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SOLUTION
(20 min.) Fixed cost allocation.
1. i) Allocation using actual usage.
Department
(1)
Actual
Usage
(2)
Percentage of
Total Usage
(3) = (2) ÷ 130,000
Allocation
(4) = (3) × $2,000,000a
expense related to building.
ii) Allocation using planned usage.
Department
(1)
Planned
Usage
(2)
Percentage of
Total Usage
(3) = (2) ÷ 125,000
Allocation
(4) = (3) × $2,000,000
iii) Allocation using practical capacity.
Department
(1)
Practical
Capacity
(2)
Percentage of
Total Usage
(3) = (2) ÷ 150,000
Allocation
(4) = (3) × $2,000,000
2.
Usage of Space
(1)
Percentage of
Total Building
Space
(2)
Total Annual
Building Cost
(3) = (2) × $2,000,000
15-1
a) $160,000 of Vacant Office Space cost will not be allocated to the departments but will be
absorbed by the university’s central administration.
b) Allocation of Office space (occupied) costs ($1,040,000) using actual usage.
Department
(1)
Actual
Usage
(2)
Percentage of
Total Usage
(3) = (2) ÷ 130,000
Allocation
(4) = (3) × $1,040,000
c) Allocation of all common space cost such as common area and meeting space, workout room,
and cafeteria ($340,000 + $160,000 + $300,000 = $800,000) using practical capacity.
Department
(1)
Practical
Capacity
(2)
Percentage of
Total Usage
(3) = (2) ÷ 150,000
Allocation
(4) = (3) × $800,000
Department
(1)
Allocated Cost of
Occupied Office Space
(2)
Allocated Cost of
Common Space
(3)
Total Cost Allocated to
Department
(4) = (2) + (3)
The departments would likely consider portions of the allocation method used here “fair.”
In particular, the individual departments do not pay for unused office space that is intended for
As for the allocation of occupied office space costs, it may have been more appropriate to
15-2
assignment of the cost will change year to year under the present system, depending on that
Finally, allocating the common space cost based on practical capacity is the most
15-30 Allocating costs of support departments; step-down and direct methods. The Eastern
Summit Company has prepared department overhead budgets for budgeted-volume levels before
allocations as follows:
Management has decided that the most appropriate inventory costs are achieved by using
individual-department overhead rates. These rates are developed after support-department costs
are allocated to operating departments.
Bases for allocation are to be selected from the following:
15-3
Required:
1. Using the step-down method, allocate support-department costs. Develop overhead rates per
direct manufacturing labor-hour for machining and assembly. Allocate the costs of the
support departments in the order given in this problem. Use the allocation base for each
support department you think is most appropriate.
2. Using the direct method, rework requirement 1.
3. Based on the following information about two jobs, determine the total overhead costs for
each job by using rates developed in (a) requirement 1 and (b) requirement 2.
4. The company evaluates the performance of the operating department managers on the basis
of how well they managed their total costs, including allocated costs. As the manager of the
Machining Department, which allocation method would you prefer from the results obtained
in requirements 1 and 2? Explain.
SOLUTION (45 min.) Allocating costs of support departments; step-down and direct
methods.
Building &
Grounds Personnel
General Plant
Admin.
Cafeteria
Operating
Loss Storeroom
1. Step-down Method: $ 45 ,000 $7,800 $ 36,120 $ 20,670 $18,300
(1) Building & grounds at $0.18/sq.ft.
($45,000 ÷ 250,000) $(45 ,000) 450 2,160 810 1,080
15-4
labor-hours
(8) Overhead rate per direct
manufacturing labor-hour $ 7.047
3 Comparison of Methods:
4. Compare the overhead rate, per direct manufacturing labor-hour, for the Machining
Department under the two methods. The manager of Machining Department would prefer the
15-31 Support-department cost allocations; single-department cost pools; direct,
step-down, and reciprocal methods. The Martinez Company has two products. Product 1 is
manufactured entirely in department X. Product 2 is manufactured entirely in department Y. To
produce these two products, the Martinez Company has two support departments: A (a
materials-handling department) and B (a power-generating department).
An analysis of the work done by departments A and B in a typical period follows:
The work done in department A is measured by the direct labor-hours of materials-handling time.
The work done in department B is measured by the kilowatt-hours of power. The budgeted costs
of the support departments for the coming year are as follows:
15-5
The budgeted costs of the operating departments for the coming year are $2,500,000 for
department X and $1,900,000 for department Y.
Supervision costs are salary costs. Depreciation in department B is the straight-line
depreciation of power-generation equipment in its 19th year of an estimated 25-year useful life;
it is old, but well-maintained, equipment.
Required:
1. What are the allocations of costs of support departments A and B to operating departments X
and Y using (a) the direct method, (b) the step-down method (allocate department A first), (c)
the step-down method (allocate department B first), and (d) the reciprocal method?
2. An outside company has offered to supply all the power needed by the Martinez Company
and to provide all the services of the present power department. The cost of this service will
be $80 per kilowatthour of power. Should Martinez accept? Explain.
