint Cost Allocation East $ 324,000 $324 ÷ $2,160=0 $1,800,000 $ 270, West 432,000 $432 ÷ $2,160=0 1,800,000 360, North 648,000 $648 ÷ $2,160=0 1,800,000 540, South 756,000 $756 ÷ $2,160=0 1,800,000 630, $2,160,000 $1,800,

  1. c. Incremental method (locations ranked in order of largest advertising dollars to smallest advertising dollars): Sales Location Allocated Cost Cost Remaining to Allocate South $ 756,000 ($1,800,000 - $756,000 = $1,044,000) North 648,000 ($1,044,000 - $648,000 = $ 396,000) West 396,000 ($ 396,000 - $396,000 = $ 0) East 0 $1,800,

  2. In this situation, the stand-alone method is probably the best method because the weights it uses for allocation are based on the individual advertising cost for each location as a separate entity. Therefore, each entity gets the same relative proportion of advertising costs and each location will have lower total advertising costs. The sales managers would likely not consider the incremental method fair because the locations with the higher advertising costs would be subsidizing the locations with the lower advertising costs (especially the East location, which would pay nothing in advertising). If the East sales manager is correct in his assertion that most of the advertising cost is for new car sales and not used car sales (the majority of the East location’s business) then Dandridge’s method of allocating costs based on number of cars sold would be particularly unfair to East, which would pay $630,000 of the $1,800,000 in total advertising cost. Dandridge could alternatively separate the total $1,800,000 of advertising cost into two cost pools: one for new car advertising and one for used car advertising and allocate on the basis of new cars sold and used cars sold, to make this method more equitable to the various sales locations.

15-27 (20 min.) Single-rate, dual-rate, and practical capacity allocation.

  • Budgeted number of gifts wrapped = 6,
  • Budgeted fixed costs = $6,
  • Fixed cost per gift based on budgeted volume = $6,650 ÷ 6,650 =$1.
  • Average budgeted variable cost per gift = 0.
  • Total cost per gift wrapped $1.
  • Women’s Face Wash (2,470 × $1) $3, 1. Allocation based on budgeted usage of gift-wrapping services:
  • Men’s Face Wash (825 × $1) 1,
  • Fragrances (1,805 × $1) 2,
  • Body Wash (430 × $1)
  • Hair Products (1,120 × $1) 1,
  • Total $ 9 ,
  • Women’s Face Wash (2,020 × $1) $2, 1. Allocation based on actual usage of gift-wrapping services:
  • Men’s Face Wash (730 × $1) 1,
  • Fragrances (1,560 × $1) 2,
  • Body Wash (545 × $1)
  • Hair Products (1,495 × $1) 2,
  • Total $ 8 ,
    1. Practical gift-wrapping capacity = 7,
    • Budgeted fixed costs = $6,
    • Fixed cost per gift based on practical capacity = $6,650 ÷ 7,000 = $0.
    • Average budgeted variable cost per gift = 0.
    • Total cost per gift wrapped $1.
    • Women’s Face Wash (2,020 × $1) $2,727. Allocation based on actual usage of gift-wrapping services:
    • Men’s Face Wash (730 × $1) 985.
    • Fragrances (1,560 × $1) 2,106.
    • Body Wash (545 × $1) 735.
    • Hair Products (1,495 × $1) 2 , 018.
    • Total $ 8, 572.

What is the most common method of allocation?

The direct method of cost allocation is the most popular method used for allocating costs. This method allocates all the service department costs to the production department and does not take into account that the service department offers services to other departments.

What is allocation method?

Allocation Methods If a cost solely benefits one funding source, it should be charged entirely to that funding source. If a cost benefits more than one funding source, the cost should be charged to each funding source in the same proportion as it provides benefit.

What is incremental cost allocation method?

The basic method of allocation of incremental cost is to assign a primary user and the additional or incremental user of the total cost. If we look at our above example, the primary user is product 'X' which was already being manufactured at the plant and utilizing the machinery and equipment.

What cost allocation method is the most accurate quizlet?

The reciprocal method of support department cost allocation is the most precise method and therefore is used most often.