Chapter 11B – Lecture Notes
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I. Appendix 11B: Service Department Charges (Slide #1 is
a title slide)
Learning Objective 6: Charge operating departments
for services provided by service departments.
A. Most large organizations have both operating
departments and service departments. The central
purposes of the organization are carried out in the
operating departments. In contrast, service
departments do not directly engage in operating
activities. This appendix discusses why and how
service department costs are allocated to operating
departments.
i. Four reasons for allocating service
department costs
1. To encourage operating departments to
wisely use service department resources.
2. To provide operating departments with
more complete cost data for making
decisions.
3. To help measure the profitability of
operating departments.
4. To create an incentive for service
departments to operate efficiently.
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ii. The service department charges considered in
this appendix can be viewed as a transfer
price that is charged for services provided by
service departments to operating departments.
B. Charging costs by behavior
i. Whenever possible, variable and fixed
service department costs should be charged
separately to provide more useful data for
planning and control of departmental
operations.
1. A variable cost should be charged to
consuming departments according to
whatever activity causes the incurrence of
the cost.
2. A fixed cost should be allocated to
consuming departments in predetermined
lump-sum amounts that are based on either
the department’s peak-period or long-run
average servicing needs. Importantly, fixed
cost allocations:
a. Are based on the amount of capacity
each consuming department requires.
b. Should not vary from period to
period.
Helpful Hint: Ask students why it is better to charge
managers a lump sum for access to service departments
rather than including a “markup” for fixed costs in the
charge for the use of services. The answer is that if the
charge for the use of services exceeds variable costs
and excess capacity exists, managers will demand too
little of the service from the standpoint of the company
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Chapter 11B – Lecture Notes
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as a whole. This discussion can be used to reinforce
ideas developed when covering transfer pricing.
ii. Budgeted variable and fixed service
department costs (rather than actual costs)
should be allocated to operating
departments.
1. Variable service department costs should be
charged using a predetermined rate applied
to the actual services consumed.
2. The lump-sum amount of fixed costs should
be based on budgeted fixed costs, not actual
fixed costs.
A. Sipco – an example
i. Assuming the facts as shown with respect to
Sipco, the allocation of maintenance costs
to the two operating departments would be
as follows:
1. The variable costs would be allocated by
multiplying the budgeted variable rate
($0.60 per machine hour) by the actual
activity level for each operating department.
2. The fixed costs would be allocated by
multiplying the percent of peak-period
capacity for each operating department by
the budgeted amount of fixed costs
($200,000).
Quick Check – allocating costs by behavior
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B. Pitfalls in allocating fixed costs
i. Rather than charge fixed costs to using
departments in predetermined lump-sum
amounts, some companies allocate them using
a variable allocation base that fluctuates
from period to period.
1. This is a pitfall because it creates a situation
where the fixed costs allocated to one
department are heavily influenced by what
happens in other departments.
ii. Sales dollars is an example of a variable
allocation base. It is a poor choice for an
allocation base because sales dollars
fluctuate from period to period, whereas the
costs being allocated are often largely fixed.
1. This creates a situation where the sales in
one department will influence the service
department costs allocated to another
department.
iii. Autos R Us – an example
1. Assume the facts as shown with respect to
Autos R Us.
2. The allocations of service department costs
for year one are as shown. Notice:
a. The New Cars Department generated
50% of total sales and was allocated
$40,000 of service department costs.
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3. The allocations of service department costs
for year two are as shown. Notice:
a. The New Cars Department increased
sales by $500,000 while the other
departments’ sales remained
unchanged.
b. The allocation of service department
costs to the New Cars Department
increased by $5,714 while it
decreased in the other two
departments.
c. The manager of the New Cars
Department is likely to complain that
as a result of his efforts to expand
sales, he is being forced to carry a
larger share of the service department
costs.
Helpful Hint: Ask students to suppose they are a
division manager in a company that allocates fixed
costs on the basis of actual sales. Ask if the fixed costs
allocated to their division will depend on sales in other
divisions. If they say yes, ask if this fair. There will
probably be a chorus of no’s. Ask how this differs from
grading on a curve. After some direction, they should
conclude that if you do better on an exam than others,
your grade will be higher and other students’ grade
will be lower. However, if your sales increase relative
to other divisions, the fixed costs allocated to you will
increase and that allocated to other divisions will
decrease.
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