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* 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
What else can I help you with?
Allocating costs using direct and step-down methods?
how does the direct method of cost allocation work
Cost Allocation Method in health care?
One can use 4 methods of Cost Allocation in Healthcare Finance:1. Direct Method2. Step-Down Method3. Double Apportionment Method4. Reciprocal Method
How do I compute predetermined overhead rate as a percentage of direct labor costs?
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
What are the advantages and disadvantages of using the direct method of cost allocation?
The direct method of cost allocation offers the advantage of simplicity and ease of implementation, as it directly assigns costs to cost objects based on actual usage or consumption. This method enhances transparency and can provide clearer insights for decision-making. However, its disadvantages include potential inaccuracies, as it may overlook interdepartmental service costs and fail to account for the indirect benefits received by various departments. Additionally, it may not reflect the true cost drivers, leading to suboptimal pricing and resource allocation decisions.
What is difference between Direct Cost and Direct Costing?
Direct cost is cost of product while direct costing is the process which study or accounts the direct cost allocation to products.
How do you compute predetermined overhead rate as a percentage of direct labor costs and direct labor hours?
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.
Difference between direct cost and direct costing?
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.
What are the three reliability allocation methods?
The three primary reliability allocation methods are the equal allocation method, the proportional allocation method, and the optimization method. The equal allocation method distributes reliability requirements equally among all components, while the proportional allocation method distributes reliability based on each component's importance or contribution to overall system performance. The optimization method utilizes mathematical techniques to assign reliability targets that minimize cost or maximize performance while meeting overall system reliability goals. Each method is chosen based on the specific requirements and constraints of the system being designed.
What are the difference methods of allocating the overheads of service cost centre?
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
Normal costing system?
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.
Why direct labor cost method?
this question doesnt make no sense
What methods used to allocate support costs?
Support costs can be allocated using various methods, including direct allocation, where costs are assigned based on actual usage or benefit received by each department. Another common method is the step-down allocation, which prioritizes the allocation of costs from support departments to production departments in a sequential manner. The reciprocal method is more complex, allowing for mutual support between departments by considering interdepartmental services. Lastly, the activity-based costing (ABC) method allocates costs based on the specific activities that generate costs, providing a more precise approach to cost allocation.
