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Chapter 15
Allocation of Support-Department
Costs, Common Costs, and Revenues
A support department, also called a service department, provides the services that
assist other internal departments (operating departments and other support
departments) in the company. Examples of support departments are information
systems and plant maintenance. Managers face two questions when allocating the
costs of a support department to operating departments or divisions: (1) should fixed
costs of support departments be allocated to operating divisions? (2) If fixed costs are
allocated, should variable and fixed costs be allocated in the same way? With regard
to the first question, most companies believe that fixed costs of support departments
should be allocated because the support department needs to incur fixed costs to
provide operating divisions with the services they require. Depending on the answer
to the second question, there are two approaches to allocating support-department
costs: the single-rate cost-allocation method and the dual-rate cost-allocation method.
LO 1: Differentiate the single-rate from the dual-rate costallocation method
The single-rate cost allocation method pools together all costs in a cost
pool.
The dual-rate cost allocation method classifies costs in each cost pool into
Two cost pools – a variable-cost pool and a fixed-cost pool.
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Chapter 15
EX 15-16 Single-rate versus dual-rate methods, support department. The Chicago power
plant that services all manufacturing departments of MidWest Engineering has a budget for
the coming year. This budget has been expressed in the following monthly terms:
Manufacturing
Needed at Practical Capacity
Average Expected Monthly
Department
Production Level (Kilowatt-Hours)
Usage (Kilowatt-Hours)
Rockford
10,000
8,000
Peoria
20,000
9,000
Hammond
12,000
7,000
Kankakee
8,000
6,000
Total
50,000
30,000
* The expected monthly costs for operating the power plant during the budget year are
$15,000: $6,000 variable and $9,000 fixed. Required
1. Assume that a single cost pool is used for the power plant costs. What budgeted
amounts will be allocated to each manufacturing department if (a) the rate is
calculated based on practical capacity and costs are allocated based on practical
capacity, and (b) the rate is calculated based on expected monthly usage and costs are
allocated based on expected monthly usage?
2. Assume the dual-rate method is used with separate cost pools for the variable and
fixed costs. Variable costs are allocated on the basis of expected monthly usage. Fixed
costs are allocated on the basis of practical capacity. What budgeted amounts will be
allocated to each manufacturing department? Why might you prefer the dual-rate
method?
Answer:
1a .
* Practical capacity :
Rockford 10,000 Peoria 20,000 Hammon 12,000 Kankakee 8,000 (Total 50,000)
*Expected monthly usage :
Rockford 8,000 Peoria 9,000
Hammon 7,000
Kankakee 6,000 (Total 30,000)
Single-rate method based on practical capacity:
Total costs in pool : 6,000 + 9,000 = $ 15,000
Total Practical capacity : 50,000 Kilowatt hours
Allocation rate : $15,000 / 50,000 = $ 0.30 per hour of capacity
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Chapter 15
1b .
*Practical capacity :
Rockford 10,000 Peoria 20,000 Hammon 12,000 Kankakee
8,000 (Total 50,000)
Rockford : 0.30 * 10,000 = 3,000
* Costs allocation at $0.30 per hour :
Rockford 3,000 Peoria 6,000 Hammon 3,600 Kankakee 2,400 (Total 15,000)
Single-rate method based on expected monthly usage :
*Total costs in pool : 6,000 + 9,000 = $ 15,000
*Total expected monthly usage : 30,000 Kilowatt hours
*Allocation rate : 15,000 / 30,000 = $ 0.50 per hour of expected usage
2.
*Expected monthly usage :
Rockford 8,000 Peoria 9,000 Hammon 7,000 Kankakee 6,000
(Total 30,000)
Rockford 0.50 * 8,000=4,000
* Costs allocation at $0.50 per hour :
Rockford 4,000 Peoria 4,500 Hammon 3,500 Kankakee 3,000 (Total 15,000)
*Variable cost Pool :
* Total cost in pool : 6,000
* Expected usage : 30,000 Kilowatt hours
*Allocation rate : 6,000 / 30,000 = 0.20 per hour of expected usage
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Chapter 15
*Fixed cost pool :
* Total cost in pool : 9,000
*Total Practical capacity : 50,000 Kilowatt hours
* Allocation rate : $9000 / 50,000 = 0.18 per hour of capacity
* Variable cost pool : ($0.20 * 8,000 , 9,000 , 7000 , 6000 )
Rockford 1,600 Peoria 1,800 Hammon 1,400 Kankakee 1,200 (Total 6,000)
* Fixed cost pool : ($0.18 * 10,000 , 20,000 , 12,000 , 8,000 )
Rockford 1,800
Peoria 3,600 Hammon 2,160
Kankakee 1,440 (Total 9,000)
Total : Rockford 3,400 Peoria 5,400 Hammon 3,560 Kankakee 2,640 (Total 15,000)
* The dual-rate method permits a more refined allocation of the power
department costs. It permits the use of different allocation bases for different cost
pools. The Fixed cost result from decisions most likely associated with the scale of
the facility ,or the practical capacity level . The variable costs result from decision
most likely associated with monthly usage .
