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1. What are support departments, and why are their costs allocated to other departments?
2. What process is used to allocate support department costs?
3. How is the direct method used to allocate support costs to operating
used
7. What are the limitations of support cost allocation, and how can the quality of information be improvedHow do support cost allocations affect decisions and managerial
Foundation: Repeat or paraphrase information; Reason to single correct solution; Perform computations; etc.
S: Questions from the study guide
W: Questions from web quizzes on the student web site
*Based on level in Steps for Better Thinking (Exhibit 1.10, textbook p. 16):
Note: Step 1, 2, 3, and 4 questions in this test bank are intentionally open-ended and subjective, giving students the opportunity to demonstrate skills such as judgment, reasoning, identification of uncertainties, identification or analysis of pros and cons, and so on. Therefore, student answers may not exactly match those shown in the solutions.
1. A support department provides internal services for both operating and other support departments.
2. Typical support departments include accounting and human resources.
3. Support department costs are generally allocated to inventory when preparing financial statements under generally accepted accounting principles.
4. Managers often allocate support department costs as a means of motivating employees.
5. Allocating support department costs has some similarities to activity-based costing, for example costs are traced and allocated to cost pools.
6. Managers need to clarify their reasons for allocating support department costs before establishing cost pools.
7. Support department costs are always allocated to individual units of products or services.
8. The direct method allocates the cost of support departments only to operating departments.
9. The direct method acknowledges services provided by one support department to another support department.
10. The direct method uses each operating department’s allocation rate to allocate costs to a support department.
11. The step-down method allocates one support department’s cost at a time.
12. The step-down method allocates support department costs in a cascading manner.
13. The step-down method does not recognize services provided between support departments.
14. The reciprocal method reflects only part of the interactions between support departments.
15. The calculations for the reciprocal method are more complex than for other support department cost allocation methods.
16. Single-rate allocation methods use only one cost pool and one base to allocate both fixed and variable costs.
17. Single-rate allocations are unlikely to reflect actual resource usage.
18. Under dual-rate allocation, costs are separated into support and operating pools before being allocated.
19. When managers use dual-rate allocation, they frequently identify cost drivers for fixed cost pools to identify resource flows more accurately.
20. A properly designed accounting system insures that costs are assigned with complete accuracy to support and operating department cost pools.
21. “Perceived fairness” is sometimes used as a criterion for allocating support department costs to operating departments.
22. Allocations using the direct method are always high quality because no judgments are made.
23. Allocation of support department costs can encourage efficient use of the support department resources.
Use the following information for the next 2 questions.
Cervantes Industries provides an in-house cafeteria for production and administrative employees. This service costs $25,000 per month, plus $3 per meal served. The company has 800 production employees and 400 administrative employees. During the past month 5,500 meals were served to production employees and 2,000 to administrative.
1. The amount of cost allocated to the administrative department using actual meals served as the basis is
a. $16,675
b. $12,667
c. $14,325
d. $18,500
2. The amount allocated to the operating department using a dual-rate basis with the fixed cost allocation based on number of employees is
a. $33,167
b. $31,683
c. $24,833
d. $41,500
The personnel department provides service to operating departments A and B. Personnel’s budget is based on 250 employees (100 in department A and 150 in department B). The budget calls for $40,000 in fixed costs, plus $140 per employee. During a recent month the personnel department incurred $41,000 in fixed costs and $42,200 in variable costs. The two operating departments, A and B, had 120 and 140 employees, respectively.
3. How much would be charged to department A if actual costs were allocated based on number of employees?
a. $36,000
b. $38,400
c. $30,000
d. $34,615
4. How much would be charged to department B if budgeted costs were allocated based on number of employees?
a. $45,000
b. $44,800
c. $43,600
d. $40,385
5. The CEO of the company described above wants to gather information for a decision to outsource the HR function. Which of the following allocation methods would provide useful information?
a. A job costing system
b. A dual rate support department allocation system
c. A single rate support department allocation system
b. A process costing system
6. Which of the following is a disadvantage for using budgeted costs instead of actual costs for support department cost allocation?
a. Managers know their exact costs in advance and have no incentive to minimize use of services
b. Budgeted costs do not reflect current usage, and so managers may overuse support services
c. Allocated support department costs are not under the manager’s control
d. Support departments might be cut back because services are likely to be underused
Use the following information for the next 5 questions
Chambers, Inc. has two support departments (utilities and computer) and two operating departments (A and B). The following data are given:
7. If the direct method were used, how much computer cost would be allocated to the utilities department?
a. $0
b. $18,750
c. $11,250
d. $ 8,250
8. If the direct method were used, how much computer cost would be allocated to operating department B?
a. $11,250
b. $25,667
c. $26,471
d. $41,250
9. If the direct method were used, how much total cost would be allocated to operating department A?
a. $60,500
b. $55,804
c. $58,500
d. $74,196
10. If the step-down method was used and utilities allocated first, how much computer cost would be allocated to the utilities department?
a. $0
b. $18,200
c. $13,750
d. $8,250
11. If the step-down method was used and utilities are allocated first, how much total cost would be allocated to operating department B?
a. $76,676
b. $44,500
c. $53,324
d. $74,196
Use the following information for the next 6 questions
The accountant for Milton, Inc. is preparing the budgets for operating department support service costs. Maintenance costs are allocated based on square feet, and cafeteria costs are allocated based on number of employees. The following data have been collected:
12. If the direct method is used, maintenance costs allocated to the cutting department will be
a. $15,909
b. $23,333.33
c. $20,520
d. $43,750
13. If the direct method is used, the total cost (including allocations) for the packaging department will be
a. $26,667
b. $355,250
c. $54,792
d. $354,792
14. If the direct method is used, maintenance costs allocated to the cafeteria will be
a. $28,571.43
b. $15,909
c. $10,000
d. $0
15. If the step-down method is used and maintenance is allocated first, cafeteria costs allocated to packaging will be
a. $34,704
b. $55,757
c. $28,125
d. $54,792
16. If the step-down method is used and maintenance is allocated first, the total cost allocated to the cutting department will be
a. $55,757
b. $39,243
c. $20,822
d. $40,208
17. If the reciprocal method is used, the total amount that will be allocated for maintenance is
a. $52,022
b. $55,952
c. $50,211
d. $57,034
Use the following information for the next 3 questions
Pardee, Inc. allocates engineering costs on the basis of the supervisor’s time and administration costs on the basis of the number of employees. The company’s accountant determined that engineering provides more services to administration than administration provides to engineering. The following data have been collected:
18. If the direct method is used, the fraction of engineering costs allocated to the finishing department will be
a. 20/55
b. 20/100
c. 20/70
d. 20/85
19. If the step-down method is used and engineering costs are allocated first, the fraction of engineering costs allocated to the assembly department will be
a. 35/55
b. 35/100
c. 35/70
d. 35/85
20. If the reciprocal method is used, what is the amount of engineering cost that will be allocated to all of the other departments?
