15-1
CHAPTER 15
ALLOCATION OF SUPPORT-DEPARTMENT COSTS,
COMMON COSTS, AND REVENUES
15-1 The single-rate (cost-allocation) method makes no distinction between fixed costs and
variable costs in the cost pool. It allocates costs in each cost pool to cost objects using the same
rate per unit of the single allocation base. The dual-rate (cost-allocation) method classifies costs in
each cost pool into two pools—a variable-cost pool and a fixed-cost pool—with each pool using a
different cost-allocation base.
15-2 The dual-rate method provides information to division managers about cost behavior.
Knowing how fixed costs and variable costs behave differently is useful in decision making.
15-3 Budgeted cost rates motivate the manager of the support department to improve efficiency
because the support department bears the risk of any unfavorable cost variances.
15-4 Examples of bases used to allocate support department cost pools to operating departments
include the number of employees, square feet of space, number of direct labor hours, and machine-
hours.
15-5 The use of budgeted indirect cost allocation rates rather than actual indirect rates has
several attractive features to the manager of a user department:
a. The user knows the costs in advance and can factor them into ongoing operating
choices.
b. The cost allocated to a particular user department does not depend on the amount of
resources used by other user departments.
c. Inefficiencies at the department providing the service do not affect the costs allocated
to the user department.
15-6 Disagree. Allocating costs on “the basis of estimated long-run use by user department
managers” means department managers can lower their cost allocations by deliberately
underestimating their long-run use (assuming all other managers do not similarly underestimate
their usage).
15-7 The three methods differ in how they recognize reciprocal services among support
departments:
a. The direct (allocation) method ignores any services rendered by one support
department to another; it allocates each support department’s costs directly to the
operating departments.
b. The step-down (allocation) method allocates support-department costs to other support
departments and to operating departments in a sequential manner that partially
recognizes the mutual services provided among all support departments.
c. The reciprocal (allocation) method allocates support-department costs to operating
departments by fully recognizing the mutual services provided among all support
departments.
15-2
15-8 The reciprocal method is theoretically the most defensible method because it fully
recognizes the mutual services provided among all departments, irrespective of whether those
departments are operating or support departments.
15-9 The stand-alone cost-allocation method uses information pertaining to each user of a cost
object as a separate entity to determine the cost-allocation weights.
The incremental cost-allocation method ranks the individual users of a cost object in the
order of users most responsible for the common costs and then uses this ranking to allocate costs
among those users. The first-ranked user of the cost object is the primary user and is allocated
costs up to the costs of the primary user as a stand-alone user. The second-ranked user is the first
incremental user 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 and is allocated the additional
cost that arises from three users instead of two users, and so on.
The Shapley Value method calculates an average cost based on the costs allocated to each
user as first the primary user, the second-ranked user, the third-ranked user, and so on.
15-10 All contracts with U.S. government agencies must comply with cost accounting standards
issued by the Cost Accounting Standards Board (CASB).
15-11 Areas of dispute between contracting parties can be reduced by making the “rules of the
game” explicit and in writing at the time the contract is signed.
15-12 Companies increasingly are selling packages of products or services for a single price.
Revenue allocation is required when managers in charge of developing or marketing individual
products in a bundle are evaluated using product-specific revenues.
15-13 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 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 the individual products. The first-ranked
product is the primary product in the bundle and is allocated revenue up to the revenue of the
primary product as a stand-alone product. The second-ranked product is the first incremental
product and is allocated the additional revenue that arises from two products instead of only the
primary product. The third-ranked product is the second incremental product and is allocated the
additional revenue that arises from three products instead of two products, and so on.
15-14 Managers typically will argue that their individual product is the prime reason why
consumers buy a bundle of products. Evidence on this argument could come from the sales of the
products when sold as individual products. Other pieces of evidence include surveys of users of
each product and surveys of people who purchase the bundle of products.
15-3
15-15 A dispute over allocation of revenues of a bundled product could be resolved by
(a) having an agreement that outlines the preferred method in the case of a dispute, or (b) having
a third party (such as the company president or an independent arbitrator) make a decision.
15-16 (20 min.) Single-rate versus dual-rate methods, support department.
The Detroit 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:
The expected monthly costs for operating the power plant during the budget year are $21,600:
$4,000 variable and $17,600 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?
