* The aim of allocating support department costs to the production departments is to inform the managers of the services provided by the support department. * This will assist them to plan and control the use of the services
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Process of allocation
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3 methods of support dept. cost allocation
* The Direct method
* The Step-down method
* The Reciprocal method
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The direct method
* Only allocate support dept. costs directly to production dept. that consume part of the support dept's. output. * Shortcoming: ignores the services provided by the support department to other support departments. * Proportion allocated to each production dept. relates to the relative proportionconsumed by the production dept.
Continued
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DirectMethod
* Suppose there are two support depts. Power & Maintenance, and two producing depts. Grinding & Assembly, each with a "bucket" of directly traceable overhead costs.
* Objective: Distribute all Power & Maintenance costs to Grinding & Assembly using the direct method (Hansen & Mowen 1997)
Continued
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DirectMethod
* DirectMethod - Allocate Power and Maintenance costs only to Grinding and Assembly
(Hansen & Mowen, 1997)
Continued
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DirectMethod
* After allocation - Zero cost in power and Maintenance, all overhead cost in Grinding and Assembly (Hansen & Mowen, 1997)
Continued
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Lecture Illustration
* Directmethod ** Refer to hand out
Continued
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DirectMethod
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DirectMethod
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The Sequential method
(Step-down method)
* This method allocates the support department costs through partial recognition of services provided by one support department to the other. * It partially overcomes the shortcoming of the direct method.
Continued
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Sequence of cost allocation
* Steps ** (1) Allocate the cost of support dept. that serves the largest no. of other support depts. The dept. with the least support services is allocated last. ** (2) Allocate each support dept's. costs among the production dept. & all the other support depts., following the sequence ** Where a tie exists, the support dept. with the largest OH budget is allocated first.
Continued
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Lecture Illustration
* Sequential Method ** Refer to handout
Continued
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Sequential method
* Suppose there are two support depts., Power & Maintenance, and two producing depts., Grinding & Assembly, each with a "bucket" of directly traceable overhead cost.
* Objective: Distribute all Power and Maintenance costs to Grinding and Assembly using the Sequential Method. (Hansen & Mowen, 1997)
Continued
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Sequential Method
* Step1: Rank support depts - #1 Power, #2 Maintenance.
* Step 2: Distribute Power to Maintenance, Grinding, and Assembly
* Then, distribute Maintenance to Grinding and Assembly
(Hansen & Mowen, 1997)
Continued
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Step-down method
* After allocation - Zero cost in Power and Maintenance, all overhead cost in Grinding and Assembly.
(Hansen & Mowen, 1997) Continued
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Sequential Method
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Sequential Method
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The reciprocal method
* This method allocates the support department costs by fully recognising the provision of services between the support depts. * It provides a more complete picture of support dept. cost allocation than the directmethod and step-down method.
Continued
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Sequence of cost allocation
* Steps: ** (1) Specify a set of equations that express the relationship between the support departments. ** (2) Solve the simulataneous equations. ** (3) Allocate the total cost of operating each support dept. to various depts., that use its services.
Continued
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Lecture illustration
* Reciprocal Method ** Refer to handout
Continued
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Reciprocal Method
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Reciprocal Method
* Simultaneous Equations
P = Direct costs + Share of Maintenance's costs = $250,000 + 0.10M………………………. (1)
M = Direct costs + Share of Power's costs = $160,000 + 0.20P ………………………..(2)
Continued
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Reciprocal Method
Solving Simulataneous Equations
M = $160,000 + 0.2 ($250,000 + 0.1M) M = $160,000 + $50,000 +0.02M 0.98M = $210,000 M = $214,286 Substituting value of M into equation (1) to find P P = $250,000 + 0.10 ($214,286) = $250,000 + 21,429 = $271,429 Continued
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Reciprocal Method
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Comparison
Direct Sequential Reciprocal Grind. Assmb. Grind. Assmb. Grind. Assmb. DC: $100,000 $ 60,000 $100,000 $ 60,000 $100,000 $ 60,000 Allo.frm Power: 187,500 62,500 150,000 50,000 162,857 54,286 Allo.frm Maint. 80,000 80,000 105,000 105,000 96,429 96,429 Total $367,500 $202,500 $355,000 $215,000 $359,286 $210,715
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Choice of method.
* The choice is simply one of costs versus benefits. * Choice of allocationbase is also a cost versus benefits decisions.
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Other issues
* Allocating support dept. costs in a service organisation. * Costallocationin modern manufacturing environments
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Summary
* Allocating support department costs helps departmental managers to plan and control the use of support dept. services. * The three methods of support dept. cost allocation are: directmethod, step-down method, & reciprocal method. * The choice of methoddepends on a cost versus benefit basis
how does the direct method of cost allocation work
One can use 4 methods of Cost Allocation in Healthcare Finance:1. Direct Method2. Step-Down Method3. Double Apportionment Method4. Reciprocal Method
Predetermined overhead rate = Est. total Manuf. Overhead Cost / Est. total amt of allocation base In this case, allocation base would be direct labor (as opposed to machine labor). Hope this helps
Direct cost is cost of product while direct costing is the process which study or accounts the direct cost allocation to products.
Predetermined overhead rate based on direct labor cost = Budgeted overhead cost / direct labor cost / 100 Predetermined overhead rate based on direct labor cost = budgeted overhead cost / direct labor hours.
Direct cost is that cost which is directly identifiable with production volume while direct costing is the method or process through which direct cost is allocated to production.
There are three methods of service department allocation are in general use . 1- Direct method Ther direct method is the simplest the direct method allocates service department costs directly to the producing departments without regard for services rendered by service departments to each other. service department costs are allocated to production departments based on an allocation base appropriate to each esrvice department's function. 2- The step or step-down method Allocates some of costs of services rendered by service dapartments of each other. The step method derives its name from the procedure involved : the service departments are allocated in order, from the one that provides the most service to other service department down to the one that provides the least . 3- the reciprocal method Is the most complex and the most theoretically sound of the three methods. it is also known as the simultaneous solution method, cross allocation method, matrix allocation method,or double distribution method. The reciprocal method recognizes services rendered by all service departments to each other. BY AMIR KAMAL MASSOUD
A costing system that traces direct costs to a cost object by using the actual direct-cost rates times the actual quantities of the direct-cost inputs and that allocates indirect costs based on the budgeted indirect-cost rates times the actual quantities of the cost-allocation bases.
allocation rate=cost pool amount/ cost driver volume
no
Because in ABC costing overheads are allocated based on activities performed by departments rather based on any rate or formula that's why as much activity any department perform as much cost will be allocated which is more accurate way of allocation.
Apportion means to assign cost based on a predetermined formula. For example, we would apportion a cost pool if the assignment of the cost was based on fixed amounts (e.g.,10 percent to cost objective one and ninety percent to cost objective two) or a three factor formula (e.g., a weighted average of sales, payroll, and asset value). In both cases the assignment of the cost is based on some predetermined method. Allocation means to assign cost on a rate or factor bases that attempts to assign cost using an allocation base that best measures a causal or beneficial relationship between the cost pool and the final cost objective.(e.g., direct labor hours, machine hours, etc.),