a. $21,456
b. $24,330
c. $26,432
d. $25,331
Use the following information for the next 4 questions. The managers of Conch, Inc. want to determine the most accurate allocation of support department costs to operating departments. To make this allocation, the accounting department has collected the following data:
21. If the reciprocal method is used, the equation representing the total cost of the computer department is
a. Computer costs = $55,000 + (0.15 × cafeteria cost)
b. Computer costs = $55,000 + (0.10 × cafeteria cost)
c. Computer costs = $55,000
d. Computer costs = $55,000 + 0.10 × ($55,000 + 0.10 × computer cost)
22. If the reciprocal method is used, the equation representing the total cost of the cafeteria is
a. Cafeteria = $35,000
b. Cafeteria = $35,000 + (0.15 × computer cost)
c. Cafeteria = $35,000 + (0.10 × computer cost)
d. Cafeteria = $35,000 + 0.10 × ($55,000 + 0.10 × computer costs)
23. If the reciprocal method is used, the total costs allocated to the operating departments will be
a. $61,168
b. $79,250
c. $41,117
d. $90,000
24. If the reciprocal method is used, the computer costs allocated to operating department 1 will be
a. $47,031
b. $27,500
c. $30,584
d. $22,000
Use the following information for the next 2 questions Cope, Inc. has the following costs and usage data for its support departments:
25. If the step-down method is used, and the order of allocation is department B first, then A, and finally C, the amount of support department A costs allocated to operating department 2 will be
a. $15,000
b. $23,250
c. $24,000
d. $18,600
26. If the step-down method is used, the total cost of support department C will be
a. $30,000
b. $37,750
c. $42,000
d. $49,750
Use the following information for the next 4 questions. Bronson, Inc. has two support departments, Personnel and Maintenance, whose costs are to be allocated to the operating department’s overhead for budgeting and inventory costing purposes. Projected amounts for the next year follow:
27. If the reciprocal method is used, the cost function representing the total cost of Personnel will be
a. $46,750 + (0.2 × maintenance cost)
b. $46,750 + (0.4 × maintenance cost)
c. $46,750 + (0.1 × maintenance cost)
d. $46,750 + (0.1 × maintenance cost) + (0.2 × personnel cost)
28. If the reciprocal method is used, the total cost of maintenance will be
a. $32,500
b. $22,500
c. $27,175
d. $31,850
29. If the reciprocal method is used, the cost of personnel allocated to maintenance will be
a. $0
b. $10,000
c. $9,350
d. $4,675
30. If the step-down method is used and the largest department (in terms of direct costs) is allocated first, the total cost allocated to assembly will be
a. $32,200
b. $39,933
c. $29,317
d. $24,500
Use the following information for the next 4 questions. Quinlan, Inc. has two support departments (maintenance and personnel) and two operating departments (tables and chairs). The maintenance department provides more services to the personnel department than the personnel department provides to maintenance. Once the support department costs have been allocated to the operating departments, each operating department allocates its total costs to units produced.
31. Assume the direct method is used. The proportion of personnel’s costs allocated to the table department is
a. 1/2
b. 4/7
c. 7/15
d. 1/3
32. Assume the direct method is used. The cost per unit in the chair department would be
a. $20.275 per chair
b. $23.509 per chair
c. $25.147 per chair
d. $25.900 per chair
33. Assume the step-down method is used. The amount of cost allocated from personnel to the table department is
a. $11,200
b. $12,503
c. $8,938
d. $12,600
34. Assume the step-down method is used. The amount of cost allocated from personnel to maintenance is
a. $1,500
b. $1,687.50
c. $9,000
d. $0
Use the following information for the next 4 questions. The accountants for Brock, Inc. are preparing the operating departments overhead budgets. The maintenance department direct costs are $12,000, and the administration department direct costs are $54,000. The following data have been collected about use of services:
35. Assume the reciprocal method. The equation to express the full cost of the maintenance department is
a. Maintenance = $12,000 + (0.50 × Administration)
b. Maintenance = $12,000 + (0.20 × $54,000)
c. Maintenance = $12,000 + (0.20 × Administration)
d. Maintenance = $12,000 + (0.25 × $54,000)
36. Use the reciprocal method. The cost of administration department after support cost allocations but before allocation to the operating departments is
a. $58,800
b. $60,800
c. $60,000
d. $59,368
37. Using the reciprocal method, the allocation from the maintenance department to Op1 department is
a. $6,000
b. $13,600
c. $13,421
d. $12,000
38. Using the reciprocal method, the total costs allocated to the three operating departments from the support departments is
a. $66,000
b. $84,000
c. $59,368
d. $60,000
39. Under the direct method
a. A support department’s costs are allocated only to final operating department users
b. A support department’s costs are allocated only to other support departments
c. The costs of the support departments are allocated sequentially
d. The costs of the support departments are allocated in order of their magnitude
40. Under the step-down method of allocation
a. The costs for the support department with the smallest total are allocated first
b. When the second support department’s costs are allocated, they are allocated to each of the other departments, but not to the first support department that was allocated.
c. Once a support department’s costs have been allocated, it is available for an additional allocation
d. Support department costs are allocated solely to operating departments
41. Which departments in an organization produce services for external clients?
a. Support departments
b. Operating departments
c. Dual-rate departments
d. Value-added departments
42. Which departments in an organization provide services internal to the organization?
a. Non-value-added departments
b. Value-added departments
c. Support departments
d. Operating departments
43. Which of the following types of organizations can have both operating and support departments?
I. Manufacturing
II. Service
III. Retail IV. Governmental
a. I and II only
b. II and III only
c. I and IV only
d. I, II, III, and IV
44. Support departments provide services
a. That support customers
b. Only for other support departments
c. For departments that interact with external customers
d. Only for administrative functions
45. When preparing financial statements under generally accepted accounting principles, support department costs are generally classified as
a. Product costs
b. Period costs
c. Nonoperating costs
d. Variable costs
46. In a discount department store, which of the following is most likely a support department?
a. Housewares
b. Furniture
c. Purchasing
d. Appliances
47. All of the following are likely to be support departments in a CPA firm except
a. Reception
b. Word processing
c. Advertising
d. Income tax preparation
48. Some organizations allocate support department costs to
I. Provide managers incentives for efficient production of operating services
II. Provide managers incentives for appropriate and effective use of support services
III. Monitor managers’ use and production of support services
a. I and III only
b. I and II only
c. II and III only
d. I, II, and III
49. Which of the following is least likely to be a reason for allocating support department costs?
a. For internal reporting purposes
b. To motivate managers
c. To assist in strategic or operating decisions
d. For financial statements prepared according to GAAP
50. The process of allocating support department costs begins with
a. Choosing an allocation method
b. Clarifying the purpose of the allocation
c. Establishing cost pools
d. Choosing an allocation base
51. To decide the type and number of cost pools to use for support cost allocation, managers should consider the
a. Reasons for allocating support department costs
b. Ability of operating departments to bear the costs
c. Method they plan to use for the allocation
d. Allocation base
52. When allocating support department costs, managers must identify cost pools. The choice of cost pools is
a. Determined by generally accepted accounting principles
b. Not influenced by the allocation base
c. Influenced by the design of the accounting information system
d. Not important, because all support department costs will eventually be allocated anyway
53. Managers need allocation bases when they
I. Allocate support department costs to operating departments
II. Trace direct costs to products
III. Trace direct labor to products
a. I only
b. I and II only
c. I and III only
d. I, II, and III
54. Which of the following is the most appropriate cost allocation base for a purchasing department?
a. Time spent speaking with other department heads on the telephone
b. Hours of training provided to purchasing department employees
c. Allocated costs of other departments
d. Number of purchase requisitions
55. Which pair below best matches a support department with an appropriate allocation base?
a. Administration, square feet occupied
b. Housekeeping, number of requisitions for supplies
c. Employee training, number of employees
d. Accounting, number of general ledger accounts
56. Which of the following steps is not always part of allocating support department costs?
a. Allocating costs to units of product or service
b. Clarifying the purpose of the allocation
c. Choosing an allocation base
d. Assigning costs to cost pools
57. The terms “direct,” “step-down,” and “reciprocal” are associated with which part of allocating support department costs?
