ACCT 312 CH7

Common costs

• Mutually beneficial costs

• Occur when the same resource is used in the output of two or more services or products

• May pertain to periods of time, individual responsibilities, sales territories, and classes of customers

Allocation

• Means of dividing a pool of costs and assigning those costs to various subunits

• Does not affect the total cost (Chosen procedure can affect the amount of cost assigned to the subunits)

• Cost objects are departments (Determining cost objects - First step in cost allocation)

Producing departments

Directly responsible for creating the products or services sold to customers

Support departments

Provide essential services for producing departments

Causal Factors

• Variables or activities within a producing department that provoke the incurrence of support costs

• Should be identified while choosing a basis for allocating support department costs

Objectives of Allocation

• Obtain a mutually agreeable price

• Compute a product line profitability

• Predict the economic effects of planning and control

• Value inventory

• Motivate managers

Charging rate

• Used to allocate costs of a support department to other departments

Factors in determining:

• Choice of a single or dual charging rate

• Use of budgeted or actual support department costs

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Single charging rate

• Conceptually similar to a plantwide overhead rate

• All support department costs are accumulated in the numerator and some measure of usage is in the denominator

Single charging rate equation

Single rate = (Fixed costs + estimated variable costs) / Estimated usage

Multiple charging rates

Dual rate with a fixed component and a variable component

Procedure for allocation of fixed costs

• Determination of budgeted fixed support service costs

• Computation of the allocation ratio

Allocation ratio

Production department capacity / Total capacity

Allocation

Allocation ratio x budgeted fixed support service costs

Fixed base

Result of using normal or practical capacity to allocate fixed support service costs

Direct method of allocation

• All costs of the support departments are allocated directly to producing departments

• Allocations are done in proportion to each producing department’s usage of the service

• Support department reciprocity or interaction is not recognized

Department reciprocity

Usage of one support department by another

Sequential method allocation

• Recognizes that interactions among the support departments do occur

• Takes only partial account of this interaction

• Cost allocations are performed in a step-down fashion, following a predetermined ranking procedure

Reciprocal method

• Recognizes all interactions of support departments

• Usage of one support department by another is used to determine the total cost of each support department

• Total cost reflects interactions among the support departments

• New total of support department costs is allocated to the producing departments

Steps in Reciprocal Method

1. Compute the allocation ratios for all support and producing departments

2. Form a simultaneous equations system with one equation for each support department'

3. Solve the simultaneous equations system for each unknown to obtain the total reciprocated cost of each support department

4. Allocate the total reciprocated costs of the support departments to other support departments and to the producing departments

Total cost of support departments

Reflects interactions with other support departments when a system of simultaneous linear equations is solved

Cost equation of supp departments

Sum of the departments direct costs plus proportion of service received from other support departments

Total cost = Direct Costs + Allocated costs

Departmental overhead rates

(Allocated service costs + producing department overhead costs) / Measure of activity (DLH, MH…)

Joint products

• Two or more products produced simultaneously by the same process up to a split-off point

• Have relatively significant sales value

Split-off point

• Point at which the joint products become separate and identifiable4

• Some joint products may require processing beyond the split off point

Separate costs

Costs that are easily traced to individual products and offer no particular problem

Nonseparable costs

Allocated to various products for various reasons

Physical units method

• Joint costs distributed on the basis of some physical measure

• Reflects interactions with other support departments when a system of simultaneous linear equations is solved

• Presumes that each unit of material in the final product costs just as much to produce any other

• Ignores the fact that not all costs are directly related to physical quantities

Weighted average method

• Weight factors are used in allocations

• Include amount of material used, difficulty to manufacture, time consumed, difference in type of labor used, and size of unit

• Predetermined and set up as part of either an estimated cost or a standard cost system

Allocation based on relative market value

• Advantageous as joint cost allocation will not produce consistently profitable or unprofitable items

Better than the physical units approach if:

• Physical mix of output can be altered by incurring more (less) total joint costs

• Alteration produces more (less) total market value

Sales value at splitt off method

• Allocates joint cost based on each product’s proportionate share of market value or sales value at the split-off point

• Share of joint cost charged against the product is greater when the market value is high

• Can be approximated through the use of weighting factors based on price

• Price-based weights do not change as market prices do

Net realizeable value method

• Used if there is no ready market price for the individual products at the split-off point

• Hypothetical sales value is obtained for each joint product

• Joint costs based on each product’s share of hypothetical sales value is prorated

• Useful when one or more products cannot be sold at the split-off point but must be processed further

Hypothetical sales value

Subtracting all separable processing costs from the eventual market value

Constant gross margin percentage method

• Recognizes that costs incurred after the split-off point are part of the cost total on which profit is expected to be earned

• Allocates joint cost such that the gross margin percentage is the same for each product

By-Product

• Secondary product recovered in the course of manufacturing a primary product

• Obtained from joint production processes that have relatively little sales value

• Can be characterized by its relationship to the main product (scrap, joint product, results froms scrap / trimmings)