Why allocate costs to departments

1
Overview

• Why allocate costs to departments?
• Three methods of allocation.
• Cost allocation issues.

2
Allocating Costs to Products

• Product mix decisions
• e.g. valves or flow controllers
• Pricing decisions
• Reimbursement requests
• e.g. government contracts
• Inventory valuation
• reporting, insurance
• Identification of inefficiencies or non-value
  added costs.

3
Allocating Costs to Operating Units

• Evaluate performance of operating unit or unit
  manager.
• identify full cost of operations
• including use of shared resources
• Provide information for decision-making.
• closing stores
• marketing strategy

Information Systems
Machining
4
Allocating Costs to Operating Units

• Motivate managers.
• discourage waste
• encourage new approaches for increasing revenue
  or decreasing costs
• Identify inefficiencies.
• excessive corporate overhead
• inefficient information systems department

Information Systems
Machining
5
Service Departments
Operating Departments
6
Support Department Allocation Base Information
systems Processing hours Payroll No. of employees
Info Payroll Stamping Assmbly Budget
overhead 9,500 5,600 38,500 27,900 Processing
hrs. 20 5 8 12 No. of employees 2 1 15 20
7

• Support costs are allocated to operating
  departments only.
• In determining allocation rates ignore the usage
  of the support departments.

8
9,500
81,500
38,500
5,600
27,900
(9,500)
(5,600)
Proc. hrs. 20 5 8 12 employ 2 1 15 20
9

• Find the support department with the most service
  to the other support departments.

9,500 5/25 1,900
5,600 2/37 303
OR

• Allocate to both operating and support
  departments (based on usage of each.)

• One step at a time never look back.

10
9,500
81,500
38,500
5,600
27,900
(9,500)
Proc. hrs. 20 5 8 12 employ 2 1 15 20
11

• Find the total (reciprocated) cost of each
  service department using a system of equations.
• Define variables for the total cost of each
  service department

I total cost of info systems P total cost of
payroll
12

• Set-up a system of equations

I 9,500 ( 2/37 ) P P 5,600 (
5/25 ) I
13

• Solve the system of equations

I 9,500 ( 2/37 ) P P 5,600 (
5/25 ) I

• Allocate reciprocated costs to all operating and
  service departments.

14
9,500
81,500
38,500
5,600
27,900
(9,910)
(7,582)
Proc. hrs. 20 5 8 12 employ 2 1 15 20
15
Cost Allocation Bases

• Cause and effect

Processing hours
Info. Systems Costs

• Benefits received
• payroll dept costs number of employees
• corporate advertising sales

• Fairness

• Ability to bear

16
Actual or Projected Usage?
Actual or Budgeted Costs?