a. Clarifying the purpose of the allocation
b. Choosing and applying a method
c. Allocating costs to units of product or service
d. Choosing an allocation base
58. Departments are often used as cost pools when allocating support department costs because
a. Many organizations already accumulate costs by department
b. Generally accepted accounting principles require it
c. All departments have easily identifiable allocation bases
d. U.S. income tax regulations require it
59. When many different types of support department costs are assigned to the same cost pool
a. Managers cannot allocate them
b. Cost allocation becomes more arbitrary
c. Cost allocation better reflects the flow of resources
d. Managers cannot use the reciprocal method for allocation
60. The practice of using only one base to allocate both fixed and variable costs is called
a. Single-rate allocation
b. Activity-based allocation
c. Budgeted allocation
d. Direct allocation
61. When managers use dual-rate allocation, they separate which kinds of costs into different pools?
a. Support and operating
b. Fixed and variable
c. Product and period
d. Operating and nonoperating
62. Which of the following is a drawback of dual-rate allocation?
I. It introduces uncertainty about cost classification
II. It costs more to develop and maintain than single-rate allocation
III. It may cause managers to believe that all support costs are variable
a. I and III only
b. I and II only
c. II and III only
d. I, II, and III
Use the following information for the next 3 questions. PIR Corporation has 2 support departments and 2 operating departments. Number of employees is used as an allocation base for personnel support costs, and square feet are used for janitorial support costs. A breakdown of their costs, along with other operating information, is shown below for a recent accounting period:
63. If PIR uses single-rate allocation and the direct method, the allocation rate for personnel will be
a. $280 per employee
b. $215 per employee
c. $187 per employee
d. None of the above
64. If PIR uses dual-rate allocation and the direct method, the variable cost allocation rate for janitorial services will be
a. $0.50 per square foot
b. $0.61 per square foot
c. $0.70 per square foot
d. None of the above
65. If PIR uses single-rate allocation and the direct method, the total cost (including support department costs) for Product Assembly will be
a. $14,000
b. $28,000
c. $30,400
d. None of the above
66. Because the process of measuring and allocating support costs is uncertain and requires judgment
a. Managers should not allocate costs to individual units of product
b. Managers should use information technology as much as possible to eliminate the need for judgment
c. Allocated support cost information can be of low quality
d. Allocated support cost information cannot be used for cost-based contracts
67. Advantages of using budgeted values to calculate support department cost allocation rates include
I. Managers know support department costs in advance.
II. Managers are motivated to use support department services efficiently.
III. Allocated support costs for the period are not affected by actual usage so managers have little incentive to minimize the use of support services
a. I and II only
b. I and III only
c. II and III only
d. I, II, and III
68. WST Corporation uses actual amounts to calculate support department cost allocation rates. A disadvantage of this practice is
a. Managers are held responsible for actual usage
b. Support charges are known in advance by managers
c. If one department uses much less of a support department’s services than others, the support charge to remaining departments will increase to compensate
d. Managers cannot measure the value of support services used
69. The stand-alone method
a. Is not a recognized method for allocating support department costs
b. Eliminates uncertainty when allocating support department costs
c. Cannot be used in retail organizations
d. Allocates common costs based on information about individual users
70. When one user is viewed as being more responsible for common costs than other users, managers can allocate support department costs more fairly with the
a. Stand-alone method
b. Reciprocal method
c. Step-down method
d. Incremental cost allocation method
71. Managers can improve the quality of information when allocating support department costs by
I. Using single-rate allocation
II. Using dual-rate allocation
III. Choosing cost drivers for allocation bases
a. I only
b. II only
c. I and III only
d. II and III only
72. Replacing cost-based reimbursement contracts with fixed fee reimbursement contracts is one way to
a. Reduce the incentive to bias information when allocating support department costs
b. Eliminate uncertainty when allocating support department costs
c. Consider perceived fairness when allocating support department costs
d. Eliminate the need to allocate support department costs
73. Which of the following contract types is most susceptible to inappropriate cost allocations?
a. Cost-based
b. Fixed-price
c. Based on activities undertaken
d. Dual-rate
74. The federal government often requires contractors to follow specific cost-measurement rules, such as those established by the
a. Internal Revenue Service
b. Cost Accounting Standards Board
c. Financial Accounting Standards Board
d. Securities & Exchange Commission
These multiple choice questions require more complex computations or present information differently than in the textbook.
75. A firm allocates the cost of electricity to its operating departments based upon the number of electrical outlets in each department. The actual cost for electricity is $20,000 per period plus $0.02 per kilowatt-hour (KWH). The $20,000 is related to the amount of capacity needed, and capacity is reasonably estimated by the number of outlets. The firm has a total of 1,000 outlets and typically uses 700,000 KWH per period. Department W has 25 outlets and typically uses 15,000 KWH per period.
If the firm switches from a single allocation rate based upon capacity to dual rates based upon capacity and actual use, Department W’s cost will
a. Increase by $121.43
b. Increase by $342l.50
c. Decrease by $50.00
d. Decrease by $121.43
s76. The allocation method that ignores all services rendered between support departments is the
a. Direct method
b. Step-down method
c. Reciprocal method
d Dual-rate method
s77. The allocation method that ignores some, but not all, services rendered between support departments is the
a. Direct method
b. Step-down method
c. Reciprocal method
d Dual-rate method
s78. The allocation method that accounts for all services rendered between support departments is the
a. Direct method
b. Step-down method
c. Reciprocal method
d Dual-rate method
s79. The allocation method that allocates fixed and variable costs separately is the
a. Direct method
b. Step-down method
c. Reciprocal method
d Dual-rate method
s80. The allocation method that can manipulate the costs allocated by changing the order of the support department cost allocation is the
a. Direct method
b. Step-down method
c. Reciprocal method
d Dual-rate method
s81. To avoid passing on inefficiencies of the support departments, support department costs should be allocated using
a. A budgeted cost allocation rate
b. An actual cost allocation rate
c. Only fixed costs per unit of service
d. Only variable costs per unit of service
Use the following information for the next 4 questions. Trucker Industries provides the following information about departmental consumption of allocation bases for its 3 support and 2 operating departments:
s82. For the direct method, what proportion of Personnel costs will be allocated to the Machining Department?
a. 30%
b. 10%
c. 42.9%
d. 14.3%
s83. For the step-down method, what proportion of Maintenance costs will be allocated to the Assembly Department if the allocation order is Personnel, Cafeteria, and Maintenance?
