CH 08

Chapter 8
Measuring and Assigning Support Department Costs

LEARNING OBJECTIVES
Chapter 8 addresses the following questions:
Q1
Q2
Q3
Q4
Q5
Q6
Q7
What are support departments, and why are their costs allocated to other departments?
What process is used to allocate support department costs?
How is the direct method used to allocate support costs to operating departments?
How is the step-down method used to allocate support costs to operating departments?
How is the reciprocal method used to allocate support costs to operating departments?
What is the difference between single- and dual-rate allocations?
What are the limitations of support cost allocations, and how can the quality of
information be improved?
These learning questions (Q1 through Q7) are cross-referenced in the textbook to individual
exercises and problems.
COMPLEXITY SYMBOLS
The textbook uses a coding system to identify the complexity of individual requirements in the
exercises and problems.
Questions Having a Single Correct Answer:
No Symbol
This question requires students to recall or apply knowledge as shown in the
textbook.
This question requires students to extend knowledge beyond the applications
e
shown in the textbook.
Open-ended questions are coded according to the skills described in Steps for Better Thinking
(Exhibit 1.10):
Step 1 skills (Identifying)
Step 2 skills (Exploring)
Step 3 skills (Prioritizing)
Step 4 skills (Envisioning)
8-2
Cost Management
QUESTIONS
8.1
Similarities:
All of the methods allocate support department costs to operating

departments
All of the methods rely on allocation bases to assign costs of support

departments to operating departments.
All of the methods result in a total allocated cost per unit
All of the methods use cost pools, and those are usually departments.
Differences:
Direct method ignores all interactions among support departments.
The step-down method takes into account some of the interactions

among support departments.
The reciprocal method takes into account all of the interactions among
support departments.
8.2
Support department costs are direct costs of the department, but indirect costs when
allocated to other departments. Manufacturing overhead is a direct cost of the production
process but it becomes an indirect cost when it is allocated to units.
8.3
Management's objectives should be the determining factor, tempered by the availability

of the data and the cost of performing the allocation. For example, if the primary purpose
is cost control, a method that recognizes interdepartmental relationships is appropriate. If
the firm has a computer and appropriate software, the reciprocal allocation method is
preferred. If the primary purpose is product costing and the firm has a manual system,
the direct method may be preferred.
Following are other factors to consider in choosing an appropriate allocation method:
As the number of cost pools increase, calculations become more complex under
the reciprocal method,
When there are four or more support cost pools, software is needed to perform the
reciprocal method calculations
The degree of interaction among support departments; fewer interactions result in
fewer differences in allocation amounts
8.4
Costs that include support department allocations using a single cost pool and single
allocation base for both fixed and variable costs would overstate the incremental costs
used in short-term decisions. This limits the use of these costs for decision-making.
However, when a dual rate system is developed, the variable costs are more likely to be
relevant information for short-term decision-making.
Chapter 8: Measuring and Assigning Support Department Costs
8-3
8.5
Following are factors to consider in choosing an allocation base

Costs and benefits of the information gathered
Does one of the bases better reflect the use of the support department resources?
Will the allocation base be easy to measure and apply?
Are data available for the allocation base? How accurate are the data?
8.6
Department 1 is an operating department because it works directly on the firm's final

product.
8.7
Operating departments manufacture goods or produce services that are sold to clients.
Support departments interact primarily with operating departments and other support
departments, and not with outside customers. Support departments provide operating
departments with internal services such as accounting, research and development,
maintenance, and so on.
8.8
The dual rate separates fixed and variable support costs. When this is done, the variable
rate can be used as information for making decisions that require incremental costs, such
as transfer prices and insource and outsource decisions. A single rate includes both fixed
and variable costs and cannot be used for any type of decision making. Another
advantage of the dual rate method is that the allocations more accurately represent the
flow of resources because fixed and variable costs are separated and usually allocated
using different allocation bases or actual usage of some sort.
8.9
Because they include fixed costs and costs allocated from other departments, support
department allocations result in very high charges for services. Because they are so high,
sub-optimal behavior occurs, such as managers duplicating services either by purchasing
them from outside the organization or providing them in their own departments. Often
support departments are then underused, but the organization still incurs their costs. In
addition, extra costs are incurred because internal services are duplicated.
8.10
Better short-term decisions would be made using the dual rate method because the
variable costs of the support departments would be easy to use in decision-making. It
would depend on the type of long term decision being made whether either method would
provide useful information.
8.11
Estimated (budgeted) cost rates provide information for managers to use in budgeting and
some of their decision-making. Managers can predict charges as they use the service. In
addition, each departments charges are not affected by other departments use of service.
A disadvantage of budgeted rates is that user departments have little incentive to use
resources efficiently because their charge is already known, and will not change with
usage, if it is based on a fixed rate.
8.12
Accounting department costs could be allocated using number of employees,

departmental direct costs, or time spent on activities for individual departments. An
advantage of number of employees is that it would be simple to use in calculations. A
disadvantage is that it probably does not reflect the use of the department by other
departments. An advantage of departmental direct costs is that accounting activities
8-4
Cost Management
probably increase as direct costs increase, and direct costs are fairly easy to measure. A
disadvantage is that there are some accounting activities that do not vary with direct
costs. And advantage of time spent on accounting activities for every department is that
it is probably most accurately reflects the use of accounting by other departments, but it
would be hard to track, and there is likely measurement error when time is not recorded
as used, but estimated or recorded after the fact.
8.13
a. GAAP requires manufacturing overhead to be allocated to units of product or service,
generally using a traditional cost accounting method such as job costing or process
costing.
b. Under GAAP, costs for departments that directly support the manufacturing function,
such as material handling are allocated. However, costs of departments that provide
non-manufacturing support, such as accounting and human resources are not
allocated to units or services, they are expensed as period costs.
8-5
EXERCISES
8.14 Allocation Rates
A. Estimated costs = $40,000 + $12(5,000) = $100,000
Estimated allocation rate = $100,000/5,000 hours = $20/hour
B. Estimated cost at actual output = $40,000 + $12(4,900) = $98,800
Actual rate = $98,800/4,900 hours = $20.16/hour
C. An advantage of using an estimated allocation rate is that managers know in advance
what their costs will be. A disadvantage is that there is no incentive to use housekeeping
hours wisely because the cost rate is known and will not change during the period.
An advantage for using an actual allocation rate is that managers have a better idea about
the effects of their use of housekeeping services on costs. A disadvantage is that they do
not know their costs ahead of time, and they may have little control over whether the rate
is higher or lower than expected.
8.15 Allocating Support Costs to Units
Monthly occupancy = 120 beds*0.8*30 days = 2,880 patient days
Monthly costs = $240,000 + $90*2,880 = $499,200
Average daily charge = $499,200/2,880 = $173.33
8.16 Devon
A.
Direct method allocation using direct labor hours:
Dept. A
Support Departments
Dept. B
Dept. C
Allocation Base:
Direct labor hours
Costs:
Direct costs
Department A
Department B
Department C
Total allocated cost
$88,000
(88,000)
$63,000
(40,000)
$
0
Total
6,000
60%
4,000
40%
10,000
100%
$ 52,800
37,800
24,000
$114,600
$35,200
25,200
16,000
$76,400
$191,000
0
0
0
$191,000
$40,000
(63,000)
$
Operating Departments
Casting
Machining
8-6
Cost Management
Direct method allocation using costs to purchase outside:

Dept. A
Support Departments
Dept. B
Dept. C
Allocation Bases:
Department A outside costs
Department B outside costs
Department C outside costs
Costs:
Direct costs
Department A
Department B
Department C
$88,000
(88,000)
$63,000
(40,000)
$
0
Total
$50,000
45.45%
$40,000
57.14%
$20,000
40.00%
$60,000
54.55%
$30,000
42.86%
$30,000
60.00%
$110,000
100%
$70,000
100%
$50,000
100%
$40,000
36,000
16,000
$92,000
$48,000
27,000
24,000
$99,000
$191,000
0
0
0
$191,000
$40,000
(63,000)
$
Casting
Machining
B. Devon could use the cost of purchasing outside as a benchmark for both departments, but
there are some advantages and disadvantages. Using the direct method, no interactions of
support department services are reflected. This might understate the cost of services.
However, fixed costs are included, and many of these may be sunk costs, for example
depreciation expense. These could overstate the support department costs. If the costs
for internal and external support services are similar, the cost to purchase outside might
provide a good benchmark if it is equal to or less than the cost of internally providing the
support. However, if the outside cost is more, incentive exists for increasing both the
cost and use of services, which may be inefficient for the company overall. Alternatively,
if the outside cost is much less, departments may begin to outsource the services and this
duplicates services and may be inefficient for the overall company as well.
8.17 Petro-X
A. Direct method allocation
Support Departments
Physical
Equipment
Plant
Maintenance
Fixed Cost Allocation:
Allocation bases:
Square feet
Machine hours
Fixed costs:
$39,000
Physical plant
(39,000)
Equipment maintenance
Allocated fixed cost
0
Dept. X
Dept. Y
5,000
8,000
13,000
38.462%
61.538%
100.00%
10,000
15,000
25,000
40.00%
60.00%
100.00%
$15,000
30,000
45,000
$ 24,000
45,000
69,000
$114,000
0
0
114,000
$75,000
(75,000)
0
Total