15-4
SOLUTION
Bases available (kilowatt hours):
Livonia
Warren
Dearborn
Westland
Total
Practical capacity
Expected monthly usage
16,000
12,000
22,000
10,000
23,000
8,000
19,000
10,000
80,000
40,000
1a. Single-rate method based on practical capacity:
Total costs in pool = $4,000 + $17,600 = $21,600
Practical capacity = 80,000 kilowatt hours
Allocation rate = $21,600 ÷ 80,000 = $0.27 per hour of capacity
Livonia
Warren
Dearborn
Westland
Total
16,000
$4,320
22,000
$5,940
23,000
$6,210
19,000
$5,130
80,000
$21,600
8
1b. Single-rate method based on expected monthly usage:
Total costs in pool = $4,000 + $17,600 = $21,600
Expected usage = 40,000 kilowatt hours
Allocation rate = $21,600 ÷ 40,000 = $0.54 per hour of expected usage
Livonia
Warren
Dearborn
Westland
Total
Expected monthly usage in hours
Costs allocated at $0.54 per hour
12,000
$6,480
10,000
$5,400
8,000
$4,320
10,000
$5,400
40,000
$21,600
2. Variable-Cost Pool:
Total costs in pool = $4,000
Expected usage = 40,000 kilowatt hours
Allocation rate = $4,000 ÷ 40,000 = $0.10 per hour of expected usage
Fixed-Cost Pool:
Total costs in pool = $17,600
Practical capacity = 80,000 kilowatt hours
Allocation rate = $17,600 ÷ 80,000 = $0.22 per hour of capacity
Livonia
Warren
Dearborn
Westland
Total
Variable-cost pool
$0.10 × 12,000; 10,000; 8,000, 10,000
Fixed-cost pool
$0.22 × 16,000; 22,000; 23,000, 19,000
Total
$1,200
3,520
$4,720
$1,000
4,840
$5,840
$ 800
5,060
$5,860
$1,000
4,180
$5,180
$ 4,000
17,600
$21,600
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 costs result from decisions
most likely associated with the scale of the facility, or the practical capacity level. The variable
costs result from decisions most likely associated with monthly usage.
15-5
15-17 (20–25 min.) Single-rate method, budgeted versus actual costs and quantities.
Chocolat Inc. is a producer of premium chocolate based in Palo Alto. The company has a separate
division for each of its two products: dark chocolate and milk chocolate. Chocolat purchases
ingredients from Wisconsin for its dark chocolate division and from Louisiana for its milk
chocolate division. Both locations are the same distance from Chocolat’s Palo Alto plant.
Chocolat Inc. operates a fleet of trucks as a cost center that charges the divisions for variable
costs (drivers and fuel) and fixed costs (vehicle depreciation, insurance, and registration fees) of
operating the fleet. Each division is evaluated on the basis of its operating income. For 2013, the
trucking fleet had a practical capacity of 50 round-trips between the Palo Alto plant and the two
suppliers. It recorded the following information:
Required:
1. Using the single-rate method, allocate costs to the dark chocolate division and the milk
chocolate division in these three ways.
a. Calculate the budgeted rate per round-trip and allocate costs based on round-trips budgeted
for each division.
b. Calculate the budgeted rate per round-trip and allocate costs based on actual round-trips
used by each division.
c. Calculate the actual rate per round-trip and allocate costs based on actual round-trips used
by each division.
2. Describe the advantages and disadvantages of using each of the three methods in requirement
1. Would you encourage Chocolat Inc. to use one of these methods? Explain and indicate any
assumptions you made.
SOLUTION
1. a. Budgeted rate =
Budgeted indirect costs
Budgeted trips
= $115,000/50 trips = $2,300 per round-trip
Indirect costs allocated to Dark C. Division = $2,300 per round-trip
30 budgeted round trips
= $69,000
15-6
Indirect costs allocated to Milk C. Division = $2,300 per round-trip
20 budgeted round trips
= $46,000
b. Budgeted rate = $2,300 per round-trip
Indirect costs allocated to Dark C. Division = $2,300 per round-trip
30 actual round trips
= $69,000
Indirect costs allocated to Milk C. Division = $2,300 per round-trip
15 actual round trips
= $34,500
c. Actual rate =
Actual indirect costs
Actual trips
= $96,750/ 45 trips = $2,150 per round-trip
Indirect costs allocated to Dark C. Division = $2,150 per round-trip
30 actual round trips
= $64,500
Indirect costs allocated to Milk C. Division = $2,150 per round-trip
15 actual round trips
= $32,250
2. When budgeted rates/budgeted quantities are used, the Dark Chocolate and Milk Chocolate
Divisions know at the start of 2013 that they will be charged a total of $69,000 and $46,000,
respectively, for transportation. In effect, the fleet resource becomes a fixed cost for each division.