LO 2: How the uncertainty user managers face is affected by
the choice between and actual cost-allocation rates?
* Budgeted
Budgeted rates let the user department know in advance the cost rates they will be
charged. During the budget period, the supplier department, not the user
departments, bears the risk of any unfavorable cost variances because the user
departments do not pay for any costs that exceed the budgeted rates.
When actual rates are used for cost allocation, managers do not know the rates to
be used until the end of the budget period.
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‫مشاعل الدايل‬.‫أ‬
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Chapter 15
LO 3: Allocate support department costs using the direct, stepdown, and reciprocal methods.
Direct method:
Allocates support department costs to operating departments only.
Step-down (sequential allocation) method:
Allocates support department costs to other support departments and
to operating departments.
Note : Must begin allocating the support department that provide the
highest proportion of services to the other support department.
Reciprocal allocation method:
Allocates costs by services provided among all support departments.
EX 1 :
*The Canton Division of Smith Corporation has :
Two operating departments : (Assembly and Finishing)
And two support departments : (Maintenance and Human
Resources)
KNOWING BELOW:
Total square feet = 255,000 , Total number of employees = 95
Maintenance is allocated using square feet.
Human Resources is allocated using number of employees.
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‫مشاعل الدايل‬.‫أ‬
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Chapter 15
1/ Direct Method :
Maintenance
Budgeted costs
Before allocations:
Square feet:
Number of employees:
Budgeted costs
Before allocations:
Square feet:
Number of employees:
$300,000
5,000
8
Human Resources
$2,160,000
30,000
15
Assembly
Finishing
$1,700,000
110,000
48
$900,000
110,000
24
Maintenance TO Assembly: $300,000 * (110,000/220,000) = 150,000
Maintenance TO Finishing : $300,000 * (110,000/220,000) = 150,000
* 110,000 + 110,000 = 220,000
Human Resources TO Assembly : 2,160,000*(48/72) = 1,440,000
Human Resources TO Finishing : 2,160,000*(24/72) = 900,000
* 48+24= 72
Original costs
Maintenance Allocated:
Human Resources Allocated
Total
‫سهام المهيزع‬.‫أ‬
Assembly
$1,700,000
150,000
1,440,000
$3,290,000
‫مشاعل الدايل‬.‫أ‬
Finishing
$ 900,000
150,000
720,000
$1,770,000
‫مها الحميدي‬.‫أ‬
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Chapter 15
2/ Step-Down Method:
* Maintenance provides 12% of its services to Human Resources.
*Human Resources provides 10% of its services to Maintenance.
Must begin allocating the support department that provide the highest
proportion of services to the other support department.
Maintenance to Human Resources :
30,000 / 250,000 * 300,000 = 36,000
* 30,000+110,000+110,000 = 250,000
Maintenance to Assembly :
110,000 / 250,000 * 300,000 = 132,000
Maintenance to Finishing :
110,000 / 250,000 * 300,000 = 132,000
Costs before
allocation
$ 300,000
$2,160,000
$1,700,000
$ 900,000
Maintenance:
Human Resources:
Assembly:
Finishing:
Allocated
costs
($300,000)
$ 36,000
$132,000
$132,000
*Human Resources costs to be allocated become
$2,160,000 + $36,000 = $2,196,000.
Human Resources to Assembly: 48 ÷ 72 × $2,196,000 = $1,464,000
Human Resources to Finishing: 24 ÷ 72 × $2,196,000 = $732,000
Total cost after allocation:
Assembly Department: $1,700,000 + $132,000 + $1,464,000 = $3,296,000
Finishing Department:
‫سهام المهيزع‬.‫أ‬
$900,000 + $132,000 + $732,000 = $1,764,000
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Chapter 15
3/ Reciprocal Method:
Maintenance
Human Resources
M
–
10%
HR
12%
–
A
44%
60%
F
44%
30%
*Maintenance cost = $300,000 + .10P
*Human Resource cost = $2,160,000 + .12M
M= 300,000 + 10%(2,160,000+12%)
10% * 2,160,000 = 216,000
M= 300,000 + 216,000 + 0.012 M
10% * 12% = 0.012
1M – 0.012M = 516000
(0.988 M / 0.988) = (516,000 / 0.988)
M = 522,267
HR = 2,160,000 + 12% (522,267) = 2,222,672
M
Before
allocation:
Allocation:
Allocation:
$300,000
(522,267)
222,267
HR
A
F
$2,160,000 $1,700,000
62,672
229,797
($2,222,672) 1,333,603
Total
$ 900,000
229,797
666,802
$3,263,400 $1,796,599
Total cost Assembly Department: $3,263,400
Total cost Finishing Department: $1,796,599
2,222,672 * 60% = 1,333,603
2,222,672 * 30% = 666,802
Comparison of Methods :
Direct labor cost:
Machine-hours:
‫سهام المهيزع‬.‫أ‬
Assembly
$698,880
24,000
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Finishing
$349,440
23,500
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Chapter 15
Q : What are the various overhead rates using the three methods?