a. 20%
b. 28.6%
c. 42.9%
d. 30%
s84. For the step-down method, what proportion of Cafeteria costs will be allocated to the Maintenance Department if the allocation order is Personnel, Cafeteria, and Maintenance?
a. 11.1%
b. 10%
c. 0%
d. 30%
s85. For the reciprocal method, what proportion of Personnel costs will be allocated to the Machining Department?
a. 30%
b. 42.9%
c. 20%
d. 28.6%
Use the following information for the next 4 questions. Arthur Henderson, LLC is a CPA firm that has a Printing Department that makes copies for its two operating departments, Audit and Tax. The Printing Department’s budget for 2005 showed budgeted fixed costs of $40,000 plus variable costs of 2 cents per copy. At the beginning of 2005, the Audit Department budgeted its usage at 80,000 copies, and the Tax Department budgeted its usage at 50,000 copies. However, actual usage was 70,000 copies and 60,000 copies made by the Audit and Tax Departments, respectively.
s86. Under the single-rate method, what is the total budgeted costs for the Audit Department?
a. $1,600
b. $1,400
c. $26,215
d. $22,938
s87. Under the dual-rate method, what amount of cost is allocated to the Audit Department if fixed costs are allocated based on budgeted usage and variable costs are allocated based on actual usage?
a. $26,015
b. $22,938
c. $26,215
d. None of the above
s88. Under the dual-rate method, what amount of cost is allocated to the Audit Department if fixed costs are allocated based on budgeted usage and variable costs are allocated based on budgeted usage?
a. $26,015
b. $22,938
c. $26,215
d. None of the above
s89. Under the dual-rate method, what amount of cost is allocated to the Tax Department if fixed costs are allocated based on budgeted usage and variable costs are allocated based on budgeted usage?
a. $17,667
b. $16,385
c. $19,661
d. None of the above
Use the following information for the next 3 questions. The cost of a taxi ride from O’Hare airport to downtown Chicago is $22, plus $1 per person in the taxi, plus $1 for each luggage item in the trunk. George is on a trip with a business associate from another department. George has one luggage item and his associate has three.
s90. Compute the portion of the taxi fare allocated to George using the stand-alone method
a. $13.44
b. $24.00
c. $14.56
d $4.00
s91. Compute the portion of the taxi fare allocated to George using the incremental cost allocation method if George is considered the primary user
a. $2.00
b. $24.00
c. $4.00
d. $28.00
s92. Compute the portion of the taxi fare allocated to George using the incremental cost allocation method if George’s associate is considered the primary user
a. $2.00
b. $4.00
c. $28.00
d. $14.56
w93. Support departments
a. Do not provide services to other support departments
b. Provide services to other departments within an organization
c. Generate revenue for the organization
d. Are not necessary in very large organizations
w94. Operating departments
a. Manufacture goods or deliver services for external customers
b. Provide services for all other departments within an organization
c. Provide marketing services for all other departments
d. Provide research and development for other departments
w95. Following are reasons to allocate support department costs:
I. To motivate managers to provide and use support services efficiently
II. For external reporting such as cost reports for government contracts
III. For economic planning and decision-making
a. I only
b. II only
c. III only
d. I, II, and III
w96. Allocation bases used in allocating support department costs
a. Can be any kind of measure
b. Should be related to the services provided by the support department
c. Are usually based only on the direct costs of the departments
d. Are not cost driver
w97. If product costs plus allocated support costs are used to set prices
I. Prices increase as the volume of production decreases
II. Price increases cause further decreases in quantity demanded, causing production to decrease
III. The company may eventually go out of business
a. I and II only
b. II and III only
c. I and III only
d. I, II, and III
w98. If support department allocations are used to motivate managers to be more efficient
I. The managers must believe the allocation system is fair
II. The managers should choose the allocation bases
III. It is not important that managers understand how the allocations are made
a. I only
b. I and III only
c. II and III only
d. II only
w99. Following are allocation bases that are often used to allocate corporate headquarters costs to segments, divisions, or departments
I. Revenues
II. Number of employees
III. Direct costs
a. I and III only
b. I and II only
c. I, II, and III
d. I only
w100. (CPA) Which of the following statements is true about support cost allocation?
a. Companies can maximize or minimize their income by selecting different allocation bases for support costs
b. Companies can select allocation bases to raise or lower reported income on given products
c. Companies’ total incomes will remain unchanged no matter how support costs are allocated
d. Companies should usually allocate support costs randomly or based on an ability-to-bear criterion
w101. The direct allocation method reflects
a. All of the support department interactions
b. None of the support department interactions
c. Part of the support department interactions
d. A relatively complex allocation method
w102. The reciprocal allocation method reflects
a. All of the support department interactions
b. None of the support department interactions
c. Part of the support department interactions
d. A relatively simple allocation method
w103. A problem with charging other departments for allocated support costs is
I. The charge is often perceived to be very high
II. Support services are likely to be underused
III. Other departments may choose to replicate or outsource internal services
a. I and II only
b. I and III only
c. II and III only
d. I, II, and III
w104. From the organization’s perspective, relevant information when deciding whether to outsource a support service is most likely to include the
a. Incremental cash flows for insourcing versus outsourcing
b. Total allocated cost of the support service
c. Number of other departments that use the support service
d. Total cost of the support department
w105. A simple method used to allocate common costs is the
I. Stand-alone cost allocation method
II. Incremental cost allocation method
III. Reciprocal method
a. I only
b. III only
c. I, II, and III
d. I and II only
w106. (CPA) Parat College allocates support department costs to its individual schools using the step-down method. Information for May 2003 follows:
What is the amount of May 2003 support department costs allocated to the School of Education?
a. $40,500
b. $42,120
c. $46,100
d. $49,125
w107. The simplest cost allocation method is the
a. Direct method
b. Step-down method
c. Reciprocal method
d. None of the above
w108. (CMA) The printing department supplies copy and printing support for both Departments A and B and has prepared its total budget using the following information for next year:
Assume that the single rate method of cost allocation is used and the allocation base is budgeted usage. How much photocopying cost will be allocated to Department B using budgeted costs and usage?
a. $72,000
b. $122,000
c. $132,000
d. $138,667
Use the following information for the next 5 questions. The managers at Ithaca Manufacturing are discussing ways to allocate the cost of support departments such as Quality Control and Maintenance to the operating departments. To aid them in this discussion, the controller has provided the following information.
w109. (CMA) If Ithaca Manufacturing uses the direct method of allocating support department costs, the total support costs allocated to the assembly department would be
a. $80,000
b. $87,500
c. $120,000
d. $167,500
w110. (CMA) Using the direct method, the total amount of overhead (production and support) allocated to the machining department for each machine hour at Ithica Manufacturing would be
a. $2.40
b. $5.25
c. $8.00
d. $15.65
w111. (CMA) If Ithica Manufacturing uses the step-down method of allocating support costs beginning with quality control, the maintenance costs allocated to the Assembly Department would be
a. $70,000
b. $108,000
c. $162,000
d. $200,000
w112. (CMA) If Ithica Manufacturing uses the reciprocal method of allocating support costs, the total amount of quality control costs (rounded to the nearest dollar) to be allocated to the other departments would be
a. $284,211
b. $336,842
c. $350,000
d. $421,053
w113. (CMA) If Ithica Manufacturing decides not to allocate support costs to the operating departments, the overhead allocated to each direct labor hour in the Assembly Department would be
a. $3.20
b. $3.50
c. $12.00
d. $16.00
1. Paradise Vacation Club International (PVCI) offers timeshare properties at various locations around the world. Its web site states, “The concept of Vacation Ownership with Paradise Vacation Club begins with the comforts of a ‘home resort’, a villa or condominium at any one of our extraordinary properties. You select the season and the one, two or more weeks you wish to vacation. Your home resort can be lushly tropical, sparkling with snow, nestled in the vibrant heart of a great city, at the edge of the vast Pacific, or lit by the warm Mediterranean light. You also have the opportunity to exchange within a worldwide system of world-class options. So you’re free to visit new destinations or trade your week(s) for cruises, airline travel, or a wealth of options offering remarkably flexibility. Only a Fortune 500 company such as Paradise could design, build and maintain the ever-expanding vacation and every spectacular one of them is yours to enjoy with a priority exchange.”
