Service Departments

Week 03 Topic 06

ACCT112: Management Accounting

Themin Suwardy, SMU 2005

Revision Question

On another fine day, the careless CFO of SMU Ltd left yet
another notepad in another restaurant. On it was scribbled
under the heading of For the month of October, 2010:
Budgeted sales = 4,000 units
Budgeted profit = $300,000
Fortunately the company is not using Variable Costing,
otherwise our budgeted profit will be only $200,000
Should consider increase production for Oct by 10% and
thereby increase budgeted profit by another $30,000.
What is the budgeted production quantity for the month of
October?
Slide 2

Answer
Given:

Budgeted Sales Qty = 4,000 units

Bud Profit under Abs costing = $300,000
Bud Profit under Var Costing = $200,000

Let:

Bud Prod Qty = Z

Then:
If
That is:

Substitute (2) in
(1) and Solve
Slide 3

Seminar Outline
1. Schema of Overhead Allocation
2. Allocating Support Service OH
3. Direct Method
4. Step Method
5. Reciprocal Method

Slide 4

1.1 Schema of Traditional Overhead Allocation

All Costs Incurred

Physically
Physically
and
and
Economically
Economically
Traceable
Traceable

Manufacturing
Costs

Direct
Trace
Product
Product A
A

Indirect

Non-Manufacturing
Costs

Supporting

Others

2
Product
Product B
B

Slide 5

Financial
Statements

1.1a Another way of looking at OH Allocations

$

Cost
Cost Pools
Pools (Service
(Service Depts
Depts.).)
$

Cost
CostPools
Pools(Operating
(OperatingDepts.)
Depts.)
$

KEY
Real Costs
Allocated
Costs

Products
Slide 6

1.2 A Fundamental Question

Why Allocate?

OH may be a
very significant
portion of Total
Costs!

REASONS?

Decision Making
Reporting
Cost Recovery
Influence Behaviour
Performance Evaluation

Slide 7

1.3 Charging Costs by Behavior

Whenever possible,
variable and fixed
service department costs
should be charged
separately.

Slide 8

1.4 Charging Costs by Behavior

Variable service
department costs should be
charged to consuming departments
according to whatever activity
causes the incurrence
of the cost.

Slide 9

1.5 Charging Costs by Behavior

Charge fixed service department costs
to consuming departments in
predetermined lump-sum amounts that
are based on the consuming
departments peak-period or long-run
average servicing needs.

Are based on amounts of

capacity each consuming
department requires.

Should not vary from

period to period.

Slide 10

1.6 Should Actual or Budgeted Costs Be Charged?

Budgeted variable
and fixed service department
costs should be charged to
operating departments.

Slide 11

An Example

Sipco has a maintenance department and two operating

departments: Cutting and Assembly. Variable maintenance
costs are budgeted at $0.60 per machine hour. Fixed
maintenance costs are budgeted at $200,000 per year.
Data relating to the current year are:

Operating
Departments
Cutting
Assembly
Total hours

Percent of
Peak-Period
Capacity
Required
60%
40%
100%

Hours
Planned
75,000
50,000
125,000

Hours
Used
80,000
40,000
120,000

Allocate maintenance costs to the two operating departments.

Slide 12

End of the Year (1)

Actual hours

Slide 13

End of the Year (2)

Actual hours

Percent of peak-period capacity.

Slide 14

Quick Check

Foster City has an ambulance service that is used

by the two public hospitals in the city. Variable
ambulance costs are budgeted at $4.20 per mile.
Fixed ambulance costs are budgeted at $120,000
per year. Data relating to the current year are:

Hospitals
Mercy
Northside
Total

Percent of
Peak-Period
Capacity
Required
45%
55%
100%
Slide 15

Miles
Planned
15,000
17,000
32,000

Miles
Used
16,000
17,500
33,500

Quick Check - Answer

How
How much
much ambulance
ambulance service
service cost
cost will
will be
be
allocated
allocated to
to Mercy
Mercy Hospital
Hospital at
at the
the end
end of
of the
the
year?
year?
a.
a. $121,200
$121,200
b.
b. $254,400
$254,400
c.
c. $139,500
$139,500
d.
d. $117,000
$117,000

Slide 16

16

Quick Check Answer

Slide 17

2.1 Allocating Support Service OH

Three Methods
Direct
Step
Reciprocal

Slide 18

2.2 Teaching Case

Three Support (or Service) Departments

Costs

Fac

IT

HR

$300,000

$500,000

$400,000

Cutting

Assembly

Finishing

Allocate

Three Production Departments

Slide 19

3.1 The Direct Method

The costs of each support
depart are allocated
Directly to the various
production departments.

It ignores the fact that

support departments also
service other service
departments.

Slide 20

3.2 Applying the Direct Method on the Case

Support (Service) Departments

Fac
$300K

IT

Production Departments

HR

Costs Driver?

Cutting Assembly Finishing

3,000 m2

4,000 m2

3,000 m2

$90K

$120K

$90K

2,500 hrs

1,500 hrs

1,000 hrs

$250K

$150K

$100K

10 pers

50 pers

20 pers

$50K

$250K

$100K

$390K

$520K

$290K

Proportional?
e.g. (3,000/10,000) x $300K = $90K

$500K

$400K

TOTAL
Slide 21

Practice Question (1) Direct Method

Support (Svc) Departments
S1
OH $ =

S2

S3

Production Departments
P1

P2

P3

400

100

500

800

70

30

70

40

3,000

1,000

2,000

P1

P2

P3

$140,000 $280,000 $420,000

S1 Driver

200

S2 Driver

70

S3 Driver

1,000

3,000

Answer:

S1

S2

S3

S1
S2
S3
TOTAL

Slide 22

Practice Question (1) Direct Method - Answer

Slide 23

4.1 The Step Method (1)

Support departments DO
service each other !

It is thus logical to
allocate each support
departments costs to all
production departments
AND to all other service
departments !
Slide 24

But if we allocate
each support
departments costs
to all other
departments, then
is it called the
Reciprocal
Method !
What then is the
Step Method?

4.2 Step Method (2) - The Algorithm

(1) Choose sequence of allocating support department.
(2) Start with the first support department of the chosen
sequence, and allocate all costs to all other support
department AND all production departments.
(3) Proceed to next support department and allocate all costs +
costs allocated from preceding support department(s) to all
remaining support departments (if any) AND all
production departments.
(4) Repeat (3) until there is no more support department.

Slide 25

4.3 Applying the Step Method on the Case

Allocation Sequence? **

Fac

IT

HR

Cutting

Assembly

Finishing

1/6

$300K

1,000 m2

1,000 m2

3,000 m2

4,000 m2

3,000 m2

1/3

750 hrs

$500K

1,750 hrs

2,500 hrs

1,500 hrs

1,000 hrs

1/2

50 pers

30 pers

$400K

10 pers

50 pers

20 pers

$125K

$75K

$25K

$125K

$50K

$75K

$250K

$150K

$100K

$500K

$150K

$200K

$150K

$425K

$475K

$300K

= (50/160)
$575K x $400K

TOTAL
Slide 26

Practice Question (2) - Step Method

Support (Svc) Departments

Production Departments

S1

S2

S3

P1

P2

P3

OH$=
S1Driver
S2Driver
S3Driver

$140,000

$280,000
200

70
1,000

$420,000
400
70

3,000

100
30
3,000

500
70
1,000

800
40
2,000

Answer:

S1

S2

S3

P1

P2

P3

Sub-Total
Sub-Total
TOTAL

Slide 27

Practice Question (2) - Step Method - Answer

Slide 28

5.1 The Reciprocal Method

Where we allocate each

support departments costs
to all production
departments AND to all
other service departments !

Slide 29

5.2 Applying the Reciprocal Method to the Case (1)

Fac

IT

$300K

HR

Cutting Assembly Finishing

1,000 m2 1,000 m2 3,000 m2 4,000 m2 3,000 m2

750 hrs

$500K

1,750 hrs 2,500 hrs 1,500 hrs 1,000 hrs

50 pers

30 pers

$400K

10 pers

50 pers

20 pers

Fac after

Fac =Fac
300=+300
(750/7500)
+ (50/160)
+ 0.1 IT IT
+ 0.3125
HR HR

IT after

IT = IT
500= +500
(1,000/12,000)
+ 0.0833 FacFac
+ 0.1875
+ (30/160)
HR HR

HR after

HRHR
= 400= +400
(1,000/12,000)
Fac ++(1,750/7,500)
+ 0.0833 Fac
0.2333 IT IT

after means the total overheads of Fac dept AFTER all the
reciprocal allocations have been completed
Slide 30

5.3 Reciprocal Method (2)

Solving the Simultaneous Equations:

The Answers?
Fac = $553K
IT = $659K
HR = $600K

Slide 31

(rounded)
(rounded)
(rounded)

5.4 Reciprocal Method (3)

Fac

IT

HR

Cutting

Assembly

Finishing

$300K

1,000 m2

1,000 m2

3,000 m2

4,000 m2

3,000 m2

750 hrs

$500K

1,750 hrs

2,500 hrs

1,500 hrs

1,000 hrs

50 pers

30 pers

$400K

10 pers

50 pers

20 pers

-$553K

$46K

$46K

$138K

$184K

$138K

$66K

-$659K

$154K

$220K

$133K

$88K

$187K

$113K

-$600K

$37K

$187K

$75K

$395K

$504K

$301K

Rounding Error!

$1,200K
Slide 32

Q&A
Cutting Assembly Finishing
Direct Method

$390K

$520K

$290K

Step Method

$425K

$475K

$300K

Reciprocal Method

$395K

$504K

$301K

What can we learn from these differences?

How to tell if a method is really better?

Slide 33

Theoretical Bases for Allocation

Cause & Effect

Benefits Received
Fairness & Equity
Ability to Bear

Slide 34

Example of Exam/Test Question for Topic 06

2014-15-T1 - Test 1 - Qn 4

Slide 35