Free Essay

Cost Allocation

In: Business and Management

Submitted By ravi30
Words 979
Pages 4
COST ALLOCATION

1

Direct Method
• Allocates s pport costs onl to Operating Departments support only • No Interaction between Support Departments prior to allocation

2

Direct Method

3

Step-Down Method p
• Allocates support costs to other support departments and to operating departments that partially recognizes the mutual services provided among all support departments • One-Way Interaction between Support Departments prior to allocation

4

Step-Down Method

5

Reciprocal Method
• Allocates support department costs to operating departments by fully recognizing the mutual services provided among all support departments • Full Two Way Interaction between Support Departments prior to allocation

6

Reciprocall M th d R i Method

7

Choosing Between Methods
• Reciprocal is the most precise • Direct and Step-Down are simple to compute and understand • Direct Method is widely used

8

COST ALLOCATION PROBLEM (Direct, Step-Down, & Reciprocal Methods)

9

COST ALLOCATION PROBLEM (Direct, Step-Down, & Reciprocal Methods) A summary of the fixed and variable support-department costs f ll f th fi d d i bl td t t t follows:

10

DIRECT METHOD DATA

Cost allocation computations:

11

STEPDOWN METHOD DATA

Cost allocation computations:

12

RECIPROCAL METHOD DATA

Cost allocation computations:

13

Footnotes:

14

Dual-Rate Method, Budgeted vs. Actual Costs, & Practical Capacity vs. Actual Quantities
Chocolat I Ch l t Inc. is a producer of premium chocolate based in Palo Alto. The i d f i h l t b d i P l Alt Th company has a separate division for each of its two products: dark chocolate and milk chocolate. Chocolat purchases ingredients from Wisconsin for its Dark Chocolate division and from Louisiana for its Milk Chocolate division. Both locations are the same distance from Chocolat's Palo Alto plant. Chocolat Inc. operates a fleet of trucks as a cost center that charges the divisions for variable costs (d i di i i f i bl t (drivers and f l) and fixed costs (vehicle d fuel) d fi d t ( hi l depreciation, insurance, and registration fees) of operating the fleet. Each division is evaluated on the basis of its operating income. Last year, the trucking fleet had a practical capacity of 50 round-trips between the Palo Alto g p p y p plant and the two suppliers. It recorded the following information:

15

Dual-Rate Method, Budgeted vs. Actual Costs, & Practical Capacity vs. Actual Quantities
Chocolat, Inc. decides to examine the effect of using the dual-rate method for allocating truck , g g costs to each round-trip. At the start of the year, the budgeted costs were: Variable cost per round-trip $ 1 500 1,500 Fixed costs $40,000 The actual results at year-end for the 45 round-trips made were: Variable costs $60,750 Fixed costs $36,000 Total $96,750

16

1. Using the dual-rate method, what are the costs allocated to the Dark Chocolate Division and the Milk Chocolate Division when (a) variable costs are allocated using the budgeted rate per round-trip and actual round-trips used by each division and when (b) fixed costs are allocated based on the budgeted rate per round-trip and round-trips budgeted for each division?

17

2. From the viewpoint of the Dark Chocolate Division, what are the effects of using the dual-rate th d th th the i l d l t method rather than th single-rate methods? t th d ? 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 made, usage or that of other divisions. g p ( q When budgeted rates and actual trips are used for allocation (see requirement 1.b. of problem 15-17), the Dark Chocolate Division is assigned the same $24,000 for fixed costs as under the dual-rate method because it made the same number of trips as budgeted. However, However note that the Milk Chocolate Division is allocated $16,000 in fixed trucking costs $16 000 under the dual-rate system, compared to $800 u 15 actual trips = $12,000 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.

18

Reciprocal Cost Allocation p
E - books, an online book retailer, has two operating departments-Corporate Sales and Consumer Sales-and two support departments - Human Resources and Information S stems Each sales department cond cts merchandising and Systems. conducts marketing operations independently. E - books uses number of employees to allocate Human Resources costs and processing time to allocate Information Systems costs The following data are available for the year: costs.

19

Reciprocal Cost Allocation p
Consider E-books again. The controller of E-books reads a widely used textbook that states that “the reciprocal method is conceptually the most defensible.” He seeks your assistance.

20

1. Describe the key features of the reciprocal method.
• 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. allocations

21

2. Allocate the support departments’ costs (Human Resources and Information Systems) t th t operating d S t ) to the two ti departments using th reciprocal method. t t i the i l th d

22

Reciprocal method using repeated iterations

23

3. In the case presented in this exercise, which method (direct, step-down, or reciprocal) would you recommend? Wh ? i l) ld d? Why?