Variable Cost Allocation:
Allocation bases:
# of employees
Maintenance hours
Variable costs:
18,000
Physical plant
(18,000)
Equipment maintenance
Allocated variable cost
0
(60,000)
0

(fixed + variable)
40
50
90
44.446%
55.556%
100.00%
200
400
600
33.333%
66.667%
100.00%
8,000
20,000
28,000
10,000
40,000
50,000
78,000
0
0
78,000
$73,000
$119,000
$192,000
60,000
8-7
B. Step-down method allocation, with physical plant costs allocated first

Support Departments
Physical
Equipment
Plant
Maintenance
Allocation bases:
Square feet
$39,000
(39,000)
0

(fixed + variable)
Total
5,000
8,000
16,900
29.586%
47.337%
100.00%
10,000
15,000
25,000
40%
60%
100.00%
$11,538
33,600
45,138
$ 18,462
50,400
68,862
$114,000
0
0
114,000
$75,000
9,000
(84,000)
0
12
40
50
102
11.76%
39.22%
49.02%
100.00%
Maintenance hours
18,000
(18,000)
Dept. Y
3,900

Allocation bases:
# of employees
Variable costs:
Step 1: Physical plant
Step 2: Equip. maint.
Dept. X
23.077%
Machine hours
Fixed costs:
60,000
2,118
(62,118)
0
200
400
620
33.333%
66.667%
100.00%
7,059
20,706
27,765
8,823
41,412
50,235
78,000
0
0
78,000
$72,903
$119,097
$192,000
8-8
Cost Management
C. Step-down method allocation, with equipment maintenance costs allocated first
Support Departments
Physical
Equipment
Plant
Maintenance

Allocation bases:
Machine hours
Dept. X
Dept. Y
10,000
15,000
25,000
0.00%
40%
60%
100.00%
Square feet
Fixed costs:
$39,000
0
(39,000)
0

Allocation bases:
Maintenance hours
$75,000
(75,000)
0
Total
5,000
8,000
13,000
38.462%
61.538%
100.00%
$30,000
15,000
45,000
$ 45,000
24,000
69,000
$114,000
0
0
114,000
10
200
400
610
1.639%
32.787%
65.574%
100.00%
# of employees
Variable costs:
18,000
984
(18,984)
0
60,000
(60,000)
0
0

(fixed + variable)
40
50
90
44.44%
55.56%
100.00%
19,672
8,437
28,109
39,344
10,547
49,891
78,000
0
0
78,000
$73,109
$118,891
$192,000
D. Ideally, departments should be allocated in the order their services are used, with
departments providing more services to other departments according to their rank of
services provided. Because services can be difficult to measure, direct costs are often
used as a measure of services provided.
8-9
8.18 The Brown and Brinkley Brokerage

A sample spreadsheet using Excel Solver for this problem is available on the Instructors web
site for the textbook (available at www.wiley.com/college/eldenburg). Below are manual
calculations.
Manual Calculations using Simultaneous Equations:
Support Departments
Research
Administration
Allocation Bases:
Research hours
Number of employees
Department costs:
Payroll costs
Other costs
Total department costs
Total
200
20%
500
50%
8
32%
300
30%
10
40%
1,000
100%
25
100.00%
$300,000
150,000
$450,000
$400,000
120,000
$520,000
$550,000
240,000
$790,000
$1,600,000
740,000
$2,340,000
7
28%
$350,000
230,000
$580,000
Institutional
Retail
Given the above calculations, create simultaneous equations for the support costs:
Research = $580,000 + 28% x Administration
Administration = $450,000 + 20% x Research
Set the two equations equal to each other and solve for the fully allocated cost of one
support department:
Research = $580,000 + 28% x ($450,000 + 20% x Research)
Research = $580,000 + $126,000 + 5.6% x Research
94.4% x Research = $706,000
Research = $706,000/94.4% = $747,881
Then solve for the fully allocated cost of the other support department:
Administration = $450,000 + 20% x Research
= $450,000 + 20% x $747,881
= $450,000 + $149,576
= $599,576
8-10 Cost Management

Finally, allocate the full cost of each support department to all departments:
Support Departments
Research
Administration
Allocation Bases:
Research hours
Number of employees
Total department costs
Cost allocations:
Research
Administration
Total allocated costs
Institutional
Retail
Total
200
20%
500
50%
8
32%
300
30%
10
40%
1,000
100%
25
100.00%
$580,000
$450,000
$ 520,000
$ 790,000
$2,340,000
(747,881)
167,881
$
0
149,576
(599,576)
$
0
373,941
191,864
$1,085,805
224,364
239,831
$1,254,195
0
0
$2,340,000
7
28%
8.19 Pauls Valley Protection Service

A sample spreadsheet using Solver for this problem is available on the Instructors web site for
the textbook (available at www.wiley.com/college/eldenburg). Below are manual calculations.
Manual Calculations using Simultaneous Equations:
Let S1, S2 and S3 represent the full cost of providing each department's service. The
simultaneous equations for support department costs are:
S1 = $30,000 + 0.1xS2 + 0.2xS3
S2 = $20,000 + 0.4xS1 + 0.2xS3
S3 = $40,000 + 0.1xS1 + 0.2xS2
Substitute S1 into the equation for S2 and solve for S2:
S2 = $20,000 + 0.4($30,000 + 0.1xS2 + 0.2xS3) + 0.2xS3
S2 = $20,000 + $12,000 + 0.04xS2 + 0.08xS3 + 0.2xS3
0.96xS2 = $32,000 + 0.28xS3
S2 = $33,333.33 + 0.291667xS3
Substitute S1 into the equation for S3:
S3 = $40,000 + 0.1($30,000 + 0.1xS2 + 0.2xS3) + 0.2xS2
S3 = $40,000 + $3,000 + 0.01xS2 + 0.02xS3 + 0.2xS2
0.98xS3 = $43,000 + .21xS2
Substitute S2 into the equation for S3 and solve for S3:
0.98xS3 = $43,000 + 0.21($33,333.33 + 0.291667xS3)
0.91875xS3 = $43,000 + $7,000
S3 = $54,422
Chapter 8: Measuring and Assigning Support Department Costs 8-11

Substitute S3 back into the equation for S2 and solve for S3:
S2 = $33,333.33 + 0.291667($54,422) = $49,206
Substitute S2 and S3 back into the equation for S1 and solve for S1:
S1 = $30,000 + 0.1($49,206) + 0.2($54,422) = $45,805
Finally, support costs are allocated to all of the departments:
Support Departments
S2
S3
40%
10%
10%
20%
20%
20%
S1
S1
S2
S3
Department Costs
Cost Allocations:
S1
S2
S3
Total Allocated Cost
$30,000
$20,000
$40,000
(45,805)
49,201
10,884
$
0
18,322
(49,206)
10,884
$
0
4,581
9,841
(54,422)
$
0
P1
P2
P3
20%
20%
10%
20%
50%
10%
40%
10%
Total
100%
100%
100%
$90,000
$ 9,161
9,841
5,442
$24,444
$ 9,161
0
21,769
$30,930
$ 4,581
24,603
5,442
$34,625
0
0
0
$90,000
8.20 Software Plus Corporation

A sample spreadsheet showing the calculations for this problem under the direct, step-down, and
reciprocal methods is available on the Instructors web site for the textbook (available at
www.wiley.com/college/eldenburg).
A. Software Plus has been using the step-down method that reflects half of the support
department interactions. The costs of support departments are allocated one at a time.
Once the costs of a particular support department are allocated, that department does not
receive allocations from the remaining support departments.
B. The direct method ignores all of the support department interactions. The costs of all
support departments are allocated directly to operating departments. No support
department costs are allocated to other support e departments.
C. The reciprocal method uses all of the support department interactions. The costs of
support departments are allocated simultaneously to each other, and then support
department costs are allocated to operating departments.
D. The following solution for the step-down method allocates the costs of Information
Systems first. This department was chosen because it is largest with respect to direct
support department costs. The costs of Information Systems are allocated to the other
departments based on the percentages given in the problem.
Administration is the next largest support department, so it is allocated second. When
reviewing the allocation for Administration, remember that Information Systems is now