1/ Overhead Rates Direct Method :
Assembly:
$3,290,000 ÷ $698,880 direct labor costs = 471% of direct labor costs
Finishing:
$1,770,000 ÷ 23,500 = $75.32 per machine-hour
2/ Overhead Rates Step-Down Method :
Assembly:
$3,296,000 ÷ $698,880 direct labor costs = 472% of direct labor cost
Finishing:
1,770,000 ÷ 23,500 = $75.32 per machine-hour
3/ Overhead Rates Reciprocal :
Assembly:
$3,263,400 ÷ $698,880 direct labor costs = 467% of direct labor cost
Finishing:
$1,796,599 ÷ 23,500 = $76.45 per machine-hour
* Comparison of Rates
Finishing
Assembly
* Direct method:
$75.32
471%
* Step-down method:
$75.06
472%
* Reciprocal method:
$76.45
467%
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‫مشاعل الدايل‬.‫أ‬
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Chapter 15
LO 4: Allocate common costs using either the stand-alone or
incremental method.
A common cost is a cost of operating a facility, activity, or like cost object that is
shared by two or more users. Common costs exist because each user obtains a lower
cost by sharing than the separate cost that would result if such a user were an
independent entity. The goal is to allocate common costs to each user in a reasonable
way .
* Two methods for allocating common cost are:
1. Stand-alone cost allocation method
The stand-alone cost-allocation method determines the weights for cost allocation by
considering each user of the cost as a separate entity.
Example: A consultant in Tampa is planning to go to Chicago and meet with an
international client. The round-trip Tampa/Chicago/Tampa airfare costs $540. The
consultant is also planning to attend a business meeting with a North Carolina client
in Durham. The round-trip Tampa/Durham/Tampa airfare costs $360. The consultant
decides to combine the two trips into a Tampa/Durham/Chicago/Tampa itinerary
that will cost $760. How much should the consultant charge to the North Carolina
client?
$360 ÷ ($360 + $540) = .40
.40 × $760 = $304
How much to the international client?
$760 – $304 = $456
* Advocates of this method often emphasize the fairness or equity criterion. The
method is viewed as reasonable because each client bears a proportionate share
of total costs in relation to the individual stand-alone costs.
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Chapter 15
2. Incremental cost allocation method
The incremental cost-allocation method ranks the individual users of a cost object in
the order of users most responsible for the common cost and then uses this ranking to
allocate cost among those users. The first-ranked user of the cost object is the primary
user (also called the primary party) and is allocated costs up to the costs of the
primary user as a standalone user. The second-ranked user is the first-incremental user
(first-incremental party) and is allocated the additional cost that arises from two users
instead of only the primary user. The third-ranked user is the second-incremental user
(second-incremental party) and is allocated the additional cost that arises from three
users instead of two users, and so on.
Example: (continued the example of Stand-Alone method)
Assume that the business meeting in Chicago is viewed as the primary party.
What would be the cost allocation?
International client (primary)
$540
= (the costs as a stand-alone)
Durham client (incremental) $760 – $540 = $220
LO 5: Explain the importance of explicit agreement between
contracting parties when reimbursement is based on costs incurred.
Contract disputes often arise with respect to cost allocation. Disputes can be reduced
by making the cost-allocation rules as explicit as possible and in writing at the time
the contract is signed. These rules should include details such as the allowable cost
items, the acceptable cost-allocation bases, and how differences between budgeted
and actual costs are to be accounted for.
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‫مشاعل الدايل‬.‫أ‬
‫مها الحميدي‬.‫أ‬
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Chapter 15
LO 6: Understand how bundling of products gives rise to
revenue-allocation issues.
Allocation issues can also arise when revenues from multiple products (for example,
different software programs or cable and internet packages) are bundled together and
sold at a single price. The methods for revenue allocation parallel those described for
common-cost allocations.