• The reciprocal method is more accurate than the direct and step-down methods when there are reciprocal relationships among support departments. • The reciprocal method is the preferred method, although the numbers for the year do not appear materially different across the alternatives.

24

Similar Documents

Premium Essay

Cost Allocation

...Methods of Allocating Costs - Overview 1. Review the three Method of Allocating Costs. - Direct Method - Step Down Method - Reciprocal Method 2. Discuss the strengths and weaknesses of each method 3. Winery Problem – platform for discussing Joint Cost Allocations 4. Review remaining cost allocation problems. 5. Summarize and Review. State College Community Hospital State College Community Hospital has 2 Service Departments: 1. Maintenance 2. Food Services The Hospital also has three patient care units: 1. General Medicine 2. OB 3. Surgery Using the following information, we will allocate the costs of these 2 service departments to the 3 patient care units using the: 1. Direct Method 2. Stepdown Method – Maintenance First 3. Stepdown Method – Food Services First 4. Reciprocal Method State College Community Hospital Amount of Cost to be allocated: Maintenance Food Services $8,000,000 $3,000,000 Allocation Methods: Maintenance Costs are allocated based on square footage assigned to the unit. Food Service Costs are allocated based on number of meals served to the unit. State College Community Hospital Expected Utilization Rates Sq Footage Meals Served Food Services 10,000 30,000 Maintenance 10,000 10,000 Surgery 20,000 40,000 OB 30,000 30,000 General Medicine 30,000 90,000 Total 100,000 200,000 State College Community Hospital Allocate Based on Direct Method Allocated Maintenance Costs Food Services Maintenance Surgery OB General......

Words: 1042 - Pages: 5

Premium Essay

Cost Allocation

...Cost Allocation ACC/561 April 23, 2012 Cost Allocation The purpose of cost allocation is to identify and correctly allocate costs associated with a job, product, or service. The main uses of cost allocation are to facilitate decision-making regarding costs, justify prices charged for products and services, cost control, and for optimal utilization of resources. There are several methods used for cost allocation, depending on the type of product or service offer by the company. Variable cost allocation includes only variable manufacturing costs, such as direct materials, direct labor, and variable manufacturing overhead. Absorption cost allocation includes manufacturing costs, including both variable and fixed overhead as well as direct labor and materials. There are advantages and disadvantages of each method, and these will be explored further. Methods of Cost Allocation There are three main methods of cost allocation used by businesses: The Direct Method, the Step Method, and the Reciprocal Method. The direct method, which is the simplest of the three, allocates the costs of service departments directly to operating departments. Under the direct method, there are no costs allocated from one service department to another service department regardless of how much service may be provided between them. For instance, there would be no cost allocation between a custodial department and the mail room, even though the custodial department cleans the mail room. ...

Words: 979 - Pages: 4

Premium Essay

Cost Allocation

...5 Cost Allocation and Activity-Based Costing Systems L E A R N I N G O B J E C T I V E S After studying this chapter, you will be able to 1. Explain the major purposes for allocating costs. 2. Explain the relationship between activities, resources, costs, and cost drivers. 3. Use recommended guidelines to charge the variable and fixed costs of service departments to other organizational units. 4. Identify methods for allocating the central costs of an organization. 5. Use the direct, step-down, and reciprocal allocation methods to allocate service department costs to user departments. 6. Describe the general approach to allocating costs to products or services. 7. Use the physical units and relative-sales-value methods to allocate joint costs to products. 8. Use activity-based costing to allocate costs to products or services. 9. Identify the steps involved in the design and implementation of activity-based costing systems. 10. Calculate activity-based costs for cost objects. 11. Explain why activity-based costing systems are being adopted. 12. Explain how just-in-time systems can reduce non-value-added activities Cost Accounting System. The techniques used to determine the cost of a product or service by collecting and classifying costs and assigning them to cost objects. A university’s computer is used for teaching and for government-funded research. How much of its cost should be assigned to each task? A city creates a special police unit to investigate a......

Words: 28659 - Pages: 115

Premium Essay

Cost Behavior and Allocations

...Cost Behaviors and Allocation Health Financial Management Cost allocation is essentially a pricing process within the organization whereby managers allocate the costs of one department to other departments (Gapenski, pg 188). Because this pricing process does not occur in a market setting, no objective standard exists that establishes the price for the transferred services (Gapenski, pg 188). Cost allocation within a business must, to the extent possible, establish prices that proxy those that would be set under market conditions (Gapenski, pg 188). The goal of cost allocation is to assign all of the costs of an organization to the activities that cause them to be incurred (Gapenski, pg 188). Ideally, health services managers track and assign costs by individual patient, physician, diagnosis, reimbursement contract, and so on (Gapenski, pg 188). Managers at all levels within health services organizations are under pressure to optimize economic performance, which translates into reducing costs (Gapenski, pg 188). Many department heads are evaluated, and hence compensated and promoted, other dimensions is satisfactory (Gapenski, pg 188). Department heads are held accountable for the full costs associated with services performed by their departments (Gapenski, pg 188). Health care costs are increasing at an annual rate of 7% a year, which if sustained will bankrupt Medicare in nine years and increase the nation’s......