Suppose the list below contains several of PVCI’s departments. Identify each one as an operating department (O) or a support department (S).
1. Accounting
2. Child care for timeshare owners
3. Customer relations
4. Child care for employees
5. Front desk (i.e., reception)
6. Housekeeping
7. Information systems
8. Swimming pool maintenance
9. Timeshare sales
10. Human resources
2. The generalized process for allocating support department costs comprises six steps, listed below in random order. In the space provided, indicate the order in which the steps should be performed (1 through 6).
Assign costs to cost pools.
Choose and apply a method for allocating support department costs to operating departments. Clarify the purpose of the allocation.
For each support department cost pool; choose an allocation base. Identify support and operating department cost pools.
If relevant, allocate support costs from the operating departments to units of goods or services.
3. RKH Corporation has 2 support departments and 2 operating departments. S1’s costs are allocated based on documents prepared; S2’s costs are allocated based on square feet. Support Departments
Match each description on the left below with the best choice on the right. Each numbered item has only one correct answer. Each lettered item may be used once, more than once, or not at all. Round all costs to the nearest dollar.
1. Total S1 costs allocated to O1 using the direct method
2. Total S2 costs allocated to O1 using the direct method
3. Total S1 costs allocated to S2 using the step-down method with S1 allocated first
4. Total S2 costs allocated to S1 using the step-down method with S1 allocated first
5. O1’s total cost (direct and allocated) after all allocations using the direct method
6. O2’s total cost (direct and allocated) after all allocations using the step-down method with S1 allocated first
7. Total S1 cost to be allocated to operating departments using the reciprocal method
8. Total S2 cost to be allocated to operating departments using the reciprocal method
9. Total support department costs to be allocated to operating departments using the reciprocal method
10. O2’s total cost (direct and allocated) after all allocations using the reciprocal method
A. $6,667
B. $7,200
C. $13,714
D. $19,794
E. $25,979
F. $31,711
G. $36,000
H. $37,067
I. $38,381
J. $18,185
K. None of the above
4. Several characteristics that may apply to single-rate allocation (S), dual-rate allocation (D), both (B), or neither (N) are listed below. Indicate, with the appropriate letter, which term applies to each characteristic.
1. Can be applied using the direct method
2. Cost drivers identified for variable cost pools
3. May lead to mismeasurement because of cost behavior classification
4. May mismeasure support resources used
5. More costly to develop and maintain
6. Reciprocal method may be used for allocations
7. Support costs separated into product and period cost pools
8. Uses one allocation base to allocate support costs
1. Krenz Foundry has 3 support departments and 2 operating departments. Support cost and allocation base information is provided below. Support
Maintenance costs are allocated on the basis of square feet, and the other support costs are allocated on the basis of number of employees. Maintenance provides the most services to other support departments, and food service provides the next most services to other support departments.
a. If the direct method of allocation is used, calculate the maintenance department cost that will be allocated to:
1) Personnel
2) Casting
b. If the step-down method is used, calculate the maintenance department cost that will be allocated to:
1) Personnel
2) Casting
c. If the step-down method is used, calculate the percent of personnel department costs that will be allocated to each of the following. (Note: You are not being asked for the dollar amount.)
1) Casting
2) Personnel
2. The accountants at King Industries want to determine the amount of support department costs that should be allocated to its operating departments. Actual support costs and allocation base information for the two support departments is shown below. The costs of support department S1 are allocated based on the number of service calls made, and the costs of support department S2 are allocated based on square feet.
Support Departments Operating Departments
Using the reciprocal method:
a. Determine the equations for allocating S1 and S2 costs
b. Determine the amount of cost allocated from S2 to S1
c. Determine the amount of cost allocated from S1 to O2
d. Determine the total support department costs allocated to the operating departments
3. Vince’s Spaghetti is a family-owned restaurant in Southern California. The corporate office provides 2 kinds of services (maintenance and personnel) to Vince’s 3 locations (Ontario, Redlands, and Temecula). In a recent accounting period, the direct cost for maintenance was $25,000 and for personnel was $15,000. Maintenance costs are allocated on the basis of square feet, and personnel costs are allocated based on the basis of number of employees.
a. If Vince’s uses the direct method, calculate the total support costs allocated to each restaurant location.
b. If Vince’s uses the step-down method with personnel allocated first, calculate the total support costs allocated to each restaurant location.
c. Assume Vince’s uses the reciprocal method to allocate costs between support departments. Calculate the total support department costs allocated to each restaurant location.
1. There is no single, “correct” way to allocate support department costs to operating departments. Explain.
2. Distinguish between support department costs and manufacturing overhead costs.
3. What should determine the choice of cost allocation method (direct, step-down, and reciprocal) discussed in this chapter?
4. Sometimes costs that include single-rate support department allocations are used in short-term decision making. List several limitations of these costs when used in decision making.
5. Sometimes costs that include support department allocations are used in short-term decision making, resulting in poor outcomes. Discuss ways to address the limitations inherent in single-rate support cost allocation information.
6. List two factors that should be considered when choosing allocation bases.
7. Explain the difference between operating departments and support departments.
8. List two advantages of the dual-rate method.
9. Explain one problem that could arise when allocated costs are used to charge other departments for support services.
1. Breakfast Bars has two support departments, Information Systems and Personnel. The Information Systems Department costs of $120,000 are allocated on the basis of hours used. The Personnel Department costs of $30,000 are allocated based on the number of employees. Costs of the two operating departments are $60,000 for Fruit Bars and $90,000 for Nut Bars. Data on information systems hours used and number of employees are as follows:
a. What is the cost of the Information Systems Department allocated to Fruit using the direct method?
b. Using the step-down method, what is the cost of the Personnel Department allocated to Fruit if the support department having the highest cost is allocated first?
c. Write the equations needed to allocate the costs of each support department using the reciprocal method.
d. Now solve for the total cost to be allocated under the reciprocal method for the Information Systems Department.
e. Breakfast Bars uses the allocation system to charge for services provided by the two support departments. Assume that Breakfast Bars uses the reciprocal method. What is the hourly charge for Information Systems’ services?
f. Identify and discuss one problem with using a single rate allocation method to develop charges for the use of services.
