The stand-alone method may use selling price or unit costs to allocate revenues.
CHAPTER 15ALLOCATION OF SUPPORT-DEPARTMENT COSTS,COMMON COSTS, AND REVENUES15-1 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. Show
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,
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).
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 ,
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
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.
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
Step 1:Allocate Information Systems first ($19533 provided to HR). Step 2: Allocate HR second ($16777 provided to Information Systems). 15-22 (30 min.) Reciprocal cost allocation (continuation of 15-21).
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 (2025 min.) Allocation of common costs.
$156055$50510a. Stand-alone cost allocation method. Ben: $$60 + $ $65 =45 $65 = $Gary: $$60 + $ $65 =15 $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 = $
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.
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
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,
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,
15-27 (20 min.) Single-rate, dual-rate, and practical capacity allocation.
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.
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