Then, each may be motivated to over-use the trucking fleet, knowing that their 2013 transportation
costs will not change.
When budgeted rates/actual quantities are used, the Dark Chocolate and Milk Chocolate
Divisions know at the start of 2013 that they will be charged a rate of $2,300 per round trip, i.e.,
they know the price per unit of this resource. This enables them to make operating decisions
knowing the rate they will have to pay for transportation. Each can still control its total
transportation costs by minimizing the number of round trips it uses. Assuming that the budgeted
rate was based on honest estimates of their annual usage, this method will also provide an estimate
of the excess trucking capacity (the portion of fleet costs not charged to either division). In contrast,
when actual costs/actual quantities are used, the two divisions must wait until year-end to know
their transportation charges.
The use of actual costs/actual quantities makes the costs allocated to one division a function
of the actual demand of other users. In 2013, the actual usage was 45 trips, which is 5 trips below
the 50 trips budgeted. The Dark Chocolate Division used all the 30 trips it had budgeted. The Milk
Chocolate Division used only 15 of the 20 trips budgeted. When costs are allocated based on actual
costs and actual quantities, the same fixed costs are spread over fewer trips resulting in a higher
rate than if the Milk Chocolate Division had used its budgeted 20 trips. As a result, the Dark
Chocolate Division bears a proportionately higher share of the fixed costs.
Using actual costs/actual rates also means that any efficiencies or inefficiencies of the
trucking fleet get passed along to the user divisions. In general, this will have the effect of making
the truck fleet less careful about its costs although, in 2013, it appears to have managed its costs
well, leading to a lower actual cost per roundtrip relative to the budgeted cost per round trip.
15-7
For the reasons stated previously, of the three single-rate methods suggested in this
problem, the budgeted rate and actual quantity may be the best one to use. (The management of
Chocolate would have to ensure that the managers of the Dark Chocolate and Milk Chocolate
divisions do not systematically overestimate their budgeted use of the fleet division in an effort to
drive down the budgeted rate).
15-18 (20 min.) Dual-rate method, budgeted versus actual costs, and practical capacity
versus actual quantities (continuation of 15-17).
Chocolat Inc. decides to examine the effect of using the dual-rate method for allocating truck costs
to each round- trip. At the start of 2013, the budgeted costs were as follows:
The actual results for the 45 round-trips made in 2013 were as follows:
Assume all other information to be the same as in Exercise 15-17.
Required:
1. Using the dual-rate method, what are the costs allocated to the dark chocolate division and the
milk chocolate division when (a) variable costs are allocated using the budgeted rate per round–
trip and actual round-trips used by each division and when (b) fixed costs are allocated based
on the budgeted rate per round-trip and round-trips budgeted for each division?
2. From the viewpoint of the dark chocolate division, what are the effects of using the dual-rate
method rather than the single-rate method?
SOLUTION
1. Charges with dual rate method.
Variable indirect cost rate = $1,350 per trip
Fixed indirect cost rate = $47,500 budgeted costs/ 50 round trips budgeted
= $950 per trip
15-8
Dark Chocolate Division
Variable indirect costs, $1,350 × 30 $40,500
Fixed indirect costs, $950 × 30 28,500
$69,000
Milk Chocolate Division
Variable indirect costs, $1,350 × 15 $20,250
Fixed indirect costs, $950 × 20 19,000
$39,250
2. The dual rate changes how the fixed indirect cost component is treated. By using budgeted
trips made, the Dark Chocolate Division is unaffected by changes from its own budgeted usage or
that of other divisions. When budgeted rates and actual trips are used for allocation (see
requirement 1.b. of problem 15-17), the Dark Chocolate Division is assigned the same $28,500 for
fixed costs as under the dual-rate method because it made the same number of trips as budgeted.
