Departmental Overhead-

Allocation of support departments

to operating department
 Learning Objectives
 Why and how are support department costs
allocated to operating departments?

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Service Department Cost Allocation

 Service departments  Administrative

provide functional tasks departments provide
for other internal units management activities
 Purchasing for the organization
 Maintenance  Human resources

 Engineering  Accounting

 Security  Legal

 Warehousing  Insurance

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a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Allocating Service Costs: Full Cost
Objective
 Reasons for:  Reasons against:
 Cost recovery  Managers cannot
 Awareness of control costs
support costs  Arbitrary costs not
 “Fair share” of costs useful in decision
making
 Regulations for some
pricing instances  Confuses costing
and pricing issues

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in
a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Allocating Service Costs: Motivation
for Managers Objective
 Reasons for:  Reasons against:
 Awareness of support  Distorts profits with
costs in production subjective allocations
managers  Managers cannot control
 Relates unit’s profit to costs
total company profits  Not material to profits
 Reflects usage of  Creates interdivisional ill
services will
 Encourages cost control  Not cost beneficial
 Encourages usage of
certain services

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a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Allocating Service Costs: Compare
Alternate Courses of Action Objective
 Reasons for:  Reasons against:
 Relevant information  Unnecessary if costs do
helps compare not change among
alternatives alternatives
 Provides best cost  Arbitrary allocations
estimates when distort cash flow and
comparing alternatives profits for alternatives

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in
a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Allocation Bases for Service
Department Costs
 Rational and systematic base
 Benefit received by revenue-producing department
 Causal relationship
 Fairness or equity of the allocations
 Ability of revenue-producing department to bear the
allocated cost
 Methods
 Direct method
 Step method
 Benefits-provided ranking
 Algebraic method
 Simultaneous equations

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a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Direct Method
Assigns costs straight to revenue-producing areas

Service Revenue
1 2 A B C
Step 1 P

Step 2 P
Does not recognize service provided
to other service departments
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a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Service Method
Partially recognizes relationships
among service departments
Service Revenue
1 2 A B C
Step 1 P

Step 2 P
Does not recognize the two-way exchange of
services between service departments
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a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Algebraic Method Provides the best
allocation
information

Service Revenue
1 2 A B C
At the P
same
time P

Recognizes all interrelationships among departments

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in
a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Service Cost Allocation

 Allocated service department costs are

included in the overhead application rate for
the revenue-producing areas
 Service department costs are allocated to
products or jobs through normal overhead
assignment procedures

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in
a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.