out of the allocation, so the allocation percentages need to be adjusted. The percentage of
Administration service remaining is (100%-50%), or 50%. To allocate Administrations
cost to Maintenance, divide 10% by 50%, so Maintenance receives 1/5, or 20% of
Administration cost. Also note that the total cost allocated for Administration is $50,000,
which is equal to the direct cost of $40,000 plus the $10,000 allocated from Information
Systems.
The final support department allocated is Maintenance. Because costs for all other
support departments have already been allocated, Maintenance costs are allocated only to
the operating departments. The total cost allocated is $34,000, which is the sum of
Maintenance direct costs ($20,000) plus the costs allocated from Information Systems
($2,500) and Administration ($11,500).
Support Departments
Admin.
Maint.
Info. Sys.
Allocation Percentages:
Step 1: Information Systems
Step 2: Administration
Step 3: Maintenance
Direct Support Costs
Allocations:
Step 1: Information Systems
Step 3: Maintenance
Total Allocated Costs
20%
20%
10%/50%
$40,000
$20,000
$50,000
17,500
(57,500)
0
$
0
2,500
11,500
(34,000)
$
0
(50,000)
0
0
$
0
Games Simulation
40%
20%
10%/50%
40%/70%
30%/50%
30%/70%
Total
100%
100%
100%
$110,000
20,000
11,500
19,429
$50,929
10,000
34,500
14,571
$59,071
0
0
0
$110,000
E. When Administration is allocated using the direct method, only the percentages from
Games and Simulations departments are used. So, Games receives 10%/(10%+30%) ,or
1/4 of Administrations cost, and Simulations receives the remaining 3/4 of cost. For the
allocation of Maintenance, 40%/(40%+30%), or 57.143% goes to Games and the
remaining 42.857% goes to Simulations. Information Systems costs are allocated in a
similar manner.
Support Departments
Admin.
Maint.
Info. Sys.
Allocation Percentages:
Administration
Maintenance
Information Systems
Allocations:
Administration
Maintenance
Information Systems
Games Simulation
10%.40%
40%/70%
40%/60%
$40,000
$20,000
$50,000
(40,000)
0
0
$
0
0
(20,000)
0
$
0
0
0
(50,000)
$
0
30%/40%
30%/70%
20%/60%
Total
100%
100%
100%
$110,000
$10,000
11,429
33,333
$54,762
$30,000
8,571
16,667
$55,238
0
0
0
$110,000

F. Below is the solution under the reciprocal method. This solution was obtained using
Solver with the following simultaneous equations:
Admin = $40,000 + 20%Maint + 20%Info
Maint = $20,000 + 10%Admin + 20%Info
Info = $50,000 + 50%Admin + 10%Maint
Support Departments
Admin.
Maint.
Info. Sys.
Use of Services:
Administration
Maintenance
Information Systems
Allocations:
Administration
Maintenance
Information Systems
20%
35%
10%
5%
50%
10%
$40,000
$20,000
$50,000
(78,964)
6,507
32,457
$
0
7,896
(32,533)
4,637
$
0
39,482
3,253
(92,735)
$
0
Games Simulation
10%
40%
40%
Total
30%
30%
20%
100%
100%
100%
$110,000
7,896
13,013
37,094
$58,004
23,689
9,760
18,547
$51,996
0
0
0
$110,000
G. The direct method does not reflect any of the interactions among support departments.
The step-down method improves upon this by allocating the costs of each support
department to other support departments and operating departments, starting with the
department that provides the most service (sometimes measured by the total direct costs
assuming that larger departments provide more services to other departments). After each
departments cost is allocated, that department drops out of the allocation scheme, so that
not all interactions are reflected, but at least some of them are.
H. The reciprocal method improves upon the step-down method by reflecting all of the
support department interactions.
8.21 Lake County Library
A sample spreadsheet for this problem is available on the Instructors web site for the textbook
(available at www.wiley.com/college/eldenburg).
A. The only cost not already assigned is the building lease cost of $24,000. Either number
of employees or square feet can be used as an allocation base. Square feet is a more
logical base, reflecting the amount of space each department occupies. For example, the
Janitorial department occupies 500/2,500 square feet, so it is allocated 20% of the lease
cost. Total costs assigned to each department are computed by adding direct costs to
allocated lease costs. Below is an excerpt from the sample spreadsheet for this problem:
B. This problem is very similar to direct method problems illustrated in the chapter.
However, students need to identify the departments that provide support services
(administration and janitorial) and the operating departments (books and other media).
The solution shown below assumes that janitorial services are allocated using square feet
and administration is allocated using number of employees. Here is an excerpt from the
sample spreadsheet for this problem:
C. Under the step-down method, it is necessary to identify the support department that
provides the most services. Because Administration is the largest department when
comparing support department costs, it will be allocated first. Below is an excerpt from
the sample spreadsheet for this problem.
D. Under the reciprocal method, the simultaneous equations for the support department
allocations are developed first.
Simultaneous equations:
Admin = $49,800 + (500/2,000 square feet) x Janitor
Janitor = $29,800 + (1/4 employees) x Admin
Here are calculations for solving the simultaneous equations manually. First substitute
the Janitor equation into the Admin equation and solve for Admin:
Admin = $49,800 + (500/2,000) x [$29,800 + (1/4) x Admin]
Admin = $49,800 + $7,450 + 0.0625 Admin
Admin = $57,250/0.9375 = $61,067
Now substitute Admin into the Janitor equation and solve for Janitor:
Janitor = $29,800 + (1/4) x $61,067 = $45,067
Below is an excerpt from the sample spreadsheet for this problem. It shows the results
using Excel Solver to solve the simultaneous equations and allocate the support
department costs.
8.22 Monty
A. Under the stand-alone method, the Frankfurt outlet would pay 250/(250+200)* 300
= $167, and Paris would pay the remaining 133.
B. Under the incremental cost-allocation method the cost to Frankfurts outlet would be
250, and the cost to the Paris outlet would be 50 (300-250).
C. A criterion is needed to evaluate fairness. In this particular problem, the perception of
fairness probably depends on each individual managers view. From the perspective of
the Frankfurt manager, the difference between the two costs depended only on who called
first. If Paris had called at a later time, after the airfare to Frankfurt had already been
booked, the cost to Paris would have been the complete round trip fare from London.
Thus, the Frankfurt managers would consider the stand-alone method to be fairer than the
incremental cost-allocation method. However, the Paris manager would probably argue
the other way around.
Another way to split the cost between the two outlets would be for each outlet to pay
50% of the total fare. This may be perceived as the most fair. For this specific problem,
the differences in amounts that each outlet pays are small, so fairness may not be an
issue. However, when differences are larger, perceptions of fairness become more
important.
8.23 Kovacik
A. Under the step-down method, the direct costs of Information Systems are allocated first
because they are larger than the direct costs for the other support department
(Engineering). In the first step, Information Systems costs are allocated to all other
departments using the percent of services used as given in the problem. In the second
step, the percentages for Engineering and Design must be adjusted to remove the percent
of services used by Information Systems. Thus, the percent allocated to the Plain Bank
department is 40%/(100%-10%), or 44.444%. The percent allocated to the Javelina Bank
department is 50%/(100%-10%), or 55.5556%. The total cost allocated in step 2 of
$4,300 is equal to the Engineering and Design direct costs of $2,700 plus $1,600 in costs
allocated from Information Systems.

Support Departments
Engineering
Information
and Design
Systems
Plain Bank Javelina Bank
Allocation Bases:
Information systems
Engineering and design
20%
Direct Costs
$2,700
Allocations:
Step 1: Information systems
1,600
Step 2: Engineering and design (4,300)
$
0
Total
30%
50%
44.4444%
55.5556%
100%
100%
$8,000
$10,000
$20,000
$40,700
(8,000)
0
$
0
2,400
1,911
$14,311
4,000
2,389
$26,389
0
0
$40,700
B. Calculation of estimated total allocated cost per unit using costs calculated under the
step-down method:
Allocated Cost/Production Volume
Plain bank
$14,311/8,000 units
Javelina bank
$26,389/4,000 units
Allocated Cost Per Unit

$1.789
$6.597
C. Actual total allocated costs will be different than budgeted total allocated costs because
budgets never exactly predict costs or production levels. Production levels change
because of unanticipated changes in product demand, unexpected production stoppages,
delays in receipt of materials, and so on. There are many reasons for actual costs
differing from budgeted costs, such as:
*
*
*
*
*
There can be unexpected inflation or deflation in the costs of materials, labor,

supplies, etc.
Employment levels fluctuate because employees leave unexpectedly, it takes
longer than expected to hire new employees, or management decides to change
the number or types of employees.
Unanticipated new types of materials, designs, or technologies can be adopted,
altering production costs.
Capacity constraints occur if demand is higher than usual. As organizations near
their capacity levels, costs of congestion increase and money may be spent to
relax the constraint.
Changes in product design or the manufacturing process affect the amount and
cost of materials and labor.
D. Under the reciprocal method, the simultaneous equations for the two support departments
are:
Engineer = $2,700 + 20% Info
Info = $8,000 + 10% Engineer