2. Universal Transport Enterprises (UTE) operates an integrated transportation network that includes both air operations and road operations. UTE has 2 support departments (Administration and Information Systems) and 2 operating departments (Air and Road). The budgeted level of services at the start of the year was
Costs for administration were $135,000, and costs for the information systems department were $75,000.
UTE monitors the cost per mile in the air for the air department and the cost per mile on the road for the Road Department. These cost figures include costs allocated from the support departments to the transportation departments. During the year, the actual transportation miles were Air operations 800,000 miles Road operations 1,500,000 miles
a. Allocate the support department costs to the two transportation departments using the direct method.
b. Using the reciprocal approach, the following amounts were derived using simultaneous equations (Admin=Administration; IS=Information Systems):
Admin = $135,000 + 0.2IS = $153,061
IS = $75,000 + 0.10Admin = $90,306
Create a schedule and allocate these amounts among the departments.
c. Suppose you have been asked to help UTE decide on a method for allocating support department costs. List one pro and one con for the direct and reciprocal methods, and then make a recommendation for this company.
3. Answer the following questions.
a. What are the three methods of allocating support department costs?
b. Which of these methods recognizes interactions between departments? Explain.
c. Which of these methods has the potential to be most accurate? Why?
d. Assume you are working for an organization and are asked to allocate support department costs. Describe how you would choose the best method.
e. Suppose a company uses the method you identified in part (c) to allocate support costs. Do the support cost allocations represent the incremental cost of providing support services? Why or why not?
4. The cost of a limousine ride from Newark airport to downtown New York is $88, plus $10 per person in the taxi, plus $1 for each luggage item in the trunk. Susan is on a trip with George, a business associate from another department. Susan has one luggage item and her associate has three.
a. Compute the portion of the limousine fare allocated to Susan using the stand-alone method.
b. Compute the portion of the limousine fare allocated to Susan using the incremental cost allocation method if Susan is considered the primary user.
c. Compute the portion of the limousine fare allocated to Susan using the incremental cost allocation method if George is considered the primary user.
d. Which method is the most fair? Explain your reasoning.
5. Handy Home Improvement Warehouse is a nationwide chain of hardware stores. It is organized into several operating departments, including (but not limited to): appliances, cabinets, doors & windows, flooring, and hardware. Handy requires several support departments, including human resources, accounting and finance, and information systems.
Suppose the accountant for Handy is considering two support cost allocation methods, direct and step-down. In a recent accounting period, assume Handy’s accounting information system reported the following data:
a. Explain the similarities and differences between support and operating departments. Why do many organizations allocate support department costs to operating departments?
b. List and discuss the steps Handy would likely use to allocate support department costs to operating departments.
c. Handy has used its departments as cost pools for the purpose of support cost allocation. List one advantage and one disadvantage of using departments as cost pools.
d. Describe in your own words the direct method of allocation. List one advantage and one disadvantage of this method.
e. Describe in your own words the step-down method of cost allocation. List one advantage and one disadvantage of this method.
f. Under the step-down method, discuss whether it is reasonable to use the total direct costs for each support department to identify which department provided the most services to other support departments.
g. Is Handy using a single- or a dual-rate allocation process? Explain.
h. List and discuss three ways Handy could improve the quality of its allocated support cost information.
6. BP Services is a large company that sells Harley Davidson Motorcycles. The company is organized with two operating departments, Premier and Elite. The premier department sells only to clients who have custom ordered a bike. The Elite department sells bikes that are already manufactured. Jan Socha is in charge of the media department that develops advertising booklets for the two product lines. The media department’s budget for the upcoming year showed budgeted fixed costs of $80,000 plus variable costs of $1.00 per booklet. At the beginning of the year, Premier budgeted its usage at 4,000 booklets, and Elite budgeted its usage at 10,000 booklets. However, actual usage was 3,000 booklets and 8,000 booklets requested by Premier and Elite, respectively.
a. Under the single-rate method, what are the total budgeted costs for the media department?
b. Under the dual-rate method, what amount of cost is allocated to Premier if fixed costs are allocated based on budgeted usage and variable costs are allocated based on actual usage?
c. Under the dual-rate method, what amount of cost is allocated to Premier if fixed costs are allocated based on budgeted usage and variable costs are allocated based on budgeted usage?
d. Which dual-rate method the one in part (b) or the one in part (c) would provide better incentives for using the company’s resources efficiently? Explain.
1. B; [($25,000 / 7,500) * 2,000] + ($3 * 2,000)
2. A; [($25,000 / 1,200) * 800] + ($3 * 5,500)
3. B; ($41,000 + $42,200) / (120 + 140) * 120
4. A; ($40,000 / 250 * 150) + ($140 * 150)
5. B
6. A
7. A
8. C; $75,000 / 85 * 30
9. D; ($55,000 / 75 * 35) + ($75,000 / 85 * 55)
10. A
11. C; utilities to B = $55,000 * 40% = $22,000; utilities to computer = $55,000 * 25% = $13,750; computer to B = ($75,000 + $13,750) / 85 * 30 = $31,324; total costs alloc to B = $31,324 + $22,000
12. B; $50,000 / 7,500 *
3,500
13. D; $300,000 + ($50,000 / 7,500 *
4,000) + ($45,000 / 400 * 250)
14. D
15. A; maint to cafeteria: $50,000 / 9,500 * 2,000 = $10,526; cafeteria to pkg: ($45,000 + $10,526) / 400 * 250 = $34,704
16. B; maint to cutting: $50,000 / 9,500 * 3,500 = $18,421; cafeteria to cutting: ($45,000 + $10,526) / 400 * 150 = $20,822
17. A; Maint = 50,000 + (15/415) * (45,000 + (2,000/9,500) * Maint) = $52,022
18. A 19. C 20. D 21. A 22. C
23. D; $55,000 + $35,000
24. C; $61,168 * 50%
25. B; B to A: $60,000 * 20% = $12,000; A to 2: ($50,000 + $12,000) / (0.1 + 0.4 + 0.3) * 0.3
26. D; B to C: $60,000 * 20% = $12,000; B to A: $12,000; A to
C: ($50,000 + $12,000) / (0.1 + 0.4 + 0.3) * 0.1 = $7,750; Total cost of C: $12,000 + $7,750 + $30,000
27. C
28. A; persl = $46,750 + 10% (maint) AND maint = $22,500 + 10% (persl); persl = $50,000; main = $32,500
29. B; $32,500 - $22,500
30. B; persl to maint: $46,750 * 20% = $9,350; persl to assbly: $46,750 * 40% = $18,700; maint to assbly: ($22,500 + $9,350) / 0.9 * 0.6 + $21,233; total cost to assbly: $18,700 + $21,233
31. C; 70/(70 + 80)
32. A; maint to chairs: $27,000 * 20/80 = $6,750; persl to chairs: $24,000 * 80/150 = $12,800; chair cost: $21,000; cost per chair: ($6,750 + $12,800 + $21,000) / 2,000
33. D; maint to persl: $27,000 * 1/9 = $3,000; persl to tables: ($24,000 + $3,000) * 7/15 = $12,600
34. D
35. C
36. C; Maint = $12,000 + 0.2 (Admin) AND Admin = $54,000 + 0.25 (Maint); Maint = $24,000; Admin = $60,000
37. D; Maint to Op1: $24,000 * 50%
38. A
39. A
86. C; $40,000 + $0.02 x (80,000 + 50,000 copies) = $42,600; $42,600/130,000 copies = $0.3277/copy; 80,000 copies x $0.3277/copy = $26,215
s87. A; $40,000/130,000 copies = $0.30769/copy; $0.30769/copy x 80,000 copies + $0.02/copy x 70,000 copies = $26,015
s88. C; $0.30769/copy x 80,000 copies + $0.02/copy x 80,000 copies = $26,215
s89. B; $0.30769/copy x 50,000 copies + $0.02/copy x 50,000 copies = $16,385
s90. A; TC=$22 + 2x$1 + (1+3)x$1 = $28; ($22 + $1 + $1 = $24)/[$24+($22 + $1 + $3 = $26)] x $28 = $13.44
s91 B; $22 + $1 + $1 = $24
s92 A; $22 + $1 + $3 = $26; $28$26 = $2
w93. B
w94. A
w95. D
w
B
w
D
w
A
w
D
w
C
w
3. Cost allocation matching
1. C; $24,000*4/7
2. A; $12,000 * 25/45
3. B; $24,000 * 3/10
4. K; -0-
5. J; $18,000 + ($24,000 * 4/7)
+ ($12,000 * 25/45)
6. H; S1 to S2: $24,000 * 3/10 = $7,200; S1 to O2: $24,000 * 3/10 = $7,200; S2 to O2: $31,200 * 20/45 = $13,867; O2 direct
4. Characteristics of single- and dual-rate allocations
Exercises
1.