Words: 854 - Pages: 4

Premium Essay

Cost Behaviors and Allocations

...HSA 525 | Cost Behaviors and Allocation | Assignment 2 | Tomeka Lewis4/29/2012 | In today’s world of businesses and corporations, there is a common goal shared throughout every industry: increase profits. With increases in skills and developing methods, businesses have come far lengths in increasing their profits, or operating income. Controlling costs is the key to a positive operation. Executives and managerial branches are using what they know about costs to create business strategies. By gathering information on market demand and combining it with a marketing strategy that focuses on higher margin products, companies are able to continue and increase profits and survive. The Cost Volume Profit Analysis is the dominant and most cost efficient way of doing so. By understanding the economic concerns of cost structure, contribution margin, and break-even sensitivity, a business can create a decision model to enhance the company’s productivity. A brief outline is required in understanding the Cost Volume Profit analysis (or CVP) and creating a decision model. In a very general outlook, the CVP looks at how fixed, variable, and mixed costs change with changes in sales volume. The main goal is to determine what factors control costs and see how management can use this information to improve planning and control activity. The first step in any CVP analysis is picking an activity base relation to the nature of the company’s operation. For example, a......

Words: 894 - Pages: 4

Premium Essay

Cost Allocation Academic Western

...Cost Allocation Assignment Kaneilia Williams Accounting in a Health Care Environment ACC/HC 561 April 23, 2012 Ruth E. Brown Academic and Western Hospitals Academic Hospital and Western Hospital share services as a result of a merger about a year ago. There is a parent organization that owns both hospitals and allows each to operate individual as its own profit center. Academic Hospital now handles all laboratory services for both hospitals and Western Hospital handles maternity services for both. Recently, an issue with the charges for amniocentesis arose because Western Hospital demanded a reduction in the price for laboratory services. This price reduction is requested because Western Hospital found an outside laboratory that will provide the same services for $375 instead of $400. The hospitals formed a joint committee address the issue. The cost allocation methods by both hospitals will be reviewed. The committee will decide how the cost centers were determined. The differences between fixed and variable costing will also be displayed. Cost Allocation Methods The cost allocation process involves transferring costs from area or department and allocates them to another area or department. “The goal of cost allocation is to associate costs as closely as possible with the patients who cause them to be incurred” (Finkler, Ward, and Baker, 2007). The main two types of cost allocation are indirect costs and allocation from one......

Words: 698 - Pages: 3

Premium Essay

Accounting- Cost Behavior, Cost Allocation, and Budget

... Introduction Costs are linked with all types of organizations- business, nonbusiness, manufacturing, retail and service. Cost behavior, Cost accounting & allocation, and Budget- these are the three key requirements to run any business nowadays. Measuring cost behavior (cost measurement) is associated with understanding and calculating how activities of an organization affect different levels of cost. On the other hand, cost accounting is a kind of accounting method that targets to capture an organization’s costs of production by evaluating the input costs of each step of production as well as fixed costs. Then, cost allocation is the allocating of a common cost to several cost substances. Additionally, budget is an estimate of earnings and expenses for a set period of time. These are commonly used terms in financial accounting information as well as in any business. My company is called The EBag Co. Ltd, which is in business for more than 5 years in the production sector of the market. This profitable business is earning its profits by manufacturing affordable bags for consumers of all ages. My company will use these three requirements of this assignment to make business more profitable in coming days. I will use the five methods (will talk about only 3) of measuring cost function for my company to identify which costs will change and which will remain the same with changes in sales volume. Then, I will use cost allocation chart to help me to identify......