Substituting Engineer into the Info equation and solving for Info:
Info = $8,000 + 10% ($2,700 + 20% Info)
0.98 Info = $8,000 + $270
Info = $8,439
Substituting Info back into the equation for Engineer:
Engineer = $2,700 + 20% ($8,439) = $4,388
The cost allocations are performed as follows:
Support Departments
Engineering
Information
and Design
Systems
Plain Bank Javelina Bank
Services used:
Information systems
Direct Costs
Allocations:
Information systems
Total
10%
40%
30%
50%
50%
100%
100%
$2,700
$8,000
$10,000
$20,000
$40,700
(4,388)
1,688
$
0
439
(8,439)
$
0
1,755
2,532
$14,287
2,194
4,219
$26,413
0
0
$40,700
20%
E. Calculation of estimated total allocated cost per unit using costs calculated under the
reciprocal method:
Allocated Cost/Production Volume
Plain bank
$14,287/8,000 units
Javelina bank
$26,413/4,000 units
Allocated Cost Per Unit

$1.786
$6.603
F. Several factors that need to be considered are competitors prices, the relation between
price and demand, and external factors such as the state of the economy and the industry
within which the business operates. Often, an organization cannot set a price that differs
much from competitors prices. If this is the case for Kovacik, the price should be set
according to the market price regardless of total allocated cost.
PROBLEMS
8.24 Physician Brother
A. Both methods are appropriate for allocating support department costs to health program
departments. The step-down method ranks support departments in order of service
provided and then allocates their costs to other departments according to a cascading
method. The support department providing most services is allocated first to all other
departments, and is then dropped from the allocation process. Next, the support
department providing the second-most services is allocated to the remaining departments,
and then it drops out, and so on until all support department costs are allocated.
Therefore, this method partially takes into account the fact that the support departments
provide services for each other.
The reciprocal method uses simultaneous equations to reflect all of the services provided
among the support departments. Therefore, the reciprocal method more accurately
measures support department costs before those costs are allocated to the health program
departments.
B. Here are some factors that the physician should consider to choose the best allocation
method and best allocation bases.
Choosing the allocation method: If you only have a few support activities, the two
methods are likely to produce similar allocations. However, the step-down method is
easier to calculate and understand, so you may prefer that method. Alternatively, if there
are a number of support departments, you will want to use the reciprocal method because
it more accurately measures the cost of support services. You can either purchase
software for these allocations, or I can set up a spreadsheet and show you how to use it.
Choosing an allocation base: An allocation base is some measure of activity that is used
to determine the amount of a support departments cost that is allocated to each of the
other departments. Ideally, you would like to choose allocation bases that are also cost
drivers, that is, they cause costs to vary. For example, the number of patients would be a
good allocation base for the cost of medical records because costs such as supplies and
employee time are likely to vary with the number of patients. Square footage might be a
good allocation base for the cost of janitorial services because those costs might vary
with the square feet of space that is cleaned. If you choose cost drivers for allocation
bases, the resulting allocations do a better job of measuring the use of resources. Give
some thought to what might cause costs to change when you choose allocation bases for
each cost pool.
C. The types of costs in a cost pool depend on the size and structure of the organization and
also the manner of service provision. Some organizations may own no vehicles and incur
costs only for renting and operating vehicles. Other organizations may have a large
motor pool that requires a manager and several employees to maintain the vehicles.

8.25 Defense Contractor
A. Examples include: new product design, design of the manufacturing process, product redesign, and product testing.
B. Possible allocation bases:
*
*
*
*
New product design: number of new products, labor hours

Design of manufacturing process: labor hours, number of designs
Product redesign: number of engineering change orders
Product testing: number of hours in testing, number of products tested
C. Factors to consider in choosing cost pools and allocation bases:

*
*
*
*
The cost and benefit tradeoffs for collecting information.

Whether cost can be measured accurately for each pool.
Whether the activity uses as an allocation base that can be measured accurately.
Whether the activity uses as an allocation base that reflects the flow of resources
used, at least partially.
8.26 Space Products

A. Step-down method allocation:
Administrative
MIS
Direct costs
$ 600,000
$ 200,000
Allocation of Administrative Costs:
Number of Employees
Percent
Cost
(600,000)
Allocation of MIS Costs:
CPUs
Percent
Cost
Total Allocated Cost
Commercial
Military
$2,000,000
$4,000,000
10
10%
60,000
$(260,000)
$
0
40
40%
240,000
50
50%
300,000
30
70
30%
70%
78,000
182,000
$2,318,000
$4,482,000
Support dept costs allocated to Military:

Total allocated cost less direct cost
$4,482,000 - $4,000,000 = $482,000
B. Average Cost Per Military Satellite
= Total allocated cost Number of satellites produced
= $4,482,000 100 = $44,820

C. The average cost is most likely an overstatement of incremental cost. The average cost
includes fixed costs, which do not vary with the level of production (in the short run).
D. Direct method allocation; Maximum support costs allocated to military
DOD allocation bases for Administrative:
Commercial
Direct costs
$2,000,000 (33%)
Employees
40 (44%)
Military
$4,000,000 (67%)
50 (56%)
More administrative costs would be allocated to Military if direct costs were used
as the allocation base (because 67% is greater than 56%).
DOD allocation bases for MIS:
Direct costs
CPUs
Commercial
$2,000,000 (33%)
30 (30%)
Military
$4,000,000 (67%)
70 (70%)
In this case, CPUs would maximize the cost allocated to the Military division.
Allocations:
Administrative (based on direct costs)
MIS (based on CPUs)
Total Allocated Support Costs
Commercial
$200,000
$ 60,000
$260,000
Military
$400,000
$ 140,000
$540,000
E. Policy to Maximize DOD Contribution

1. The DOD does not mandate a single allocation method because different defense
contractors are organized differently and have different types of costs. In addition,
there is always discretion because there are uncertainties in defining cost pools,
assigning costs to cost pools, and specifying allocation bases. It would be impossible
to prescribe a single allocation method that would accurately measure support costs
on defense contracts and that would be fair to all contractors.
2. As a taxpayer, I would prefer that the cost be allocated in a manner that fairly
represents the amount of overhead used by military projects. I would prefer not to
subsidize the overhead costs of a private corporation.
3. As a competitor, I would prefer that the cost be allocated in such a manner that the
contractor did not have an unfair competitive advantage. The government should pay
its fair share, but no more. I would like to see some benchmark information about the
amount of internal support department cost per job for commercial versus
government contracts.

8.27 Food on Wheels
A. Uncertainties in cost classification:
1. The newsletter costs have no clear classification because the function of the
newsletter seems to be partly fundraising and partly educational. Perhaps the cost
should be allocated between fundraising and program. However, it might not be
possible to identify an appropriate allocation base to separate these activities. Also, it
could be argued that providing recipes is not educational. However, the recipes are
most likely designed to save costs and to be nutritious, which would support their
classification as educational. In addition, classification as educational does not
necessarily mean that the newsletter is a program activity. On the one hand,
knowledge about the needs of low-income individuals is probably conveyed through
the newsletter. Educating the public and promoting greater awareness can be
important program goals for a charitable organization. It can also be important for the
public to learn about the activities of charitable organizations. On the other hand, the
newsletter probably provides little, if any, direct benefit to the target of its charitable
missionlow-income individuals who are unable to leave their homes.
2. Classification of the directors salary and benefits is uncertain because the proportion
of cost is unknown that relates to fundraising activities, to administration, or to
program activities. Even if detailed information were available about the time the
director spends on various activities, there would still be uncertainty about whether to
use time spent to assign her salary and benefits. An alternative might be to identify
the proportion of value she devotes to various activities. In addition, some of the
directors activities probably relate to more than one cost category. For example, her
time at a board of directors meeting might be considered administrative. However,
the board probably discusses program issues such as whether to hire a new cook or to
purchase a new delivery vehicle. She might also persuade board members to donate
money while at a meeting.
B. This situation involves an ethical dilemma for the bookkeeper, who must decide how to
assign costs. It also involves an ethical dilemma for the director, who is responsible for
the financial statements. Both of these individuals have a responsibility to the
organization, to individuals who receive the organizations services, and to donors and
other parties who rely on its financial statements. This situation involves a possible
conflict of interest among interested parties, and requires the bookkeeper and director to
apply judgment, along with personal and organizational values, in deciding what to do.
C. The director probably prefers to classify costs as related to the program cost pool. A
larger proportion of program costs makes the organization look more efficient in its use
of resources, and also gives the appearance of appropriate effort from management.
D. Donors would prefer costs to be assigned in an unbiased wayprogram costs should
include the resources used for program purposes, fundraising costs should include
resources used for raising money, and administrative costs should include resources used
for general management of the organization. However, as discussed in Part A above,
there are many uncertainties about classification. Therefore, it is also not clear how the
donors would prefer to see these costs classified.
E. Because of the incentives discussed in C above, costs are likely to be classified in the
program cost pool when (1) the classification is uncertain and (2) a reasonable argument
can be made for classification as program. This creates a bias in favor of classifying
costs as program. Accordingly, program costs on average are likely to be overstated.
F. This is an open-ended problem, so there is no single solution. It is possible to argue for
different types of allocations. The best solutions: (1) take into account uncertainties
about how the costs should be classified, and (2) are designed to create an unbiased
classification of costs (i.e., to avoid misleading donors and others).
8.28 Middletown Clinic
A sample spreadsheet using Solver for the allocations in this problem is available on the
Instructors web site for the textbook (available at www.wiley.com/college/eldenburg).
A. Following is a diagram of the direct method allocation for Middletown Childrens Clinic.
Support Departments
Units
Medical Patient Visits
Administration
Medical
Department
Cost Pool
Accounting
Housekeeping
Dental
Department
Cost Pool
Dental Patient Visits