a. Direct method
1) $0
2) $10,000 * 10/15 = $6,667
b. Step-down method
1) $10,000 * 1/19 = $526
2) $10,000 * 10/19 = $5,263
c. Step-down method
1) 2/5 = 40%
2) 0%
2. Reciprocal method
a. S1 = $73,000 + 10% (S2) AND S2 = $35,000 + 25% (S1)
b. S1 = $73,000 + 10% ($35,000 + 25% (S1)) → S1 = $78,461
S1’s native costs = $73,000 → S1’s allocated cost = $5,461
c. $78,461 * 6/20 = $23,538
d. $73,000 + $35,000 = $108,000
Temecula = $25,000 * 3/14 + $15,000 * 10/40 = $9,107
b. Personnel to maintenance = $15,000 * 15/55 = $4,091
Total maintenance cost to allocate = $4,091 + $25,000 = $29,091
Ontario = $15,000 * 12/55 + $29,091 * 5/14 = $13,662
Redlands = $15,000 * 18/55 + $29,091 * 6/14 = $17,377
Temecula = $15,000 * 10/55 + $29,091 * 3/14 = $8,961
costs = $16,000; Total costs for O2 = $7,200 + $13,867 + $16,000
7. J; $25,979 * 0.7 = $18,185
8. K; $19,794 * 0.9 = $17,815
9. G; $24,000 + $12,000 = $36,000
10. F; S1 to O2: $25,979 * 30%; S2 to O2: $19,794 * 40%; O2 direct costs: $16,000
c. Maintenance = $25,000 + 15/55 (personnel) AND Personnel = $15,000 + 1/15 (maintenance)
Maintenance = $29,630 AND Personnel = $16,975
Maintenance = $1,975 to Personnel, $9,877 to Ontario, $11,352 to Redlands, and $11,852 to Temecula
Personnel = $4,630 to Maintenance, $3,704 to Ontario, $5,555 to Redlands, and $3,086 to Temecula.
Totals to restaurants:
Ontario = $13,580
Redlands = $17,407
Temecula = $9,012
1. There are three different traditional methods for allocating support department costs, and there are likely to be a number of nontraditional methods that organizations have developed to suit their needs. Because each of these methods is appropriate under some circumstances and not others, there is no one single correct way to allocated support department costs. The appropriate method depends on the nature of the products and the use of allocation information. In addition, the cost pools could be departments or some other type of cost pool, such as an activity. These vary among organizations. Some organizations may want to allocate only department costs, others may divide functions within a department and set up cost pools by function. The allocation bases will vary with the types of cost pools, information available, and ease of tracking measures that could be used as allocation bases. Student responses will vary.
2. Support departments are those departments within an organization that provide services that enable the production departments to operate more efficiently. These include services such as accounting, information systems, marketing and so on. These are not related to manufacturing or providing services to external customers, except in the support that they provide for the operating departments. The costs incurred by these departments are called support department costs. Manufacturing overhead costs are all of the indirect costs associated with manufacturing a product. They include plant-related costs such as insurance, property taxes or rent, supervisors’ salaries, and other indirect costs. These costs are allocated to product using methods that are specific to the production process, such as job costing and process costing.
3. The choice of cost allocation method depends on the proposed use of information and the nature of the organization, among other things. In general, the reciprocal method provides the most accurate allocation amounts. However, this method is more complex and may require a spreadsheet or linear program. The direct method is the most simple, but the allocations are the least accurate because they do not reflect the interactions among support departments. However, this method might be appropriate if there are few support departments with few interactions, or if accuracy of allocation amounts is not important. The step-down method is between the direct and reciprocal methods in terms of computational complexity and accuracy of allocation. This method might be appropriate if there are several support departments, but only one or two of them provide significant services to other support departments.
4. Under the single rate allocation method, fixed and variable costs are aggregated and allocated together. When fixed costs are used in short-term decision making, they do not reflect the relevant costs that would vary depending on the decision. The quality of the decision would then be poor.
5. The dual rate allocation method produces higher quality information for short term decision making, as long as managers use only the variable allocation amounts and not the fixed amounts. However, there are still problems with using allocations in decision making because the accuracy depends on the choices of allocation bases, the ability to measure and track the base accurately, and the ability to accurately reflect the interactions among departments. Measurement error arises no matter how well all of these choices are made.
6. Here are some factors that should be considered when choosing allocation bases; students may think of others. One factor is the relationship between the cost pool and the allocation base. Ideally, cost drivers would be chosen as allocation bases. However, some cost pools may be based on the costs from a variety of activities, none of which are very similar. In such cases there may not be a single allocation base that would also be a cost driver. Another factor to consider is the ease of tracking the allocation base and the accuracy of allocation base data. Sometimes the cost exceeds the benefit of obtaining better cost driver information, or it may not be possible to collect reasonably accurate information. Still another factor is the planned use of the allocation information. It is more important to use cost drivers as allocation bases when the allocation information will be used for decision making or for monitoring and motivating manager performance.
7. Operating departments are those departments within an organization that generate revenue in for-profit and some not-for-profit organizations, or those that provide services to external customers such as government agencies and some not-for-profit organizations such as homeless shelters. Support departments, on the other hand, provide services that support the operating departments.
8. Two advantages of the dual rate method include greater accuracy of allocations, and the potential use of information in some decision making, and as an internal transfer price. Further, in the development of the dual rate system, accountants and manager may gain a better understanding of the use of services and interactions among departments.
