Reallocation of overheads: Inter-service dept...

Reallocation of overheads: Inter-service dept reallocations MAC3701

Results using ‘Repeated distribution (reciprocal)’ method:

Results using the ‘Simultaneous equations’ method:

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Results using ‘Step Allocation’ Method:

If

this method (also known as the sequential or step allocation method) is used, the service departments' overheads are allocated to the production departments in a certain order. The service department that does the largest proportion of work for other service departments is closed first; the service department that does the second largest proportion of work for other service departments is closed second; and so on. Return charges are not made to service departments whose costs have previously been allocated.

Results using ‘Direct Allocation’ method:

It ignores inter-service department service reallocations. Therefore service department costs are reallocated only to production departments. This means that the proportions allocated have changed, as 10 per cent of the costs of service department 1 have not been allocated to service department 2. Therefore, 20 per cent out of a 90 per cent total, or 2/9 of the costs of service department 1, are allocated to department X, 4/9 are allocated to department Y and 3/9 are allocated to department Z. Similarly the proportions allocated for service department 2 have changed with 4/8 (40 per cent out of 80 per cent) of the costs of service department 2 being allocated to department X, 2/8 to department Y and 2/8 to department Z. The only justification for using the direct allocation method is its simplicity. The method is recommended when inter-service reallocations are relatively insignificant.

Summary of the results using the different methods of allocation.

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Reallocation Method Production Department X

R

Production Department Y

R

Production Department Z

R

TotalR

Repeated distribution R 59 520 R 53 160 R 39 360 R 152 040

Simultaneous Equations R 59 520 R 53 160 R 39 360 R 152 040

Step Allocation R 59 120 R 53 440 R 39 480 R 152 040

Direct Allocation R 60 120 R 52 740 R 39 180 R 152 040

Exercise 3.24 Drury

Departments OverheadsMachining R 400 000Finishing R 200 000Assembly R 100 000Materials handling R 100 000Inspection R 50 000

Estimates of benefits received by each department are as follows:

Machining Finishing Assembly Materials handling

Inspection

Materials handling

30% 25% 35% - 10%

Inspection 20% 30% 45% 5% -

Required:a) Calculate the charge for overhead to each of the three production cost centres, including the

amounts reapportioned from the two service centres, using:i. The continuous allotment (or repeated distribution) method;ii. An algebraic method

i) The continuous allotment (or repeated distribution) method;Machining Finishing Assembly Materials Inspection

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Highest Dept X - Direct


handlingInitial cost R 400 000 R 200 000 R 100 000 R 100 000 R 50 000Materials handling

R 30 000 R 25 000 R 35 000 (100 000) R 10 000

Total R 430 000 R 225 000 R 135 000 R - R 60 000Inspection R 12 000 R 18 000 R 27 000 R 3 000 (60 000)Total R 442 000 R 243 000 R 162 000 R 3 000 R -Materials handling R 900 R 750 R 1 050 ( 3 000) R 300Total R 442 900 R 243 750 R 163 050 R - R 300Inspection R 60 R 90 R 135 R 15 (300)Total R 442 960 R 243 840 R 163 185 R 15 R -Materials handling R 5 R 4 R 6 (15)Total R 442 965 R 243 844 R 163 191 R - R -

ii) An algebraic method

X = Material handlingY = Inspection

X = R 100 000 + 5% YY = R 50 000 + 10% X

Substitution method

X = R 100 000 + 5% (50 000 + 10% X) = R 100 000 + 0.05(50 000 + 0.01X) = R 100 000 + R 2 500 + 0.0005XX – 0.0005X = R 102 5000.995X = R 102 500 X = R 102 500/0.995

= R 103 015

Y = R 50 000 + 10% X = R 50 000 + 10% (R103 015) = R 60 301.50

Machining Finishing AssemblyInitial cost R 400 000 R 200 000 R 100 000Materials handling R 30 905 R 25 754 R 36 055Inspection R 12 060 R 18 090 R 27 136Total R 442 965 R 243 844 R 163 191Revision exercises

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Material handlingMachining: R103 015 x 30% = R 30 905

Finishing: R103 015 x 25%= R 25 754

Assembly: R103 015 x 35%= R 36 055

InspectionMachining: R60 301 x 20% = R 12 060

Finishing: R60 301 x 30%= R 18 090

Assembly: R60 301 x 45%= R 27 136


Chapter 11 Activity 2.2 Ex11.20

Product A B C DOutput in units 120 100 80 120Costs per unit R R R RDirect material 40 50 30 60Direct labour 28 21 14 21Machine hours (per unit) 4 3 2 3

• The four products are similar and are usually produced in production runs of 20 units and sold in batches of 10 units.