B. Following is the dual-rate, direct method allocation for Middletown Childrens Clinic.
Support Departments
Administration Accounting Housekeeping
Medical
Dental
Total
Allocation Bases:
Variable and fixed administration costs:
Number of employees
Variable and fixed accounting costs:
Time spent accounting
Variable housekeeping costs:
Time spent cleaning
Fixed housekeeping costs:
Square feet
62.5000%
37.5000%
100%
(50%/75%)
67%
(25%/75%)
33%
100%
(55%/85%)
65%
(30%/85%)
35%
100%
8,000
88.8889%
1,000
11.1111%
9,000
100%
Cost Allocations:
Direct support costs
$61,400
Allocate administration:
Variable
(11,052)
Fixed
(50,348)
Allocate accounting:
Variable
Fixed
Allocate housekeeping:
Variable
Fixed
Total Support Allocations $
0
$36,840
$60,360
$158,600
$
(9,210)
(27,630)
(30,180)
(30,180)
$
0
6,908
31,468
$ 4,145
18,881
0
0
6,140
18,420
3,070
9,210
0
0
19,528
26,827
$109,290
10,652
3,353
$49,310
0
0
$158,600

C. Following is a diagram of the step-down method allocation for Middletown Childrens
Clinic.
Step 1 Allocation:
Other Support Departments:
Administration
Accounting
Housekeeping
Medical
Department
Cost Pool
Dental
Department
Cost Pool
Step 2 Allocation:
Other Support Department:
Accounting
Administration
Operating Departments:
Medical
Department
Cost Pool
Dental
Department
Cost Pool

Step 3 Allocation:
Operating Departments:
Medical Patient Visits
Medical
Department
Cost Pool
Accounting
Dental Patient Visits
Dental
Department
Cost Pool
D. When performing dual-rate allocations under the step-down method, it is necessary to

decide whether to rank supports based on their total services performed, or to rank them
separately for fixed and variable support services. Solutions for both approaches are
shown below. (Differences in addition are due to rounding.)
Approach #1: Rank support departments based on total services (fixed and variable costs)
Under this approach, Administration costs are allocated first because its total direct costs are
greater than the other two support departments. Housekeeping is allocated second, and
Accounting is allocated third.
Support Departments
Administration Housekeeping Accounting
Medical
Dental
Total
Allocation Bases:
Variable and fixed administration costs:
Number of employees
Time spent cleaning
Square feet
Variable and fixed accounting costs:
2
18.1818%
1
9.0909%
5
45.4545%
3
27.2727%
11
100%
(5%/90%)
5.5556%
(55%/90%)
61.1111%
(30%/90%)
33.3333%
100%
300
3.2258%
8,000
86.0215%
1,000
10.7527%
9,300
100%
50%/75%
66.6667%
25%/75%
33.3333%
100%

Cost Allocations:
Direct support costs
$61,400
Variable
(11,052)
Fixed
(50,348)
Step 2: Housekeeping
Variable
Fixed
Step 3: Accounting
Variable
Fixed
Total Support Allocations $
0
$36,840
$60,360
2,009
9,154
1,005
4,577
(32,189)
(39,334)
1,788
1,269
(12,003)
(33,476)
$
0
$158,600
$
5,024
22,885
$ 3,014
13,731
0
0
19,671
33,836
10,730
4,229
0
0
8,002
22,317
$111,736
4,001
11,159
$46,864
0
0
$158,600
Approach #2: Rank support departments separately for fixed and variable cost allocations
For variable support costs under this approach, Housekeeping costs are allocated first because its
direct variable costs are greater than the other two support departments. Administration is
allocated second, and Accounting is allocated third. For fixed support costs, Administration is
allocated first, Housekeeping second, and Accounting third.
Support Departments
Administration Housekeeping Accounting
Medical
Dental
Total
Variable Support Allocation Bases:

Time spent cleaning
10%
Variable administration costs:

Number of employees
5%
55%
30%
100%
1
11.1111%
5
55.5556%
3
33.3333%
9
100%
50%/75%
66.6667%
25%/75%
33.3333%
100%
1
9.0909%
5
45.4545%
3
27.2727%
11
100%
300
3.2258%
8,000
86.0215%
1,000
10.7527%
9,300
100%
50%/75%
66.6667%
25%/75%
33.3333%
100%
$ 16,599
7,817
8,188
32,604
$ 9,054
4,690
4,094
17,838
$ 50,442
0
0
0
50,442
Variable accounting costs:

Fixed Support Allocation Bases:

Fixed administration costs:
Number of employees
2
18.1818%

Square feet
Fixed accounting costs:
Variable Cost Allocations:

Variable support costs
Step 3: Accounting
Total Variable
$11,052
3,018
(14,070)
0
$30,180
(30,180)
0
$ 9,210
1,509
1,563
(12,282)
0

Fixed Cost Allocations:
Fixed support costs
Step 3: Accounting
Total Fixed
$50,348
(50,348)
Total Allocations
$30,180
9,154
(39,334)
0
0
$27,630
4,577
1,269
(33,476)
0
22,885
33,836
22,317
79,038
13,731
4,229
11,159
29,119
108,158
0
0
0
108,158
$111,642
$46,958
$158,600
E. The dual-rate method requires two sets of simultaneous equations for the reciprocal
allocations.
Variable support cost simultaneous equations (Note: These equations were shown in the
textbook on page 313):
Administration = $11,052 + 15%*Accounting + 10%*Housekeeping
Accounting = $9,210 + (1/11)*Administration + 5%*Housekeeping
Housekeeping = $30,180 + (2/11)*Administration + 10%*Accounting
Fixed support cost simultaneous equations:
Administration = $50,348 + (600/9,900)*Housekeeping + 15% * Accounting
Accounting = $27,630 + (1/11)*Administration + 300/9,900)*Housekeeping
Housekeeping = $30,180 + (2/11)*Administration + 10%*Accounting

F. Below is an excerpt from the sample spreadsheet for this problem, showing the variable
support cost allocation under the reciprocal method. Except for minor rounding
differences, these allocations agree with those shown in Exhibit 8.12, textbook page 315.

Below is an excerpt from the sample spreadsheet for this problem, showing the fixed
support cost allocation under the reciprocal method. Except for minor rounding
differences, these allocations agree with those shown in Exhibit 8.12, textbook page 315.
Here is a summary of the reciprocal method variable and fixed support cost allocations to
the operating departments:
Variable support costs

Fixed support costs
Total allocation
Medical
Dental
$ 32,559
$17,883
79,268
28,890
$111,827
$46,773
Total
$ 50,442
108,158
$158,600

8.29 Danish Hospital
A. The fixed costs should be allocated based on total activity during the period, which in this
case is a month. If minutes are used as an allocation base, this means that total minutes
per month must first be estimated.
Minutes per scan
Times number of scans per month
Total minutes per month
Percent of Combined Minutes
Cancer
30 min
20 scans
600 minutes
Birth Defects
10 min
40 scans
400 minutes
60%
40%
Using total minutes per month as the allocation base, the cost allocations and cost per
scan are calculated as follows:
Lease
Operator salary
Cancer
$3,000
1,800
$4,800
Birth Defects
$2,000
1,200
$3,200
Divided by number of scans
20 scans
40 scans
$240
100
$340
$ 80
50
$130
Allocated cost per scan

Add direct costs per scan
Total assigned cost per scan
Note: Caution should be exercised in interpreting the $340 as the cost of a

cancer scan. It is the average cost, including allocated fixed costs. This cost
does not represent the incremental cost of a cancer scan.
B. Following is a comparison of the percent of costs that would be allocated to each type of
scan under each of the allowed allocation bases:
Number of scans
Minutes
Cancer
20 (33%)
600 (60%)
Birth Defects
40 (67%)
400 (40%)
The percent of costs allocated to cancer scans would be higher using minutes as an
allocation base (60% of allocated costs, compared to only 33% using number of scans).
Thus, the maximum reimbursement from the NIH would be achieved using minutes as
the allocation base. As computed in part A, this means that the maximum reimbursement
would be $340 per scan.
C. Since there is ample idle capacity, the total amount of fixed costs would probably not be
affected if the hospital receives the contract. The direct costs are primarily for supplies
that are consumed with each scan, so these costs are probably variable. The relevant
costs for this decision are the costs that Danish would charge under the contract. In this

situation, incremental costs consist only of the direct costs. As long as the fee at least
covers the direct cost per scan of $50, the hospital is not expected to lose money and
more patients will be served.
D. The minimum acceptable fixed fee is the fee that would cover the hospitals incremental
costs, as discussed in Part C. The calculation in Part C assumed that no fixed costs would
change based on the state contract. However, the hospital managers cannot be certain
that fixed costs would be unaffected by the contract. For example, demand for the
machine is uncertain. More paying patients might need the machine, leading to a
capacity constraint. In that case, the contract would cause the hospital to forego
providing services to other patients (an opportunity cost). Even if no capacity constraint
occurs, the hospital managers might want the state contract to cover some of its fixed
costs. In that case, the managers would need to decide which fixed costs to include in the
bid calculations. They cannot be certain which fixed costs to include because the
inclusion of more costs would increase the bid price and reduce the likelihood of
obtaining the contract.
E. Possible arguments to discuss in favor of using total allocated costs:
*
*
*
*
*
The organization calculates them for other reports, so the information is readily
available.
Because the information is available, the cost of providing reports for the state
will be low if the hospital wins the contract.
By incorporating overhead costs into the bid, the hospital can recover some of
those costs.
This cost measure approximates the complete cost of providing scan services, at
the predicted volume levels
It is not fair to require other hospital services to pay for support that is necessary
for the scan services.
Possible arguments against using total allocated costs:

*
*
*
*
It is not necessary to cover all costs; support costs such as administration are
covered by the hospitals primary activities
Part of the hospitals mission is to serve indigent individuals; it is unfair to use a
cost measure that might reduce the availability of services to those in need.
The hospital might lose the contract if it uses total allocated costs; another
hospital could submit a lower cost bid.
The total allocated cost changes as volumes change. If the number of indigent
patients varies widely from period to period, this cost can underestimate or
overestimate the hospitals actual costs by large amounts. Factors such as
economic changes and occasional flu epidemics that are worse than usual will
affect volumes of indigent patients using services.
F. This is an open-ended problem, so there is no single solution. It is possible to reasonably

argue for several different types of cost to be included or excluded. The best solutions to
this question provide: (1) a clear recommendation for the cost report, (2) reasonable
arguments for the recommendation, (3) evidence of having considered multiple cost

measures, (4) evidence of having considered major issues, and (5) support for the
hospitals interests while also considering interests of other stakeholders, such as the
state, taxpayers, and service recipients. In addition, the memo should follow proper
formatting and conventions. It should be concise, but at the same time provide sufficient
information for the reader to evaluate the quality of the recommendation and to draw his
or her own conclusions. In this scenario, the memo can use technical accounting jargon
because the hypothetical reader is the head of the accounting department. However, if the
memo were written to a non-accountant, technical jargon should be avoided.
8.30 The Gleason Company
A. Building and grounds costs are most often allocated based on square feet. None of the
other potential allocation bases relate to the services provided by building and grounds.
The proportion of square feet used by each department is as follows:
Administration
Square feet
Percent
Direct Costs
Allocation:
Building and grounds
Total Assigned Costs
Cafeteria
Machining
Assembly
Total
500
5%
1,000
10%
3,500
35%
5,000
50%
10,000
100%
$78,270
$4,920
$104,100
$146,700
$333,990
2,051
$80,321
4,101
$9,021
14,353
$118,453
20,505
$167,205
41,010
$375,000
B. Administration provides services to other departments, making it a support department.

Cafeteria provides meals for the employees, so it is a support department. Products are
machined and assembled in Machining and Assembly. Because these products are then
sold, these departments are considered operating departments.
C. The support departments consist of Factory Administration and the Cafeteria, so this
question requires selection and justification of an allocation base for the costs of each of
these departments. This is an open-ended question; there is no single answer. The best
solutions would evaluate the likelihood that a given allocation base would adequately
differentiate between the service resources used by the other departments. This means
that reasonable judgment needs to be applied in evaluating how well the various
allocation base options would correlate with the use of service resources. Following are
examples of reasonable arguments for each of the support departments:
Allocation Base for Factory Administration: The services of Factory Administration
relate to running the factory operations. Square feet might be a reasonable choice if
administrative services are driven by the physical space a department occupies.
However, this is unlikely. The number of purchase orders might be a reasonable choice if
administrative services are driven by responsibility for departmental costs, which may be
related to the effort involved in purchasing and paying for supplies. Using this same line
of reasoning, the dollar amount of direct or assigned costs in each department might be
appropriate as an allocation base. Direct labor hours, total labor hours, or number of

employees are reasonable choices if administrative services tend to be driven by the
management of employees. For Gleason, insufficient information is available about the
types of activities that are most closely related to administration services. However, the
management of employees is often the primary administrative service in a factory, and
number of employees is likely to be representative of this effort. Therefore, the solution
in Part D uses number of employees as the allocation base.
Allocation Base for Cafeteria: The services of the Cafeteria relate to providing meals for
employees. Because of this, a measure of employees (number or hours) would be the
best choice. Because each employee would probably eat one or two meals a day,
regardless of hours worked, hours may not reflect the use of meals as well as number of
employees. In the following computations, the number of employees is used as the
allocation base.
D. In this part, students are NOT asked to calculate total allocated costs. Instead, they are
asked to calculate the amount of overhead costs allocated to each operating department
using the step-down method and then to compute an overhead rate per direct labor hour.
For this reason, the calculations shown below do not include the operating department
direct costs.
Although the number of employees is used to allocate the costs for both support
departments, the percentages are different because (1) the total volume of the allocation
base does not include the volume of the support department being allocated, and
(2) under the step-down method the total volume of the allocation base used in the second
step excludes the volume of the support department that was allocated in the first step.
Support Departments
Administration
Cafeteria
Number of employees:
For administration allocation
2
18.1818%
For cafeteria allocation

10%
Support Costs (Part A)
Allocations:
Step 2: Cafeteria
Allocated Overhead Costs
Divide by direct labor hours
Overhead rate per hour
$ 80,321
(80,321)
$
Machining
Assembly
4
36.3636%
4
44.4444%
5
45.4546%
5
55.5556%
$ 9,021
14,604
(23,625)
$
0
Total
11
100%
9
100%
$89,342
$29,208
10,500
$39,708
$36,509
13,125
$49,634
3,000
6,000
$13.236
$8.272
0
0
$89,342

E. Calculate the plant-wide overhead rate by dividing total overhead costs by total direct
labor hours as follows:
Total overhead costs (Part B) / Total operating department direct labor hours
= $89,342 / (3,000+6,000)
= $9.927
F. When the step-down method is used, half of the support department interactions are
reflected. Because assembly uses more direct labor hours than machining, it receives
more overhead cost when direct labor hours are used in a plant-wide, single cost pool.
Therefore, it receives more cost than if the services of departments are allocated based on
use of the services. The opposite is true for the machining department; it receives less
cost under a plant-wide allocation rate than when support costs are allocated based on
services used. The step-down method more accurately reflects the use of resources.
G. An advantage of this method is that it is easy to calculate and understand. A disadvantage
is that the cost per labor hour is likely to be high because it includes fixed costs that do
not change with the number of employees or hours worked. High charges could lead
other departments to consider reducing the number of employees in the department by
outsourcing some service or product when it may not be cost effective to outsource.
Another disadvantage is that the allocation does not attempt to match the flow of
resources to products, so some products will appear to be subsidizing other products
because overhead resources used by all products is aggregated into only one pool.
H. The machining department manager would consider the cost of outsourcing versus the
cost of using direct labor. Quality could also be a factor. In addition, the manager would
want to know how department performance would appear to change as a result of
outsourcing. If the manager receives a bonus based on the departments performance
(including allocated costs) and is able to offload part of the overhead allocation by
reducing use of labor hours, then he/she would have a greater incentive to outsource.
I. The Director of Finance would be unhappy with the decision to outsource. The overhead
that is not allocated to machining is spread among other departments, so the overhead
allocations to other departments increase. Because the machining managers decision
increases incremental costs and does not reduce any of the overhead costs, it increases
total cost and is suboptimal for the company as a whole.
8.31 Steve Kurl
A. There are many uncertainties in allocating overhead costs to each game, and these
uncertainties affect the allocation of costs and, in turn, the measurement of profits. For
example, until the season is over, no one knows how many games will be played.
Therefore, it is difficult to use number of games as the allocation base. If more games are
played than planned, there will also be extra overhead cost incurred, so uncertainties exist
about the dollar amount that needs to be allocated. If the number of total hours played is
used, these would change with number of games played. The number of players per
game could be used, especially if a lot of overhead expense is tied to providing support