SOLUTION
(40-60 min.) Support-department cost allocations; single-department cost pools; direct,
step-down, and reciprocal methods.
All the following computations are in dollars.
1.
Direct method:
To X To Y
Step-down method, allocating A first:
A B X Y
Step-down method, allocating B first:
A B X Y
Note that these methods produce significantly different results, so the choice of method may
frequently make a difference in the budgeted department overhead rates.
Reciprocal method:
15-6
Stage 1: Let A = total costs of materials-handling department
Stage 3:
A B X Y
SOLUTION EXHIBIT 15-31
Reciprocal Method of Allocating Support Department Costs for Martinez Company Using
Repeated Iterations.
Support Departments Operating Departments
AB X Y
Budgeted manufacturing overhead costs
15-7
Total accounts allocated and reallocated (the numbers in parentheses in first two columns)
Dept A; Materials Handling: $420,000 + $158,400 + $19,008 + $2,282 + $274 + $34 + $4 = $600,000
Dept B; Power Generation: $264,000 + $31,680 + $3,802 + $456 + $56 + $6 = $300,000
Comparison of methods:
Method of Allocation X Y
2. It appears that the cost of power is $72 per kilowatt-hour ($180,000 ÷ 2,500 Kwh) plus the
material handling costs. But Martinez should make the decision after considering the effects of
the interdependencies and the fixed costs. Note that the power needs would be less (students
frequently miss this) if they were purchased from the outside:
Outside
Power Units
Needed Needed
In contrast, the total costs that would be saved by not producing the power inside would depend
on the effects of the decision on various costs:
15-8
Avoidable Costs of
2,500 Units of Power
Produced Inside
Variable indirect labor and indirect material costs
Supervision in power department
Materials handling, 20% of $300,000*
Probable minimum cost savings
Possible additional savings:
a. Can any supervision in materials handling be saved
because of overseeing less volume?
Minimum savings is probably zero; the maximum is
probably 20% of $90,000 or $18,000.
b. Is any depreciation a truly variable, wear-and-tear type of
cost?
Total savings by not producing 2,500 units of power
$ 30,000
50,000
60 ,000
$140,000
?
?
________
$140 ,000
+ ?
* Materials handling costs are higher because the power department uses 20% of materials handling. Therefore,
materials-handling costs will decrease by 20%.
In the short run (at least until a capital investment in equipment is necessary), the data
suggest continuing to produce internally because the costs eliminated would probably be less
than the comparable purchase costs.
15-32 Common costs. Tate Inc. and Booth Inc. are two small manufacturing companies that are
considering leasing a cutting machine together. If Tate rents the machine on its own, it will cost
$26,000. If Booth rents the machine alone, it will cost $14,000. If they rent the machine together,
the cost will decrease to $36,000.
Required:
1. Calculate Tate’s and Booth’s respective share of fees under the stand-alone cost-allocation
method.
2. Calculate Tate’s and Booth’s respective share of fees using the incremental cost-allocation
method assuming (a) Tate is the primary party and (b) Booth is the primary party.
3. Calculate Tate’s and Booth’s respective share of fees using the Shapley value method.
4. Which method would you recommend Tate and Booth use to share the fees?
SOLUTION
(25 min.) Common costs.
1. Stand-alone cost-allocation method.
15-9
2. With Tate Inc. as the primary party:
Party Costs Allocated
Cumulative Costs
Allocated
With Booth Inc. as the primary party:
Party Costs Allocated
Cumulative Costs
Allocated
3. To use the Shapley value method, consider each party as first the primary party and then
the incremental party. Compute the average of the two to determine the allocation.
Tate Inc.:
Booth Inc.:
15-10
4. The results of the four cost-allocation methods are shown below.
Tate Inc. Booth Inc.
The allocations are very sensitive to the method used. With the incremental cost-allocation
method, Tate Inc. and Booth Inc. would probably have disputes over who is the primary party
because the primary party gets allocated all of the primary party’s costs. The stand-alone method
15-33 Stand-alone revenue allocation. Magic Systems, Inc., sells computer hardware to end
consumers. The CX30 is sold as a “bundle,” which includes three hardware products: a personal
computer (PC) tower, a 26-inch monitor, and a color laser printer. Each of these products is
made in a separate manufacturing division of Magic Systems and can be purchased individually
as well as in a bundle. Magic Systems sells roughly equal quantities of the three products. The
individual selling prices and per unit costs are as follows:
Required:
1. Allocate the revenue from the computer bundle purchase to each of the hardware products
using the stand-alone method based on the individual selling price per unit.
2. Allocate the revenue from the computer bundle purchase to each of the hardware products
using the stand-alone method based on cost per unit.
3. Allocate the revenue from the computer bundle purchase to each of the hardware products
using the stand-alone method based on physical units (that is, the number of individual units
of product sold per bundle).
4. Which basis of allocation makes the most sense in this situation? Explain your answer.
15-11