• The production overhead is currently absorbed by using a machine hour rate and the total of the production overhead for the period has been analysed as follows:

Machine dept costs (rent, business rates, depreciation & supervisor R 10 430Set-up costs R 5 250Stores receiving R 3 600Inspection / quality control R 2 100Materials handling and dispatch R 4 620

The cost drivers to be used are as listed below for the overhead costs shown:

Cost Cost DriverSet up costs Number of production runsStores receiving Requisitions raisedInspection/quality control Number of production runsMaterials handling & dispatch Orders executed

The number of requisitions raised on the stores was 20 for each product & the number of orders executed was 42, each order being for a batch of 10 of a product.

Solution:a) Total machine hours = (120 x 4) + (100 x 3) +(80 x 2) + (120 x 3)

= 1300 hrs

Machine hour overhead rate = Total overheads Total Machine hours= (10430 + 5250 + 3600 + 2100 + 4620) 1 300 hours = £ 26 000/1300hrs = £20 per machine hour

Product A B C DCosts per unit R R R R

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Direct material 40 50 30 60

Direct labour 28 21 14 21

Overheads @ £20 per machine hr (4x20)80

(3x20)60

(2x20)40

(3x20)60

Total Cost per unit 148 131 84 141

Units of output 120 100 80 120

Total cost (Total Cost per unit x Output) £17 760 £ 13 100 £6 720 £16 920

Costs Cost DriverCost driver transaction

s

Cost per unit

Machine dept costs R 10 430 Machine Hours 1 300hrs R10430/ 1300 £8.02

Set-up costs R 5 250 Production runs 21 R5250/21 250Stores receiving R 3 600 Requisitions raised 20 x 4 R3600/80 45Inspection / quality control R 2 100 Production runs 21 R2100/21 100

Materials handling and dispatch R 4 620 Number of orders

executed 42 R4620/42 110

Cost Cost DriverSet up costs Number of production runsStores receiving Requisitions raisedInspection/quality control Number of production runsMaterials handling & dispatch Orders executed

Product A B C DOutput in units 120 100 80 120Costs per unit R R R RDirect material 40 50 30 60Direct labour 28 21 14 21Machine hours (per unit) 4 3 2 3No. of production runs 120/20 = 6 100/20 = 5 80/20 = 4 120/20 = 6No. of requisitions raised 20 20 20 20No. of orders executed 120/10 = 12 100/10 = 10 80/10 = 8 120/10 = 12

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Product A B C D

120 100 80 120Costs per unit R R R RDirect material 40 50 30 60Direct labour 28 21 14 21Direct costs per unit 68 71 44 81

Direct Costs x output 8 160 7 100 3 520 9 720

Set-up costs per product

(6x250)1 500

(5x250)1 250

(4x250)1 000

(6x250)1 500

Stores /receiving (20 each) 900 900 900 900

Inspection/quality control

(6x100)600

(5x100)500

(4x100) 400

(6x100)600

Materials handling and dispatch

(12x110)1 320

(10x110)1 100

(8x110)880

(12x110)1 320

Machine dept costs 8.02/hr

(120x4x£8.02)

3 851

(100x3x£8.02)2 407

(80x2x£8.02)1 284

(120x3x£8.02)2 888

Total cost £16 331 £ 13 257 £7 984 £16 928

Revision Activity 11.23

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Revision Activity 11.24

A healthcare company specialises in hip, knee and shoulder replacement operations, known as surgical procedures. As well as providing these surgical procedures the company offers pre operation and post operation in-patient care, in a fully equipped hospital, for those patients who will be undergoing the surgical procedures.Surgeons are paid a fixed fee for each surgical procedure they perform and an additional amount for any follow-up consultations. Post procedure follow-up consultations are only undertaken if there are any complications in relation to the surgical procedure. There is no additional fee charged to patients for any follow up consultations. All other staff are paid annual salaries.The company’s existing costing system uses a single overhead rate, based on revenue, to charge the cost of support activities to the procedures. Concern has been raised about the inaccuracy of procedure costs and the company’s accountant has initiated a project to implement an activity-based costing (ABC) system.The project team has collected the following data on each of the procedures.