for the players (physicians, coaches, etc.) The problem with this measure is that it will
change if someone is injured or expelled for a number of games.
In addition, the amount of overhead costs that should be allocated against the profits of
each game is uncertain. At one extreme, it is possible to argue that administrative costs
are not expenses at all for individual games because those costs are fixed and must be
incurred to run the organization. When Steve signed his contract, he might not have
considered the possibility that any administrative expenses would be allocated to each
game. The owners, not surprisingly, would argue the opposite extremethat all
administrative costs occur because of the games and should be total allocated.
B. This is an ethical issue for the owners, managers, and accountants of the team. From
Steves perspective, the team is unfairly allocating overhead expense. Even if the parties
agree that overhead should be allocated to each game, the method being used is likely to
allocate more costs than the team incurs when there are post-season games. If the
allocated overhead is larger than actual overhead and no adjustments are made when
profits are measured for player bonuses, Steves bonus is smaller than it should be. The
owners, managers, and accountants of the team might not view this as unfair to Steve
because they might believe that team players are highly compensated through their
regular contracts. However, they have an ethical responsibility for fairness in the way
they report profits for each game.
C. If the budget is based on the number of regular season games, then the allocation might
be unbiased if the team fails to play post-season games. However, when the team plays
championship games the total amount of allocated overhead is likely to exceed total
actual overhead. This bias occurs because many of the overhead costs are likely to be
fixed and do not increase proportionately with post-season play. On the other hand,
player strikes can cause fewer games to be played. This could cause total allocated
overhead to be less than actual costs.
D. Some amount of administration work and public relations work needs to be performed for
each game. Presumably, these services contribute to both the teams win-loss record and
to ticket sales revenue and, thus, affect the profits of each game. In addition, some
portion of these costs is likely to be variable. Additional costs are probably incurred
during post-season play.
E. Many of the administration and public relations costs are likely to be fixed costs and
should not change with number of games. Therefore, any allocation based on number of
games is arbitrary and inaccurate. Also, there are questions about what it means to
measure the profit of each game. Perhaps overhead costs do not belong in a measure of
game profitability.
F. This is an open-ended problem, so there is no single solution. If students decide that it is
fair to allocate both fixed and variable administration and public relations costs against
individual game profits, then one possibility would be to adjust the allocations at the end
of the season based on the actual number of games. Another possibility is to separately
allocate fixed and variable overhead costs. Fixed costs could be allocated only against
regular season games, and the incremental costs would be individually subtracted from

the profit of each game (regular and post-season). Still another possibility is to avoid
allocations to individual games and to base bonuses on the overall profitability for the
season. Any logical and unbiased allocation method would be appropriate. If students
decide that it is not fair to allocate fixed costs, then they might recommend a system that
measures profits for each game based on revenues minus variable costs.
8.32 University Overhead Costs
A. Although cost-based contracts usually provide guidance about which costs to include and
which allocation methods are acceptable, there is room for judgment about many
different types of costs and about the method that would most fairly allocate costs. The
guidance usually provides large categories of costs that are acceptable or not acceptable,
but does not address each individual cost. Therefore, a number of costs are likely to
require judgment as they are categorized for cost reports.
B. Maximizing reimbursements under cost-based contracts is an ethical issue for
accountants because of conflicting interests. Managers, shareholders, and regular
customers most likely prefer more costs to be assigned to cost-based contracts. This
preference conflicts with the interests of cost-based contract customers and, for
governmental contracts, with the interests of governmental agencies, competitors,
taxpayers, and other potential recipients of governmental funds. The accountants who
perform the accounting for cost-based contracts must consider these conflicting interests
when using judgment to assign costs.
C. Most people would agree that a large overstatement of costs under a cost-based contract
is unethical, unless the overstatement is clearly accidental. However, there is likely to be
no consensus about smaller overstatements. One perspective is that materiality is
irrelevant. An ethical issue concerns the welfare of various stakeholders. Even if the
amount seems immaterial, to be fair to everyone, the allocation process should consider
the viewpoints of all parties affected by the allocations, no matter how large or small the
amounts are. In addition, it can be argued that there is no such thing as a small ethical
violation. From this perspective, it is not the size of the overstatement that matters, but
rather the intent behind the overstatement. Any intentional misstatement would be
considered unethical. Another perspective is that misallocations of costs will always
occur when judgment is involved. As long as the misallocations are small, then it can be
argued that no ethical issue was involvedi.e., that the organization did not attempt to
maximize reimbursements under its cost-based contracts.
D. The major stakeholder groups were identified in Part B above. Below are brief
comments about the preferences of each group.
Managers and shareholders: It is simple to say that managers and shareholders prefer
receiving greater payments under cost-based contracts and, thus, have incentives to
overstate contract costs. However, overstatement of contract costs can also have adverse
reputation effects and reduce an organizations ability to obtain future contracts. Contract
customers are also likely to increase their monitoring of contract costs, increasing the
organizations compliance costs.
Cost-based contract customers: Clearly, these customers prefer for contract costs to be
accounted for properly. However, they must be aware that it is impossible to
unambiguously define all allowable and unallowable costs. Therefore, they expect the
use of judgment, which can lead to disagreements about allowable costs. In addition,
these contracts typically include provisions allowing the customer or an independent
party (such as a CPA) to periodically audit compliance with contract provisions.
Regular customers: Regular customers are not directly affected by these issues.
However, companies that obtain greater reimbursement of overhead costs under costbased contracts may be able to charge lower prices to regular customers.
For cost-based governmental contracts:
Governmental agencies: Governmental agencies are responsible for monitoring
compliance with cost-based governmental contracts. Their preferences are similar to
those of the cost-based contract customers discussed above. In addition, governmental
agencies are charged with a fiduciary responsibility for spending public funds
appropriately. This additional responsibility increases their incentives to monitor contract
compliance.
Competitors: If a cost-based customer pays more than its fair share of a companys
overhead, the company could be more competitive in pricing other business. Competitors
would prefer to have a level playing field.
Taxpayers: Taxpayers want to ensure that their funds are being used appropriately. Thus,
their preferences are similar to those of cost-based contract customers. However, most
taxpayers are not knowledgeable about accounting and might fail to recognize legitimate
accounting uncertainties.
Other potential recipients of governmental funds: Other potential recipients want a level
playing field, in which their opportunity to obtain funds is not diminished because of
excessive spending on other organizations contracts. Overcharging by other
organizations reduces the quantity of available funds. It also has indirect effects, such as
a reduced willingness of taxpayers and governmental agencies to fund cost-based projects
and an increase in compliance and monitoring costs.
E. The trade-offs made by accountants in deciding whether to help their organizations
maximize reimbursements under cost-based contracts include all of the issues discussed
in the preceding questionsthey must evaluate the implications to their own organization
as well as to other stakeholders. In addition, they must consider their own ethical values
as they establish criteria for recording costs. To clarify their values, they might consider
asking questions such as the following. Is it acceptable to recognize all costs under a
cost-based contract except those that are explicitly disallowed? Should an attempt be
made to classify costs from the perspective of the customer or other stakeholders? Does
materiality matter? What are the short-term and long-term implications of assigning a
particular cost to the contract?

F. There is no one answer to this part. Sample solutions and a discussion of typical student
responses will be included in assessment guidance on the Instructors web site for the
textbook (available at www.wiley.com/college/eldenburg).
8.33 Vines Company
A sample spreadsheet showing the calculations for this problem under the direct, step-down, and
reciprocal methods is available on the Instructors web site for the textbook (available at
www.wiley.com/college/eldenburg).
A. Below are excerpts from the sample spreadsheet for this problem, which show the direct,
step-down, and reciprocal method allocations of fixed support costs. The reciprocal
method allocations were performed using Excel Solver.
1. Direct method
2. Step down method

3. Reciprocal method
B. Below are excerpts from the sample spreadsheet for this problem, which show the direct,
step-down, and reciprocal method allocations of variable support costs. The reciprocal
method allocations were performed using Excel Solver.
1. Direct method

2. Step-down method
3. Reciprocal method
C. For accounting I would use time spent because it probably reflects the use of accounting
employees and their salaries would be a large part of the fixed costs. Number of
employees is already used for both fixed and variable costs, so I would continue to use it.
Time spent in janitorial services probably provides a more accurate reflection of the
resources used by each department for janitorial staff, and its likely as they spend more
time in an area they also use more supplies.
D. Managers may want to use this information for benchmarks to compare current
performance to past performance. Its possible that they use these calculations to develop
a transfer price policy for the use of support services.

