L6- Support Departments and Common Cost Allocations Flashcards
What are the 2 types of departments in an organisation
Operating and service
Define Operating department
are units where the central purposes of an organization are carried out
Examples of operating department
surgery department in a hospital, assembling department in a car company
Define Service Department
are units that provide services to the operating departments and do not directly participate in the operating activities of an organization
Example of Service Department
cafeteria, personnel (HR), purchasing, cost accounting etc.
4 Purposes of cost allocation
1) to provide information for managerial decisions
2) to motivate managers and employees
3) to justify costs or calculate reimbursement
4) to measure income and assets for reporting to external parties
When the cost of the final product is calculated…….
–The cost of service departments needs to be considered as well
–For that, it is required to allocate the costs of service department to operating department
What are the 3 ways of service dept cost allocation
–Direct method
–Step method
–Reciprocal method (rarely used in practice)
TRUE or False. All allocation methods use allocation base
TRUE
Define Allocation base or cost driver
is the basis that is used to allocate costs (overhead costs) to cost objects (a measure of activity e.g. machine hours)
How to select an allocation base?
–Theallocation baseshould bear causal relationship between the incurrence of the cost and the basis used for cost assignment
–To the extent possible, it should reflect in a reasonable manner how the cost object consumes the resources being allocated.
Allocation Bases (Cost drivers) for airport ground services
Number of Flights
Allocation Bases (Cost drivers) in Cost Accounting
Labour-hours; clients serviced
Define the Direct allocation method
allocates each support department’s costs directly to the operating departments
Characteristics of the direct allocation method
–It ignores all services provided by one service department to the other service departments
–It directly allocates the cost to the operating departments
–In calculation, all allocation bases to themselves (service departments) are ignored
Direct Method Calculation
–Determine and calculate the allocation base
–Allocation of service departments to operating departments
Example on slides
What are the three methods of allocating the costs of support departments
Direct
Reciprocal
Step
Define Step Method allocation
Costs are allocated to both service and production departments in a certain order. The order is that the cost of the service department having the largest proportion of work is allocated first
Characteristics of step method
–In step method, interdepartmental costs are considered
–When one department costs are allocated, it is not considered in subsequent calculations
–Also, the department for which the allocation, is not considered
–The cost of the department that is being allocated is ignored
–The department whose costs are already been allocated is ignored from subsequent allocation
Step Method Calculation
1)Order the by service department that served the highest.
First: Security; Second: Cafeteria
2)Determine and calculate the allocation base
–Using judgment, it should be easy to understand that ‘number of employees’ and ‘square feet occupied’ are the allocation base for cafeteria and security department, respectively.
3) Allocation of service departments to subsequent departments
Define Reciprocal Method
This method allocates service department costs to operating departments by fully recognizing the mutual services provided among all service departments
Characteristics of Reciprocal Method
–Rarely used, because
–The equations are complex
–Offers little value beyond the step method results
Calculation: Comparison and Limitations (possibly reciprocal method)
There is no clear answer how to allocate cost of service departments when they serve to each other
Step methods though minimizes this problem a little, it is not a complete solution
The selection of allocation is a matter of judgment i.e. subjective selection
This can produce different results across the decision-makers
What if Service departments earns revenue?
It might happen that a service department charge for its service and thus generate revenues
For example, cafeteria
In this case, the earned revenues are offset against costs and the remaining costs (only) are then allocated to the operating departments
Joint costs are allocated
allocated to end products on the basis of the relative sales value of each product at the split off
Example of allocating joint costs
Sawmill plc. cuts logs from which unfinished lumber and sawdust are the immediate joint products.
Use Text book for more
CHapter 5/6