Procedure information Hip Knee ShoulderFee charged to patient per procedure 8 000 10 000 $6 000Number of procedures per annum 600 800 400Average time per procedure 2 hrs 1.2 hrs 1.5 hrsNumber of procedures per theatre session 2 1 4In-patient days per procedure 3 2 1Surgeons fee per procedure $1 200 $1 800 $1 500% of procedures with complications 8% 5% 10%Surgeons fee per follow-up consultation $300 $300 $300Cost of medical supplies per procedure $400 $200 $300

Activity Cost Driver Overheads $000

Theatre preparation for each session Number of theatre preparations 864Operating theatre usage Procedure time 1 449Nursing and ancillary services In-patient days 5 428Administration Sales Revenue 1 216Other overheads Number of procedures 923

9 880

a) Calculate the profit per procedure for each of the three procedures, using the current basis for charging the costs of support activities to procedures.

b) Calculate the profit per procedure for each of the three procedures, using activity-based costing.

c) Discuss the ways in which the information obtained by the project team may be of benefit to the management of the company.

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Procedure information Hip Knee ShoulderFee charged to patient per procedure 8 000 10 000 $6 000Number of procedures per annum 600 800 400Average time per procedure 2 hrs 1.2 hrs 1.5 hrsNumber of procedures per theatre session 2 1 4In-patient days per procedure 3 2 1Surgeons fee per procedure $1 200 $1 800 $1 500% of procedures with complications 8% 5% 10%Surgeons fee per follow-up consultation $300 $300 $300Cost of medical supplies per procedure $400 $200 $300

Procedure information Hip Knee Shoulder TotalSales revenue 8 000 x 600

$4 800 00010 000 x 800

$8 000 000$6 000 x 400

$2 400 000$15 200 000

Overheads $9 880 000Overhead / sales revenue 0.65 or 65%Overheads per procedure 8 000 x 65%

$5 200 00010 000 x 65%$6 500 000

$6 000 x 65%$3 900 000

ProfitHip Knee Shoulder

Fee charged to patients 8 000 10 000 6 000Surgeons fee per procedure (1 200) (1 800) (1 500)Fee for follow up consultations (24) (15) (30)Medical supplies (400) (200) (300)Overhead costs (5 200) (6 500) (3 900)Profit $1 176 $1 485 $ 270

b)

Activity Cost Driver Overheads $000

No of Cost Drivers Cost per Driver

Theatre preparation for each session

Number of theatre preparations

864 (600/2 + 800/1 + 400/4) 1200

$720 per theatre prep

Operating theatre usage

Procedure time 1 449 (600x2) + (800x1.2) + (400x1.5)= 2760

$525 per hour

Nursing and ancillary services

In-patient days 5 428 (600x3)+(800x2)+(400x1)= 3800

$1 428 per day

Administration Sales Revenue 1 216 15 200 000 $0.08 per $ of sales

Other overheads Number of procedures

923 (600+800+400) 1 800

$513 per procedure

b) ABC overhead cost per procedure

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Hip Knee JointTheatre preparation for each session

720/2 = 360 720/1 = 720 720/4 =180

Operating theatre usage 525x2 = 1050 525 x 1.2 = 630 525 x 1.5 = 788Nursing and ancillary services

1 428 x 3 = 4 284 1428 x 2 = 2856 1428

Administration 0.08 x 8 000 = 640 0.08 x 10 000 = 800 0.08 x 6 000 = 480Other overheads 513 513 513Total overhead/procedure $6 847 $5 519 $3 389

Profit per procedure

Hip Knee ShoulderFee charged to patients 8 000 10 000 6 000Surgeons fee per procedure (1 200) (1 800) (1 500)Fee for follow up consultations (24) (15) (30)Medical supplies (400) (200) (300)Overhead costs (6 847) (5 519) (3 389)Profit ($471) $2 466 $ 781

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