E. If Vines is using this information for transfer prices, the variable portion is probably a
better reflection of the marginal costs to the company of providing support services.
These categories also give more precise information for benchmarks. It would be easier
to investigate variances if cost pools are smaller and reflect only fixed or variable costs.
BUILD YOUR PROFESSIONAL COMPETENCIES

8.34 Focus on Professional Competency: Leverage Technology to Develop and Enhance
Functional Competencies
A.
1 and 2. Business decisions addressed in Chapter 8 and relevant information that might
be stored in an electronic database:
Examples of Electronic
Decisions in Chapter 8
Database Information
Business Decisions:
Data used to estimate future relevant
Insourcing or outsourcing
costs: Historical costs
Product pricing
Data used to estimate future prices, costs
and profits: Historical average product
cost per unit, historical overhead costs
Improve cost control and efficiency
Data used to evaluate trends: Historical
and budgeted costs, volumes, and profits
Accounting Method Decisions:
Departments currently used for
Identifying appropriate cost pools for budgeting and accounting
support and operating departments
Whether to establish separate pools
Evaluate the behavior of costs:
for fixed and variable costs
Historical costs and volumes of cost
drivers
How to assign costs to cost pools (this Electronically-stored policy manuals and
includes classification of overhead
contractual terms; Classifications used
costs under governmental cost-based
for similar items in the past based on
contracts)
historical accounting and cost report
records
Identifying the most appropriate
Data currently available, such as
allocation bases for each cost pool
historical production volumes, employee
time records, direct costs, etc.
Identifying the most appropriate
Information for making this decision
allocation method
would not likely be stored electronically
Whether the benefits exceed the costs Information for making this decision
of establishing a more detailed support would not likely be stored electronically
cost allocation system
Under the step-down method,
Historical data that could be used for
identifying the best measure for
ranking, such as direct costs
ranking the amount of service
provided by support departments
Whether to allocate support costs
Information for making this decision
based on estimated versus actual costs would not likely be stored electronically
and rates.
B.
1. A sample spreadsheet for this problem is available on the Instructors web site for the
textbook (available at www.wiley.com/college/eldenburg). The documentation in the
sample spreadsheet assumes that the data in the spreadsheet is not directly linked to
the sources of the data. Therefore, the spreadsheet includes comments describing the
sources of information. The sample spreadsheet does not include any other
explanations for the reciprocal allocations because it is assumed that the spreadsheet
will be used only by people who are familiar with the reciprocal method and how it is
performed.
2. This answer will vary from student to student. The purpose is to engage students in a
discussion of what it means to document work performed and also to gain an
appreciation of the need to design spreadsheets that can be easily understood by other
people.
3. This answer will vary from student to student. The purpose is to encourage students
to implement recommendations.
C. This answer will vary from student to student. The purpose is to help students reflect on
their approaches to technology adoption.
8.35 Integrating Across the Curriculum: Governmental Accounting
A. This answer will vary from student to student. Additional guidance for locating
information on the web about state or local government internal service funds is available
on the textbook web site (www.wiley.com/college/eldenburg). The descriptions of funds
for the state and local governments listed in the problem are as follows:
City of Laguna Beach, California:1
An internal service fund is a revolving fund established to isolate the costs of a
particular function and then to allocate those costs to the various operating
divisions.
Costs for the functions of the internal service funds are allocated to individual
operating divisions through the use of an annual rate which is adjusted each year
to reflect anticipated costs. For example, the rates for vehicle replacement are
based on the specific vehicles assigned to each division, and the rates for
employee medical insurance are based on the number of employees in each
division.
Based on this rate, each division pays to the internal service fund an annual
amount which is shown as an expenditure item in the division budget. This
1
Quoted from Internal Service Funds, Adopted BudgetFiscal Year 200304, City of Laguna Beach, California,
available at 4.18.61.11/government/reference/budget/.

payment becomes the revenue for the internal service fund which in turn directly
pays for the goods and services provided, such as new vehicles or medical
insurance.
State of Michigan, Department of Management and Budget:2
The State Sponsored Group Insurance Fund, which was administratively
established to reflect financial transactions of the state -sponsored insurance
plans.
The Information Technology and Energy Fund was established to account for
various services provided to all state agencies. These services include
telecommunication and information technology and the purchase of bulk natural
gas used by State agencies.
The Motor Transport Fund was created to provide vehicle and travel services to
state agencies. Services include lease, purchase, replacement, and maintenance of
automotive equipment. Vehicles are furnished to agencies on a permanently
assigned basis or through the motor pool for short-term usage.
The Office Services Revolving Fund was created to provide printing,
reproduction, microfilm, mailing, and material management services. The cost of
these services is charged to user departments and agencies.
The Risk Management Fund was established to account for centralized risk
management functions performed by DMB [Department of Management and
Budget] for other state agencies. The Fund provides automotive and other
insurance coverage to state departments and agencies.
City of Arlington, Texas: 3
Internal Service Funds - includes General Services, Communication Services,
Fleet Services, and Information Technology Services. These funds provide
services such as printing, computer support, communications and vehicle
maintenance for all City departments, and are supported by scheduled transfers or
direct charges from other funds.
Multnomah County, Oregon:4
These funds account for activities and services performed primarily for other
organizational units within the County. Charges to the County agencies are
calculated to recover costs and maintain capital. The County accounts for certain
2
Adapted from Executive Digest #0713701, Selected Internal Service Funds, Michigan Office of the Auditor
General, June 2002, available at www.audgen.michigan.gov/digests/01_02/0713701.htm.
3
Quoted from Executive Summary, FY 2004 Annual Operating Budget, City of Arlington, Texas, available at
www.ci.arlington.tx.us/budgets/.
4
Quoted from Internal Service Funds (under Supplementary Information), Comprehensive Annual Financial
Report, fiscal year ended June 30, 2002, available at www.co.multnomah.or.us/dbcs/finance/cafr2002/

expenditures of the Internal Service Funds for budgetary purposes on the
modified accrual basis of accounting. For financial reporting purposes the accrual
basis of accounting is used. Such differences relate primarily to the methods of
accounting for depreciation and capital outlay. Funds included are:
*
*
*
*
*
*
Risk Management Fund - accounts for the County's risk management

activities including insurance coverage.
Fleet Management Fund - accounts for the County's motor vehicle fleet
operations.
Telephone Fund - accounts for the County's telephone operations.
Data Processing Fund - accounts for the County's data processing
operations.
Mail/Distribution Fund - accounts for the County's mail/distribution
operations.
Facilities Management Fund - accounts for the management of all County
owned and leased property.
B. Internal service funds allow governments to measure the cost of support services and to
assign their cost to other departments that use the support resources.
C. Many internal services are accounted for in the general fund of a state or local
government, which is similar to an overall administration cost pool in a business
organization. If internal services are used by non-administration government activities,
then the pooling of internal services with general administration overstates the cost of
general government management. Essentially, 100% of the internal service costs are
assigned to general management, which understates the cost of other activities which
should have received a portion of the internal service costs. The result is that general
government costs appear to be higher than they actually are, making the general
government appear to be less efficient. At the same time, the costs of other services
appear to be lower than they actually are, making those services appear to be more
efficient.
D. There is no single answer to this question. The benefits must be weighed against the
costs in reaching a conclusion to this question. While internal service fund accounting
might improve cost measurement, several costs and limitations must also be considered.
For example, if general government uses most of an internal service, then there may be
no benefit from establishing a separate fund. Legal and political issues should also be
considered. The creation of new funds often requires the passage of legislation. It can be
quite costly to legally establish a new fund and then to modify information systems to
account for it.

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Chapter 8

Measuring and Assigning Support Department Costs

Step 1 skills (Identifying)

Step 2 skills (Exploring)

Step 3 skills (Prioritizing)

Step 4 skills (Envisioning)

All of the methods allocate support department costs to operating

All of the methods rely on allocation bases to assign costs of support

All of the methods result in a total allocated cost per unit

Direct method ignores all interactions among support departments.

The step-down method takes into account some of the interactions

Management's objectives should be the determining factor, tempered by the availability

Chapter 8: Measuring and Assigning Support Department Costs

Following are factors to consider in choosing an allocation base

Department 1 is an operating department because it works directly on the firm's final

Accounting department costs could be allocated using number of employees,

Chapter 8: Measuring and Assigning Support Department Costs

Direct method allocation using costs to purchase outside:

Chapter 8: Measuring and Assigning Support Department Costs

Total allocated cost

B. Step-down method allocation, with physical plant costs allocated first

Total allocated cost

Variable Cost Allocation:

Fixed Cost Allocation:

Variable Cost Allocation:

Total allocated cost

Chapter 8: Measuring and Assigning Support Department Costs

8.18 The Brown and Brinkley Brokerage

8-10 Cost Management

8.19 Pauls Valley Protection Service

Chapter 8: Measuring and Assigning Support Department Costs 8-11

8.20 Software Plus Corporation

8-12 Cost Management

Chapter 8: Measuring and Assigning Support Department Costs 8-13

8-14 Cost Management

Chapter 8: Measuring and Assigning Support Department Costs 8-15

8-16 Cost Management

Chapter 8: Measuring and Assigning Support Department Costs 8-17

Allocated Cost Per Unit

There can be unexpected inflation or deflation in the costs of materials, labor,

8-18 Cost Management

Allocated Cost Per Unit

Chapter 8: Measuring and Assigning Support Department Costs 8-19

8-20 Cost Management

New product design: number of new products, labor hours

C. Factors to consider in choosing cost pools and allocation bases:

The cost and benefit tradeoffs for collecting information.

8.26 Space Products

Support dept costs allocated to Military:

Chapter 8: Measuring and Assigning Support Department Costs 8-21

E. Policy to Maximize DOD Contribution

8-22 Cost Management

Chapter 8: Measuring and Assigning Support Department Costs 8-23

Dental Patient Visits

8-24 Cost Management

Chapter 8: Measuring and Assigning Support Department Costs 8-25

8-26 Cost Management

Medical Patient Visits

Dental Patient Visits

D. When performing dual-rate allocations under the step-down method, it is necessary to

Chapter 8: Measuring and Assigning Support Department Costs 8-27

Variable Support Allocation Bases:

Variable administration costs: