Support Department Cost Allocation

Topic 2- Red Ball Printers

ACCT2160 Cost Analysis and Applications

 Lecture Illustration Part 1

• Red Ball Printers has 3 operating departments

–Catalogue, Magazine and Book Departments
• The Cleaning Department provides services to these
departments
• The allocation base for Cleaning is cleaning hours to
represent usage of Cleaning Services
– Budgeted cleaning hours for November is 5,000 based on the following
budgeted usage:
Catalogue Department 1,200 hrs
Magazine Department 1,600 hrs
Book Department 2,200 hrs
Total 5,000 hrs

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 Lecture Illustration Part 1

• Budgeted costs of Cleaning for November are $200,000

• These costs comprise the following:
– Fixed: $130,000 (fixed within relevant range of 1,000 -10,000
cleaning hours)

– Variable: $14 per cleaning hour ($70,000)

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 Determine a single budgeted application rate
for November

• November’s single budgeted application rate is

$200,000/5,000 hrs = $40 /hour

• Equivalent to -
• $14 of variable costs per hour and;
• $26 of fixed costs per hour ($130,000/5,000)

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 Allocate Cleaning costs to Departments using
single rate

• Actual usage of Cleaning Department for November is

Catalogue Department 1,200 hrs
Magazine Department 1,800 hrs (not 1,600)
Book Department 1,900 hrs (not 2,200)
Total 4,900 hrs

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 Allocate Cleaning costs to Departments using
single rate

Cost allocation to Departments

Catalogue: $40 x 1,200 hours = $48,000
Magazine: $40 x 1,800 hours = $72,000
Book: $40 x 1,900 hours = $76,000
Total Allocation: $196,000

• Total allocation is $196,000 not $200,000

• Is this an appropriate allocation?

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 Allocate Cleaning costs to Departments using
single rate

Did the 3 operating departments “cause” $196,000 of

Cleaning services?
• They required Variable Costs of 4,900 hrs x $14 = $68,600
– Not $70,000 as only 4,900 hrs (not 5,000) were used

• BUT still required Fixed Costs of $130,000 – no change as

they are FIXED with output (cleaning hours) in the short-
term
• Total “caused” = $68,600 + $130,000 = $198,600
– Therefore Cleaning costs have been underallocated by $2,600

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 Allocate Cleaning costs to Departments using
single rate

• What caused Cleaning costs to be incorrectly allocated?

– The incorrect allocation of fixed costs

• Remember the single allocation rate of $40/hour

– Fixed costs were treated as variable with cleaning hours – even though they
are FIXED costs

• As a result, when cleaning hours amounted to only 4,900 the

fixed cost allocation ended up being only
– $26 x 4,900 hours = $127,400 instead of $130,000
– i.e. $2,600 underallocated

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 Allocate Cleaning costs to Departments
using dual rates

• The problem with fixed costs can be solved if separate

rates for Variable and Fixed support department costs
are used
• Use dual rates for Red Ball Printers Cleaning department
– Variable cost application rate will not change
– $14 per cleaning hour used

– Fixed cost allocation?

– Need to find a suitable allocation base – not cleaning hours used

Refer to Illustration 2 part C

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 Allocate Cleaning costs to Departments
using dual rates

• Fixed Costs are incurred to provide support departments with

the ability to satisfy the demands of the operating departments
in the long-term
– In any given month operating departments may not use all a support
department’s capacity available
– However over time it is assumed they will

• Therefore long-term average usage of support departments

is likely to represent the “cause” of Fixed Costs
– “Average actual capacity” or “Practical capacity”

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 Allocate Cleaning costs to Departments
using dual rates

• Red Ball Printers’ 3 operating departments have the following

practical capacity
Catalogue Department 1,375 hrs
Magazine Department 1,925 hrs
Book Department 2,200 hrs
Total 5,500 hrs
• Need to determine allocation ratios (allocation bases) for
each operating department based on practical capacity
proportions
Catalogue Department 1,375/5,500 = 25%
Magazine Department 1,925/5,500 = 35%
Book Department 2,200/5,500 = 40%
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 Allocate Cleaning costs to Departments
using dual rates
• Budgeted Cleaning Fixed Costs =$130,000
• Cleaning Fixed Cost allocation to operating departments

Department Ratios Fixed Cost Allocation

$32,500
Catalogue 25%
(25% x $130,000)
$45,500
Magazine 35%
(35% x $130,000)
$52,000
Book 40%
(40% x $130,000)

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 Allocate Cleaning costs to Departments
using dual rates
• Total of Fixed and Variable Cost allocations

Fixed Cost Variable Cost

Department Total Allocation
Allocation allocation
$32,500 $16,800 $49,300
Catalogue
($14 x 1,200)
$45,500 $25,200 $70,700
Magazine
($14 x 1,800)
$52,000 $26,600 $78,600
Book
($14 x 1,900)
Total $130,000 $68,600 $198,600

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 Allocate Cleaning costs to Departments
using dual rates

• Things to note:
– Fixed costs have not been “unitised” as allocation base ratios were used
to allocated fixed costs
– Ratios stay constant until long-term capacity changes
– Ultimately dual rates provide more accurate support department cost
allocation as they use the “cause and effect” rule

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 Comparison of single and dual rates for
support department costs

Dual
Single rate
Department rate
Allocation
Allocation
Catalogue $48,000 $49,300
Magazine $72,000 $70,700
Book $76,000 $78,600
Total $196,000 $198,600

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 Lecture Illustration Part 2

Recall Red Ball Printers

• Dual Rate variable cost allocations based on budgeted
variable costs were;

Catalogue Department $16,800

Magazine Department $25,200
Book Department $26,600
Total $68,600

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 Budgeted vs actual cost allocations- lecture
illustration using variable costs

• At the end of November actual Cleaning variable costs

amounted to $78,400

• The Cleaning department did not operate as efficiently as

expected in November

• In particular, three employees from the Cleaning department

have been disciplined for wasting time on jobs undertaken for
the Catalogue and Book Departments.
– This inefficiency resulted in additional costs of around $7,000

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 Budgeted vs actual cost allocations- Part 2a)
What should actual variable costs have equalled?

What should actual variable costs have equalled?

• Actual cleaning hours used x application rate
– 4,900 hours x $14 = $68,600 (not $78,400)

• Most of the difference appears to be due to the

inefficiencies in the Cleaning Department

• What happens if actual costs are allocated?

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 Budgeted vs actual cost allocations- Part 2b)
Allocation of actual Cleaning variable costs

Actual Cleaning Department variable costs = $78,400

Actual Allocation rate = $78,400/4,900 = $16/hour

Department Actual Usage Actual Variable Cost

(hours) Allocation
Catalogue 1,200 $19,200
($16 x 1,200)
Magazine 1,800 $28,800
($16 x 1,800)
Book 1,900 $30,400
($16 x 1,900)
Total 4,900 $78,400

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 Part 2c) Comparison of the allocation of actual
and budgeted costs?

Actual Budgeted
Variable Cost Variable Cost
Department Allocation Allocation Difference
Catalogue $19,200 $16,800 $2,400
Magazine $28,800 $25,200 $3,600
Book $30,400 $26,600 $3,800
Each department has higher actual cost allocations
o However the difference in allocations is caused by the
actions of the support department, not the operating
department
• The difference shouldn’t be allocated

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 What if there is more than one support
department?

• If multiple support departments exist, they are likely to interact

– i.e. Supply services to each other as well as to operating departments
• Allocation Methods used:
– Direct method;
– Sequential or step-down method; and
– Reciprocal method
• The most accurate cost allocation takes into account these “reciprocal”
sharing of services

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 Lecture Illustration Part 3

• Red Ball Printers actually has two Support Departments

– Cleaning and Maintenance

• Budgeted Cleaning costs (as previously)

– Fixed = $130,000
– Variable = $70,000

• Budgeted Maintenance costs

– Fixed = $100,000
– Variable = $80,000

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 Multiple Support Departments – An
Illustration

• Budgeted usage of support departments is as

follows:
Cleaning Mainten. Catalogue Magazin Book Total
e
Cleaning
Hours * -- 1250 1200 1600 2200 6250

Mainten.
Hours # 80 -- 150 130 140 500
* Allocation base for Cleaning is Cleaning Hours
# Allocation base for Maintenance is Maintenance Hours

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 Multiple Support Departments -
Illustration

• Note that Cleaning provides services to Maintenance

– Therefore some Cleaning costs should be allocated to Maintenance
– Maintenance costs of $100,000 are understated

• Note that Maintenance provides services to Cleaning

– Therefore some Maintenance costs should be allocated to Cleaning
– Cleaning costs of $130,000 are understated

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 1. Direct Method Allocations- Variable Costs only
(Figures rounded)

Cleaning Mainten. Catalogue Magazine Book

Initial Costs
$70,000 $80,000 $300,000 $350,000 $480,000
Cleaning 24% 32% 44%
Ratios (1200/5000) (1600/5000) (2200/5000)
Cleaning No
Alloc’n -$70,000 Allocation $16,800 $22,400 $30,800
Mainten. 35.7% 30.95% 33.34%
Ratios (150/420) (130/420) (140/420)
Mainten. No
Alloc’n Allocation -$80,000 $28,560 $24,760 $26,680
Totals $0 $0 $345,360 $397,160 $537,480

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 2. Sequential (step down) method

• Only partially recognises interactions among support depts

–Support department cost allocation is only one way
–E.g. If Maintenance is allocated first some of its costs will be
allocated to Cleaning
• Cleaning will be allocated second, but will not allocate some of
its costs back to Maintenance even though Cleaning provides
services to Maintenance
–This means the first department is allocated accurately, the
second less accurately and so on

Allocation order (ranking) affects accuracy

of cost allocations
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 Sequential method and allocation order (ranking)

How can rankings be determined?

• Several options
– Textbook ranks based on “percentage of total services provided to other service
departments”
–Cleaning provides 20% (1250/6250) of services to maintenance
–Maintenance provides 16% (80/500) of its services to Cleaning
– Therefore allocate Cleaning first – highest percentage

OR

-rank based on dollar value of services provided

–Cleaning provides 20% * $70000=$14,000
–Maintenance provides 16% *80,000=$12,800
- Allocate Cleaning first!
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 Sequential (step down) method -illustration

Allocation base ratios

‘ Cleaning Mainten. Catalogue Magazine Book
Cleaning -
Hours 1250 1200 1600 2200
Ratios - .20 .192 .256 .352
1250/6250 1200/6250 1600/6250 2200/6250
Mainten.
Hours - 150 130 140
Ratios .357 .31 .333
150/420 130/420 140/420

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 Sequential Method – Allocations (rounded)

Cleaning Mainten. Catalogue Magazine Book

Initial
Costs $70,000 $80,000 $300,000 $350,000 $480,000
Cleaning
Ratios .20 .192 .256 .352

Alloc’n -$70,000 $14,000 $13,440 $17,920 $24,640

Mainten. No
Ratios .357 .310 .333
Allocation
Alloc’n -$94,000 $33,572 $29,095 $31,333
Totals $0 $0 $347,012 $397,015 $535,973

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 3. Reciprocal Method

• Recognises ALL interactions among support departments

• Uses simultaneous equations to determine the cost
allocations required to reflect these interactions
• Start with equations that represent TOTAL support
department costs – as if support department allocations
had occurred

Maintenance cost (M) = $80,000 + 20% of C

Cleaning cost (C) = $70,000 + 16% of M

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 Reciprocal Method

Solve for M and C using simultaneous equations

Maintenance costs
M = $80,000 + .20($70,000+.16M)

M = $80,000 + $14,000 + .032M

.968M = $94,000  M = $97,107 (rounded)

Cleaning Costs
C= $70,000 + .16($97,107)

C = $70,000 + $15,537= $85,537 (rounded)

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 Reciprocal Method

Now allocate these “new” costs using allocation ratios

Cleaning Mainten. Catalogue Magazine Book

Initial
Costs $70,000 $80,000 $300,000 $350,000 $480,000
Cleaning
.2 .192 .256 .352
Ratios
Alloc’n -$85,537 $17,107 $16,423 $21,898 $30,109
Mainten.
.16 .30 .26 .28
Ratios
Alloc’n $15,537 -$97,107 $29,132 $25,248 $27,190
Totals $0 $0 $345,555 $397,146 $537,299

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 Comparison of Methods

Final Allocations to Operating Departments

Direct Sequential
Reciprocal Method
Method Method
Catalogue $345,360 $347,012 $345,555
Magazine $397,160 $397,015 $397,146
Book $537,480 $535,973 $537,299
Total $1,280,000 $1,280,000 $1,280,000

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 Comparison of Methods

• Note: Allocations are quite similar

• Why?
– Because there very few support departments, and
– the interactions between the support departments are relatively small (16%
and 20%)

• Choice of method should be based on cost-benefit

– Benefit to allocation accuracy vs. costs of method
– See tutorial questions for a greater analysis of this issue

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