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Allocating Costs To Responsibility

Centers

CHAPTER 13

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Managerial Accounting 11E

Maher/Stickney/Weil

CHAPTER GOAL

Chapter 13 discusses concepts and methods of assigning indirect costs such as overhead, to departments. Additionally, service department cost allocation and joint-process cost allocation are explained.

☼ ☼

DIRECT COST: DefinitionDIRECT COST: Definition

Is one that firms can identify specifically with, or trace

directly to a particular product, department, or process.

LO 1

INDIRECT COST: DefinitionINDIRECT COST: Definition

Results from joint use of a facility or service by several

products, departments, or processes.

LO 1

What are common costs?

Common costs are indirect costs that cannot be

identified by a cost object.

LO 1MANAGERS WANT TO KNOW!

Why allocate indirect costs to products?

Full product costs should be known, including

allocated indirect costs, for pricing and planning

decisions.

LO 1MANAGERS WANT TO KNOW!

SERVICE DEPARTMENT

Service department costs, a source of indirect costs, should be charged to users because:These costs should be covered by the

contribution margin of revenue-generating departments

User departments must be aware of what costs their department must cover

User departments should not treat service departments as if they are free

LO 2

COST ALLOCATION

The cost allocation process has three steps:1) Assign direct costs to departments

2) Allocate indirect costs to departments

3) Allocate service department costs to production departments

LO 3

EXAMPLE: First Bank

First Bank (FB) has 4 departments. Production departments are the Commercial Department and the Personal Department. Service departments are Computer Services and Processing.

Indirect costs are allocated to each department.

Service department costs are allocated to production departments in order to properly price their products.

LO 3

Continued

FB

EXHIBITEXHIBIT 13.113.1

LO 3

What department would be

responsible for cost allocation and

preparing accounting reports for

managerial use?

What department would be

responsible for cost allocation and

preparing accounting reports for

managerial use?

FB

EXHIBITEXHIBIT 13.213.2

LO 3

Step 1: Distribute

direct overhead costs.

Step 1: Distribute

direct overhead costs.

FB

EXHIBITEXHIBIT 13.213.2

LO 3

Step 2: Allocate indirect

overhead costs.

Step 2: Allocate indirect

overhead costs.

FB

ALLOCATION

First Bank has four indirect costs: security, property taxes, rent and utilities and miscellaneous. When allocating indirect costs, First Bank must select a cost driver for each indirect cost, although miscellaneous costs may not have a cost driver.

First Bank has four indirect costs: security, property taxes, rent and utilities and miscellaneous. When allocating indirect costs, First Bank must select a cost driver for each indirect cost, although miscellaneous costs may not have a cost driver.

LO 3FB

EXHIBITEXHIBIT 13.413.4

LO 3

Cost drivers for First Bank’s

indirect costs. Miscellaneous costs will be

allocated evenly.

Cost drivers for First Bank’s

indirect costs. Miscellaneous costs will be

allocated evenly.

FB

EXHIBITEXHIBIT 13.513.5

LO 3

Example: proportionate allocation of indirect costs

based on department use

of indirect costs.

Example: proportionate allocation of indirect costs

based on department use

of indirect costs.

FB

EXHIBITEXHIBIT 13.613.6

LO 3

Allocation of security costs to four departments. Cost driver: # of security visits.

Allocation of security costs to four departments. Cost driver: # of security visits.

EXHIBITEXHIBIT 13.613.6

LO 3

Allocation of property tax costs to four departments.

Cost driver: book value of assets.

Allocation of property tax costs to four departments.

Cost driver: book value of assets.

EXHIBITEXHIBIT 13.613.6

LO 3

Allocation of rent and utilities

to four departments.

Cost driver: floor space.

Allocation of rent and utilities

to four departments.

Cost driver: floor space.

EXHIBITEXHIBIT 13.213.2

LO 3

Step 3: Allocate service department costs to production

departments.

Step 3: Allocate service department costs to production

departments.

How should service department costs be

allocated?

Service department costs should be allocated by one of three methods: direct,

step, or reciprocal.

LO 3MANAGERS WANT TO KNOW!

SERVICE DEPARTMENT ALLOCATIONS

Under the direct method, service department costs are only allocated to production departments.

Under the step method, service department costs are sequentially allocated to other service departments pro rata and finally to production departments.

The reciprocal method employs matrix algebra to simultaneously allocate all department costs to each other.

Under the direct method, service department costs are only allocated to production departments.

Under the step method, service department costs are sequentially allocated to other service departments pro rata and finally to production departments.

The reciprocal method employs matrix algebra to simultaneously allocate all department costs to each other.

LO 3

MARKETING and ADMINISTRATIVE COSTS

Allocating marketing and administrative costs and finding a basis for allocation are difficult. They are separate from overhead costs that are allocated to production departments. But allocation is important for pricing and planning decisions.

Allocating marketing and administrative costs and finding a basis for allocation are difficult. They are separate from overhead costs that are allocated to production departments. But allocation is important for pricing and planning decisions.

LO 5

JOINT PROCESS: DefinitionJOINT PROCESS: Definition

Simultaneously converts common input into several

outputs.

Example: timber logs are processed into lumber of various grades and sizes.

LO 6

SPLITOFF POINT: DefinitionSPLITOFF POINT: Definition

Is the stage of processing when two products are

separated.

LO 6

The NRV method implies a matching of input costs with revenues generated by

each output.

LO 6

The physical quantities method is used whenoutput product prices are highly volatileor when significant processing occurs

between split off and the 1st point of marketability.

ALLOCATING JOINT-PROCESS COSTS

Organizations allocate joint costs for many reasons:Measuring performanceDetermining and responding to regulatory

rate changesEstimating casualty lossesResolving contractual interests and

obligationsFinancial and tax reporting

LO 7

27

End of CHAPTER 13