Words: 2670 - Pages: 11

Premium Essay

Cost Allocation

...CHAPTER 16  COST ALLOCATION: JOINT PRODUCTS AND BYPRODUCTS  16­1  Exhibit  16­1  presents  many  examples  of  joint  products  from  four  different  general  industries. These include:  Industry  Separable Products at the Splitoff Point  Food Processing:  • Lamb  • Lamb cuts, tripe, hides, bones, fat  • Turkey  • Breasts, wings, thighs, poultry meal  Extractive:  • Petroleum  • Crude oil, natural gas  16­2  A joint cost is a cost of a production process that yields multiple products simultaneously.  A  separable  cost  is  a  cost  incurred  beyond  the  splitoff  point  that  is  assignable  to  each  of  the  specific products identified at the splitoff point.  16­3  The distinction between a joint product and a byproduct is based on relative sales value.  A joint product is a product  from a  joint production process (a process that yields two or more  products) that has a relatively high total sales value. A byproduct is a product that has a relatively  low total sales value compared to the total sales value of the joint (or main) products.  16­4  A  product  is  any  output  that  has  a  positive  sales  value  (or  an  output  that  enables  a  company to avoid incurring costs). In some joint­cost settings, outputs can occur that do not have  a positive sales value. The offshore processing of hydrocarbons yields water that is recycled back  into the ocean  as  well  as  yielding  oil  and  gas.  The  processing  of  mineral  ore to  yield  gold  and ......

Words: 10875 - Pages: 44

Premium Essay

Rio Grande Medical Center Cost Allocation Concepts

...additional space. The dialysis center should not suffer all the cost. Moving the dialysis center makes more sense because they can increase their revenue if they could take on more patients. The Outpatient Clinic increased their capacity thus should pay the costs of this consumption of the usage of 25% increase. Question 2 Yes. they should be charged the actual cost of the new facility because they are using the new facility. They were spending $300,000 allocating 20,000 square feet. Now they are spending $100,000 extra for an entire building. The outpatient clinic assumed the additional cost for the expansion of space they will be using as well. All departments’ costs would increase since the dialysis center is out of the building and not sharing the indirect costs for the facility use and other general indirect costs. Question 3 No, this only designates the money for the building and facility itself others costs. This is not including inflation, depreciation, insurance, and other fees. There are also advantages of the new building which includes the parking structure and easy access ability, newer equipment and facility therefore less maintenance required. Even though the building has a useful life over 20 years. On the 21st year it will be mortgage free however there still be other general indirect costs that makes up $270,000 of costs as well, these costs will only increase due to inflation and cost increase. Question 4 The revenue the pharmacy is making......

Words: 341 - Pages: 2

Premium Essay

Cost Allocation and Profitability

...Cost Allocation and Profitability at Hers Realtors Property Management In the property management business, empty units are lost money. Not only are they lost revenue, they have associated costs with them such as taxes, electricity, and yard upkeep. An empty unit represents a direct allocated cost for that unit. Per customer profitability increases with long term renters. When a renter vacates a property it will sit empty for a minimum of one month or more. Turnaround on units varies and with each passing month the costs allocated to that unit increase. In addition, there are the costs of obtaining a new renter, such as advertising and administrative costs. A unit that sits empty for more months out of the year than it is rented represents a loss position at the end of the year, rather than a revenue generating asset. The longer a unit sits empty, the lower the return on the investment and the lower the performance on the asset. Long term renters are preferable because it increases the overall demand for the units. Keeping tenants happy is the key to customer retention. The goal is to get them to sign another lease term. In the property management business this means responding promptly to service calls, enforcing noise ordinances, and attending to the overall upkeep of the units. When renters are happy, they are more likely to renew their lease when the term is up. They are also more likely to refer others who are looking for housing, building a close knit community......

Words: 329 - Pages: 2

Premium Essay

Bridgeton Cost Allocation

...from simple writing implements (such as pens, pencils, and markers) and fasteners to specialty paper for modern highspeed copiers and printers. MOP had an excellent reputation for customer service and responsiveness. Warehouse personnel at MOP’s distribution center unloaded truckload shipments of products from manufacturers, and moved the cartons into designated storage locations until customers requested the items. Each day, after customer orders had been received, MOP personnel drove forklift trucks around the warehouse to accumulate the cartons of items and prepare them for shipment. MOP ordered supplies from many different manufacturers. It priced products to its end-use customers by first marking up the purchased product cost by 16% to cover the cost of warehousing, order processing, and freight. Then it added another 6% markup to cover the general, selling, and administrative expenses, plus an allowance for profit. The markups were determined at the start of each year, based on actual expenses in prior years and general industry and competitive trends. Midwest adjusted the actual price quoted to a customer based on long-term relationships and competitive situations, but pricing was generally independent of the specific level of service required by that customer, except for desktop deliveries. Typically, MOP shipped products to its customers using...