However, note that the Milk Chocolate Division is allocated $19,000 in fixed trucking costs under
the dual-rate system, compared to $950 15 actual trips = $14,250 when actual trips are used for
allocation. As such, the Dark Chocolate Division is not made to appear disproportionately more
expensive than the Milk Chocolate Division simply because the latter did not make the number of
trips it budgeted at the start of the year.
15-19 (30 min.) Support department cost allocation; direct and step-down methods.
Phoenix Partners provides management consulting services to government and corporate clients.
Phoenix has two support departments—administrative services (AS) and information systems
(IS)—and two operating departments—government consulting (GOVT) and corporate consulting
(CORP). For the first quarter of 2013, Phoenix’s cost records indicate the following:
A
Required:
1. Allocate the two support departments’ costs to the two operating departments using the
following methods:
a. Direct method
b. Step-down method (allocate AS first)
c. Step-down method (allocate IS first)
15-9
2. Compare and explain differences in the support-department costs allocated to each operating
department.
3. What approaches might be used to decide the sequence in which to allocate support
departments when using the step-down method?
SOLUTION
1. AS IS GOVT CORP
a. Direct method costs $600,000 $2,400,000
Alloc. of AS costs
(40/75, 35/75) (600,000) $ 320,000 $ 280,000
Alloc. of IS costs
(30/90, 60/90) (2,400,000) 800,000 1,600,000
$ 0 $ 0 $1,120,000 $1,880,000
b. Step-down (AS first) costs $600,000 $2,400,000
Alloc. of AS costs
(0.25, 0.40, 0.35) (600,000) 150,000 $ 240,000 $ 210,000
Alloc. of IS costs
(30/90, 60/90) (2,550,000) 850,000 1,700,000
$ 0 $ 0 $1,090,000 $1,910,000
c. Step-down (IS first) costs $600,000 $2,400,000
Alloc. of IS costs
(0.10, 0.30, 0.60) 240,000 (2,400,000) $ 720,000 $1,440,000
Alloc. of AS costs
(40/75, 35/75) (840,000) 448,000 392,000
$ 0 $ 0 $1,168,000 $1,832,000
2. GOVT CORP
Direct method $1,120,000 $1,880,000
Step-down (AS first) 1,090,000 1,910,000
Step-down (IS first) 1,168,000 1,832,000
The direct method ignores any services to other support departments. The step-down method
partially recognizes services to other support departments. The information systems support group
(with total budget of $2,400,000) provides 10% of its services to the AS group. The AS support
group (with total budget of $600,000) provides 25% of its services to the information systems
support group. When the AS group is allocated first, a total of $2,550,000 is then assigned out
from the IS group. Given CORP’s disproportionate (2:1) usage of the services of IS, this method
then results in the highest overall allocation of costs to CORP. By contrast, GOVT’s usage of the
AS group exceeds that of CORP (by a ratio of 8:7), and so GOVT is assigned relatively more in
support costs when AS costs are assigned second, after they have already been incremented by the
AS share of IS costs as well.
15-10
3. Three criteria that could determine the sequence in the step-down method are as follows:
a. Allocate support departments on a ranking of the percentage of their total services
provided to other support departments.
1. Administrative Services 25%
2. Information Systems 10%
b. Allocate support departments on a ranking of the total dollar amount in the support
departments.
1. Information Systems $2,400,000
2. Administrative Services $ 600,000
c. Allocate support departments on a ranking of the dollar amounts of service provided to
other support departments
1. Information Systems
(0.10 $2,400,000) = $240,000
2. Administrative Services
(0.25 $600,000) = $150,000
The approach in (a) above typically better approximates the theoretically preferred reciprocal
method. It results in a higher percentage of support-department costs provided to other support
departments being incorporated into the step-down process than does (b) or (c), above.
15-20 (50 min.) Support-department cost allocation, reciprocal method (continuation of 15-19).
Refer to the data given in Exercise 15-19.
Required:
1. Allocate the two support departments’ costs to the two operating departments using the
reciprocal method. Use (a) linear equations and (b) repeated iterations.
2. Compare and explain differences in requirement 1 with those in requirement 1 of Exercise 15-
19. Which method do you prefer? Why?