A bundled product is a package of two or more products (or services) sold for a
single price. Bundled product sales are also referred to as “suite sales”.
Examples of business that provide bundled products are: Banks, Hotels and Tours.
The individual components of the bundle also may be sold as separate items at their
own “stand-alone” prices.
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‫مشاعل الدايل‬.‫أ‬
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Chapter 15
LO 7: Allocate the revenues of a bundled package to the
individual products in that package.
There are two main revenue allocation methods (as in the common-cost
allocation):
A. The Stand-Alone method
The stand-alone revenue-allocation method uses product-specific information on the
products in the bundle as weights for allocating the bundled revenues to the individual
products. The term stand-alone refers to the product as a separate (nonsuite) item.
There are four types of weights for the stand-alone revenue allocation method:
1. Selling prices
This method uses the selling prices of the individual products to determine the
weights for the revenue allocations.
2. Unit costs
This method uses the costs of the individual products to determine the weights for the
revenue allocations.
3. Physical units
This method gives each product unit in the suite the same weight when allocating suite
revenue to individual products.
4. Stand-alone product revenues
This method captures the quantity of each product sold as well as their selling prices.
Which method is preferred? The selling prices and stand-alone revenues methods
are best, because the weights explicitly consider the prices customers are willing to
pay for the individual products. Weighting approaches that use revenue information
better capture “benefits received” by customers than unit costs or physical units. The
physical-units revenue-allocation method is used when any of the other methods
cannot be used (such as when selling prices are unstable or unit costs are difficult to
calculate for individual products).
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Chapter 15
Example: English Languages Institute buys English language software programs
locally and then sells them in Mexico and Central America. English sells the
following programs: Grammar, Translation, and Composition These programs are
offered stand-alone or in a bundle. If you are given that:
Stand-alone
Price
Grammar
$255
Translation
$ 85
Composition
$185
Purchasing these software programs costs English the following:
Grammar
$180
Translation
$ 45
Composition
$ 95
Bundle (Suites)
Price
Grammar + Translation
$290
Grammar + Composition
$350
Grammar + Translation + Composition
$410
Consider the Grammar and Translation suite, which sells for $290 per day.
How much weight should English Languages Institute assign to each item?
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Chapter 15
Answer:
1- using Selling prices:
The individual selling prices are $255 for Grammar and $85 for Translation.
Grammar: $255 ÷ $340 = 0.75 , $290 × 0.75 = $217.50
Translation: $85 ÷ $340 = 0.25 , $290 × 0.25 = $72.50
2- using Unit costs:
Grammar: $180 ÷ $225 = 0.80 , $290 × 0.80 = $232
Translation: $45 ÷ $225 = 0.20 , $290 × 0.20 = $58
3- using Physical units:
With two products in the suite, each product is allocated 50% of suite revenues.
1 ÷ (1 + 1) = 0.50
$290 × 0.50 = $145
4- using Stand-alone product revenues:
Assume that the stand-alone revenues in 2003 are Grammar $734,400,
Translation $81,600,and Composition $133,200. What are the weights for the
Grammar and Translation suite?
Grammar: $734,400 ÷ $816,000 = 0.90, $290 × 0.90 = $261
Translation: $81,600 ÷ $816,000 = 0.10, $290 × 0.10 = $29
Revenue Allocation Weights using the four methods:
Grammar
Translation
Selling prices
$217.50
$ 72.50
Unit costs
232.00
58.00
Physical units
145.00
145.00
Stand-alone product revenues
261.00
29.00
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‫مشاعل الدايل‬.‫أ‬
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Chapter 15
B. Incremental Revenue Allocation Method
The incremental revenue-allocation method ranks individual products in a bundle
according to criteria determined by management—such as the product in the bundle
with the most sales—and then uses this ranking to allocate bundled revenues to
individual products. The first-ranked product is the primary product in the bundle.
The second ranked product is the first-incremental product, the third-ranked product is
the second-incremental product, and so on.

If the suite selling price exceeds the stand-alone price of the primary product,
the primary product is allocated 100% of its stand-alone revenue. In other
words, If the suite price is less than or equal to the stand-alone price of the
primary product, the primary product is allocated 100% of the suite revenue.
All other products in the suite receive no allocation of revenue.
Example: (continued the example of Stand-Alone method)
Assume that Grammar is designated as the primary product. And Grammar and
Translation suite selling price $290 per day.
Answer:
Revenues Allocated to Grammar: $255 = (the selling price as a stand-alone)
Remaining to be allocated: ($290 – $255) = $35
Allocated to Translation: $35
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‫مها الحميدي‬.‫أ‬