9. When allocated costs are used to charge other departments for support services (i.e., as transfer prices), several problems arise. One problem is that the charges using a single rate system are usually relatively high because they include fixed costs from the support departments. Therefore managers may outsource the service, believing that it is cheaper to do so, even if the organization continues to incur the fixed costs. In addition, because the calculations are somewhat complex, the allocation amounts are always somewhat arbitrary, and managers may believe that the allocation are accurate reflections of the costs incurred to provide these services and base prices or other short term decisions on these allocated costs. This may result in poor pricing policies and poor decision-making.
1. Schedules for each allocation method are shown below. (Answers to individual questions follow the schedules.)
Solver spreadsheet results: Info. Systems Personnel Change cells for Solver $124,200 $71,400
Simultaneous equations $124,200 $71,400
Target function: $195,600
a. $60,000
b. $17,500
c. Info. Systems = $120,000 + 20/180 *Personnel Personnel = $30,000 + 600/ 1,800* Info. Systems
d. $124,200
e. The hourly charge is $124,200/ 1,800 = $69 per hour
f. These charges include fixed costs and allocations from other departments are therefore very high. They do not reflect the incremental cost of providing services. When these high values are used as a charge, the other departments may outsource the service, believing that it is cheaper for the whole organization. To make these types of decisions, the incremental costs of providing services needs to be calculated, and the variable costs are often cheaper than outsourcing.
2. The following spreadsheet was used to develop the answers for this problem.
a. See the spreadsheet
b. See the spreadsheet
c. Direct method: Pro is that it is a simple method that is easy to calculate and explain. Con is that it is inaccurate because it does not reflect the support department interactions. Reciprocal method: Pro is that it is more accurate than direct because it reflects the support department interactions. Con is that it is a little more complex and can be difficult to explain.
Students may have good arguments for either method, but should support their arguments with logic. For example, the reciprocal method is more accurate and once a spreadsheet is set up, it is easy to do each month, so the company should use it. Alternatively, the direct method is better because the cost per mile of air travel and per mile of road travel are very similar under both methods and the direct method is easier to perform and understand.
3. a. The direct, step-down, and reciprocal methods are the three used to allocate support department costs.
b. The step-down method recognizes some of the interactions, and the reciprocal method reflects all of the interactions.
c. The reciprocal method has the potential to be the most accurate because it reflects the interactions of the support departments.
d. My recommendation would depend on the nature of the business and the reason for making the allocations. The reciprocal method is the most accurate. If there are a large number of support departments it would most likely be the best recommendation. However if there were only two or three support departments, it is possible that the direct or step-down method are nearly as accurate, and they are easier to calculate and easier to explain. Therefore I would want to know about the number and type of support departments, as well as the company’s planned use for the information. If the information is used for cost reports for an agency, the agency may have requirements that limit the choices of method, and that would need to be considered.
e. The support cost allocations do not necessarily represent the incremental cost of providing support services, particularly when a single-rate allocation is used for both fixed and variable support costs. Under a dualrate system, the variable cost allocation might represent incremental costs. However, the identification of incremental costs depends on the type of decision being considered. Sometimes fixed costs are incremental, for example if they may be avoided if a service is outsourced.
4. a. TC=$88 + 2x$10 + (1+3)x$1 = $112; ($88 + $10 + $1 = $99)/[$99+($88 + $10 + $3 = $101)] x $112 = $55.44
b. $88 + $10 + $1 = $99
c. $88 + $10 + $3 = $101; $112 - $101 = $11
5.
d. The fairness criterion often depends on the situation. If the two individuals are seen as equally responsible and able to pay for the limousine cost, then the stand-alone method would probably be considered most fair. However, if one of the individuals or departments is primarily responsible for the purpose of the business trip, then the incremental-cost allocation method might be most fair.
a. Operating departments are those that have direct interaction with external customers; support departments sustain the operating departments in that interaction. Organizations allocate support costs for a variety of reasons, including contractual obligations, product pricing, and cost control.
b. Handy would follow a generic six-step model to allocate support costs to operating departments
1. Clarify the purpose of the allocation
2. Identify support and operating department cost pools
3. Assign costs to cost pools
4. For each support department cost pool, choose an allocation base
5. Choose and apply a method for allocating support dept. costs to operating depts.
6. If relevant, allocate support costs from operating depts. to units of goods
There is no single, correct way to allocate support department costs to operating departments because managers must make judgments in all of the six steps. For example, in step “5,” managers can choose among direct, step-down, and reciprocal methods. Managers also exercise judgment in assigning costs to cost pools.
c. Advantages of using departments as cost pools include:
* The accounting information system is typically set up to gather costs on a departmental basis
* Managers can understand the concept of departments more easily than the concept of nondepartmental cost pools
Disadvantages include:
* Departments are somewhat arbitrary
* All the costs in a department may not have a common set of cost drivers
d. Allocating costs with the direct method involves allocating support costs directly to operating departments; support costs are not allocated to other support costs. To use the direct method, decision makers determine what proportion of each support department’s services is used by each operating department, and allocate costs on that basis. Managers at Handy might use the direct method to allocate support costs because: the direct method is more easily understood; it doesn’t involve a lot of time or information technology; the results aren’t typically materially different from the more complex methods.
e. In the step-down method of cost allocation, managers choose one support department to start allocating. That department is allocated to other support departments and operating departments. However, once a support department’s costs are allocated, it doesn’t receive any more allocated costs. The process continues until all support costs end up in the operating departments. The pros of using the step-down method include: it recognizes that some service exchanges happen between support departments and it is not as complex mathematically as the reciprocal method. On the other hand, the use of the step-down method involves more judgment from managers; it is also more complex than the direct method, and the results are often not materially different.
f. Under the step-down method, support costs should be allocated sequentially based on the degree of support services provided to other departments. Total costs are a reasonable measure in cases where support departments provide proportionally similar amounts of services to other support departments as to the operating departments. For example, if the information systems department has the highest total direct costs and this department provides a high amount of services to other support departments as well as to operating departments, then the direct costs may be a reasonable way of identifying which support department provides the most services to other support departments. However, a support department could have high direct costs but not provide a significant amount of services to other support departments. Suppose a maintenance department has the highest direct cost amount support departments. If it provides only minor housekeeping services for other support departments but major cleaning, maintenance, and repair work for operating departments, then its direct costs may be a poor measure of the degree of services it provides to other support departments.
g. Handy is likely using a single-rate allocation process. We have no indication that fixed and variable costs have been separated in performing the allocations under either method.
h. Handy could improve the quality of its allocated support cost information by
* Using a dual-rate method
* Making a conscious choice, based on the allocation objective, regarding estimated versus actual costs
* Using the stand-alone or incremental cost allocation methods
6.
a. $94,000 ($80,000 + 14,000 x $1)
b. $25,857 (4,000/14,000 x $80,000 + 3,000 x $1)
c. $26,857 (4,000/14,000 x $80,000 + 4,000 x $1)
d. When allocated costs are based completely on budgeted usage (part c), there is no incentive for managers to use the services efficiently because their usage will not affect costs. If anything, there is an incentive to over-use services because managers want to be sure they get at least the level of services for which they have been charged. Alternatively, under part b, the fixed costs are allocated based on budgeted usage, but variable costs are allocated based on actual usage so managers have incentives to use the services efficiently to keep their allocated variable costs minimized.