Words: 1694 - Pages: 7

Premium Essay

Acc650 Module 7 - Quiz Product Costing Systems and Cost Allocation

...ACC650 Module 7 - Quiz Product Costing Systems and Cost Allocation Click Link Below To Buy: http://hwcampus.com/shop/acc650-module-7-quiz-product-costing-systems-cost-allocation/ 1) Indiana Company incurred the following costs during the past year when planned production and actual production each totaled 20,000 units: a. Direct material used $280,000 b. Direct labor $120,000 c. Variable manufacturing overhead $160,000 d. Fixed manufacturing overhead $100,000 e. Variable selling and administrative costs $60,000 f. Fixed selling and administrative costs $90,000 g. If Indiana uses variable costing, the total inventorial costs for the year would be: h. $400,000. $460,000 $560,000. $620,000. $660,000. 2) Garage Specialty Corporation manufactures joint products P and Q. During a recent period, joint costs amounted to $80,000 in the production of 20,000 gallons of P and 60,000 gallons of Q. Garage can sell P and Q at split-off for $2.20 per gallon and $2.60 per gallon, respectively. Alternatively, both products can be processed beyond the split-off point, as follows: i. P Q Separable processing costs $15,000 $35,000 Sales price (per gallon) if processed beyond split-off $3 $4 The joint cost allocated to Q under the relative-sales-value method would be: b. $40,000 $62...

Words: 1373 - Pages: 6

Premium Essay

Zzzz Best Company

...The single-rate cost-allocation method may base the denominator choice on: A) master-budget capacity utilization B) normal capacity utilization C) practical capacity D) All of these answers are correct. 2) Benefits of the single-rate method include: A) the low cost of implementation B) fixed costs that are transformed into variable costs for user decision making C) signals regarding how variable and fixed costs behave differently D) information that leads to outsourcing decisions that benefit the organization as a whole 3) Benefits of the dual-rate method include: A) variable costs that are transformed into fixed costs for user decision making B) the low cost of implementation C) avoidance of expensive analysis for categorizing costs as either fixed or variable D) information that leads to outsourcing decisions that benefit the organization as a whole 4)The advantage of using practical capacity to allocate costs: A) is that it allows a downward demand spiral to develop B) is that it focuses management's attention on managing unused capacity C) is that budgets are much easier to develop D) Either A or B are correct. Answer the following questions using the information below: The Bonawitz Corporation has a central copying facility. The copying facility has only two users, the Marketing Department and the Operations Department. The following data apply to the coming budget year: Budgeted costs of operating......

Words: 1260 - Pages: 6

Free Essay

Case Study 4

...the differences in the four allocation methods discussed in the case. From your standpoint, which of the four methods is conceptually the most reasonable? Why? Direct allocation: each support department costs are allocated directly to the service departments that use the services. The direct allocation method is relatively simple to apply. None of the costs of providing support services is allocated to other support departments. Only the direct costs of the support departments are allocated to the patient services departments because no indirect costs have been created by intrasupport department allocations. This method is the least costly of the four. Step down: this method is a compromise between the more simple direct allocation method and the complex reciprocal method. This method recognizes that intrasupport departments effects that the direct method ignores but it doesn’t recognize the full range of interdependencies. It is a sequential, stair step pattern of allocation. Step down allocation talks place in a specific sequence. After each allocation is made in this method, a support department is removed from the process. Double apportionment: a slightly more complicated version of the step down method. This method first recognizes support provided by service departments to all other service departments as well as to the patient service departments. That first step is called the first allocation/apportionment. Some costs still remain in the......

Words: 835 - Pages: 4

Premium Essay

Transcript of Copy of Case Number Three.

...Advantages Makes cost allocation more fair Recognizes it’s true quality Could give a break because they are using the Same equipment and staff Dialysis Center is already using the same equipment and personnel Is there a better way? In order to offset the large facility costs; the Dialysis center should be able to claim revenues on direct utilization of pharmaceutical supplies; increasing their bottom line and potentially allowing them to remain financially stable through the facility transition. Is it “fair” for the Dialysis Center to suffer in profitability, and hence for the department head to possibly lose his bonus, just because the Outpatient Clinic needs additional space? Incentives Performance improvements Performance measures Disadvantages Costs more per square foot for the dialysis center For the Dialysis Center to bear the true costs, they forfeit the chance of generating true net profit. There will be more incentive to focus on outpatient services than Dialysis patients Other departments will find it less appealing to relocate if they know their profitability or contributions to the Hospital will decline severely when incurring true facility costs. How is pharmacy revenue handled? Pharmacy supplies used for dialysis cost the pharmacy $400,000 They profit $400,000 on drugs used Dialysis center books $800,000 in annual revenue They are charged $800,000 for the drugs they use Do you support the new allocation scheme? We......

Words: 341 - Pages: 2